Athene Holding's (ATH) CEO Jim Belardi on Q3 2018 Results - Earnings Call Transcript

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About: Athene Holding (ATH)
by: SA Transcripts

Athene Holding Ltd (NYSE:ATH) Q3 2018 Earnings Conference Call November 1, 2018 10:00 AM ET

Executives

Noah Gunn – Head-Investor Relations

Jim Belardi – Chairman and Chief Executive Officer

Bill Wheeler – President

Marty Klein – Chief Financial Officer

Analysts

Alex Scott – Goldman Sachs

John Nadel – UBS

Ryan Krueger – KBW

Suneet Kamath – Citi

Erik Bass – Autonomous Research

Jimmy Bhullar – JP Morgan

Tom Gallagher – Evercore

John Barnidge – Sandler O'Neill

Elyse Greenspan – Wells Fargo

Humphrey Lee – Dowling & Partners

Andrew Clurman – Andrew Kligerman

Mark Hughes – SunTrust

Operator

Good day, and welcome to the Athene Holding's Third Quarter 2018 Conference Call. During today’s presentation all callers will be placed in a listen only mode. And following managements prepared remarks the conference call will be open for questions. This conference call is being recorded.

I would now like to turn the conference call over to Mr. Noah Gunn, Head of Investor Relations. Mr. Gunn the floor is yours sir.

Noah Gunn

Good morning, and welcome to our third quarter 2018 earnings call. Joining me this morning are Jim Belardi, Chairman and CEO; Bill Wheeler, President; and Marty Klein our Chief Financial Officer.

As a reminder, this call may include forward-looking statements and projections, which do not guarantee future events or performance. We do not revise or update such statements to reflect new information, subsequent events or changes in strategy.

Please refer to our most recent quarterly and annual reports and other SEC filings for a discussion of the factors that could cause actual results to differ materially from those expressed or implied. We'll be discussing certain non-GAAP measures on this call, which we believe are relevant in assessing the financial performance of the business.

Reconciliations of these non-GAAP measures can be found in our earnings presentation and financial supplement, which is available at ir.athene.com. I will now like to turn the call over to Jim.

Jim Belardi

Thanks Noah and good morning everyone. This call provides us with an opportunity to highlight the continued momentum we are seeing across our business. I'd like to frame my comments on our third quarter results through the lens of the key business attributes discussed at our recent Investor Day.

First, we are a profit driven growth company and we have superior financial performance. During the third quarter, we generated $381 million of adjusted operating income, a quarterly record and 65% greater than the prior year level.

Our strong results were enabled by the fact that our team continues to leverage our structural advantages and differentiated capabilities to build value. One of the primary ways we drive superior financial performance is by having a highly scalable platform.

I'm pleased to report that the third quarter operating expenses as a percentage of average invested assets were 31 basis points continuing a downward trend to a level, which is the best in the industry.

At Athene, we have the ability to grow sustainably across multiple channels. At any given time, our retail flow reinsurance funding agreement and pension risk transfer businesses can pivot their level of activity depending on market dynamics and a relative return opportunity.

When all these businesses are combined with our strategic inorganic capabilities, the result is a powerful engine driving sustainable growth. Through the first three quarters of the year, we’ve generated more than $27 billion of total organic and inorganic deposits, which has driven 31% growth in our retirement services reserve liabilities year-to-date.

The organic channels alone have produced $8 billion of deposits year-to-date, including $3.3 billion during the third quarter. My comments on liability growth naturally lead to the next point, which is that a core part of our strategy is to create value on both sides of the balance sheet.

In addition to sourcing all the attractively priced liabilities, I just discussed, we also outperform in how we manage our $100 billion investment portfolio. Our net investment earned rate has significantly had significant upside potential given the ongoing Voya portfolio redeployment, rising rates and our investment in floating rate securities.

