ING U.S.'s CEO Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 7.13 | About: Voya Financial, (VOYA)

ING U.S., Inc. (NYSE:VOYA)

Q2 2013 Earnings Call

August 7, 2013 10:00 am ET

Executives

Darin Arita - SVP, IR

Rod Martin - Chairman & CEO

Alain Karaoglan - COO

Ewout Steenbergen - CFO

Analysts

Nigel Dally - Morgan Stanley

Mark Finkelstein - Evercore

Jimmy Bhullar - JPMorgan

Chris Giovanni - Goldman Sachs

Tom Gallagher - Credit Suisse

Eric Berg - RBC Capital Markets

Erik Bass - Citigroup

Operator

Good morning, and welcome to the ING U.S. Second Quarter 2013 Earnings Conference Call. All participants will be in a listen-only mode. (Operator Instructions).

After today's presentation there'll be an opportunity to ask questions. (Operator Instructions). Participants are limited to one question and one follow-up. Please note this event is being recorded.

I would now like to turn the conference over to Darin Arita, Senior Vice President, Investor Relations. Please go ahead.

Darin Arita

Thank you, Emily, and good morning everyone. Welcome to ING U.S.'s second quarter 2013 conference call. A slide presentation for this call is available on our website at investors.ing.us or via the webcast.

Turning to Slide 2, on today's call we will be making forward-looking statements. Except with respect to historical information, statements made in this conference call constitute forward-looking statements within the meaning of the federal securities laws including statements relating to trends in the company's operations and financial results and the business and the products of the company and its subsidiaries.

ING U.S.'s actual results may differ materially from the results anticipated in the forward-looking statements as a result of risks and uncertainties including those from time to time in ING U.S.'s filings with the U.S. Securities and Exchange Commission. ING U.S. specifically disclaims any obligation to update or revise any forward-looking statements, whether as a result of new information, future developments or otherwise.

Slide 2 also notes that the call today includes non-GAAP financial measures. An explanation of how we calculate these measures and the reasons we believe they are useful can be found in the quarterly investor supplement available on our website at investors.ing.us. Reconciliations to the most directly comparable GAAP measures are included in the press release and the quarterly investor supplement.

Joining me this morning on the call are, Rod Martin, Chairman and Chief Executive Officer of ING U.S.; Alain Karaoglan, Chief Operating Officer; and Ewout Steenbergen, Chief Financial Officer. After their prepared remarks, we will take your questions.

With that, let's turn to Slide 3, and I'll turn the call over to Rod.

Rod Martin

Thank you, Darin, and good morning. During the second quarter we continue to deliver on our retirement readiness focus as well as our return on equity improvement plan. We continue to generate results in line with our strategic objectives and we remain on track with regard to the plans we previously discussed with all of you.

I begin with some highlights on Slide 4. Total company after-tax operating earnings of the second quarter were $177 million or $0.71 per share. Our ongoing business pretax adjusted operating earnings grew to $303 million, up 9% year-over-year. This was due to earnings growth in all of our ongoing businesses. Our annualized ongoing business adjusted ROE for the first half of 2013 was 9.9%, this is up from 8.3% at the end of 2012. The strong increase during the first six months of the year was due to variety of factors, including increase fees on higher asset levels, exits and run-off of capital intensive products and improved underwriting in employee benefits.

Turning to the GAAP bottom-line results, here they were driven by our closed block variable annuity segment. As you know, our hedging program for this business is designed to help protect regulatory and rating agency capital from market movements rather than minimize GAAP earnings volatility. As a result this quarter, our CBVA book reported a GAAP net loss, which drove our total company GAAP net loss of $82 million. Despite this, several key measures for the CBVA book improved during the quarter, including a significant year-over-year decrease in a net amounted risk.

So, we are pleased with our overall performance during the second quarter and the first half of 2013.

If you turn to Slide 5, you will see how ING U.S. is well-positioned as a premier franchise with diverse earnings. In the first half of 2013, we achieved $581 million in pretax adjusted operating earnings. 75% of these earnings came from retirement solutions and investment management, which are our higher growth and least capital intensive businesses.

Retirement and Investment Management achieved $442 million and $3.1 billion in net flows, respectively in the second quarter. As of June 30th, total assets under management and administration grew to $482 billion, up 5% from the end of June 2012 or the end of 2012. Insurance solutions contributed 25% of the earnings in the first half of 2013.

We continue to reposition our individual life business with a focus on less capital intensive products. And as you know, we have made a number of changes to our business mix in order to improve our performance. At the same time, we continue to invest in our employee benefit business a further success given this low capital intensity and the opportunity for future growth. With access to 13 million customers and more than 200,000 points of distribution ING. U.S is well-positioned to generate steady growth.

