F&G Annuities & Life Inc

NYSE:FG

Earnings Call Transcript 2018-Q3

[Operator]

Good morning and welcome to the FGL Holdings Third Quarter 2018 Earnings Conference Call and Webcast. All participants are in a listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Diana Hickert-Hill, Senior Vice President of Marketing, Investor Relations and Communications. Please go ahead.

[Diana Hickert-Hill, SVP of Marketing, IR and Communications]

Thank you, operator, and good morning everyone. We appreciate you joining our earnings call. Today, we will discuss our financial results for the third quarter of 2018 which ended on September 30th. You can find the financial information for FGL Holdings on the Investors section of our website, fglife.bm. Today's presenters include Chris Littlefield, President and Chief Executive Officer; and Dennis Vigneau, Executive Vice President and Chief Financial Officer.

Some of the comments we make during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. We do not intend to update any comments on this call to reflect new information, subsequent events, or changes in strategy. A number of risks and uncertainties exist that could cause our actual results to differ materially from those expressed or implied. We discussed these factors in detail in the Form 10-K that we filed with the SEC on March 15th of this year.

During this conference call, we may refer to non-GAAP financial measures that we believe may be meaningful to investors. Please refer to our third quarter earnings release, financial supplement and investor presentation that we posted to our website. These documents contain a reconciliation of non-GAAP financial measures to GAAP. And finally, all comparison comments today will be to the third quarter of 2017 unless we state otherwise.

I will now turn the call over to Chris.

[Chris Littlefield, President & CEO]

Thank you, Diana, and good morning everyone. Before I talk about our third quarter results, I wanted to take a couple minutes to report on how we are progressing against the strategic initiatives and priorities we outlined in our Investor Day earlier this year.

First, as you know, one of our top priorities has been to work on securing ratings upgrades which would accelerate organic growth and provide us with greater strategic flexibility. You may remember that A.M. Best raised our outlook on our rating from stable to positive in March and we have been cautiously optimistic that we can secure an upgrade by the end of the year. At this time, we do not believe the upgrade will occur this year, but remain optimistic that we will secure an upgrade to A minus in 2019 after we file our full year 2018 statutory financials.

Second, we stated that we are focused on driving profitable organic growth in our existing businesses. I'll go through our detailed top line results in a minute but it's clear we've made great progress on this objective. Most importantly, we explained that we would continue to be disciplined in writing new business at or above our return targets and I'm pleased to report our sales this year have exceeded our new business profitability targets.

Third, we believe that by partnering with Blackstone on investment management, we'd be able to leverage their world-class origination, structuring and underwriting capabilities to execute our portfolio rotation. To date, we focused on reducing corporate bond holdings, which are largely BBB rated in favor of investment-grade structured security sourced by Blackstone. 2018 is a transitional year and there is no doubt that, when completed, this repositioning will be accretive to portfolio yields and net investment income while improving diversification and the overall risk profile. Dennis will go into more details on the portfolio repositioning in a minute.

Next, we highlighted the transaction would bring a significant advantages because we now have a reinsurance company in Bermuda that we can use to pursue block and flow reinsurance business. We are achieving success here as well. We expect to generate more than a 175 million of flow reinsurance deposits in our first year and have a number of potential transactions that we believe will drive significant growth in 2019. We also pointed out that growing our reinsurance business is a high priority because it helps diversify our business and ultimately will help lower our overall effective tax rate.

We also stated that M&A would be part of our strategy and we are open to looking at whole companies as well as blocks of business, leveraging the deal expertise of our sponsors and management team, we've evaluated and continue to evaluate a number of different opportunities. We look at each target in a disciplined manner and with a focus on areas we know well annuities and life insurance. Although, we have not completed transaction to-date we are active in the market and given the deep M&A experience of our board and leadership team, we remain confident in our ability to execute our acquisition strategy as the right accretive opportunities arise.

And finally, we stated that we want to take an opportunity sometime in the first year to clean up our capital structure and eliminate the overhang created by the outstanding warrants. In October, we did just that and completed a successful tender for 92% of the outstanding warrants. So as you can see, we've made tremendous progress in just our first three quarters as a new company and we are excited about the position we are in and as we work to wrap up our first year.

Now turning to our third quarter results. Our sales totaled 894 million in the quarter, up 51% from last year. We are seeing these results come from across our product portfolio in line with the overall market demand. FIA sales totaled 631 million in the quarter, up 49% over the last year and up 15% over the second quarter. Year-to-date, FIA sales are 1.6 billion, up 23% over last year. Our multiyear guaranteed annuity or MYGA sales were 211 million in the quarter up 29% from last year. Year-to-date, MYGA sales were 573 million up 28% from last year.

In previous calls, we've noted that we expected strong annuity sales this year. This strong sales momentum is coming from a number of factors, attractive market demographics, strong long tenure relationships we have with our distribution partners, our distribution partners increasing confidence in our company's future and capital strength, recruitment of new agents who want to sell our products to meet their client needs, in fact, new agents have accounted for 11% of our FIA sales year-to-date.

