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Fidelity & Guaranty Life (NYSE:FGL)

Q3 2014 Results Earnings Conference Call

August Date, 2014 09:00 AM ET

Executives

Molly Carman - Investor Relations

Lee Launer - Chief Executive Officer

Dennis Vigneau - Chief Financial Officer

Analysts

Jimmy Bhullar - JP Morgan

Sean Dargan - Macquarie

Operator

Good morning and welcome to the Fidelity & Guaranty Life Earnings Conference Call. All participants will be in 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 will now like to turn the conference call over to Miss Molly Carman. Miss Carman, the floor is yours, ma'am.

Molly Carman

Thank you. Good morning and welcome to Fidelity & Guaranty Life’s third quarter earnings conference call. Our earnings release, Form 10-Q and financial supplement were released last night and can be found at our website www.fglife.com. Today you will hear from our Chief Executive Officer, Lee Launer; followed by Dennis Vigneau our Chief Financial Officer. Following our prepared remarks, we will open the call up for question-and-answer period. In addition to our speakers, Raj Krishnan, Chief Investment Officer; and John O'Shaughnessy, Chief Actuary will be available to take your questions.

Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation reform act. The company does not intend to revise or update any comments on this call to reflect new information, subsequent events or changes in strategy. There are number of risks and uncertainties that could cause actual results to differ materially from those expressed or implies. Factors that could cause actual results to differ materially are discussed in detail in our initial public offering perspective as filed with the SEC.

During this conference call we may make reference to non-GAAP financial measures that we believe maybe meaningful to investors. We refer you to our third quarter earnings release available on our website which contains a reconciliation of non-GAAP financial measures to GAAP we’re required in accordance with SEC rule.

Today’s call is being recorded. An audio replay of this conference call will be available shortly after today’s call and until August 29, 2014. The replay access information is toll-free 1877-344-7529 or for international 1412-317-0088, conference ID number 10049684.

With that it is now my pleasure to introduce our CEO, Lee Launer.

Lee Launer

Thanks Molly. Good morning everybody. Thanks for joining us today. I know everybody is certainly busy at this time of the year, so I appreciate your attention here. I wanted to report on kind of our overall results which are very solid for the third quarter as we continue to execute on the plan that we laid out 10 months ago or so, at the time of IPO, and talk a little bit about sales and then turn it over to Dennis who is going to through kind of more the number piece.

Regarding sales, very positive for us in the quarter, sales of annuities and IUL continued to grow at a strong prudent pace I would say. Sales of $379 million for FIA in the quarter that’s 44% over last year and 19% up sequentially. IUL of $6 million in annualized that’s up of 37% year over -- over the prior year period. The FIA sales continued to kind march steadily up this highest level in the last eight quarters. And what’s working for us as is what we talked about before, our strategy which focuses on the IMOs regularly coming out with new products. And we view a very favorable market for us to do business.

And let me talk about each of those very briefly. Our top IMOs, independent marketing organizations grew FIA sales of 41% over the prior year, 14% over last quarter. They continued to gravitate to our platform, because of the collaborative product design that we produce for them, top service to their agents, good compensation, speed, responsiveness and I can’t emphasize enough; we have a capital base committed for the growth.

On the product front, as I mentioned, we launched two new products FIAs in March and they delivered about 11% of our total annuity FIA sales in the quarter end of 6/30 and about a third of our figures in July. So looking ahead, we’re going to launch two more products in the fourth quarter and certainly more we have lined up after that. So, that's part of our routine as we continue to bring products to the marketplace.

With regard to market conditions, there continues to be -- I’m struggling with how to say that's exactly, the kind of production fluctuation I guess you’d say with the manufactures. And in that environment, IMOs and their agents are attracted to us, because we’re consistent carrier and again we have the capital on the balance sheet committed to future growth. In that dynamic where you have the capital, new product launches, total focus on the IMOs; that's what's behind setting line at our FIA sales up again 44% over last year.

Stepping back and if you look at all of our annuity sales including MYGA, and as you remember we had a fairly large program at the beginning of the year. We delivered $1.7 billion of new business in nine months and that’s two times double of what we did the same year before. And that’s right in line what we had talked about again to prefer to the IPO, but at the time of IPO when we were seeking to materially increase our sales.