As you move to Slide 6, you will see the annualized ongoing business adjusted operating ROE growth I referenced earlier. Our annualized ROE for the first half of 2013 was 9.9%, up 160 basis points from year-end 2012. We are committed to an aggressive yet attainable goal of a 110 basis points of annual improvement in our ROE over the next several years. We are encouraged by our year-to-date ROE growth. And while there are several items that bolstered the growth in the first half of the year, we remain on track to achieve our ROE target of 12% to 13% by 2016. Overall, we are making good progress with our transformation efforts in the first six months of 2013, and more recently, we completed our recapitalization plan with our senior note offering last month. We are committed to maintaining this positive momentum into the second half of 2013 and beyond.

I will now turn it over to Alain for more details about the progress we are making with our ROC improvement work. Alain?

Alain Karaoglan

Thank you, Rod, and good morning everyone. We continue to make steady progress in executing our return on equity and return on capital improvement program. And our primary focus is on the execution of our 30 plus return on equity and return on capital improvement initiatives.

Let me remind you of the fundamental elements of this program. The 30 initiatives fall into three categories: margin initiative, growth initiatives and capital initiatives. And each initiative has an owner, each initiative has clear targets and each initiative is actively monitored and actively tracked. And we are constantly evaluating new opportunities to add to the program. And execution remains the key focus for us.

On Slide 8, you see a consolidated view of our return on capital progress. Our total return on capital improved 110 basis points to 8.3% in the first half of 2013 from 7.2% in 2012, and our target is to reach a return on capital of 10% to 11% by 2016. We are a little ahead of where were expect it to be. And the macro environment of increasing interest rates will help us going forward. Ewout will address that in more detail.

The first half return on capital improvement was driven by strong executions in two areas. First, we generated higher fee base margin on assets under managements and assets under administration, which have grown to $482 billion from $461 billion since year-end 2012. Strong net flows from Retirement and Investment Management were healthy contributors to the growth.

Second, we made progress in shifting the composition of our product portfolio to be less capital intensive and more fee-based. We are running off and closing less profitable products and introducing new products in line with this operating philosophy.

In addition, our first half return on capital improvement benefited from record keeping change orders, favorable prepayment income and from a first quarter favorable impact due to true-up in variable compensation accrual, which we highlighted last quarter.

Turning to Slide 9, Retirement improved its return on capital by 190 basis points to an annualized 9.1% in the first half of this year from 7.2% in 2012. We are improving our return on capital by maintaining pricing discipline on retained and new contracts as this relates to targeted internal rates of returns.

Let me provide you with an example. In the second quarter, we renewed a tax exempt plan sponsor with significant assets that had historically been priced below our targeted internal rates of return. The plan sponsor was a very valuable customer, but not as profitable as we would like and need the business to be. And so, during repricing we improved the internal rate of return by 500 basis points by reducing the guaranteed minimum interest rate. So, through a disciplined approach to pricing we effectively managed guaranteed minimum interest rate and variable fund revenue in relation to our targeted returns as was the case with this customer.

Lowering the guaranteed minimum interest rate allow us to exercise management discretion around crediting rate in response to changes and the external rate environment over the course of the contract. Maintaining flexibility with these levers is key as we contemplate long-term repricing initiatives.

Furthermore, we combined our repricing actions with a very clear focus on preserving value with customers. This customer has access to a local sales office that helps plan participants with education, enrollment assistance and financial planning services.

Moving to Slide 10, annuities improved its return on capital by 110 basis points to an annualized 7% in the first half of 2013, up from 5.9% in 2012. The two key return on capital improvement initiatives wherein annuities include running off multi-year guarantee annuity and annual reset loss and growing our mutual fund IRA custodial products called Select Advantage.

Let me highlight some key points about how Select Advantage is helping our return on capital improvement. First of all, it’s an important product because it has attractive returns with low capital requirements. We generated more than $300 million of net flows through the first quarter of 2013 and the second quarter was our highest flow quarter since 2011.

Strong sales and flows of Select Advantage are being driven by the expansion of our distribution model with an increase in wholesaling focus. Our success with Select Advantage amplify our commitment to the core principals of our return on capital improvement program, which are capital efficiency focused on fee based products, efficient distribution and delivering a product that clearly meets a growing customer need.

As we move to Slide 11, let me remind you that we focus on operating margins rather than return on capital for our investment management business because it is not a capital intensive business. Investment Management’s operating margin increased to an annualized 25.4% in the first half the year compared to 24.6% in 2012. Our 2012 results were helped by strong returns on invested capital and our target is to reach 30% to 34% margin by 2016.

Excluding those investment return, which is a better indication of the business improvement, our margin improved to 22.9% from 18.4% in 2012. One of our key initiatives were improving investments management’s operating margin is to continue to leverage our strong investment performance and improve our sales force productivity in higher fee asset categories.

Let me give you some color on how this is taking shape. 74% of our fixed income assets achieved above benchmark performance on a five year basis. This is up from 54% as of year-end 2012, and 89% of our equity assets achieved above median return on a five-year basis in the first half of 213. This performance helps our sales force attract more assets.

Winning Defined Contribution Investment only mandate is also a key part of our improving operating margin and in the second quarter several new DCIO mandates were funded, including in the higher fee asset categories of senior loans and small cap equities and each one was driven by strong investment performance combined with strong distribution.