Our comprehensive competitive product portfolio that meet the range of consumer needs, the successful launch of new products, including a new performance-based income and accumulation product series in February, which has contributed 10% of our FIA sales so far this year and the elimination of the distraction from the Department of Labor rule. While we don’t have industry-wide data for the third quarter yet, we expect that it will be another very strong quarter for annuity sales and perhaps another record quarter.

Turning to our indexed universal life or IUL business, we delivered 7 million of target premium in the quarter, up modestly from last year and about flat with the second quarter. On the flow reinsurance front, our deposits totaled 45 million in the quarter and a 132 million year-to-date. We expect total flow reinsurance deposits to exceed 175 million for the full year. We are very bullish on our ability to grow our flow reinsurance business at F&G Re and are in discussions on a couple opportunities that we believe could drive nice growth in 2019. So it's been an outstanding quarter from a top line basis.

And with that, I'll turn the call over to Dennis to discuss our results in more detail.

[Dennis Vigneau, EVP and CFO]

Okay. Thanks, Chris, and good morning everyone. Today, I'll focus my comments on the following. Earnings including any areas where results were impacted by purchase accounting, the investment portfolio performance and progress on the reposition, an update on our plans related to tax reform, and lastly some thoughts on capital and liquidity.

Adjusted operating income available to common shareholders for the third quarter was 62 million or $0.29 per share, compared to 65 million or $0.30 per share last year. I'll note that both periods benefited from some favorable items that, although a part of our overall operating performance, are not consistent period to period. Beginning with the third quarter of 2018, there were 10 million of benefits from two items.

First, 5 million of favorable actual to expected mortality in the immediate annuity product line, which by its nature and given the average age of the policyholders will have variability quarter to quarter. We also had 5 million of favorable adjustments related to lower amortization of intangibles from the annual assumption review.

The third quarter of last year benefited primarily from $21 million of favorable adjustments for lower amortization from the annual assumption review and an out of period actuarial item. These items are part of the Company's overall financial performance, and we highlight them to provide insight to the financial and operational trends. The trended details of these items can be found in our quarterly financial supplement.

AOI after considering these items was 52 million in Q3, an increase of 8 million or 18% over the prior year. This strong growth in AOI was driven by invested asset growth, a lower effective tax rate, disciplined expense management and stable underlying trends and net investment income and net spread. For the first nine months of 2018, we reported 181 million of adjusted operating income or $0.84 per share. This is up nearly 25% compared to 145 million or $0.68 per share in the prior year.

Our outlook for 2018, AOI available to common shareholders remains in the range of 235 million to 245 million or $1.09 to $1.14 earnings per share when adjusted for the recent warrant tender we closed in Q4. That’s relative to our previously provided outlook of a $1.10 to $1.15 of earnings per share.

To recap, we successfully completed a warrant tender and 92% of the warrants were exchanged for 7.2 million of common shares and 64 million in cash. This action cleaned up the capital structure, provides great value for warrant shareholders at 35% premium and reduced the ultimate potential dilution at max warrant valuations by more than 7% or 16 million shares. The additional common shares issued will be reflected commencing in the fourth quarter.

I'll now turn to the investment portfolio performance for which we have provided additional information in the presentation. Overall, the portfolio is performing well and the portfolio reposition is progressing albeit at a slower pace to ensure that we optimize the ultimate earnings lift, we realized. More and how we see this developing in a few moments. I would highlight that in addition to purchase accounting effects, this quarter's results also reflect the full grading of the annualized 30 basis point investment fees under the new Blackstone investment management agreement.

Let's walk through the quarter's results and then I'll turn to progress on the reposition. Average assets under management totaled 25.4 billion at September 30th, reflecting an increase of 4.9 billion over last year and included 1.8 billion of net asset flows over last year or growth of about 9% year-to-date excluding the PGAAP impacts, which were 1.2 billion for the mark on the portfolio and 1.9 billion of additional assets from the Front Street Re inclusion and FGL holdings at the merger date.

As a reminder, the purchase accounting or PGAAP mart-to-market aspect is a non-cash adjustment, which will amortize as a reduction to net investment income over the remaining asset life. GAAP earned yield on investment portfolio was 4.13% for the third quarter. This is down about 90 basis points than the 5% premerger yield in the third quarter of 2017, reflecting the net impact of PGAAP, higher planned investment fees, which were partially offset by portfolio reposition lift.

It's important to note that on a statutory basis which is not impacted by PGAAP, the economic yield was approximately 4.9%. It's also important to note that this yield on both a GAAP and statutory basis will continue to expand as we further reposition the portfolio to enhance investment income and earnings.

Net investment income overall was 267 million in the quarter compared to 261 million in the prior year. Let me break that down for you into its component pieces. This reflects a $29 million increase from net asset growth and $11 million from the portfolio reposition lift. That was partially offset by 17 million of the non-cash premium amortization and 17 million of higher planned fees. The after-tax non-cash impact of the premium amortization was 11 million or $0.05 per diluted share.