Through the third quarter, we are on track to invest approximately $30 billion for the full year, which is 30% more than in 2017. The main categories driving the year-over-year increase are residential mortgage loans, commercial mortgage loans, corporate private asset-backed and alternatives.

Given increases, we've seen in rates and spreads current on-the-margin deployment is accretive to our existing portfolio yield, while reflecting on our investment portfolio activities, it's worth reiterating that we do not achieve outperformance by taking outsized credit risk. In fact, our asset management philosophy demands an intense focus on downside protection.

In a world where passive investing has driven alpha out of many areas of the public market. We have been able to maintain a margin of outperformance through differentiation, which comes through asset allocation and how we underwrite. Our ability to underwrite illiquidity and complexity risk is one of the primary reasons we can invest in directly originated credit.

Given it’s alpha generating qualities, we believe directly originated credit will become a larger component of our portfolio over time. Our ongoing emphasis on asset differentiation is one of the primary reasons we announced the revision of our investment management agreement with Athene Asset Management and Apollo. The new fee arrangement, which is expected to be effective next year better aligns incentives and continues to pave the way for our ability to access even more alpha generating assets going forward.

We have learned from experience that the most attractive alpha generating investment opportunities often surface amid periods of dislocation. We believe market instability ultimately benefits our business and we welcome it. Not surprisingly, periods of market volatility can be our most active periods of investing.

Moving forward we will continue to leverage the combined expertise of Athene and Apollo to identify areas of the market offering compelling risk adjusted returns. As a reminder, our value generating strategic partnership with Apollo, which includes world-class asset management, transactional and advisory capabilities provides us with a meaningful competitive advantage.

Since, we are Apollo's largest relationships and they are Athene's largest shareholder our interest remains strongly aligned and they are our key partner in building our business.

Before, I turn the call over to Bill the last and most important message that I want to drive home this morning is that we are a patient and disciplined stewards of capital. We take capital and financial strength very seriously and so we were very pleased to receive the ratings upgrade to A from S&P in mid-August. Because we believe it will accelerate our business momentum and drive further capital generation.

Our approach to capital management has resulted in significant equity value creation over time, and we believe this will continue. During the third quarter, we generated an 18% adjusted operating ROE on a consolidated basis, which was underpinned by a 24% adjusted operating ROE in our retirement services segment.

Our strong ROE performance, ultimately led to continued growth in adjusted book value of 23% year-over-year to approximately $46 per share. Importantly, this level of book value growth is higher than our already attractive historical compound growth rate of 17% over the past nine years, which is more than four times the industry average.

Our ability to be a solutions provider to the life insurance industry as it undergoes a meaningful restructuring presents us with an abundance of opportunity. We are armed with more than $4 billion of combined excess capital and untapped debt capacity. However, as we mentioned at our Investor Day, that amount of capital would only accommodate about half of the $100 billion plus of inorganic opportunities we see in the market today.

This dynamic of living amid an abundance of opportunity while simultaneously operating a thriving organic business everyday has led us to raise the bar in everything we do starting with returns.

Amid the benign market backdrop we've been living, we have met or exceeded our return targets and grown tremendously. So, we believe the timing is appropriate to position ourselves for the next leg of growth one that will likely include greater market volatility.

This strategy dictates, we focus on the higher return areas of our organic business, while also pursuing opportunistic inorganic transactions with above average rates of return. As we evaluate all the ways, we can allocate capital going forward, moving forward we expect these priorities will guide our decisions.

As I've said in the past our goal in continuing to build this business is to create extraordinary long-term shareholder value for all of you, not just incremental value. With that I'll now pass the call over to Bill.

Bill Wheeler

Thanks Jim. I'd like to continue the call by offering some additional perspective on our liability origination activities. As we've always done, we're continuing to opportunistically grow our base of liabilities both organically and inorganically in a manner, which generates our desired levels of profitability.

Simply stated, we prioritize profit over volume and growth. Interestingly, we've observed increasing volumes and increasing market share growth in the absence of managing to specific targets.

