Protective Life Corporation (NYSE:PL) Company Update Meeting Call April 11, 2016 12:00 PM ET
Eva Robertson - Vice President, Corporate Communications
Steve Walker - Executive Vice President and Chief Financial Officer
Lance Black - Senior Vice President and Treasurer
Mike Temple - Executive Vice President, Finance and Risk
Casey Hardeman - Vice President, GAAP Financial Reporting
Andy Buck - Senior Associate Counsel
Wayne Stuenkel - Senior Vice President and Chief Actuary
Yoshimasa Oshirabe - Executive Vice President, Dai-ichi
Steven Schwartz - Raymond James
Diane Ferguson - Mizuho
Joel Gross - ICMA Retirement Corporation
Nicole Limberg - PNC Bank
Jon Zobel - Citi
Great. Good morning. I am Eva Robertson, the Vice President of Corporate Communications for Protective and I would like to welcome you to the 2016 Protective Life Corporation Company Update Meeting. And we really appreciate the fact that you would spend your lunch time today, braved the weather to be here with us. We hope to spend the next hour or so giving you an update about what’s going on at Protective and what we see. So, we hope to make it very, very useful to you.
Today, we are webcasting the meeting, so for those of you who are listening on the webcast, of course, the presentation is located there for download as well as the webcast itself. Later, there will be a replay available.
I would like to introduce our speakers today. We have with us Steve Walker. Steve is Executive Vice President and Chief Financial Officer for Protective. Also, we have Lance Black. He is Senior Vice President and Treasurer. Lance is also responsible for the Stable Value Products Division. Now original plans were to have Mike Temple with us today. Mike is Executive Vice President of Finance and Risk, but unfortunately, Mike had a last minute issue come up and is not able to be with us. So, Steve and Lance will be covering the risk material today. Don’t ask them any really hard questions. We will have to get Mike on the phone.
Also with us though, we have some more, some additional Protective Life team. We have Casey Hardeman, who is Vice President of GAAP Financial Reporting. We have Andy Buck, who is our Senior Associate Counsel. We have Wayne Stuenkel, our Senior Vice President and Chief Actuary. Jill Harris is the woman you met when you came in. She did a great job of setting up our meeting for us today. She checked you and she is part of our event planning team. And last but not least, I want to introduce some of our Dai-ichi colleagues. Dai-ichi has set up a regional headquarters for North America here in New York City. And so with us today, we have Yoshimasa Oshirabe, who is Executive Vice President for Dai-ichi, as well as Satoru Abe-san, and he is with Dai-ichi here in New York. And last but not least, we also have Eric Windsor with us. And Eric was very recently – until very recently a Protective employee who has now become a Dai-ichi employee as our first liaison working with Dai-ichi. So, we have a great group of people.
After the presentation this morning, we are going to have a brief Q&A session, and afterwards, there is coffee and dessert in the back. So, we would love very much to have the opportunity to speak with you individually and have a chance to meet you individually. So, if you are here in the room with us and can stay for dessert, please do that. We will have a chance to introduce ourselves.
So, one last bit of housekeeping, one second. We can’t go anywhere without this. In addition to the information contained in this presentation, we have a supplemental financial information available on our website at protective.com. The information found on our website is not part of the presentation, but the presentation includes forward-looking information, which is – express expectations or future events. Actual results and events may differ materially from these expectations. For information about the risk, uncertainties and other factors that could affect our future results, please refer to Part 1, Item 1A, Risk Factors of the company’s most recent annual report on Form 10-K.
Certain information included in this presentation may contain non-GAAP financial measures. For information related to non-GAAP financial measures like operating earnings, shareholders’ equity excluding AOCI and the associated reconciliation to GAAP financials, please refer to Note 26 on our consolidated financial statements included in our most recent annual report on Form 10-K.
Operating earnings or losses referenced throughout the presentations, referred to as segment operating income in our annual report, the preparation of the company financial statements requires management to make estimates and assumptions that impact the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported periods.
So we got that out of the way. Now I’d like to introduce to you your first speaker. That is Lance Black, our Senior Vice President and Treasurer. Thank you.
So, I realize the applause was for Eva finishing the forward-looking statements comment and not for me, but I do appreciate it and see if we can get past that. I would like to add my welcome to you. I appreciate you taking the time out of your schedule and joining us today. And hopefully, you will find it to be informative around where we are at Protective, especially since it’s been a while since we have had a communication like this with the investing public.
Here is the agenda. You also have obviously copies of the presentation in front of you, so I am not going to read that. I think she did that. So, we will go on to the company overview. For those of you that may not be overly familiar with Protective, we are focused on providing traditional life and annuity products into the U.S. market. As you see, we were founded in 1907 by Governor Jelks of Alabama. We currently, as of 12/31/15, have $767 billion of life insurance in force and we have 7.8 million contracts and policies also as of 12/31/15. We are going to spend a good bit of time today talking about our recent track record, especially post the financial crisis and the strong financial performance that we have had. And within that, we will discuss our retail franchise and how it is complemented by our acquisitions capability that has been quite distinctive for us for some period of time. In addition, we will discuss the acquisition by Dai-ichi, which closed on February 1, 2015. And one thing we do want to reiterate is that our experienced management team, quite talented management team is still in place in Birmingham, Alabama, and we continue to operate the company on a go-forward basis.
Then turning to the overview of our SEC reporting segment, we won’t spend much time here, but if we start to work from left to right, our Life Marketing segment is our retail life franchise that sells traditional life and UL – traditional term life and UL products into the retail market through our distribution partners. One thing to note about Protective is that we do not have any of our own captive distribution. All of our products are distributed through independent broker, general agents, broker-dealers and banks.
Next, our Acquisitions segment obviously speaks for itself, where we acquire blocks of business and companies from other partners here in the U.S. And that business is primarily life focused. About 90% of that business is in the mortality side of the space with – at times, we will acquire annuities through these acquisitions. Especially the whole company acquisitions will oftentimes have a segment of that company that’s involved in the annuity space as well, but traditionally, we focus on mortality or life business in that segment.