Net investment income in the third quarter was down 15 million compared to the second quarter, and there were a couple of drivers in there that I'll highlight. First, we had 5 million of bond prepayment income in the second quarter that did not reoccur, 3 million from higher cash balances during the quarter as we time sales early in the quarter to minimize any realized losses as we reposition the portfolio, 2 million of unfavorable impact during the third quarter related to CLO redemptions held at a premium, and lastly a planned step up in the annualized 30 basis point management fee of $7 million. Offsetting this was a $2 million sequential increase in the quarterly portfolio lift run rate to $11 million.

We are now once again fully invested as of the end of the quarter and do not expect material cash drag as we complete the remainder of the reposition. As well given the progress on phase 2 shift from public corporates and munis structures, we expect net yield NII and net investment spreads to resume quarterly growth in Q4. Net investment spread for our core product FIAs, which have historically achieved a range of 280 to 300 basis points, have now been reset post-PGAAP for the non-cash premium amort and the increases in the fees.

Page 11 in the earnings presentation posted to the website lays out the trend in net investment spreads since the transaction closed. As you can see, the underlying trends are squarely within our targeted range, which reflects very stable policyholder option and crediting cost and overall profit margins.

As we have discussed at Investor Day in our call since, the portfolio transition will play out over several quarters and fluctuations are to be expected as that work progresses. Overall, we are confident that the gross annualized lift in NII we forecasted will be achieved and when combined with the runoff of the non-cash PGAAP premium amortization will drive sustainable increases in reported net investment spread.

Let me shift to a few details on where we are putting money to work. Fixed income asset purchases during the quarter totaled 2.4 billion at an average net yield of 5.23%. Those purchases were primarily in structured security such as CLOs mortgage-backed securities and ABS and represent both repositioning and new money flows. On a year-to-date basis, we have purchased 7.6 billion of fixed income assets at a weighted average NAIC rating of about 1.5 and an average book yield of 5%. Overall, we are seeing meaningful benefits on new money flows and generating higher risk-adjusted returns than we have achieved historically.

Let me share some further details on the reposition of the in-force that's coming in four phases. First you recall, we executed the block transaction that was 2.7 billion in the first quarter, and we picked up 150 basis points of yield at an average quality of 1.5. We extended duration a bit because we had flexibility within the portfolio and this trade will provide 40 million of annualized gross net investment income lift for the full year 2019 was about 33 million of that for 2018.

Secondly, with respect to structured products, we have got a $5 billion rotation underway that will be fully repositioned by early 2019. We are taking a disciplined approach to achieve targeted opportunities so although it's progressing a bit slower than planned. We are pleased with the results we are achieving. Under this phase, we are taking a blend of relatively low yielding public corporates, structured and munis, migrating in the higher yielding structured assets both CLOs under a mandate with Blackstone's GSO, capital and real estate debt investing with a mandate with the BREDS Blackstone's real estate debt manager.

As of today, we've completed in excess of 3 billion of the targeted 5 billion rotation. This trade will provide approximately 60 million to 75 million of gross annualized net investment income lift was about 12 million of that uplift being realized in 2018. We continue to favor these structured assets which provide attractive yields significantly enhanced credit protection and floating rate upside relative to corporate public bonds. And we expect this asset class to be about 35% of the portfolio once completed. This action will reduce the overall duration of the portfolio while supporting the ALM profile, cash flow testing and provides flexibility to manage the portfolio irrespective of the rate environment, again this phase will wrap-up the first quarter of 2019.

Third, with respect to alternative assets, this program is well underway as we grade towards a targeted, funded allocation of 5% of the overall portfolio. At this time, we have just over 400 million of funded assets, we will be at about 1.7 billion of commitments, and 500 to 600 funded by year-end, a good portion of that will further fund in 2019 and the remainder by the end of 2020. On average, we're assuming a net 12% return over the life of those investments.

Our alternative asset allocation will be across a wide range of assets including private equity, real estate, credit and multi-strategy types sourced by Blackstone in both Blackstone managed investments and other third-party managers. Overall once completed, we believe the shift to alternatives will add approximately 100 million to 125 million of gross annualized net investment income lift. Finally, we are pursuing some additional portfolio optimizations across other operating subsidiaries, the combined actions there will generate about 20 million on a gross annualized basis once that's completed, most likely at the end of the first quarter of 2019 as well.

Let me shift to a few comments on where we are with tax reform. We continue to await clarification from tax and treasury on the topic of gross versus net for affiliated reinsurance. You recall that earlier this year, we made a tax planning election to have our Bermuda-based affiliated company treated as a U.S. taxpayer. This selection has maintained flexibility for our reinsurance platform to assure we don't have any exposure to be and we estimate our effective tax rate on a reported AOI basis will be 19% to 20% for the full year.

At this time, we have positioned the business such that if treasury guidance is net then we could release the previously accrued tax expense at the 21% rate and resume new business reinsurance, or if it's gross or guidance is delayed until 2019 then we could recapture all of the affiliated business and repatriate the majority of the capital from Bermuda by yearend. If the BEAT guidance is delayed until 2019 and ultimately ends up net, we would resume affiliate reinsurance next year.