Of course, the key to success in growing any book of liabilities is appropriately pricing risk. Today, Athene maintains one of the cleanest liability profiles in the industry. We have limited legacy issues on our balance sheet, since we are relatively younger company.

For our organic transactions, we've had the opportunity to re-underwrite, re-price and increase reserves at the time of purchase. And in our organic channels we conservatively write spread based products. The bulk of our annuity sales do not contain riders. Our pension business has modest underwriting risk and funding agreements have essentially no underwriting risk.

Moving to activity in the quarter, we’ve generated total organic deposits of $3.3 billion, which was driven by a record quarter in retail of $2.2 billion. While our flow and PRT businesses added more than $1 billion combined.

Importantly we maintained our underwriting discipline by continuing to price our businesses to mid-teens returns on an aggregate basis. In the first nine months of the year, our retail annuity business exhibited the strongest growth in sales among all the leading carriers and notwithstanding fourth quarter dynamics such as holidays and takeout. We expect our momentum to continue.

In retail, we are taking an increasing portion of a growing pie. And we are seeing new distribution partners added in the past year increase the amount of Athene products they are selling. The new product we launched earlier this year, Agility continues to show a strong momentum and has proven to be a disruptor in the marketplace. We expect Agility to be a meaningful contributor to deposits going forward.

Turning to PRT, as we spoke on our prior call, outside of one large deal we've observed somewhat slower risk transfer market in 2018 versus 2017, particularly in the first half. That said, we felt confident that industry activity levels were likely to pick up before the calendar year closed. And that's exactly how we're seeing it play out.

I'm pleased to report that we won three deals during the third quarter, two of which closed totaling $480 million and the third which closed in early October, totaling approximately $800 million. As we sit here today, we believe the pipeline for deal flow in the fourth quarter and beyond is strong.

As it relates to Flow Reinsurance, the $610 million of volume generated during the quarter was the highest quarter we've had in the past two years. The strong result was driven by improved competitive positioning and the onboarding of new clients. During the quarter, we signed new agreements and began reinsurance activities for two household name companies including Brighthouse Financial.

We believe these new relationships and other potential partnerships in the future bode well for the level of consistent activity, we can achieve in this business. In the funding agreement backed note market, new issuance has remained muted across issuers during the quarter. As we've said in the past, we remain disciplined regarding the returns we are willing to accept and we'll be back in the market when the economic improves.

Turning to our inorganic channel, as Jim mentioned, we see an abundance of opportunity out there which is driving a robust pipeline. In an effort to strengthen our capabilities in addressing the strong pipeline, I'm pleased to announce that Devanshu Dhyani will be joining Athene as Executive Vice President of Corporate Development effective November 19.

Devanshu will join us from Goldman Sachs, where he served as Managing Director in the financial institutions group, specializing in insurance. We're excited to welcome Devanshu and believe he will be a valuable addition to our team. As we observe the life insurance industry continue its restructuring, we believe we are well positioned to be the solutions provider of choice because of our expertise. Our successful track record of closing complex deals, our strong capital position and our ability to leverage the strong partnership we have with Apollo.

Right now, we're seeing a variety of potential deal types out there from carve-outs, the whole company acquisitions and fixed annuity only blocks to portfolios of other types of spread based liabilities that may require a more complex multi-party solution in order to transact. We're actively evaluating numerous opportunities and we look forward to updating you on this important growth driver of our business as potential transactions materialize.

Now I'd like to turn the call over to Marty, who will discuss our financial results.

Marty Klein

Thanks Bill and good morning everybody. For the third quarter, GAAP net income was $640 million or $3.23 per diluted share. The elevated level of net income benefited from $380 of favorable change to net fixed index annuities derivatives, driven by our annual process of unlocking, favorable equity market performance and an increase in discount rates.