So, when one steps back and looks at all of our initiative and efforts over the past 12 months, Investment Management has increased its third-party asset of the management by $90 billion to over a $110 billion, that’s more than a 20% increase.

Turning to Slide 12, Individual Life improved its return on capital approximately 20 basis points to an annualized 4.5% in the first half of 2013. Progress with our return on capital improvement is not where we would like to see it as we continue to reshape this business, although we are taking step to address our plan and expected to improve over time.

First, we are adjusting crediting rates where possible in the second quarter due to the low interest rate environment. We have moved 76% of our book to guaranteed minimum, up from 72% at year end 2012, which helps improve the return on capital. Second, we are repositioning the business to focus on capital efficient products, specifically Indexed Universal Life. We launched a new Indexed Universal Life product in July called Protector, which will help build its momentum in the second half of 2013 and help in our return on capital improvement.

Protector is ideal for clients seeking low funded way to obtain life insurance protection with the potential for cash value accumulation via an index product. Protector's low fixed expense structure makes the product attractive to the underinsured middle market.

Turning to Slide 13, employee benefits return on capital is a solid annualized 16.8% in the first half of 2013, compared to 16.9% for 2012, and our target is to reach 18% to 22% by 2016.

One of our core return on capital initiatives for employee benefits is to expand our voluntary business with an emphasis on our product suite called Compass. The Compass suite includes three products, Critical Illness, Accident, and in July we launched a Hospital Confinement Indemnity product. Voluntary sales increased 14% in the first half of 2013 and we have positive momentum adding in to the second half of the year.

Our Compass products fit perfectly in to capital efficient operation philosophy. They are capital efficient. They produce high returns. They meet an expanding need in the marketplace as employers manage rising healthcare costs and they have a simple administrative platform, which is attractive to employers and provides us with cross selling opportunities. For example, two of our second quarter Compass case wins were in the existing Group Life and an existing Stop Loss customer.

Overall, we are pleased to be ahead of our target for an annualized ongoing business with adjusted return on equity. We are committed to delivering on our long-term return on equity goal of 12% to 13% by 2016. We are focused on our improvement initiatives which can be achieved by continuing to establish, expand and leverage our executions culture.

Now, let me turn to over to Ewout, who will go into our financial results into more detail, Ewout?

Ewout Steenbergen

Thank you, Alain. Good morning, everyone. I would like to highlight some of our key business, operating and balance sheet metrics for the second quarter.

Turning to Slide 15. This slide reconciles adjusted ongoing business, operating earnings to net income. The ongoing business adjusted operating earnings after-tax was $197 million. After DAC, VOBA unlocking, the ongoing business operating earnings after-tax was $199 million, adding corporate expenses of $34 million and those are mostly interest expenses and operating earnings of $12 million from the closed block institutional spread products and other closed blocks will reach an after-tax operating earnings of $177 million. The closed block variable annuity result excluding non-performance risk was an after-tax loss of $141 million reflecting an accounting asymmetry between GAAP and statutory results. On top of that we sell non-performance risk impact of $79 million driven by a slight tightening of our own credit spreads in relation to an overall rate increase environment.

We also have some other after-tax items which mostly consist of one time expenses related to the IPO and tax differences, which brings us to a net loss through our common shareholders of $82 million.

Slide 16, we are managing our business, as you know, on the basis of three main drivers of operating earnings. We saw the investment spread and the other investment income coming down slightly during the second quarter driven by the low rate environment and offset by some crediting rate actions we have taken. We saw a nice increase in the fee base margin, mostly in retirement and investment management driven by positive net flows and also helped by the equity market appreciation. The net underwriting gain and other revenue in the quarter saw a positive increase and that was primarily helped by the improvement of the loss ratios in employee benefits.

Slide 17, a material development in the quarter was the rising interest rate environment which overall is economically positive for the company. A key benefit of rising rates is that we will be able to achieve higher new money rates on our investment portfolios which will lead to an improvement of approximately $60 million annual operating earnings after-tax by 2016. This translates into an ROC walk erosion now being approximately half of our initial estimates over negative 110 to 130 basis points.

In the short term the rising rate environments will lead to a reduction of OCI and we saw reduction of $1.4 billion during the second quarter but over time it will be a positive for the balance sheet. Rising rates also leads to an improvement in the risk profile of our closed block variable annuity.

The living benefit net amounted risk improved by approximately $1 billion in the quarter as a result of rising rates partially offset all the factors netting to $600 million improvement.

Other considerations with respect to the rising rate environment includes lower bond fund assets and fees which will lead to less than $10 billion after tax reduction to annual operating earnings and its mostly on our retirement business and there is a potential increase in liquidity needs in a sharp rising rate environment for which we have significant protection. For instance, we have $2 billion of liquid assets to cover our closed block variable annuity hedging requirements, $3.6 billion in interest rate caps in retirement and a robust liquidity monitoring program in place.