Separate from BEAT, we are working on third-party strategies and opportunities to grow our reinsurance platform. These strategies should reduce our overall effective tax rate to about 15% overtime and flow re reinsurance and block M&A pipeline is very active, and we are making good progress developing several opportunities.

Let me wrap up my comments, a few thoughts on capital and other topics. We finished the third quarter in a strong capital position with an estimated risk-based capital or RBC ratio of about 460% including the expected adjustments for tax reform. Without tax reform and help put this on a comparable basis to the peer group that would've been about 485% RBC ratio. Looking ahead, we are managing capital to fund new business, maintain that RBC ratio at greater than 450% and secure ratings upgrades. I will note that S&P affirmed our ratings in September.

Next with regard to liquidity and deployable capital, we have approximately 300 million on hand comprised of insurance company surplus, available debt capacity, and holding company assets. One note on accounting matters, in the quarter we identified an error in the newly implemented PGAAP reserve calculation model that over accrued the FAS 133 liability since the merger. The cumulative impact net of intangible amortization and taxes was $44 million.

The error is both qualitatively and quantitatively immaterial to any one quarter, but it is material in the aggregate, resulting in a material weakness in internal controls, which is now fully remediated as of 9, 30, 2018. This error does not require any restatement of previously issued financial statements, but rather will be corrected as each period affected is included as a comparative period in this quarters and future quarters financial statements. A summary of those amounts and periods can be found in the form 10-Q filed last night in footnote 2. To be clear, these adjustments do not impact AOI as the FAS 133 impacts are fully removed from that calculation.

In summary, since the merger closing, we have good momentum in executing on the strategy, and we have delivered strong growth again this quarter. To recap the indicative outlook provided for 2018, we see top line annuity sales above 20% of annual growth overall while achieving our profitability and capital targets, our AOI expectation remains within a range of 235 million to 245 million or EPS of $10.09 to $1.14 per share, adjusted for the warrant exchange and we will continue to maintain RBC at greater than 450%. We view 2018 as a transformational year following our merger transaction and remain very focused on achieving these objectives.

With that, I'll turn the call back to the operator to begin the Q&A.

[Operator]

[Operator Instructions] The first question comes from John Barnidge of Sandler O'Neill. Please go ahead.

[John Barnidge, Sandler O'Neill]

How quickly do you think you can get to that 15% tax rate driven by reinsurance or at the very at least below 20%?

[Dennis Vigneau, EVP and CFO]

This is Dennis. I would estimate that to get to that 15%, we need somewhere in a range of $7 billion or $8 billion of liabilities and assets under management sitting in that offshore platform. One way to think about it is, it will come from two factors that will come both from flow reinsurance deals that we currently have and are working on to increase. As I mentioned, we have got a nice pipelines building, and for just two three quarters outside of the merger close. So, I'm excited and optimistic about 2019 in getting some of those under our belt in addition to the one that we already have that’s going to generate 175 million this year.

The other avenue that we are actively working is block reinsurance, again, that pipeline is full, blocks tend -- they come in all sizes and shapes. We could get there with one single transaction. We certainly have the capital availability and resources to do that, or it could come in a series of smaller block 2 billion, 3 billion, 4 billion type transaction. So, I believe we will make material progress on building that offshore business in 2019. I can't give you an exact estimate as to when that will happen, but we have got a great pipeline and as soon as something breaks, we will be backed to update you.

[John Barnidge, Sandler O'Neill]

And my other question. You bought back the warrants in the quarter. It's good to see the capital structure clean up a bit but the stocks really lagged and is now trending around book value ex-AOCI. Why not pursue some level of share repurchases or just have a share repurchase authorization out there?

[Chris Littlefield, President & CEO]

Yes, fair question. As we entered the quarter and as we have been thinking about capital structure throughout this year, our first priority was get to the warrants and get those cleaned up. Now with that under our belt, we will certainly -- as we think about future capital deployment certainly, organic growth is our number one priority as you can see from our sales performance thus far in the quarter and thus far this year year-to-date, we are really having a great year. That is our number one priority. And then after that, we would look at share buybacks, M&A, dividends all the things you would expect, but we just got the warrant wrapped up, and we will certainly be considering other alternatives for capital redeployment.

[Operator]

Our next question comes from John Nadel of UBS. Please go ahead.

[John Nadel, UBS]

So, as first question, if I think about the operating income this year against your full years target and then strip out some of the one-time items that I think you mentioned about $10 million this quarter as an example. You are tracking a bit below the full year target. I'm just curious, would you characterize that shortfall is driven primarily by the timing of the repositioning of the portfolio and the commensurate investment income uplift? Or are there any other contributing factors that you would point to?

[Chris Littlefield, President & CEO]

I would characterize it as timing on the reposition, but I would also note that we do have blocks unlike some of our peers that are strictly FIAs. We do have an IUL business and we do have some legacy blocks of business, single premium immediate annuity being the largest one. We consider that, although less predictable quarter-to-quarter, we do consider that income as part of our core operating earnings. And so, as we look forward and as we think about the full year, there are some shortfalls as we think about net investment income, but we have got a diverse business and our guidance was predicated on an all-in view when we spoke at Investor Day.