Our adjusted operating income was $381 million or $1.95 per adjusted operating share, generating an adjusted operating ROE of 17.5%. Total notable items of $23 million net of tax included decrease in other liability costs to $38 million from favorable rider reserves and DAC amortization, primarily due to strong equity market performance, partially offset by a $13 million increase in other liability costs from our annual process of unlocking.

After excluding notable items, total adjusted operating income was $358 million, while retirement services adjusted operating income was $366 million, resulting in an adjusted operating ROE for this segment of 22.2%.

Our third quarter results reflect the full quarter contribution of the Voya transaction, which added an incremental $30 million and modestly outperformed our expectations. Our third quarter results also included a $40 million benefit, resulting from the reversal of previously accrued taxes during the first half of 2018, which I'll discuss further in a moment.

Our net investment earned rate for the quarter and retirement services was 4.55%, down 9 basis points from the prior year, driven by the addition of assets from the Voya transaction, which decreased the rate by 20 basis points, largely offset by higher income from floaters, which increased yields by 13 basis points and $25 million in the quarter. The Voya assets decreased consolidated rates by 12 points when compared to the second quarter of this year.

I'll note that the redeployment of the Voya portfolio was going well. The alternatives portfolio in the segment continued to perform well again this quarter, yielding annualized net investment earned rate of 10.65%, supported by the ongoing strong performance of both MidCap and AmeriHome.

Our cost of crediting was 1.98%, up 10 basis points over the prior year, primarily driven by a higher rate on the Voya reinsurance liabilities and an increase in hedging costs over last year, resulting from higher volatility in interest rates. Our investment margin on deferred annuities continues to remain strong at 2.57%.

Other liability costs as a percentage of average invested assets were 1.07% during the quarter, a level which can fluctuate quarter-to-quarter since there’s a variety of items included within that line. The addition of the Voya liabilities reduced the rate of other liability costs by 7 basis points. While the benefit of $38 million from favorable rider reserves and DAC amortization due to strong equity market performance was partially offset by the unfavorable unlocking of $13 million.

As we noted at our Investor Day, we strive to keep our assumptions updated as experience emerges. As part of the unlocking process, we updated our last assumptions as we have in past years with an unfavorable impact of approximately $100 million offset in part by a favorable adjustment of $65 million related to utilization of certain rider benefits and some policies among other assumptions changes.

With this unlocking update, our rider reserves are now $3 billion and represent 8.4% of the associated account value. To provide enhanced transparency and disclosure, we have added a table in our financial supplement disclosing these rider reserve figures, as well as the new table which details the components of other liability costs.

Our third quarter tax provision was a modest benefit due to a $40 million favorable true-up in our accrual for the first half of the year, the true-up was driven by the implementation in the third quarter of a change in our operating model, consistent with our previous disclosures that we intended to execute actions in the third quarter with a retroactive impact to January 1. The benefit was triggered by the implementation of additional reinsurance arrangements which are common in the insurance industry, which reduced our overall tax rate from that which had been previously reflected in the first half results.

For the full year 2018, we expect that our overall tax rate including income tax, the BEAT and excise tax will be approximately 8% to 9%. We expect this rate will increase slightly to approximately 9% to 10% in 2019, subject to a variety of factors including business mix. I'd note that going forward excise tax, which is included in other liability costs is expected to be immaterial.

Turning to capital, our position remains strong with $9.1 billion of adjusted shareholders equity, an increase of 23% year-over-year. We continue to have approximately $2 billion of excess capital and $2 billion of debt capacity which we expect will contribute to our growth in ratings improvements over time. Our capital ratios remain very strong with an ALRe estimated RBC ratio of 513% and U.S. estimated RBC ratio of 446%.

We continue to manage our investment portfolio with discipline and with our downside protection mindset, which is as important as ever at this part of the credit cycle. I'd note that impairments for the quarter remain very low at less than one basis point for the quarter as well as year-to-date.

We have very significant statutory capital $10.6 billion, which is about $1.5 billion more than our adjusted GAAP equity and are among the most capitalized in the life insurance industry for C1 or asset risks.