Next is our Annuity segment. That is our retail-focused Annuity segment, where again we are distributing fixed and variable annuities through banks and broker dealers primarily. Stable Value Products represents our institutional funding again as Eva mentioned, the segment that I am responsible for. Here, we are traditionally issuing guaranteed investment contracts to managers of retirement plans, 401(k)s, pension, deferred compensation plans and funding agreements, in particular, the funding agreements largely issued to the Federal Home Loan Bank. And as we reinsured the funding agreement-backed note market last November, the product we are using there is a funding agreement-backed note program through a trust.
Then finally, from an operating perspective, asset protection is our property and casualty operation. We focus on providing principally vehicle service contracts and it’s sold through auto dealers across the country. In addition to the kind of car warranty vehicle service space, we are also involved in credit insurance and gap coverage. And then finally, our last SEC reporting segment is our Corporate & Other segment. This segment represents our invested capital or the income on our invested capital. We do pay the interest expense on our debt out of this segment, and then any expenses that remain that are not allocated out to the divisions resides in Corporate & Other.
From a business mix perspective, from the revenue side, approximately 75% of our revenue or premium comes from the life side of our business or the mortality side. That’s represented within Life Marketing and Acquisitions and we will go into a little more detail, especially Steve in his presentations around these segments. And again, the acquisitions with 90% or so of that premium coming from the life side, we have a very good balance on an earnings perspective where approximately 50% of our earnings are from the life mortality side of the business, 45% or so from the deposit side being the Annuities and Stable Value and then the remainder coming from Asset Protection.
I want to spend a few minutes talking about our retail, life and annuity strategy. This is just to provide a brief overview in how it relates to the life and annuity operations. We believe there is significant opportunity for growth in the U.S. life and annuity space and that opportunity is driven by the decline in life insurance ownership that we have seen in the U.S. Actually, life insurance ownership is at a low within our country. And then as we are all aware, there is a looming retirement crisis in our country that could be aided in terms of fulfilling a need in the retirement world through our annuities.
So, a number of years ago, Johnny’s concern – Johnny Johns, our CEO, in case you didn’t know, concern for meeting these unmet or un-reached needs led to the development of the mission that you see here, which is to tear down the barriers, preventing Americans from protecting the ones they love. And that kind of became – I mean, this was probably 4 or 5 years ago easily that we developed this, and everything we have done since then is focused on trying to meet unmet needs that exist in our market today. And we’ve developed underneath our core strategy three primary areas of focus. The strength existing is kind of what it says, where we are focused on, what we have been doing and what we have been doing what we believe is really well but trying to make it better, make it easier for distribution and customers to do business with us, focused on technology to support how we interact with our customers and operational excellence.
Next, shared value represents a process of reconfiguring our value chain. Here, the best example of that is our relatively recent, although I believe it’s been over a year, partnership with Costco. And in that partnership, we have been able to successfully deliver a product that represents value to Costco’s customers as well as by reengineering the delivery of that product using only online communication, application filing and our tell-a-life underwriting process. It’s actually delivered value to us as well. So, we provide a win-win situation to Costco in meeting that affinity partners’ needs as well as to Protective in streamlining our own operations on our side. And then finally, the direct is – encompasses meeting the needs of our distribution partners and our customers in a self-service or kind of direct manner making sure that we are like many other financial institutions, providing the appropriate technology where the customers can serve their own needs as many out there want to do and that does not necessarily require a phone call into our call center.
And again, as with many other financial institutions or financial service companies, we are exploring the opportunity of using innovative products and technology or ideas. And actually, Johnny, again, our CEO and Rich Bielen, our President and Chief Operating Officer, have actually spent a fair amount of time over the last year in trips to Silicon Valley to meet with up and coming technology innovation – innovative companies that – to determine if there are opportunities for us to use their technology in our operations. And we are quite aware that there are other – whether it’s banks or insurance companies that are also involved in that type of research.
Now, turning to the financial side of the world, as you see, we ended 2008 with $2 billion of statutory capital. We have grown that nicely to a record $4.1 billion at the end of 2015. The only thing I do want to note on this slide is the slight dip down that occurred in 2013. If you recall, on October 1, 2013, we closed on the acquisition of MONY Life from Axa Financial and that was a $1.1 billion deployment of capital at that point. So that reflects that acquisition of MONY. And that even shows up more on the next slide. We are looking at our risk-based capital ratio where we’ve grown nicely from basically 300% to a record 562% in each of the last year ends. But again, you note that our required capital increased with the acquisition of MONY in 2013, leading to that dip at that point in time.
And turning to our ratings. We have solid investment grade ratings and consider our relationship with the rating agencies to be quite strong. We engage them often in quarterly communications and reviewing our earnings each quarter and giving them a preview of that. And also, at this point in time, all of our ratings have a stable outlook, with each of the major rating agencies represented here.
Now, turning to our relationship with Dai-ichi, I wanted to give you a kind of brief overview of Dai-ichi and we’ll go into a little more detail in a second. This map just does a nice job of presenting their geographic reach. Obviously, Dai-ichi is headquartered in Tokyo, Japan, and it has largely been focused on the Japanese domestic market up until a few years ago when they began to expand internationally. And you see they have quite a significant reach in the Pan-Asian region. Their entry into the U.S. was via the acquisition – into the U.S. life market, I am sorry, was their acquisition of Protective. And as you note, they also have a minority interest in Janus funds headquartered in Denver, Colorado, which I guess was their first true acquisition into the U.S. or investment in the U.S., but they – as you see from the quote from Watanabe-san, their President, they very much view Protective as – or their acquisition of Protective as their engine for growth in the U.S. market.