Slide 18, strong ongoing business operating earnings was achieved while keeping the administrative expenses flat. As you can see, there was no increase in administrative expenses from a year ago. In fact, cost reductions that are being executed are offset here by high variable expanses related to higher sales and other higher volume effects from some of our businesses. Also, the 9% year-over-year improvement in operating earnings was achieved in light of approximately $800 million lower capital in the ongoing business.

Slide 19, Retirement has seen positive net flows in the quarter of $442 million based on sales that are priced at or above our 12% target return level. The $442 million is a good result. We believe this is a reasonable quarterly run rate for the second half of the year.

Turning to Slide 20, in the Annuity segment we have seen an improvement of our sales and net flows from our mutual fund custodial product where we earn attractive margins. At the same time, we have seen a continuation of the outflow of the low or negative margin products being the annual reset and the multi year guaranteed annuities.

Turning to Slide 21, we saw very strong commercial performance of investment managements where the net flows reached the level of $3.1 billion especially helped by the strong institutional entries of assets sourced by investment management. This was driven by some bank loan products, public equity, and a private equity fund launch. In addition, we had known ING US SIP Advisor replacements of $537 million during the quarter. At the bottom, you see that the total outflows for the closed block variable annuity for funds that are managed by investment management were $618 million.

Slide 22. This slide shows that we are continuing to execute on our strategy to shift our Individual Life business to less capital intensive products. We have right sized our expenses relative to the new skill of the Individual Life business.

Turning to Slide 23, in employee benefits we saw a strong improvement in our loss ratios during the quarter with the loss ratio for Group Life at 75.4%, and the loss ratio for Stop Loss is 72.1%. Sales are always lumpy with the majority of sales being driven during the second quarter. We also saw a continuation of the softness in some of the employee benefits markets in the quarter, especially in the Stop Loss and Group Life sales areas, while we continue with our pricing discipline.

Turning to Slide 24, in the closed bock variable annuity we see that our hedged programs has offset the change in statutory reserve liability as a consequence of the equity market movements during the quarter. Our hedged programs for the closed block variable annuity continue to perform well in protecting regulatory capital for market movements. We have seen the net amounted risk for living benefits beings reduced by $600 million during the quarter to $3.8 billion, and that is now covered by $4.7 billion in statutory reserve for the living benefits.

We've also seen for the past five quarters an increase in the net outflows as a percentage of assets. The net outflows were just over $1 billion for the quarter, which leads to a 9.1% annualized net outflows as a percentage of the beginning of period assets. At the bottom of the page, you see the new sensitivity tables for the end of the second quarter for both regulatory capital, as well as GAAP earnings for equity markets and interest rate movements.

Turning to Slide 25, our combined estimated risk based capital ratio at the end of the second quarter was 454%. The RBC ratio was more or less flat compared to the first quarter, which was as expected. Statutory income from our businesses was offset by the loss of an admitted tax assets, which was linked to the $1.4 billion extraordinary distribution that to place in conjunction with the IPO.

Slide 26, we have previously indicated that we turnout our debt maturity profile. We have completed our recapitalization program as of two weeks ago with the issuance of $400 million of 30 year senior notes. During the third quarter, we will repay $139 million and that is a tranche of the old Aetna debt that is maturing and we will repay that with a cash on hand from the holding company. After this repayment, we have no debt maturing until 2018. We are pleased that we have been able to recapitalize the company in very attractive period of rates from a historical prospective.

Moving to Slide 27. The debt to capital ratio at the end of the second quarter was 25.4%, which is pro forma for repayment of an ING securing a loan of $150 million in July. 20% of our leverage ratio is senior debt, and 5.4% is junior subordinated debt. This is also in line with our target to bring the leverage ratio to the 25% area.

And with that, I will turn it back to the operator to start the Q&A session.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from Nigel Dally of Morgan Stanley. Please go ahead.

Nigel Dally - Morgan Stanley

First question, the $60 million positive impact from higher end spreads by 2016, how should we expect that positive influence to build up to that level, should it be in that pretty linear fashion and how much of that would be coming into results in 2014? Then, second also on interest rate. You said the -- with the CBVA, the NAI benefited by roughly a $1 billion from higher rate but was offset by $400 million of some other factors, if you can just discuss what those other factors were? Thanks.

Rod Martin

Nigel, good morning, it's Rod. Ewout we will take those questions. Ewout?

Ewout Steenbergen

So, Nigel good morning. With respect to your first question, let's put it into following perspective. If you look at our portfolio yield the portfolio yields during the second quarter was 5.09%. If you look at new money rates and where they are today for our investments, it's about 4.25%. So we are approximately still 85 basis points off from our portfolio yields. So we have closed more or less half of the GAAP we saw before because our previous projections were based on the forward curve in the mid of 2012.

The $60 million after-tax improvement we expect to come in gradually overtime up to 2016. So this will really happen as long as the new money rates stay where they are and the new money investment we are doing overtime will pick up the higher rates that we saw before. So you should see a gradual improvement probably more liner backwards to 2016.