[John Nadel, UBS]

Yes, I appreciate that, I mean, the mortality gain this quarter maybe a little bit outsized, but when you spread it out over the year-to-date its certainly something that's within the realm of possibilities right. That’s sort of what you're saying?

[Chris Littlefield, President & CEO]

Yes, and one more thing I would add, I would just say that beyond those two categories of income items. There is no other underlying issues or things that we are concerned about or are right in line with our expectations. As I mentioned, the top line is coming in great, profit and margins and core underlying spreads are performing. Expenses are in lockstep with our forecast and we are being very disciplined there and capital is in great shape. So it's really just need of the reposition as we try to be prudent and maximize the economic gains that we expect to get.

[John Nadel, UBS]

The second question is just a little bit nitpicky, but cost of crediting an option increase I guess 7 or 8 point quarter-over-quarter versus the second quarter. Is there anything in particular driving that? Is cost of options simply higher?

[Chris Littlefield, President & CEO]

We looked at that and as we -- although, there are a few basis points of differential quarter-over-quarter. We are not seeing any trends that give us any pause when you look at it on a year-to-date basis, year-over-year I think they're actually down. They are sort of in the range of normal fluctuation. And again, we watch it every quarter but there's nothing that gives us pause.

[John Nadel, UBS]

And then last one real quick. If average alternative investments, I don’t know let's call it $500 million $600 million $700 million average during 2019. Can we think about generating that 10% to 12% targeted yield that quickly? Or is there a ramp that you guys would expect to achieving that yield overtime?

[Chris Littlefield, President & CEO]

Yes, great question and an important one. As you know, there's a J-curve to all these assets not only get funded but then the speed at which in the rate at which the return starts to materialize. We are going to have to take throughout 2019 and it will probably continue into 2020, as we continue that ramp and we complete the full funding and then some of the earlier assets that are already funded now start to peak maturity. Some of those have lower income earlier on, and much greater payouts above that 12% in later year, so it's a mix. And I think we will be in the ballpark of that 12% and on our way to that 12%, as we get into the middle of 2020, it could come faster some of the speed at which these things respond are bit unpredictable.

[Operator]

The next question comes from Pablo Singzon of JP Morgan. Please go ahead.

[Pablo Singzon, JP Morgan]

I just wanted to follow up on your earnings guidance of 235 million to 245 million this year. Is that dependent on hitting your spread margin guidance of about 195 to 200 points for 2018? And if yes, it seems like that would imply meaningful uptick from spreads at least in the third quarter. So, I just want to get a perspective on that?

[Dennis Vigneau, EVP and CFO]

Yes. So, as we think about that range of 235 to 245, we are looking at our outlook for how the net investment income due to the reposition and just net asset flow is going to mature and build in the fourth quarter, how that's going to the earn rate on the portfolio given what rise in the Blackstone team have accomplished on the structured portfolio. We are not seeing, as I mentioned earlier, any meaningful shifts in our interest crediting option cost our policyholder behavior.

So, we feel good about that 235 to 245 range, and there isn't any specific factor that we are watching that would give me -- if it doesn't play out exactly as forecasted, it's going to take us off of that. I think the business is operating, there will be deviations basis point here and there, whether it's net investment income, interest and option cost, and ultimately net spreads quarter-to-quarter, but we are confident that we are going to land in that range. Certainly, there is nothing from the net spread factor that’s going to take that off course.

[Pablo Singzon, JP Morgan]

And my second question was. I'm just looking at Slide 11 of the deck, there was about an 11 point uptick in PGAAP amortization sequentially. Is that 17 point drag a good a good run rate or should it revert back to around 60 points where it was in the first half of this year?

[Dennis Vigneau, EVP and CFO]

Yes, sure, Great question and happy to clarify. That PGAAP amort and expenses includes both the investment expenses related to the portfolio management and PGAAP. That’s why you see the increase. In the third quarter, our rate that we are paying Blackstone as planned increase, there was a $7 million nominal dollar impact increase in that expense in the third quarter. We are now at an annualized 30 basis points run rate as we look out and go forward. We had a lower rate in the first half of the year.

[Pablo Singzon, JP Morgan]

So around 70 points is a good level?

[Dennis Vigneau, EVP and CFO]

Yes, I think that’s in the right ballpark. Now what will drive that off, take that off course, and we'll certainly update as we go forward as, the PGAAP amortization as we are repositioning the portfolio and selling down some of those assets, the associated amortization with those assets all of which are not fully identified. We will shift as those are sold, the PGAAP amortization will fluctuate. So, as we wrap through fully Phase 2, we will be able to give a clearer picture at the end of the first quarter next year as to what that amort run rate residual will be each quarter and then combined with expenses will give you good insight as to what that total number will be. But we need two more quarters to finish that reposition to get that thing to settle down.

[Operator]

The next question comes from Andrew Kligerman of Crédit Suisse. Please go ahead.

[Andrew Kligerman, Crédit Suisse]

Back on that 8% sequential basis point increase in crediting rates. So, if I understand the response, it was due to some bumpiness in the options?