Going into little more detail, Dai-ichi was founded – it was interesting as we were going through the acquisition process, we really discovered there was a lot of similarities between Dai-ichi and Protective. Now obviously, we are from different cultures, speak different languages, but when you look back over time and the histories of our companies, there really is a lot of similarity. They were actually founded a few years before us, in 1902. They were a mutual company until 2010 when they became a public company. They like us provided individual life – focused on the individual life and savings market in Japan and have a successful track record of – as we saw in the prior slide, of growing globally and diversifying outside of the Japanese market. They also are highly rated with basically an A+ rating on a financial strength basis from all the major rating agencies. They do have a good number of employees. We have approximately 2,500 employees. They have 60,000. And that’s somewhat reflective of the fact that they do have some captive distribution, especially in the Japanese market that reflects a good number of those employees and their total assets after the acquisition of Protective exceeds over $400 billion. And you see that, the table there, they actually became the 10th largest global life insurer based on assets after the acquisition of Protective.
So as I mentioned, Protective is viewed as their growth platform in the U.S. Their acquisition of Protective gave Dai-ichi a strong presence in both the two largest life markets, the largest being U.S., the second largest being Japan and focused on diversifying outside of the Japanese market. As I mentioned earlier, all of our management has stayed in place post the acquisition. We are fortunate to have three liaisons with us in Birmingham. These three individuals have done a phenomenal job over the last 1.5 years of facilitating communication between ourselves and the New York office, as Eva alluded to earlier and in particular Tokyo. So, when it gets down to the 6:00 p.m. to 10:00 p.m. conference calls with Tokyo, it’s actually our liaisons taking those calls and not Protective management. So that has worked out quite nicely from management’s viewpoint. And in all honesty, since the acquisition was closed, I have only spoken to Tokyo once and I count it a true tribute to the role of liaisons in that time. And then the New York office facilitates decision-making and communication as well. Dai-ichi has a fairly significant presence here in New York and they allow us and our liaisons in Birmingham again to deal with somebody in a very similar time zone as opposed to having to do the overnight calls and meetings.
Okay. I want to – I do want to spend a minute on the investment portfolio before – but before we go there, our ALM process really drives our investment philosophy and how we manage our assets. And so I wanted to spend a little bit of time on it before actually getting into the investment portfolio. We very much consider ourselves to have a very disciplined ALM process. And what that means is literally for each liability we write, we are assuming current market rates in the current market environment when we write that liability. We have a team that reviews the rates offered in our product each week and out of that process, we will actually set our rates. Typically, we try not to change them, but every other week – but we are reviewing them each week. And given some volatility in the market, we’ll actually change rates on an interim basis if necessary. When we price our product, we are assuming current market rates. We do not assume any kind of reversion to the mean or increase in rates. And none of that is embedded, and that’s been the discipline in our ALM process. I’ve been with the company now 13 years, and that has been our discipline in the entire time that I’ve been there, that the current rates are assumed to be the ones that back the product, that we are not assuming on an increase in rates when we’re looking at our returns and ROA. We seek to be duration matched versus our liabilities. So when we are providing guidance, my ALM team providing guidance to the investment folks, we are looking at what our sales are and where they are coming from and what duration they require and what rates were priced into that sale when we are giving them kind of their yield bogeys and duration targets.
Our investment managers are measured purely on how they manage against our liabilities. They are not measured on a total return basis or against the Barclays Agg Index. They are purely measured on how we perform as a company within our ALM matching process. So as a result, it’s very much a buy and hold investor. We are not trading bonds that often. So basically, when a bond comes into our portfolio, it remains with us until maturity unless there is a credit issue or some other issue that might arise.
This chart provides a graphical presentation of our matching. So as I said, we seek to be duration matched at the time we put the liability on the books. And then we also look for a cash flow matching, and in particular, we are focused on the next 3 to 5 years of being perfectly cash flow matched. And what you see in the red line in this chart represents our asset balance, and you see it tracks very nicely against our in-force life, stable value and annuity reserves as they run down. Then we – each month, we look at this. We project out our cash flows on a monthly basis for the next 10 years and are always evaluating what we are doing in terms of writing liabilities or the assets we are purchasing in order to maintain this matched book of business.
So and turning to the investment portfolio, you see we are a fixed income shop, as most life insurers are. 80% of our portfolio is in the fixed income security, and you see the breakdown within that 80%. That’s largely corporate bonds. And I would say, this has been a change post the crisis a modest change post the crisis. We have definitely increased our exposure to corporates in light of the government involvement in the – in particular, in the RMBS space so that we don’t necessarily find value currently in that space and have been shifting more towards A-rated and higher rated corporates. We still remain committed to the mortgage loan – commercial mortgage loan market. It’s a market we have been involved in for decades, and I will go into that in a little more detail. And you see the composite – the policy loans currently represent 4% and then various other assets, 3% of our portfolio.
And looking at – in more detail at the fixed maturities in terms of their quality, you see that we are – 5% of our exposure is below investment grade. All of – the large majority of that are fallen angels. We do not make a practice in investing in high yield or below investment grade securities. So, these are bonds that were investment grade, typically BBB, that have been downgraded over time into below investment grade status. Now given the market turmoil especially in relations to the energy and gas sector, I did want to spend a few minutes here. I would say that this particular sector, all of our investments in this sector were investment grade at the time of the investment. And you see that now, 93% are investment grade reflecting a downgrade. Given the fact that they were all investment grade at the time of purchase that does mean we are dealing principally with larger companies that have more flexibility in how they can manage their cash flows and the options available to them and sourcing capital. So we feel fairly comfortable with where we are in this sector. And as you will note, a good bit of our exposure is to the midstream and distribution portions of the sector, and especially the distribution largely represents regulated entities, and the midstream, more diversified operations. So we do feel fairly confident that at this point in time, we would expect to see continued downgrades in our exposure here, but we do not expect to see material losses in our exposures to this sector of the market.