As we mentioned at the Investor Day, the use of asset leverage metrics to measure credit risk exposure is essentially meaningless. With a rating agency in NAIC capital models providing much more useful information since their model adjusts for varying levels of risk for each type of investment. In August, the FASB issued new accounting standards for the life insurance industry which are currently mandated for adoption beginning in 2021.

Along with others in the industry, we’re in the early stages of working through the guidance, developing feedback and questions for the FASB on interpretation. The standards call for increased disclosure which we think will benefit investors in understanding reserving for benefit riders. It's possible there could be amendments along the way that alter the course of the standard. And we'll continue to monitor and update you on any developments as they arise.

Our third quarter results continued our track record of execution on key operating and financial objectives. We expect our earnings momentum to continue as our business growth through organic and inorganic channels as well as from adjusted operating spread increases. In addition to the guidance provided at Investor Day, we currently expect average invested assets for the fourth quarter of 2018 and full year 2019 to be $101 billion to $102 billion and $105 billion to $107 billion respectively.

It's worth noting that our volumes tend to be back-loaded to the latter part of the year, which may impact our quarterly trending of results. Also it's important to point out that our outlook does not include any of the attractive upside potential from capital deployment into inorganic growth opportunities. So to wrap up, we're excited about our near-term and our long-term prospects and we believe our business is very attractive embedded earnings growth and valuation expenses potential.

With that, we’ll now turn the call back to the operator and open the line for questions.

Question-and-Answer Session

Operator

Thank you, sir. The floor is now open for questions. [Operator Instructions] The first question we have will come from Alex Scott of Goldman Sachs. Please go ahead.

Alex Scott

Hi, good morning. First question I had was just on the equity market sensitivity. I know you guys have provided some disclosure already on this in your 10-K. But I was just wondering if you could kind of give us a feel for how much of it, how much of the impact you kind of disclose in your 10-K is related to sort of the rider reserves, the impact on DAC, that maybe more onetime in nature, sort of an ongoing impact whether it's volatilities impact on crediting rates and so forth?

Marty Klein

Sure, Alex. It’s Marty, I'll take that. Thanks. Yes, I think the volatility in equity markets kind of hits our income statement in really three different places, the largest one is really non-operating item, the kind of net change – the change in net fixed indexed annuity derivatives and that by far has the largest impact quarter-to-quarter. But really we think it's all kind of timing related and not really economic because our derivative hedging is hedged to the – really to the guarantees that are in the embedded liabilities.

So that is a non-operating item in the 10-K, as our biggest one and certainly you saw this quarter with a big up equity market. We saw $380 million overall in uptick from that although, that included some unlocking benefits. So that's by far the largest one. And I wouldn't say that's really truly economic, that's really just kind of reporting volatility. There are – in our operating income some items that can be impacted either, for better or for worse depending what happens to the equity markets.

We’re primarily impacted by the fixed income markets by far and away. But we do – as we see in this quarter and in previous quarters have some variability in our rider reserves and DAC amortization that shows up in other liability costs, that was a $38 million good guide this quarter, up 7% market, and down 10% market to kind of go the other way, that similar or maybe slightly greater magnitude.

That too though, it does represent quarter-to-quarter volatility but unless one's view of the long-term equity market return changes dramatically, we're going to have some volatility there – here and there but unless there's a deviation from that overall roughly 6% a year, asset appreciation growth and say the S&P, I don’t think is going to be material economic change over time although this quarter-to-quarter volatility.

Last but not least, our alternatives do show some variability with equity markets but they are by and large very cash flowing. We focus on things that are downside protected. So I think very little exposure just pure private equity and things like that. So but there can be in some of the strategies a little bit of exposure and variability with the equity markets.

Alex Scott

Thanks. I’ll re-queue.

Operator

Next we have John Nadel of UBS.