Shifting to life, and I want to make the point that we sale Life and we continue to make progress in our life book as well, sales were 637%, 20% sequentially nine months. Annualized premiums reached 16 million, up 11%, we also took another 13 million in single premium wise. So all well there and we are on track to launch a new product right in the fourth quarter. And I would say also with all of these sales including our Life all of these were achieved with pricing levels that are well within our target IRRs and our target risk metrics. So we are very pleased with that.

Before I hand it off to Dennis let me touch on a couple of additional things. AUM I would hope you know it up to $16.5 billion and then 7% you have to do a little adjustment for funds fit in there, but that’s up 7% year-over-year. Regarding investments Raj is here to answer questions on investments, but average yields are up net investment spread is up. We are working very hard on the investment portfolio to get it in exactly the right position and you are starting to see the effects of that.

And holding an average (inaudible) rating of 1.4 even after. Lastly I hope you noted that the financial street rating of our primarily insurance company was upgraded by Moody’s to investment grade in July so that’s another positive step in the right direction. Overall, and then I will turn over to Dennis, company is doing well to execute on our growth strategy plan and I see no reason we can’t do so in the future.

So I will come back for questions but hand it over to Dennis.

Dennis Vigneau

Great, thanks Lee and good morning everyone. Before I get into the details of the quarter I just want to mention that we’ve added several additional disclosure items in our quarterly financial supplement. Including we now are breaking out separately the net investment spread for, fixed indexed annuities. We're splitting out the acquisition operating and deferred expenses and as well, we're providing a reconciliation of AOI adjustments to the specific income statement line item. We'll continue to expand here in the future quarters and appreciate the feedback that this group has given us today.

Shifting to the details of the quarter, I want to focus my comments on three areas this morning. One, the overall performance of the investment portfolio, the adjusted operating earnings trend and I'll wrap up with some thoughts on the company's capital position.

I get to the details on the portfolio for the third quarter in a minute, but at I first want to provide some context on the portfolio shifts that we've had over the past several quarters. Over the last two years, we've undertaken a measured approach to rerisk the portfolio by broadening its asset mix. Along with, we've also implemented two tax planning strategies, realizing significant investment gains, tax benefits for shareholders, while also defensively positioning ourselves for a higher rate.

When we met in the second quarter, we've just completed a $1.7 billion asset repositioning program. This action alone added $30 million of net investment income on an annualized basis and by design, left the portfolio duration about one year short of the assets about one year short of the liabilities.

Coming into the year, we were focused on taking gains under the tax planning strategy to capture the tax benefits. These proceeds were slated to further diversify portfolio’s asset mix and lengthen the portfolio duration should the opportunity present itself. I'm pleased to say that we have successfully executed on both of those objectives.

Asset purchases in the third quarter totaled 1.6 billion and included 1 billion of tax related sales proceeds, 400 million of new business cash flows and 200 million of maturities and income. The average purchase yield for the quarter was 5.29% or 67 basis points above the total portfolio effective yield of 4.62%. Given the very positive outcome here I’d like to share some specifics on these actions and what it means to the overall portfolio position.

These purchases were largely investment grade fixed income securities with an average NAIC rating of 1.6 and in the asset classes that we’ve been focused on throughout the repositioning efforts, specifically, U.S. dollar pay emerging market debt, investment grade rated structured securities, public and private corporate bonds, municipals and investment grade rated preferred stocks. The net result of these purchases leave the overall portfolio at an average NAIC rating of 1.4 right in line with our risk tolerances and in line with peers. As I mentioned the blended yield on these purchases was 5.29% and the average duration was 7.2 years. This outcome being heavily influenced by the impact of the $1 billion tax related proceeds.

This targeted lengthening of the asset duration brought the asset and liability duration even at roughly 5.6 years. We continue to retain our 25% position in floating rate assets and maintain a fairly barbell AOM profile.

From an earnings perspective, we’ve added about $8 million of annualized net investment income to the portfolio with the actions this quarter. This essentially completes the large scale repositioning of the portfolio. Looking ahead we do see additional opportunity to lift earnings by activities around the margins that are more incremental in nature. Let me give you a few examples.