Now, turning to the commercial mortgage portfolio, the bulk of our commercial mortgages that we have on our books were originated by our staff of folks in Birmingham. The only ones basically that were not originated by our own staff are those that we acquired in acquisitions of blocks of business. In particular, the Liberty Life acquisition and the MONY acquisition both contained commercial mortgage portfolios. You see it’s a very diversified portfolio with a total portfolio of $5.7 billion, but the average loan size is only $3 million. We do focus on what we call necessity-of-life loans, where we are looking to originate transactions that are retail in nature but are really your typical drugstore/grocery store combos and not your large-box specialty retailer or high-end retailers but more those that are needed in terms of to live a life on a daily basis. And then outside of that, we focus on apartments that aren’t necessarily your high-end, new, flashy apartment. It’s what we’d call Class B, A-, Class B type apartments. And then the office building exposure is principally medical office buildings, so your typical doctor’s office building that might be associated with an actual – next to a hospital or situated near a hospital to provide services there. So again, all three of those kind of represent necessities of life.
Our practice when it comes to making our loans is that we focus on 75% loan to value or lower at the time of origination, and we require amortization of principal. So as you see in the table, the weighted average loan to value is down at 46.5%, and that is reflective of that amortization that occurs. Under certain circumstances, we will lend up to 85% loan to value. But that is in exchange for us to have a participating interest in the property. So for example, we would lend the extra funds into the development, but upon the sale of the property – typically, this is either a rehab or a new development that once the property is sold, we would participate in the income generated in the sale of the property. And for example, in 2015 alone, we had approximately $30 million of additional investment income resulting from participating mortgages. As of 12/31/15, we had approximately $450 million of these loans on our books. So obviously, a little less than 10% of our portfolio is the higher loan-to-value participating mortgages. In addition to the amortizing nature of exposure and the lower – and the requirement that developers put money into the property, we do target the credit anchor tenants and this would especially be in relation to the retail operations, that the credit anchor tenant – that their rent payments exceed at least 70% of the debt service and operating expenses of that property. So, we are not relying upon the outparcels in that strip center to provide the debt service coverage. Thankfully, when it comes to problem loans, we don’t have that many. Even if you will see back through the crisis, there are – many of you represent banks in the room. And I imagine if you went to your chief risk officers and ask them if they would trade our problem loan ratio for your problem loan ratio, probably 100% of you would have taken us up on that, but that offer was not there, by the way. As you see, we ended last year with only 8 basis points of problem loans, troubled loans, so that represented $4.7 million of non-perform, restructuring or foreclosed loans as of 12/31/15.
So in summary, we remain committed to our disciplined ALM process. We are continuing to focus on high quality assets and making sure that we are diversified in our exposures. One thing I do want to note is that we have not strayed from our practices in the past. We have not been investing in alternative asset classes. We have no hedge fund exposure or the like there. Only 5% of securities are rated below investment grade, and again, largely, those are fallen angels that are high investment grade – or excuse me, below investment grade. And we continue to maintain and enjoy a very healthy commercial mortgage loan origination and production there.
So at this time, I would like to invite Steve Walker to come up and Steve is going to walk us through our 2015 performance and then our 2016 plan. And then I will be back to discuss the risk management culture of Protective. So, Steve?
Thank you. Good afternoon. How you doing? I am going to spend a few minutes talking about our business segments. So Lance gave you an introduction, but I’m going to go into a little bit more detail on that. But first, I have the duty to talk to you about purchase accounting, which is not something you typically want to have during your lunch, a discussion of purchase accounting, but I think it’s necessary evil in order for us to have a good understanding of our go-forward financials on a GAAP basis. And the one thing I would emphasize here as part of this is that effective February 1, 2015, upon the closing of the Dai-ichi transaction, we had to apply purchase accounting, which basically changed all of our GAAP balance sheet numbers, and so I’ll talk a little bit about the effects there. But just keep in mind that none of this changed the cash flows of the company, and our statutory financials were unchanged as a result of this. So, none of that changes. It just changes our GAAP numbers.
But in looking at the balance sheet, the GAAP equity reset to the purchase price of $5.6 billion occurred and that is the total reset of our equity. All identifiable assets and liabilities were recorded at fair value. We did recognize $683 million of intangible assets and most of that came from our distribution relationships and technology. Most of that will be amortized over anywhere from a 15 to 22-year period. So, we’ll have about $41 million of additional expense from intangible amortization. We did write off the deferred acquisition costs at the time of the acquisition, and we established our value of business required asset or VOBA. That was recorded at fair value, which resulted in premiums being established at the time of the acquisition. Insurance liabilities, basically including the traditional life, we reset all of our assumptions based on our best estimates at the point of the acquisition. And lastly, on the balance sheet, we established a goodwill asset of $736 million based on the premium that was paid for the company.
In terms of the income statement impact, the biggest impact was we have lower investment income going forward, and that was a result of the amortization of premiums that were established on our invested assets. At the time of the closing, our unrealized gain position was about $4.1 billion on our available-for-sale portfolio. And so that premium has to be amortized now through our income statement over the duration of those securities. We also will have an increase from amortization of intangibles, and as I said earlier, that’s going to be about $41 million per year.
And then lastly, another big impact was we have lower GAAP interest expense due to the amortization of our premiums that we established on that debt at the acquisition date. But effectively, just keep in mind, all of the earnings are basically, going forward on a GAAP basis, just being pushed down due to these impacts that I mentioned in general. Our book yield went from a 5% yield to a 3.5% yield, so you can see the dramatic impact on the GAAP book yield.
Now, I’ll briefly discuss each business segment. And Lance gave you a preview of Life Marketing, but basically on there, we market fixed, indexed and variable universal life products. And we distribute these, as you can see on the chart there, through independent agents, institutional, and we have this affinity channel that we talked about. And one of the products that we offer through this affinity channel with a Costco partner is our traditional level premium life type product. And it’s unique to Costco, and it was designed for them and only their members. And they have 81 million members, and that was a good start for us in that affinity channel. But you can see that’s only 4% of our total sales, but that’s going to be a focus as we go forward to look at some future growth opportunities.
Now I am going to cover the Life Marketing earnings. And as I go through all of the segments, I want to point out that throughout this presentation, you will see numbers presented for 2015 and those numbers are going to represent the 11 months, February 1 to December 31 from our purchase accounting date as of the close of the Dai-ichi transaction. We will show sales results for the full 12 months, because those are comparable. So, that’s why you see that dark line there that those numbers are not comparable to the current year and going forward.