John Nadel

Hey, excuse me. Good morning everybody. Just wanted to go back to the Investor Day and while I appreciate, there's some moving parts beneath the surface. I just want to focus on the adjusted operating spread guidance that you guys had provided. For 2018 I think the range was 125 to 135 basis points and then about 10 basis points higher for 2019. If I apply the year-to-date tax rate, mid-8% level to your third quarter core results, I'm getting about 136 basis points.

So you're already sort of in that 2019 range. I guess, first question, does that jive with your math. And then second question if we think about the sustainability of the tax rate, all else equal should we be adjusting that range or did your range for 2019 already reflect that?

Marty Klein

We don't really have new guidance for 2019, John. I think we couldn't exactly tell precisely at the time we had Investor Day, where we're going to land on some of the tax stuff. And we did ended up with the kind of rate where we are and we think for this year given the way we've executed these reinsurance contracts and also the mix of the business we have and some of the things that we ended up – we’ll probably be in the mid-8s, between 8% and 9%. Next year it’ll go up just a little bit that tax rate, I just said a little bit ago to the 9% to 10% range, which is kind of baked into that 2019 guidance essentially.

John Nadel

Okay, okay. And just and just as a quick follow-up. Again that 2019 range that 130s but I think it's 135 to 145 that includes no benefit from any capital deployment beyond organic growth, correct?

Marty Klein

That's correct. Any deals would be incremental, absolutely.

John Nadel

Thank you. I’ll re-queue.

Marty Klein

Thanks John.

Operator

Next is Ryan Krueger of KBW.

Ryan Krueger

Hi thanks. Good morning. I had a question on investment income. I guess, it grew sequentially a bit less than you had guided to last quarter. I think there are some timing impacts. Can you give a little bit more detail on that? And then just going back to the guidance you gave last quarter I think you had guided to $175 million increase in the fourth quarter relative to the second quarter? Has anything changed in that regard?

Marty Klein

Hey, Ryan, it’s Marty, I'll take that. We did have a bit of a mess I think a lot of those things, a couple of the things really corrected. The midst on investment income for the third quarter was really twofold by and large. One was we ended up having PRT business that was more back-loaded than we thought. So we ended up not benefiting on the investment income line from that PRT business until later. I think we’ve said in the press release and as Bill noted, we ended up closing on a pretty nice PRT deal of $800 million just after the end of the quarter.

So that has a function of delaying investment income, have to stay on that. Now that almost all of that offset – a lot of that's offset by the cost of crediting associated on that businesses, its not really overall, that big of an earnings impact for that but obviously if you look at the geography of investment income and cost of crediting, the fact that the PRT business was more back-loaded than we've been anticipating. It does have an impact and it kind of reduces both those lines.

And then the other thing was we had a pretty sizable alternative investment that was intended to close middle of the year and ended up closing in October. So it's not closed. So in any event, the two things that ended up happening a bit later than we thought. I mean, how basically happened so we feel pretty good about the 2014 relative pattern. So we had called out that we were going to grow by $35 million for the third quarter and fourth quarter, right, 140 to 175 that delta of roughly $35 million from this quarter and next quarter roughly should still hold.

Ryan Krueger

Okay, got it.

Marty Klein

For 2018, correct.

Ryan Krueger

Yes. And then can you just – how big was the alternative investment that funded in October?

Marty Klein

It was – between 250 – around $250 million roughly.

Ryan Krueger

Okay, great. Thank you.

Marty Klein

Yes.

Operator

Next we have Suneet Kamath of Citi.

Suneet Kamath

Thanks. Just a question on the other liability costs, I think if I normalize for the rider reserve, DAC in the unlocking, I think its 117 basis points. And I think your guidance was 125 to 135 and I know it moves around a lot. But what drove it down on a normalized basis and then should we still expect going forward that 125 to 135?