We think looking forward that we will reduce cash on hands. There's opportunities to build on our existing exposure to typical life and annuity asset mix at a less liquid such as commercial mortgage loans and private placements, refining schedule BA asset mix and depending upon market conditions moving a portion of the floating portfolio to higher yielding fixed rate assets. As those manufacturer realized all within our risk tolerances will provide additional contacts.

Turning to net investment income for the quarter. NII was $191 million in the current period up 4% on a reported basis and up 13% when you adjust for the impact of reinsurance.

Sequentially net investment income increased 4% over the second quarter. Total interest credited and option costs for the quarter was 2.88% compared to 2.92% a year ago, net investment spreads for all products widen by 30 basis points year-over-year from 144 to 174 basis points.

For the fixed index annuity product, net investment spread was 2.90% up from 2.49% a year ago. This lift of 41 basis points is largely due to the combination of the portfolio repositioning, efforts I spoken of previously and the addition of approximately 1 billion of new business coming on at or above our pricing target.

Wrapping up on the portfolio, we ended the third quarter with average assets under management of 16.5 billion, up 1.1 billion or 7% adjusted for reinsurance and down 2% on a reported basis.

Moving to adjusted operating earnings, let me start with the comparison of earnings relative to the prior year period. Adjusted operating earnings in the third quarter of 2014 was $35.2 million or $0.60 per diluted share as compared to $14 million or $0.30 per share in the third quarter of last year.

I’ll note that the current period includes 24% increase in diluted share count from the IPO and that had a $0.15 per diluted share impact. Items of note in the impacting earnings year-over-year included the following. In the current quarter, we benefited from $5.7 million or $0.10 per share of after-tax favorable mortality experience in the life contingent immediate annuity product line. This product line has approximately $2 billion in total reserves of which $327 million relates to close block of impaired risk policyholders having an average age of 89 years. I’ll note that as this block continues to run off, there is a potential for quarterly volatility of $5 million after-tax.

Also benefiting the current quarter’s results was $4.7 million or $0.08 per share of after-tax favorable DAC amortization. Again, this is within a range of normal volatility given market performance. Its volatility generally smoothes itself out over longer period and does not impact lifetime product IRRs or ROEs.

Shifting to the third quarter of 2013 of which $5 million or $0.11 per share reserve strengthening across the immediate annuity product line to correct for cost [delivering rider], not previously approved for. As well in the prior year period, it was 2.7 million or $0.06 per share of project related expenses.

Stepping back and looking at the progress year-to-date, we've delivered $108 million of adjusted operating earnings compared to $58.6 million for the same period of 2013, an 84% increase year-over-year. In terms of the underlying earnings performance since the IPO, that’s improved from $20 million in the first quarter, $22 million in the second quarter and now roughly $25 million in the third quarter. This steady progress largely reflects the now completed portfolio repositioning, new business growth and disciplined expense management.

Looking ahead, earnings and ROE expansion will come from growth in AUM as we deploy our capital to new business.

Let me close with a few thoughts on capital. We ended the quarter well positioned on that front. The estimated RBC ratio for the insurance companies was above 400%. This does not include an additional 170 million of capital at the holding company which if we contributed to the operating company would bring the RBC to roughly 475%. In total, this puts about $370 million of deployable capital at our disposal to support our growth initiatives.

With that I would like thank everyone for the time this morning. And I will turn it over to the operator to take the first question.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Jimmy Bhullar of JP Morgan. Please go ahead.

Jimmy Bhullar - JP Morgan

Hi, good morning. First, just a question for Lee; you mentioned this in your remarks but maybe talk a little bit more about your views of the indexed annuity market, what you’re seeing in terms of competitive trends and your comfort in being able to achieve your sales goals that you had outlined at the time of the IPO? And then secondly, on new money yields, you're one of the few companies that's actually seeing an increase in new money yields or that has seen an increase in new money yields over the past few months. And maybe talk about what your expectation for that is given the decline in interest rates that we saw during the quarter and where do you see your portfolio yields going if we stay in this type of rate environment a year from now?