Life earnings in 2015 were $57 million, and that was about $8 million unfavorable to plan mainly due to some difficulty that we had in various UL benefits that we had to forecast under purchase accounting. And really now that we have got about three quarters under our belt to be able to really see numbers for a full quarter, we feel more confident in our ability to forecast some of those effects that we saw from the purchase accounting. But we did have favorable mortality in 2015 of about $7 million in this segment. And over that period of time, 2012 to 2014, we have had lower than 100% actual to expected in favorable mortality in each of those years. We have grown life sales in 2015 by 20%, and you can see a nice uptick there and that was about $3 million better than our plan.
Moving on to annuities, here, we market fixed and variable annuity products primarily through the institutional channel. And you can see the breakdown there of our variable and fixed in the chart to the right. 40% of our account – average account balance for 2015 came fixed and 60% is variable. The majority of our variable annuity policies written were written post-2009 that have the GMWB feature on them. And right now, we are targeting about a 50-50 mix in sales between variable and fixed.
If you look at the earnings, in 2015, we had $180 million of earnings and we were $2 million above our plan. That was mainly due to favorable spread in our fixed product. You can see that in the chart, the green bar there, the sales of variable annuities, we have consciously managed that down to be closer to this 50-50 mix that we want to have. We have seen some falloff in sales in the VA for the last couple of quarters mainly due to some of the market volatility that we’ve seen. Typically, the demand for VA does drop off when you see more volatility in the equity market. But you can see that there, we had sales of $1.750 billion in 2015. And one thing I will mention is in our fixed sales, which is the brown bar there, most of those sales, about 81% of those, are coming from our fixed indexed annuity, which is a more popular noun given the lower rate environment. The SPDAs are not in that much demand at this point in time.
Moving on to the Acquisitions segment, in this segment, as Lance said, this is a core business for us. Acquisitions segment focuses on acquiring and integrating, servicing policies originally underwritten by other insurance companies. And our primary focus is on long-dated life insurance policies that were sold to individuals. So, we are really interested in looking for mortality risk in these blocks. Our target block size is anywhere from $500 million to $1 billion and the last two acquisitions have been in that range or a little above that. If you can see there in the chart, we have had 48 successful transactions over the past several years. And recently, we did close the Genworth transaction, which is a reinsurance block of level term premium business that was closed January 15. And that will start to become in our earnings in the first quarter of this year.
We have significant institutional experience and know-how around things like due diligence, valuation, negotiation and systems consolidation. That’s one of the things that makes our retail segment’s cost structure to be very favorable. We are able to leverage the systems that we use for acquisitions also with our retail products and lower our unit cost. We also have been able to execute some innovative deal structures, so we have a very talented deal team. And we have a very strong reputation among potential counterparties around closing the deal. We have really good relationships with our regulators and that’s able – that has enabled us to always get a deal closed. And that closing certainly is very important as you’re working with counterparties.
Now, moving on to the acquisitions earnings. First, I will say that as Lance pointed out, that acquisition is composed of predominantly life insurance, about 90% of that is mortality risk. And 85% of that comes – of the life insurance in-force is traditional life and this would include traditional participating life policies. But what this does for us is it gives us a very stable set of cash flows and earnings stream coming off of this block of business. Earnings were $195 million in 2015. That was $16 million above our plan. And that was really driven by favorable mortality results and lower lapses in the blocks. The MONY acquisition, as Lance pointed out, was closed October 1, 2013. And you can see how our earnings have been supercharged as a result of that acquisition. And that acquisition is performing well above our pricing and also given us some good earnings growth as we move forward.
Moving on to stable value products, Lance talked a little bit about this segment that we sell fixed and floating rate funding agreements. We also market GICs to the 401(k) and other qualified savings plans. We have used this opportunistically to complement asset liability management and product cash flows, and it’s a very efficient operation. It’s basically Lance, part of his time, and another individual that does some of the other work for him. So it’s a very efficient operation. One of the things I will mention on this slide is that stable value earnings were $57 million in 2015. And you can see that was significantly above our plan. We had a $23 million item here that came through for participating loan income that was not in our plan. And participating loans are shorter in duration and they are mostly allocated to stable value to match up with the shorter duration of the liabilities here. We do not plan for this extraordinary income since realization is subject to market conditions and borrower decisions that are somewhat out of our control. We did launch the inaugural $400 million of our funding agreement-backed notes program in November of 2015. We were very active in this area in 1999 through 2008, where we had a lot of notes out in the market. We did establish a $5 billion facility in 2015. And this program does further complement our overall asset liability management that Lance talked about earlier, and it is available both domestically and internationally.
Moving on to stable value spreads. In 2015, if you adjust out the participating income, we had a 188 basis point spread in stable value and we ended the year at a balance of $2.1 billion, which was a little bit above our target of $2 billion.
Moving on to asset protection, we sell extended service contracts in credit, life and disability insurance, mainly on automobiles, but also we have RVs and other power sports. We also sell a guaranteed asset product in this segment, and it’s marketed through a national network of approximately 8,500 auto, marine and RV dealers. Protective has about a 7% market share in this specialty area. About 50% of the market comes from the manufacturers that have their own captive programs. Asset protection does not require a significant amount of capital and does provide nice earnings diversification for Protective.
Moving on to earnings. Asset protection 2015 earnings were $21 million and exceeded plan by $3 million, and this was driven by higher fees and lower expenses. Earnings have steadily increased due to strong expense control and disciplined pricing. You can see sales were up about 7% in 2015. And that was mainly on the back of very strong auto unit sales in the U.S. at a record of 17.5 million units.
This next chart I won’t cover because we talked about each segment, but it’s basically a nice summary of the 2015 earnings. Again, this is 11 months ended 12/31/15. We did have after-tax operating income of $323 million, and that was up 20% above our plan. And net income was up 16% over our plan. So we were very pleased with our 2015 performance.