Marty Klein

Yes, I think for this year, we do – Suneet, it’s Marty. I think there were couple of puts and takes very small but in aggregate when they add them up, they kind of got us to below the lower end of the range, you're right. I think if you exclude the notables, we came in at 117, if you adjust for the $38 million from equity market, favorable benefits netted against the unlocking of 13. Our other liability costs were about 117, which is obviously below the lower end of the 125 to 135 range.

Couple of things happened. One was Voya, as I mentioned in my remarks, ended up with $30 million versus we had kind of expected $25 million. That really came from a little bit less than other liability cost than we initially kind of predicted as we were kind of modeling out Voya, and ended up being better in the quarter. We don't really think that's going to continue to go forward but that helps reduce other liability costs further from what we've been predicting.

And then there was some excise tax variability, ended up being little bit more favorable for the quarter than we expected. So those things kind of serve to drive down the liability costs below that low end of the range, but they're now really on a go forward. What I would expect to continue.

Suneet Kamath

So we should still use that 125 to 135 going forward?

Marty Klein

That's right. Yes.

Suneet Kamath

Okay, thanks Marty.

Marty Klein

A little bit of higher number for next year as we have more institutional business as we anticipate and we – for our 2019 guidance on Investor Day we had.

Operator

Next we have Erik Bass of Autonomous Research. Please go ahead.

Erik Bass

Hi, thank you. Jim, I want to follow-up on your comments about raising return targets for deploying capital. I was hoping you could provide some more specifics on what you made and I guess are you alluding to actions like pulling back from the funding agreement market and avoiding sort of smaller more competitive M&A opportunities. And related should we think of now the kind of the return target particularly for M&A being more in the high teens range?

Jim Belardi

Yes, thanks Erik. So my comments really focused on all the opportunity we have in front of us. And we just want to – as we've always been want to continue to be careful stewards of our capital, of your capital and our capital. So we just want to focus on the higher returning portions of our business. I don't think it means we're going to necessarily pull back on anything we're doing. But anything that's marginal, we probably will stay away from, meaning we need to meet our returns for us to do it. Nothing more than that we haven't been in FA backed note market because we haven't been able to achieve our mid-range returns when we can we'll go back in.

But just truly what we've already done and just making sure that it all meets our return hurdles as well as going forward, just continue to focus on the mid-teens returns, nothing more than that in the organic space. And Bill can talk more about as you did on the call, the inorganic space where we've never seen the opportunity and the magnitude that we have now. So we just want to make sure that we deploy the capital to the highest returning parts of our business, really nothing more than that.

Erik Bass

Got it. But I mean it would be fair for M&A given the size of the pipeline relative to kind of capital on-hand, that it's giving you the opportunity to be potentially more selective and target a slightly higher return than mid-teens?

Jim Belardi

Yes, I think that's probably right.

Erik Bass

Okay, thank you.

Operator

Next we have Jimmy Bhullar of JP Morgan.

Jimmy Bhullar

Hi, good morning. Just had a question on competition for deals and whether you feel that you could realistically deploy all of your available capital for acquisitions in the next few years, if there's sort of no crisis or recession type environment. And sort of relatedly at what point would you consider instituting either a dividend or thinking about share buybacks in case you are not able to deploy capital and continues to build up?

Bill Wheeler

Sure. Hi Jimmy. So with regard to the competitive environment and sort of the M&A outlook. I do believe it's quite possible we could deploy all our capital in the next couple of years that we have. So it's I would say that's not a hopeful outlook. Okay, I think it's quite possible. And maybe others want to comment on buybacks or dividends. Look I think we're always going to be open-minded about that. But we really do believe that the best use of our capital with today is to keep it and deploy it at the kind of returns we can get. And I just I feel like that'll be borne out over the next near-term in terms of what we have in front of us.

Operator

Next we have Tom Gallagher of Evercore.

Tom Gallagher

Good morning. I think Marty, I wanted to come back to Ryan's question on NII, I just want to make sure I understand what you expect for 4Q. So you said, you expect if $35 million increase in NII. In 4Q, is that in total meaning you will end up being more or like 155 million above where you were running in 2Q versus the 175 million. Or is there another piece of that that I need to consider to?