[Dennis Vigneau, EVP and CFO]

Well, that’s an all-in crediting rate, that includes not just our FIA product, but also our other legacy lines like the SPIA block, et cetera, as well as IUL. So, there are pieces in there. When you break that apart into the SPIA versus the other products, there's no material trend or anything that gives us pause in those minor quarterly fluctuations.

[Andrew Kligerman, Crédit Suisse]

So, it's kind of bumpiness around what's in just …

[Dennis Vigneau, EVP and CFO]

Well, I mean, Andrew, we actively look at and adjust the crediting rates on business that’s maturing as part of our annual reset cycle. There are fluctuations or maturing blocks of business. You have to think about it as we are putting on individually priced tranches of business 12 times a year. And as those individual tranches cycle through and mature and there's as the policyholder run off, there is just going to be quarterly fluctuations.

Some carriers sort of set their prices and sort of set it and forget it, and then don't actively manage their crediting rate strategies at the time of renewal. We are in net spread focused on the bottom line carrier, and we actively manage the business to deliver the net spread that we put on the books at the time we write the business. So, over the course of the life and those tranches of business, there will be quarterly fluctuations.

[Andrew Kligerman, Crédit Suisse]

So based on what said, would it be appropriate to kind of model for something near where the credited interest rates settled out this quarter, and then secondly, not to anticipate any upticks?

[Dennis Vigneau, EVP and CFO]

I think there will be the point I think there will be quarterly fluctuations plus and minus on the crediting rates.

[Andrew Kligerman, Crédit Suisse]

And no trend right now, you are not seeing any next pressure to raise rates?

[Dennis Vigneau, EVP and CFO]

No trends right now that I could say yes, there is a permanent shift in the rate of crediting.

[Andrew Kligerman, Crédit Suisse]

And then lastly, I'm just curious as you look at this flow reinsurance and you speak with potential clients. You are competing with traditionals like RGA or companies more focused the way you are like Athene. What's the FG pitch to win a flow reinsurance deal?

[Chris Littlefield, President & CEO]

This is Chris. So, we really partner with carriers to help them design and develop products. There's a lot of carriers out there that don't have indexed product capabilities that have captive distribution or other forms of distribution that are interested in being able to provide their advisors with indexed product capabilities. So, I think what we are able to do from our reinsurance company led by our former Chief Actuary, John O'Shaughnessy, is to really partner with them closely to develop product, to help design it, to help them get it implemented…

[Technical difficulty]

[Operator]

And the next question comes from Kenneth Lee of RBC Capital. Please go ahead.

[Kenneth Lee, RBC Capital]

Just one on potential in organic growth opportunities. You mentioned in your prepared remarks, you could look at block transactions or whole companies. I'm just wondering what kind of return hurdles would you be expecting for other blocks or whole companies? And under what scenario would a whole company acquisition makes sense and what kind of liabilities could these be?

[Dennis Vigneau, EVP and CFO]

So, I think we've stated consistently that we are looking at mid teens returns, and we are trying to drive ROEs higher than they are already at. So, we are going to be very disciplined on our pricing, but we are looking to price things in mid teen ROEs things that will be accretive to ROE. And we have said that we are interested in primarily annuity blocks and life insurance the things that we know well, and we probably would stay away from things like long-term care and other liabilities that we think we don't have a great advantage not sure that those are favorable to our business.

[Kenneth Lee, RBC Capital]

And just one follow-up. In terms of the potential ratings upgrade, what drove the change in the timeframe expectations?

[Dennis Vigneau, EVP and CFO]

I think what drove is just a recognition of the positive outlook is in March and generally A.M. Best wants to see a full year of results before they're going to take action following the positive outlook. So, we have had a lot going on this year. They are very pleased with the progress and the strengthening of the capital. They are pleased with the capabilities that we are getting on the investment management side, and they just want to see us land the full year 2018 statutory financials and have a conversation about one year after the positive outlook.

[Operator]

The next question comes from Alex Scott of Goldman Sachs. Please go ahead.

[Alex Scott, Goldman Sachs]

The first one I had was just a follow-up on the increase in the option costs. I think could you describe the kind of cap rate adjustments that you are able to make right now to offset some of the things you're seeing in the option market having to do with volatility? Do you expect any of that to cause a take up and surrenders it all?

[Dennis Vigneau, EVP and CFO]

This is Dennis. Without getting into the specific pricing actions on various tranches of business, what I will say is we have a pretty methodical and purposeful approach to setting crediting rates at time of renewal. Our goal is to manage and maintain business and recognize and realize the returns that we get at the outset when we put the business on the books. You should not expect and our policy and practice is not to take radical changes to our crediting rates. These are minor tweaks as we manage these various tranches of business that when in the aggregate we look at the profitability that comes out we are satisfied that its meeting our aggregate return.