Next, I am going to spend a few minutes talking about our 2016 financial plan. First, I would say that we have a very robust modeling capability at Protective. We basically do a seriatim policy-by-policy projecting every quarter and this incorporates current capital requirements, accounting and reserve standards. And as I said, we update this model based on the prior quarter end’s in-force and re-project our cash flows and our statutory and our GAAP earnings going forward. So, we feel very good about this. What this does for us is it gives us the ability to analyze our results each quarter against these reforecast and these plans so that we can have a good handle on what are the key elements in moving the business. And it does have pretty much a complete income statement in there for – at a pretty granular level as we roll it up and look at it each quarter, but this planning discipline has been in place for several years and we have continued to refine and improve this.
Now, I will talk a little bit about our key plan assumptions. Typically, we do not assume any DAC unlocking or VOBA unlocking in our planning process. It’s difficult to predict these type of events, but we do look at all of our assumptions in the third quarter each year as required under GAAP to determine whether we have to unlock any of our DAC or VOBA. We did assume a reinvestment rate and it does include a credit spread. These are not Treasury rates. At a 10-year level, we assumed 4.10%. At a 30-year level, we assumed a 4.7% return. And these rates were kept level over the entire projection period. So, we do go out and project – do a 50-year projection, but we really focus on the next 3 years as we look at our results. And I would say that we are currently achieving these assumed reinvestment assumptions on new assets that we are purchasing, looking back at the first quarter. We do assume a 3.5% earned rate on capital. Variable annuity fund returns are 8% annually assumed and that’s based on our historical experience. We did assume a GAAP effective tax rate of 34%, which is in line with our previous couple – last couple of years.
Also, in terms of dividends to the parent, in 2016, we did pay an $89 million dividend to Dai-ichi, which represented about 33% of our 2015 GAAP net income and we do plan to increase this to a level of 40% by 2017. Dai-ichi has a target of 40% payout of net income to their shareholders and this is a part of that overall program for their subsidiaries. The 2016 plan also assumes no acquisition this year, but Genworth is included, as I mentioned earlier, as that is effective 1/1/16. And that reinsurance transaction is expected to be accretive to earnings in 2016.
Looking at our sales assumptions, we are assuming about a 10% increase in life marketing and that’s on the back of a 20% increase in 2015. Annuity sales, our plan is $2.3 billion. It’s about a 50-50 mix assumed between fixed and variable. Asset protection, a little bit more modest increase of 2% to $528 million of sales and stable value, we have conservatively put a plan together with a target balance of $2 billion. Since these sales are somewhat opportunistic, they’re subject – very much subject to market conditions. We try to be conservative here. What this did is it resulted in our 2016 plan of an after-tax operating income of $350 million, net income of $307 million. We did assume 15 basis points pre-tax of impairments in our plan for each of the years presented. We do expect in our plan to end the year at a 605% RBC ratio. We are targeting the end of the year in our plan to be at a debt-to-capital ratio of 25%. We already talked about the dividend to Dai-ichi. And then we put all that together and the capital that’s above 400% RBC is expected to be about $1.5 billion at the end of the year. So, Nancy Kane, who’s Head of Acquisitions, is really working hard to try to find additional opportunities to deploy that capital as we kind of move forward.
We do produce about – or deploy about $300 million to $400 million of capital in our retail businesses each year, and that allows us to grow our excess capital to $100 million-plus each year. I will say that the pace of earnings going forward beyond 2016 will be very dependent upon the pace of potential future acquisitions. Our focus is on managing debt to capital and we’ll see continued strong and growing RBC as some of the acquisitions where we’ve deployed capital have capital coming back to us.
So at this point, I am going to turn it back over to Lance Black to finish us off on risk management.
Thank you, Steve. So, we will spend a few minutes here and just try to bring us home quickly so we can get back on schedule. As you know insurers and really any company out there has to basically take some form of risk in order to make profit, because otherwise you really shouldn’t get paid unless there is – you are bearing in some form or fashion a level of risk. So what we have here demonstrated for you is our risk appetite framework, and it describes the amount of risks, we believe as management and as our board, we can take in pursuit of our goals in order to fulfill the needs of our policyholders and distribution as well as our shareholder. So as you see, we have earnings, capital and new business profit elements are all incorporated in these standards. And one thing to note is that our incentive compensation for management is aligned with this risk appetite. That if you were to look at the details of our incentive compensation plans, you would find elements of these risk appetite limits embedded in that – in those goals that we have each year. And one thing I will note, for example, the statutory capital level, RBC of 3 – of greater than 375% that our incentive plans actually have a negative modifier to our goals if we were to go below 375% RBC ratio. And that’s really around instilling discipline in the acquisition process and making sure that we do not sacrifice our capital solvency for the sake of growth.
So, as we look at how do we actually measure on – and measure up currently on all of these limits? I am not going to go through each of these, but you see there is a healthy cushion that exist that we have capital adequacy, leverage and interest coverage and liquidity that we monitor on a quarterly basis. One thing I do want to note is that these reflect basically our own internal management cushions as well as the limits or criteria the rating agencies would like to see from us to maintain our ratings. We did end 2015, obviously, with healthy cushions here. I do want to go into a little detail in the debt-to-capital ratio and why we have the 16% and the 25%.
As part of the acquisition of the Genworth blocks of business that Steve alluded to closed in January, we did a restructuring of one of our captive financing arrangements. And that particular captive, our Golden Gate I captive, was financed via the 2009 issuance out of our holding company. We have a 2019 maturity and a 2039 maturity out there that those bonds were issued in order to buy a surplus note from Golden Gate I. When we did the Genworth transaction, we restructured Golden Gate I into an unfunded note-for-note structure. And as a result, the debt that was out there, the $700 million at par is currently outstanding that in the GAAP process. As Steve alluded to, we marked both our assets and liabilities to market and those liabilities were marked to market on 2/1/2015 and increased in value to $940 million. Well, currently, as of 12/31/15, they were at $940 million. So basically, we had to convert the – those notes from operating to financial leverage. And so that $940 million came into our leverage calculation post year end. So at year-end ‘15, we were at 16% and we are currently at 25% and that’s consistent with where we believe we will end year end ‘16, as Steve showed you on the plan chart.