The second question with respect to the attribution of the net amount at risk. So the $1 billion improvement is especially the improvement that comes from the discount rate. So we are discounting based on swap rates and with the improvement of the rate environment, this has led to the benefit of $1 billion. That was offset by approximately $250 million of funds value reductions, a part of the VA funds are invested in bond funds, so there is some reduction and that we have decrements and rollups and other elements that make the overall the difference to the $600 million. So overall I have to say we are very pleased because clearly in the low rate environment we see a strong improvement of the risk profile of our closed block favorable annuity.

Operator

Our next question is from Mark Finkelstein of Evercore. Please go ahead.

Mark Finkelstein - Evercore

Question on the surrender activity in annuities. I guess the first question is can you just kind of talk about may be how July is looking, and I guess secondly, are you doing anything different in may be trying to accelerate some of the surrender activity?

Rod Martin

Ewout?

Ewout Steenbergen

Mark, good morning. So if you look at our surrender rate you have to see that in the perspective also of the in the moneyness level of the book. So we have always said that we have dynamic lapse assumptions where lapses are lower when the book is more in the money and where lapses are expected to be higher when the book is less in the money. So in fact that is the pattern on what we are seeing today. So we see the increase now for five quarters in a row of the surrender rate, and that is really driven by the improvement of the in the moneyness of the book.

We are not able to give you any information on the July results. At the end of the third quarter we'll update you on the results in the quarter itself as well as you know we always do our annual assumption review and update during the third quarter. So that is also the moment we'll update you in that respect if there is any update of assumptions that we have to do during the third quarter.

Mark Finkelstein - Evercore

I guess are there any broader strategic things that you're contemplating, as markets have gotten better in terms of trying to accelerate that that process?

Rod Martin

Mark, its Rod. During the Road Show as you recall we certainly discussed our plan. We provided some forward thinking around to not anticipate a release of capital from this book of business sooner than five years. That said, we certainly discussed that we are both open, and in listening actively, and engaging actively on other ways in part or in whole that we could pieces of what you see with a variety of other players happening in the market to accelerate a capital release. We are continuing to look at that on a very proactive basis. And as we discussed during that period when we have an answer and it's different than what we shared on the road show we will certainly share with you and all of you on the call. So, we continue to look at all of those things and we will keep you posted.

Operator

Our next question is from Jimmy Bhullar of JPMorgan. Please go ahead.

Jimmy Bhullar - JPMorgan

Hi, good morning. So, I just had first to follow up on Mark's question and maybe a little bit more directly. Like a lot of your competitors have had success with buyout options on VAs, have you considered those and what are the potential -- what are the plusses and negatives on you doing something similar to what some of the other companies have done? And then, also, I had a question on just your investment management business. You've had very strong third party net flows and you mentioned the strong performance, so wondering if you could just discuss on what are some of the factors that are driving that, and what your expectations are, not specific numbers but in general going forward for those?

Rod Martin

So, Jimmy, its Rod. Let me take first part of it and then Alain will jump in a second. The first part and I'll come back to really the point I was making earlier. We aren’t going to be speculating about every single idea that's being pursued. There are many that are happening in the marketplace; you just cited two very good examples. We have a large book business, its $40 billion plus. We are looking for both holistic solutions that might help advance our capital release and we're looking at really all options that are being considered, but what we're not going to do is speculate from call to call when aren’t complete with both analysis and thinking. We will keep you updated, you broadly, I'm talking about everyone on the call, and when we have something we want to report and we will share. Alain?

Jimmy Bhullar - JPMorgan

Okay.

Alain Karaoglan

Good morning, Jimmy. Yes, investment management business had very strong net cash flows. If you recall during the road show one of the way we described our investment management it was one of our best kept secrets in terms of their strong investment performance. And it is coming into its stride with both investment performance, we're publicizing it, we're more active about it. And the change in the environment, with people looking at more equities, more alternatives than they were looking before. So, we had a very strong quarter in terms of net flows. The areas were throughout our franchise. So, senior bank loan had what had very strong product sales in this second quarter.

Our return to equity investing and we have very strong equity performance, as I mentioned, has also like to strong sales and interest in growth strategies. We also had closing of private equity fund launch. These things tend to be lumpy. It came in the -- it will happen over time. It happened to come in the third quarter, so we're very pleased with the net cash flows. It's both the performance, the improving sales productivity; it's the initiatives that we put in place that are coming to fruition.

Jimmy Bhullar - JPMorgan

And then, lastly, you announced $0.01 dividend which is obviously a plus but a very small amount in terms of percentage of your earnings so the payout ratio is pretty low. How should we consider about the payout ratio going forward?

Rod Martin

Alain?

Alain Karaoglan

Jimmy, Good morning. The $0.01 dividends per share per quarter was an indication we had given in the S1 that has been approved now by our board, so basically what we are doing is to put in place what we have signals to investors in our IPO-S1documents.