We are not expecting any of our actions to drive any shifts any discernible shift in our policyholder behavior. Again, these are minor tweaks across multiple tranches, multiple years worth the business and it's a very purposeful process and you shouldn’t expect to see any significant change. But in the aggregate we manage it regularly. And again that's why we are not concerned and there's really no underlying unfavorable trend that’s going on with option cost and interest credit it's just normal fluctuation and we manage for the long haul and for the bottom line.

[Alex Scott, Goldman Sachs]

Then on excess capital, I just had one there. It looks like there was a bit of I guess some modest decline in deployable sort of access. I think that's just mechanically the RBC ratio coming down a little bit quarter-over-quarter. How much of that's driven by just growth in new business exceeding near levels that can be capitalized with the capital coming off of the existing book? Would you expect that to continue at these levels of sales?

[Dennis Vigneau, EVP and CFO]

Yes, I would say certainly we're very pleased with the strong top line performance we're managing. We're slightly ahead of our outlook from last quarter when we updated everybody. We've been managing that very effectively. The biggest driver is just the $64 million of cash that we used for warrant tender. The rest of it is sort of a rounding error.

[Alex Scott, Goldman Sachs]

One more, quick one, if I could. One of your peers has mentioned the lifetime income benefit reserves for the industry may be understated. Any thoughts you have on now like, what level of lifetime income benefit reserve do you guys hold? And then any color that you have on discount rates you used and any kind of impact you would expect from the new FASB guidance that came out recently?

[Dennis Vigneau, EVP and CFO]

Yes, I guess I would sum it up like this. When you think about the underlying assumptions for income benefit riders, it's pretty tough for anyone to look across the industry and say, here's what our number is and here's what we think the industry should be, in general. There are mortality laps and other election assumptions that all impact those reserve levels.

Most importantly, the level of role up rates and whether or not they are capped or not, is a huge driver of the level of reserves that any carrier would be required to hold. There are some legacy blocks of older business out there where role up rates were lifetime. And that add significant cost as opposed to our block of business and more current vintages of business across the industry where role up rates typically or are for 10 years or the life the initial life of the product and then the Company has full discretion to reset or not at that time.

So our particular block of business has limits on the role up rates. They are capped. So, on a comparable basis, we would have a much lower need for income rider reserves relative to someone who had a block of business with those high guarantee and unlimited uncapped benefit type of roll ups.

So we are very comfortable. I'm not really going to get into the specifics of the actual level of reserves. We are very comfortable with our reserves. We have got a very tight reserve in process and we are very comfortable there. On the discount rate we are still working through that and I really don't have an update for everyone at this time.

[Operator]

We have a follow-up question from John Barnidge of Sandler O'Neill. Please go ahead.

[John Barnidge, Sandler O'Neill]

You guys had a small long-term care block that was acquired with the original transaction. I know you have talked previously about wanting to divest that. Can you maybe talk about what you're seeing on opportunity on that?

[Dennis Vigneau, EVP and CFO]

So, we have explored and continue to explore what our opportunities are with the block. It just to put in comparison is something like 200 million of reserves. It's a very small block for us. We think it's well-managed. We've been able to get the rate increases through and we haven't received a mark on the business that we thought acceptable given the quality of the overall business. So, we are not actively marketing it at this point in time, and we are going to continue to manage that business and explore a future opportunity beyond the road to take another look at it maybe later in 2019 or 2020.

[John Barnidge, Sandler O'Neill]

Do you have a morbidity improvement assumption in there? And how does that compare with the experience of the block?

[Dennis Vigneau, EVP and CFO]

Yes, there is not a material morbidity assumption in there and everything has been performing in line with the assumptions in the block. And most importantly, we have been very successful 2017 rate increases got push through and it's generally performing. The other benefit we have here as well is large and the Blackstone team, are actively working on repositioning that portfolio to squeeze out a little extra investment income. So again, it's sort of a managerial distraction, it's not an economic issue that we are that concerned about.

[Operator]

We have a follow-up question from Pablo Singzon. Please go ahead.

[Pablo Singzon, JP Morgan]

So, Dennis, I'm getting a tax rate below 20% for this quarter. I just wanted to confirm it if that’s the case? And if yes, what drove that or where you see the tax rate in the fourth quarter?

[Dennis Vigneau, EVP and CFO]

Yes, we were couple of points down. I want to say there was like 17% on an NOI basis. We just had some minor true ups to -- I think it was a valid allowance and one of our smaller entities. I'm sorry I'm quoting the wrong-ish topic. It was a credit for the DRD deduction that we were able to book in the quarter. So, that will influence the overall rate for the year, but we are not going to be a 17. Again, we are still accruing at that 21% rate that will bring us down to benefit this quarter slightly to that.

As we potentially line up the business for in light of the B tax and for recapturing that business we are looking to optimize. So there's a chance we may squeeze out a few tax benefits as we recapture that block of business the Modco business from Bermuda. We will have more to update on that of course when we chat in fourth quarter. 20% 21% is where we are going to be.

[Pablo Singzon, JP Morgan]

And just following up your comments regarding speed of mortality it's been favorable for the three quarters this year and I understand that it can fluctuate, but I was wondering if you could give us perspective on whether or not it's been a net positive or negative longer-term?