So, this chart here represents our 2016 plan. Obviously, earlier, I showed you a similar chart that represented our 2015 actual operating earnings. And the point here from a risk management perspective, is we are focused on diversification in our plan and in our operations, the diversified business mix promotes stable returns that as natural hedges exist in between some of these lines of business. For example, an increasing rate environment can be very beneficial to our life operations as we invest recurring premium. But obviously, it can somewhat be challenging environment in annuities in terms of the in-force block as we manage the existing credited rates on existing policies versus market rates. But as you notice, we do have a bias towards mortality risk and as indicated, that’s also evidenced in our focus on mortality risk in our Acquisitions segment.
We do perform regular stress testing within our risk management area. I don’t expect to – I am not going to read you this chart nor do I expect you to read through all of that at this point in time, but you can see all the various things that we test for as we stress test our organization. And this analysis allows us to understand the potential gaps that might exist or how adverse events would impact us and helps us developing a contingency plan and assess target capital and liquidity levels from a management perspective.
Now the next couple of slides, there is a new NAIC requirement out there that began last year. And we filed for the first time in 2015 ORSA, which stands for own risk and solvency assessment. And we provided this information to our regulators. And what I want to walk through here briefly with you is as you see on the left side of the chart that represents the capital hit that we would take on a statutory basis from the two largest worst case scenarios that we test. And the far left is a severe pandemic, which is equivalent to the 1918 flu epidemic in our country, which resulted in two excess deaths per 1,000 of insured at that point in time. And you see that, that would require $308 million of capital.
Now, what I want to stress to you is what’s on the right side in the blue that at year end ‘14, because again, this was done – all the ORSA work – we are in the process of doing ORSA work for year-end ‘15, but this is year-end ‘14 data. We had stat capital at PLICO of almost $3.9 billion, so obviously quite adequately capitalized. And then the far right looks at our excess capital position at PLICO as of that point in time and what our stat earnings were, again, quite adequate to absorb the $308 million. And then the right – or the orange bar on the right just combines the severe pandemic with a severe recession. And the severe recession we are looking at is the ‘08, ‘09 crisis and along with the severe pandemic of the 1918 flu, and you see that it would require $419 million of capital. Again, we are substantially capitalized to weather those types of storms. And basically, the bottom line is Protective has been in business over 100 years. And you think back over the 100 years, we’ve gone through world wars, catastrophes, pandemics and outbreaks and have survived them all and we plan on continuing to survive those types of elements on an ongoing basis, but we do monitor them and to make sure that we appropriately establish policies and procedures within the company to make – to have adequate cushion on a go-forward basis.
Now, turning from capital to liquidity, unlike banks who have illiquid assets or loans backed by liquid liabilities, being deposits, life insurance companies have illiquid liabilities, being our policies backed by our portfolio of liquid assets, principally bonds and securities. And you see here that we are looking at Protective, our ratio of liquid assets to liabilities is in excess of 5:1. And in addition to our portfolio, we have other means of liquidity being our relationship, primarily our relationship with the Federal Home Loan Bank and our bank line of credit and our ongoing operating cash flow that can supplement any liquidity needs we might have.
As Steve mentioned, we do have a very complementary relationship between our retail operations and our acquisition line of business, and this allows us to balance our growth and capital deployment between retail and acquisitions. Steve mentioned we deployed $300 million to $400 million each year in our retail lines and in our organic business. And then in the Genworth transaction that closed just this year, we deployed $640 million of capital. Basically, having these options allows us to rationally allocate capital to the best risk-adjusted return option and exercise discipline rather than chasing market share.
So with that, I would like to wrap us up and basically reiterate we remain in a very strong capital position with adequate solvency and liquidity. We have grown nicely, as I alluded to in my earlier presentation, in our statutory capital and risk-based capital ratios. Our talented and experienced management team remains in place in Birmingham. We are focused on delivering prudent growth and we have very much enjoyed our relationship with our strong parent and the collaboration we have experienced there and the support that we would expect in the future and the continued financial success.
So with that, I think we will open it up to Q&A and ask Steve to come back up, because we are being webcast, we would ask that you wait for a microphone, both Eva and Jill will have a microphone. And that when you get it, that you would give your name as well as your firm’s name. And as a reminder, we would like to spend some time with you after the Q&A session in the back of the room and meet each of you individually and share some dessert and coffee. So with that, are there any questions?
Q - Steven Schwartz
Hi. Steven Schwartz, Raymond James. Equity markets, equity people who – buy side, sell side have been somewhat concerned about Protective, the possibility that your cost of capital – Dai-ichi’s cost of capital now being your cost of capital will be much lower than the rest of the industry’s, making it potentially possible for you to be very competitive relative to others. I am wondering about, do you think that’s correct and how do you deal with that? Do you think about this, we are a U.S. company and that’s our cost of capital or you think about this we are a Japanese company and that’s our cost of capital?
As you saw in our risk appetite, we expect 10% IRR and at minimum, 50 basis points. And those are minimums, 10% IRR and 50 basis points of ROA. I would say that is not materially different than what we experienced prior to the acquisition by Dai-ichi. And Dai-ichi actually has a requirement where they look to achieve 8% return plus the differential between our 10-year Treasury rate and the 10-year JGB. So essentially, 10% is our required return on our product. So despite what our competitors or the industry might believe, we have not in any way really deviated from our historical discipline and pricing of our product.
Okay. And then Steve, could you maybe address some of the regulatory issues I am thinking with regards to universal life captives, AG 48 and PBR?
Sure. Well, first of all, on our life insurance business, we have not had to use captives on our new product sales since 2011. So anything we’ve been selling since that point, we really have not had to use. We’ve structured the product in a way where we’re not required to securitize or finance any non-economic reserves. We have had some acquisition blocks that we have done during that period of time where we have put those into an existing captive. With respect to AG 48, there’s still some uncertainty as to how exactly that would be applied in the transaction and we have not done a transaction under AG 48 at this point in time. It’s possible that we would have a transaction in the future if there’s an acquisition that we do that would require financing of non-economic reserves, but it’s still too early to tell there, but it’s not required by current business.