Lee Launer

Okay. Thanks Jimmy, Lee here. Yes, the market, you almost have to go competitor by competitor; and I'm not going to do that. But if you did do that and look at the major competitors in the FIA space, you're going to see some dramatically increasing their sales, some dramatically decreasing their sales, some staying flat. And in the eyes of IMOs and I talk to them constantly, they are wondering exactly is that trend going to continue or some going to continue to grow, or some going to come back to the pack. And it's that kind of environment where they on the margin come to us and they’d say we’d like to do more business with you, because you are bringing up the new products and you are -- you have the capital committed to sales.

And so, you are just -- if you go back and historically look at the main players in the FIA space, it's just a little bit of chalking around there and a little bit of continued uncertainty as to what they really are able to do or want to do in the future.

And I hope that makes sense, I just don’t want to go down each one.

Jimmy Bhullar - JP Morgan

But overall, are you still like is the environment conducive to you achieving the goals that you had outlined?

Lee Launer

Absolutely. It sets up very nicely for us actually.

Dennis Vigneau

Hey Jimmy, it’s Dennis. Let me just comment on your question about the new money yields and remind you, we did have a blended purchase rate this quarter at 5.29. The reason we hit 5.29 is it was heavily influenced by the work we’re doing with the tax strategy and the final leg of repositioning there. As I said, there were about $1 billion of purchases that influenced that. We not only diversified into the asset classes that I mentioned but we also lengthened the duration modestly about that third of the year and brought the asset duration in line with the liabilities. So that’s why we’ve got such a nice purchase yield this quarter.

If you think about what it means going forward, I think relative to our 462 yield that we had in this quarter, you should -- new business we expect to bring on around the 490 to 5ish range and over time our effective yield on a portfolio as we view the market going forward should continue to rise and come up towards that level.

Jimmy Bhullar - JP Morgan

Okay. Thank you.

Dennis Vigneau

Yes. You bet.

Operator

The next question we have comes from Sean Dargan of Macquarie.

Sean Dargan - Macquarie

Thank you. I would just like to go back to MYGA sales. How should we think about your willingness and capacity to flip the switch and turn on those sales again because it does introduce some volatility into sales and maybe how we were thinking of adding assets to the go forward? Should we think of it that when you get a window where spreads gap out that you'll sell that product?

Lee Launer

Yes. Lee here. Well, I think overall, overall we view, MYGA as maybe a third of our mix when you look at kind of an expanded period of time. And then you said, when will we really do something special and promote product more than we promoted right now and there’d be a few things. One would be the asset availability as you mentioned just now; two would be there is really no disruption to the momentum we're creating in our FIA product line. These people sell both and we want to not cause any kind of pulling away from the sale of the underlying core product. And three is that we have to be able to obviously do that and service that product and bring it in pretty flawlessly. And so, when those three things line up we’re ready to go. So, we’re looking at it again very closely right now but I can’t out and be committed to anything but we are looking at it very closely again. So, I am sorry I can’t be a little bit more specific than that but that's kind of how we view it philosophically.

Sean Dargan - Macquarie

Okay, got it. And thank you for the increased disclosure around the annuity asset roll forward. So, should we assume that all of the difference between that and the consolidated average AUM is IUL?

Dennis Vigneau

What particularly are you looking at?

Sean Dargan - Macquarie

Yes. So, in other words, the asset balance at the end of period for annuities is $12.3 billion and the average AUM for the company is 16.546?

Dennis Vigneau

Yes, okay, great. Thanks for the clarification. What's not included in that AUM roll forward is a [split bloc], which as I said is just over a few billion dollars, that makes up the majority of it.

Sean Dargan - Macquarie

Okay great.

Dennis Vigneau

And you've got like business as well.

Sean Dargan - Macquarie

Okay. Alright, thank you.

Dennis Vigneau

Sure.

Operator

(Operator Instructions). As we're showing no further questions, I would now like to turn the conference call back over to Ms. Molly Carman for any closing remarks. Ma'am?

Molly Carman

Thank you. Thank you for your interest in Fidelity & Guaranty Life and for participating on the call today. Please feel free to contact us if you have any follow-up questions. Thanks and have a good day.

Operator

And we thank you ma'am and to the rest of the management team for your time today. The conference call is now concluded. Again, we thank you all for attending today’s presentation. At this time you may disconnect your lines. Thank you and have a great day everyone.

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