If you look to our RBC ratio it was 454%, it's above our target of 425. It's approximately $400 million over but we're really looking our excess capital generation over a longer term period. We have a plan in place, as you know, to generate excess capital between $1.2 billion and $1.4 billion up to 2016, mostly in 2015 and 2016, and we will re-evaluate where we are with our excess capital at the end of this year and have a discussion with our board at that time about their ratio. It is just too early to commit to any pay out ratios at this point in time but we're very pleased that we're on the top to generate the excess capital as we have indicated to the market.

Operator

Our next question is from Chris Giovanni of Goldman Sachs. Please go ahead.

Chris Giovanni - Goldman Sachs

Thanks so much. Good morning. Just one quick follow-up just on CBVA. When we think about New York regulations looking at some of the private equity backed players, just wondering if that’s caused the change in maybe the pace of conversations you've had with those types of suitors?

Rod Martin

Sure, Chris, it's Rod. Good morning. I think it's well noticed in the market that the New York regulators and I would submit all of the regulators of paying appropriate attention to those options and alternatives that are being kind of discussed in the market. I would not say it's necessarily slowed it down. I think it's caused people to be both realistic, cautious and prudent and thorough in the conversations. And so, it's hard to gauge and we're not as you've heard beating on two previous answers, we're not going to be in the speculation business about timing of conversations.

I think that the choices and options that will present itself will emerge over time. I think the regulators are being appropriately thoughtful as they go through these discussions. The companies will be and I think the other side of the equation is also. So, I guess it's a moment to both think carefully and thoughtfully as we go through and make sure that the options that are being both offered considered and evaluated and ultimately implemented on the right options for all the stakeholders, so more to come.

Chris Giovanni - Goldman Sachs

Okay. And then Senator Hatch from Utah, I guess he's been vocal for a period of time, but more recently around trying to find solutions for the troubles facing the public pension market and points to the life insurance possibly playing the a bigger role in that. So, wanted to get kind of your thoughts around maybe some of his proposals and if you see this is a good opportunity for you guys specifically?

Rod Martin

Just attended this interesting question. The most recent ACLA meeting in June, there was a series of discussions very much focused around broadly the emerging problem that Americans are facing and what are potentially solutions. What felt good about that conversation more broadly I think it very much it reinforces our basis that the most daunting issue facing America today is preparing for retirement and I think we're uniquely well-positioned. I think as this emerges through this fall and certainly into the next years whether it's Senator Hatch's thesis, Senator Bach's thesis or others and there are many that are being proposed right now. Usually from that I think good choices and options begin to emerge and shining a light on this issue, I think it’s a good thing for Americans. It's a good thing for companies like ours with a focus on Retirement Readiness and the tools that we have to help our customers. So, I think more to come on that there'll be a lot more written and a lot more discussed. We are actively part of this discussion and the engagement.

Operator

Our next question is from Tom Gallagher of Credit Suisse. Please go ahead.

Tom Gallagher - Credit Suisse

Good morning. Few questions on the closed blocked variable annuities. So, with the last rates now running at least outflows as a percent of AUM running at around 90%. Is that the way apples-to-apples comparison with where your lapse rate assumptions in your reserves were said which were I believe around 5.50 meaning it now has a pretty favorable deviation when we think about your next balance sheet review or is it more nuanced than that?

Rod Martin

Ewout.

Ewout Steenbergen

Tom, good morning. The actual lapse experienced versus what we have assumed in our assumptions that is one I cannot compare to you today and certainly it's very hard to compare that at a high aggregation level. If you look at lapse assumptions it's really said with a lot of details and a lot of dimensions and lot of factors. You have to think about the summer short, you have to think about how long the policy is in place is it before or after surrender charge period, the moneyness level of the policy and many other factors.

We have all of those factors in our assumptions. So our assumptions are very, very multidimensional. It's very hard to compare it with an aggregate number of a surrender rate in the quarter. We will review that and a lot of detail during the third quarter in our normal annual review process of our assumptions and then we'll update you at the end of the third quarter where we land and if there is a need to make any changes or not and what is the impact if there is a need. So just too early to give you any indication on that right now, Tom.

Tom Gallagher - Credit Suisse

But Ewout at a high level that your comment that lapses have seen a pickup, I think in each of the last five sequential quarters, is a favorable development as it relates to when you think about your inputs in terms of the review, I presume that would be a positive development at high level, is that fair to say?

Ewout Steenbergen

Yeah. Let's say in the fuller way, Tom, I think if you look to the risk profile of the book we see very favorable developments. We see the net amount of risk coming down. We see an improvement of the front values. We see the improvement of the lapse rate and the lapse rates going up. We see hedge notion also coming down. So there is many indications we have that our book is developing in the right way.

I think you know that we are really comfortable in managing this as part of ING U.S. We're protecting regulatory and raising agency capital. We're trying to make sure that we overtime can generate excess capital and release some of the capital and redistribute that. We have $5.4 billion of statutory reserve resources both for the living benefits and the debt benefits, as well as cash flow testing. So we feel that we are that all the movements are in a positive direction.

But specifically on lapse assumption, I cannot give you more detail today, we really have to wait until we have finished the assumption study in the third quarter.