[Dennis Vigneau, EVP and CFO]

Yes, it’s a great question. And if you were to go back to 2014, 2015, 2016, we had several quarters and one particular tranche of that block. I think it was about 3 billion, almost 4 billion of reserves legacy reserves on the books for that. But we have a one particular tranche that's about 300 million of reserves that older age, impaired risk. The average age on that portfolio of customers is 93 or 94 years old at this point. And we had several quarters in those historical periods where mortality was unfavorable. So throughout 2018, we have had three quarters of favorability.

As I look forward, it just given the characteristics of that policyholder group average age of 93, 94, I would like to think, there is more favorable mortality results to come out of that block. We are going through our annual planning cycle now and we will probably put a pen on what our estimate is sometime in December. So, there will be volatility fluctuations quarter to quarter maybe in that plus 5 million range if it turns positive. Certainly, I don’t see anything maybe slightly less than that if we do have a quarter or two of unfavorability, but nothing material to the downside. I think it's more likely a favorable item as we go forward and that block continues to run off given the average age.

[Operator]

There is a follow-up question from John Nadel from UBS. Please go ahead.

[John Nadel, UBS]

There are two, if I could. First is, I just want to make sure I understand the comment about the 30 basis points Blackstone fee. Was there a catch up related to that that worked through the third quarter? Or is that just you are pointing it out because it stepped up from the original 22.5 basis points to the 30 basis points this quarter?

[Dennis Vigneau, EVP and CFO]

Yes, it was a step up, a planned step up in the rate. The first quarter was 10 basis points. Second quarter was 20 basis points. Third quarter went to 30 basis points on an annualized basis. I believe the step up impact Q2 to Q3 was $7 million pretax.

[John Nadel, UBS]

And then the second question is more of a follow-up around capital deployment, capital management, potential for a buyback, and I put it in this context rather than your stock price relative to GAAP book value. If I think back, if I get the numbers right, I think back in 2009, when Apollo bought Aviva's U.S. life and annuity business, I believe the valuation was something like 60% of statutory book value. And if I look at your stocks today, your stock's trading at about 68 let's call it round number 70% of the statutory book. I would tell you, nine years later. It's clearly a significantly better operating environment. I would expect it to Apollo would have had pay something much greater than 60% of statutory book, if that deal were done today. How is there any real opportunity to deploy capital in a block transaction or even organic growth that is better than buying back your own stock here?

[Dennis Vigneau, EVP and CFO]

Fair question and it's certainly something that we are evaluating as we think about capital deployment appointment plans for 2019 and beyond. I just want to check the numbers. I don't have it here right here, but I believe our stat book value is just over somewhere between 8 and 8.50 as opposed to the current share price being at a significant discount to that. So I think it's probably trading right on top or slightly less than current stat book value.

[John Nadel, UBS]

I was thinking about just statutory book adjusted for the interest maintenance reserve and the ABR.

[Dennis Vigneau, EVP and CFO]

Yes, fair point, yes.

[John Nadel, UBS]

I think that's north of a…

[Dennis Vigneau, EVP and CFO]

Yes, you are right, that’s about $11 so little over 11 bucks.

[John Nadel, UBS]

Yes.

[Dennis Vigneau, EVP and CFO]

So, fair question and look as we are in the middle of our planning cycle, and thinking about where are the best and most accretive places we can put capital. That’s certainly on the list and given where we are today and in today's trading environment. So I don't have any answer for you today rather than you make a very astute observation. And it's on our list and we are thinking about it.

[John Nadel, UBS]

I think that's really important for shareholders to understand, at least from the, and may be Chris you can comment, but from some sort of a board perspective. I realize, there is a real desire to grow, but buying back the shares it's not something that's off the table.

[Chris Littlefield, President & CEO]

No, it's certainly not off the table. The board is having active discussions about capital, I think at this point in time. I think you've heard others comment. We do think that there are significant inorganic opportunities that we are pursuing that we think would provide better long-term value at this point in time, but it is an active conversation and we are trying to balance that with the other comments we hear from time to time, which is people can't get a large position in the shares because there's not a lot of liquidity in the stock. So we are kind of trying to balance all of that and continue to believe that we have an opportunity to deploy our capital in new business in inorganic as a higher priority right now, but it's an active conversation it's not off the table and we will continue to conserve it.

[John Nadel, UBS]

My true sense, I have very little sympathy for people not being able to buy a bigger position.

[Operator]

And ladies and gentlemen, this will conclude our question-and-answer session. I would now like to turn the conference back over to CEO Chris Littlefield for closing remarks.

[Chris Littlefield, President & CEO]

Yes, thank you very much for you time this morning and your interest and investment in our company. I think we're demonstrating, we've got strong sales momentum. Our AOI is growing significantly. We're delivering ROEs in excess of 15% and we're just really creating real value that's going to emerge over the next several quarters and we look forward to updating you on that as we go along in 2019.

So thank you very much and have a great rest of the day.

[Operator]

Thank you, sir. Ladies and gentlemen, the conference has concluded. Thank you for attending today's presentation. You may now disconnect.