With respect to PBR, we have our PBR expert, Wayne Stuenkel, in the back of the room, but I will just say that we do, based on where we are right now, I expect to see PBR be available to us for new business starting 1/1/17. But that still has to be confirmed as of July 1 of this year when NAIC completes their assessment of all the states that have passed the PBR legislation and make sure it’s substantially similar to what’s in the model law. And we are evaluating the PBR in how that might impact the sale of our life products going forward and whether we can take advantage of that legislation in setting our reserves. So at this point, I think it’s still early to tell in terms of how that will impact us going forward.
Thank you. Diane Ferguson from Mizuho. Dai-ichi has recently announced that they are creating a holding company structure. Can you tell us how that will impact Protective?
Well, the short answer is we don’t expect any impact upon Protective. As Diane referred to, Dai-ichi actually announced last year that they were going to convert to a holding company structure. When the acquisition occurred, we were actually acquired by Dai-ichi Life Limited, which is their operating company. They did not have a holding company. As part of this restructuring, they will actually transfer the business that resides in Dai-ichi Life Limited into a new entity. So, our ownership actually will not change. We will still be owned by the current entity that owns us. If we were talking in U.S. parlance, the same tax ID per se, but it will be renamed into the holding company name. There is good detail about this out on Dai-ichi’s website. Matter of fact, I think they have passed a board resolution this week approving the move and continuing down the path. And I believe it will be in October of this year is when that would become effective, but obviously, once that it was announced last year, the rating agencies looked into it and as I alluded to all of our ratings will have a stable outlook.
Thank you. Joel Gross from ICMA Retirement Corporation. In regards to the excess free capital for – that is available for investing in the business and acquisitions, should we look on that $1.5 billion figure that you quoted earlier as a cap or if there is acceptable opportunities that would go above that, would additional capital be available from Dai-ichi?
As you see there, we do have significant excess capital to deploy and that $1.5 billion figure, just to be clear, is our plan for 12/31/16. We had excess capital above 400% RBC of about $1.2 billion as of the end of ‘15. So, we can do a fairly sizable acquisition with that level of capital. But having said that, one of the reasons that Dai-ichi was interested in Protective is for our acquisition capability and for further growth in the United States. Basically, I think they would be happy to deploy additional capital through Protective if that opportunity becomes available to us.
Okay. And has Dai-ichi made any commitments to rating agencies or regulators about Protective Life capitalization standards and liquidity?
No, there is really – Dai-ichi is not providing any keep well or any guarantees to Protective.
Okay. And then finally, in terms of asset protection and stable value, are these considered core businesses long term?
Well, let me take the one on asset protection. We get that – we had that question a lot when we had public equity. We do believe it’s a very stable business now. The management team there has done a fantastic job of really focusing the business on service contracts and gap business. They have gotten a nice market share. They’re up to almost 7% market share. Just provides some earnings diversification for Protective and it’s roughly 4% or 5% of our total earnings. So it’s not large, but it is something that we believe is very much under control and performing well. So at this point, we have no intention of changing that. With respect to stable value, I think it provides some great ALM opportunities for us. It’s been a good earnings contributor for the company over time and provides solid earnings for us. But I’ll let the head of stable value give you any of his comments.
The answer may seem a little disingenuous coming from me. So, I was kind of glad that Steve went on to answer. But Joel, I mean, one thing that we would stress is that, that business line in rather opportunistic for us that we have remained disciplined and really, that refers to the discipline in our pricing. We don’t have a huge staff that we need to chase market share to keep that business alive, so – and that’s really where it’s focused. So, with the way we run the business, where it’s really integrated in with our ALM staff, there are a few more than me and one other working on the business, because it really is integrated into our ALM team that it’s efficient for us to keep it going on an ongoing basis. And as Steve mentioned, it is very important as the person responsible for asset liability management for the firm, it is a very important ALM tool that I would not want to lose in any way. And it is a business we have been in, really, since the ‘80s. So, it’s been a very good, longstanding business for us and very profitable business, as Steve alluded to.
Good afternoon. Nicole Limberg from PNC Bank. You mentioned that the $89 million dividend you paid to Dai-ichi or that you will be paying to Dai-ichi for 2015 represented 33% of your net income and that you expect that to grow to 40% over the next couple of years. Do you have any thoughts on how that might change thereafter after the 2017 timeframe or do you have any forecasting on that?
Right now, we are forecasting that, that would be a level after 2017 going forward and that, as I said, Dai-ichi has publicly stated that they have a goal to return about 40% of their net income to their shareholders either through dividends or stock buybacks. So, this is just consistent with their goal over time. Any more questions?
Jon Zobel, Citi. Any sort of speculation on DOL and how that might impact annuity sales or profitability or is it too early to tell? And how might it affect the competitive environment around you?
Well, we have been very focused on the DOL rule and when it was first exposed over a year ago and we’ve had a team – had a project management company helping us with it, an actuarial firm and a legal firm really intensely studying the proposed rule and now the rule that was issued last week. We do think under the rule that just came out it gives us a little bit more time than what we originally thought to get that implemented. So, that’s a good thing. But we are very focused on that with our distribution partners and trying to understand how they are going to handle some of the changes as a result of the rule in the way they distribute their product. So, we will adapt to them and we’ve had a long history of doing that with other regulatory changes that have come around over time in the life business and annuities. And I am sure we will be very focused on that over the next 6 months in terms of coming up with a very good game plan. We do believe it could have an impact on sales, but it also could have – give us an opportunity to make some changes going forward. And right now, it’s just too early to tell, I believe. Any other questions?
Well, again thank you for joining us today. And please join us in the back of the room. We would like to spend some time – additional time with you guys and hope you have a great rest of your day. Thank you.