Tom Gallagher - Credit Suisse

Got it, okay. And then, one other thing I -- though just a little bit confused by the $200 million change in the variability annuity reserves in the quarter, which was released, was offset by a $200 million loss on the hedge assets. So, those two essentially offset each other, yet the change in the VA reserves that it has on slide 24, I believe it is, is $600 million. So, I was just trying to track what was the change in reserve to what was the change in hedge asset performance and that for me off little bit, was it $200 million or was it $600 million, can you help me reconcile that?

Ewout Steenbergen

And Tom, if we look at the graph, what we are trying to do here to look at the statutory results for the closed block variable annuity and to make an attribution of the impact of equity markets on the one end on our reserves and on the other hand with respect to our hedges, and you see that both are opposite direction of $200 million, so more or less offsetting. If you look at the delta of statutory results for the variable annuity block in the quarter, there was a positive 82 and this is the -- out of the 82, this is the attribution that can be described to the movements in the equity markets. If you look at the reserves, debt reserves is an all in movement that also reflects changes in rates and other elements. So that is how you should compare one to the other. But the $200 million movement is very specifically for the equity market movement impact only.

Tom Gallagher - Credit Suisse

And are you -- what about the interest rate component, which has sounds like that is even bigger delta, was that something that was additive to statutory capital for the quarter if I consider how hedge assets performed relative to the movement of the liability?

Ewout Steenbergen

Yes. So if you look at the impact of rates on a statuary basis that was overall enough positive for the results on a statuary basis for the closed block variable annuity.

Tom Gallagher - Credit Suisse

Okay. And then -- and sorry, if I could just squeeze you one last one for Alain. So, just following your commentary about the very strong flows within asset management, are you able to I guess separate it between what you would deem to be more of one-time fund launches, because I know you mentioned a private equity fund launch, you also mentioned the commercial bank loans? Can we separate out kind of recurring flows on fund that you already had versus may be new fund launches, whether that close end funds or the like that might be more one-time in nature? Is there a way to separate that out?

Alain Karaoglan

Yeah. Thanks Tom. And we can work more detail offline with Darin on the detail. But conceptually, I would change a little bit your terminology in terms of one-time. These can be lumpy. And the lumpiness comes in quarters, but of course because we have strong capabilities we expect overtime to do more of theses. But in the second quarter, you can count a about a billion dollars of what I would call the lumpy net flows that came in and the two sort of broad categories are the CLOs and the private equity fund. I hope that gives you enough detail and information and we can follow-up offline if you want the exact numbers.

Operator

Our next question comes from Eric Berg of RBC Capital Markets. Please go ahead.

Eric Berg - RBC Capital Markets

Thanks very much and good morning to everyone. Most of your competitors when thinking about the change in reserves versus the change in the value of the hedge assets do not disaggregate the effect of say the equity market from the effective interest rates, from the effective changes in implied volatility. Why do you give us this separate brick? And I realize it is just that, its additional information. But in the end, is not the whole picture what matters rather than the effective the equity markets alone?

Rod Martin

Very good morning, this is Rod. Ewout will take that.

Ewout Steenbergen

Eric, that is a fair color. Ultimately, our objective is to protect regulatory and raising easy capital for whatever reason that can move that capital and we have to make sure that our current comfort levels, which are very comfortable as we have explained that we keep that in place for the future.

Why are we really showing the equity market movement only? This is just to illustrate that our hedge program has been effective during the quarter and to compare it with brief this quarters, where we have showed you similar indications. So, this is really -- to be consistent and to show you for a longer-term pattern about the hedge program performance and effectiveness because it is very important that we are able to make the case, and you and investors get confidence that our hedge programs behave as we expect.

So this is just an attribution to illustrate that point. But you are right overall, it is important that the impact of all our hedge programs are really protecting us against many, many different market movements. That is why I gave that number of $82 million overall stat income for the closed block VA. That's all in number to give you another indication that also the other hedge programs have worked well, especially the (inaudible) hedge program.

Eric Berg - RBC Capital Markets

Good. Moving on, in the same slide 24, you compare the net amount at risk on the right side of the slide to the statutory reserves. But am I right when I say that in terms of the resources that are available to the company to defeat that net amount at risk, should it need to do so today, is it not only the statutory reserves but also the value of our hedge assets? In other words, have we omitted an important element to depict from the picture here?

Ewout Steenbergen

And let us say in the following way, Eric. Our hedges are not based on option instruments, our hedges are based on either swaps with respect to the interest rate protection, as well as future short future positions with respect to the equity protection.

Eric Berg - RBC Capital Markets

Okay.

Ewout Steenbergen

So, these are not derivatives that can contain a value itself. But we have the middle impact of value movement of the swaps and the futures going through the P&L and therefore, you see again loss that is being offset every quarter. So, if you look at the 4.7, you are looking really at the statutory reserve. The 8043 reserve we have available for the living benefits that is the 4.7. You can add they are also the reserves, the statutory reserves for the debt benefits. You can add the cash flow testing reserves. So, everything we have in terms of hard assets and resources that is backing this book and that is another -- that leads to a total of 5.4, so it is another $700 million we have available. But there is not another element of certain derivatives that have a value that is not being captured in these numbers given the particular type of hedging instruments we use.

Eric Berg - RBC Capital Markets

Okay. Final question, I am intrigued. I will not understand better than I do this custodial product. Really briefly, for the purposes of allowing us to press ahead year, can you help me explain, can you help me understand very succinctly, why you are able to earn target rates of return on that product but not on a conventional fixed annuity product? What is different about it?

Alain Karaoglan

Eric, it's Alain, thank you. I will try to do my best at succinctly. But the mutual fund custodial product attracts investors who are looking for the flexibility of investing in multiple fund families without the hassle of transaction cost. And so, it is a product where we offer a 100 plus mutual funds in one platform, including ING Investment Management, as well as third party funds. So, there is no fee switching between the third party mutual funds, and unlike a fixed annuity product there is no guarantee on any of the fund, so there is not much in terms of capital commitment that is required. And what it does is it allows investors to switch from one family of fund to another within the platform without incurring significant cost in doing so. And so, the product is really targeted to small size IRA roll-overs and we have expanded our target market to include startup IRAs by lowering the startup contribution in it.

Operator

In the interest of time, our last question comes from Erik Bass, Citigroup. Please go ahead.

Erik Bass - Citigroup

Just a couple of questions on Retirement, I was hoping you could comment a little bit more about the flow trends and, in particular, are you starting to see a pickup in terms of return deposits or employer matches?

Alain Karaoglan

I’m sorry, could you repeat the question?

Erik Bass - Citigroup

Sure. Just on the retirement business in the flows, are you starting to see any pickup in terms of recurring deposits or employer matches in that business?

Rod Martin

It’s Rod speaking, sorry. We are viewing, what we are seeing right now is more of a steady trend. So, it certainly isn’t -- we are not seeing a pickup, but we are certainly not seeing any degradation of that either. So, it’s more of a steady course and we view that as a healthy part of the business and reflected in the growth that you are seeing in and with our retirement business.

Erik Bass - Citigroup

Okay. And then could you comment it on how retention rate have been on retirement cases that you are repricing?

Rod Martin

Yes, as we have discussed previously the book is roughly a five or six-year duration. Client retention as remain stable. We are achieving, most importantly, our ROCs equal to or higher than what we signal to you, which is 12% are better. And that’s both in our full service as well as in our tax exempt business. So, that's continued to move forward very nicely.

Erik Bass - Citigroup

Okay, and then just finely just one number if you can provide on the CBVA. Can you update us on what percentage of your guarantees are currently in the money and the approximate level of in the moneyness?

Ewout Steenbergen

Good morning, Erik. I will give the one number. The in the moneyness expressed as the policies that are considered in the money in terms of the net amount of risk calculation came down from 65% last quarter to 61% this quarter.

Erik Bass - Citigroup

Okay. So that just as a percentage of the number of guarantees that are in the money, is that correct?

Ewout Steenbergen

It is number of policies where there is still a level of in the moneyness on our policies.

Erik Bass - Citigroup

Okay. And your lapse assumption, on the dynamic lapse assumption assumes is that pickup one-third contracts kicking to being out of the money. Is that correct?

Ewout Steenbergen

So, just to be specific, that’s one number to 61% is then for the living benefits, so the in the moneyness of the living benefit. If you asked a question about what does that mean for lapses so again that doesn’t look only at is a policy in the money or not. This percentage shows is it in the money yes or no, but also the level of in the moneyness. So, one policy are more deeper in the money, you have much lower lapses and the other way around.

So, that is we need to dynamic assumptions so that is not a binary assumption that is really dynamic taking in to account the actual level of the in the moneyness. But this number is only the number of wage percentage of our policies are from a net amount of risk calculation are showing in the moneyness for living benefits and that came down from 65% of all of our policy count to 61% at the end of the second quarter. I hope that helps.

Erik Bass - Citigroup

Yes, that certainly. Are you -- in the Q do you provide or plan to provide the level of in the moneyness, in terms of I guess the second part of your point?

Ewout Steenbergen

Yeah, there is some information in the Q. So, the 10-Q will be filed at the end of this week. And you will see specific information about the in the moneyness level in the Q. So, it goes maybe a little bit too far to provide you the numbers now, but you can find that later this week.

Operator

And this concludes our question-and-answer session. I'd like to turn the call back over to Rod Martin for any closing remarks.

Rod Martin

Emily, thank you. And thank you everyone for joining us today. You can see from the results we reported we are marking strong progress with our transformation story. We are focused on achieving our vision to be America’s retirement company. ING U.S. is a premier franchise with leading positions in attractive markets and this management team is committed to executing a 400 to 500 basis point improvement in our ROE by 2016. We will continue to build on our solid foundation, which is based on our recapitalized and de-risked balance sheet.

In short, we are well positioned to create long-term value for our stakeholders. Thank you for joining us today. Good day.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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