Marty Klein

No. You got that right, Tom. The first piece is probably going to be more or like 155 – between 150 and 155, that's right. So the delta of 35 from this third quarter but a little bit lower than we thought and some – a big part of that you will also see a little bit lower crediting rate as well. That's right.

Operator

The next question we have will come from John Barnidge of Sandler O'Neill. Please go ahead.

John Barnidge

Thanks. This year we've seen an increase in withdrawal rates. Can you talk about maybe what a driver is this, is this more of a secular thing with baby-boomers turning on their annuity portion?

Marty Klein

No, it's not. I think it's just the age of the book, Athene had, prior to Athene, the old Aviva has sold a lot of business about 10 years ago. So that cohort of business is now leaving surrender charge and when that happens, you always see a shock lapse and it's just a little lumpier than any other buyers might expect because there were some heavy sales years. And then there were some relatively lean years.

So you're just seeing a cohort of business that's going through surrender charge. The other thing that's going on by the way is now with Voya added to the mix that sort of – the Voya block is a little older, you're seeing more surrenders out of Voya, consistent with our expectations but that'll drive volumes as well.

Operator

Next we have Elyse Greenspan of Wells Fargo.

Elyse Greenspan

Hi good morning. My first question is on the tax rates. You said 9% to 10% for 2019. Is that the right way that we should think about modeling for 2020 and onwards.

Marty Klein

Yeah, I think the 9% to 10% should hold, we believe over the next few years. It's been very subject to business mix. As we do more business through Bermuda directly. So for example, if we're very successful inorganically in block fields and if we do those direct with our Bermuda company ALRe that rate will go lower or it could go a little bit higher depending on what we do in blocks. But I think at least for the next few years 2018, 2020 and so forth this could be that 9% to 10% rate.

Elyse Greenspan

Okay great. And then going back to some of the color on the investment income side. It sounds like Q4 might be a little bit lighter versus prior expectations, but when we look at the figures that you guys played out at your Investor Day, the net investment earned rate you guys said about 4.7% to 4.8% for 2019.

I'm assuming that still holds and I guess is part of – are we start to see more re-investment of the Voya assets that might leave, like I guess I'm more thinking about sequential NII when we go from Q4 to Q1 of next year.

Bill Wheeler

Yeah. I think there's – we think it still holds that guidance and I’d say a couple of things. One is obviously as rates have gone up we’re benefiting from floaters and that's not always instantaneous. Some of our floaters are on a lagged basis, believe me if rates don't continue to go up some of the floaters that have reset for six months or one month or one year reset. So, we'll kind of catch up.

So that's one dynamic. You mentioned the Voya redeployment and we'll continue to see some benefit from that in the fourth quarter and into next year. The other thing and I think Jim mentioned this in his comments, is that with interest rates and spreads where they are now, as we have a portfolio roll off or is that we have new money coming in, we're investing going forward. We think these rates at a level that's accretive to the overall portfolio. Those are sort of three things to think about as we head into the fourth quarter and beyond.

Operator

Next we have Humphrey Lee of Dowling & Partners.

Humphrey Lee

Good morning. Congratulations on a good sales quarter this quarter. Just looking at your production overall just think above retail sales and REIT flow reinsurance I think you're well positioned to exceed your full year 2018 target of $7.25 billion for retail and $1.5 billion for flow reinsurance. Like – and my thinking about that correctly and any reason why you would not exceed those two targets?

Jim Belardi

I think you are looking at that correctly. We're having a better sales year so far in retail. I think some of that has to do with the overall environment. There has clearly been a big rebound in annuity sales for the market overall, and I think we're enjoying that as well. We are taking market share though and I think that has to do with some of the new products that we've rolled out, and are continuing to execute on our banker broker-dealer strategy.

We've just done some really good work and I think that's why we're on track to probably exceed our target. Flow reinsurance slightly different story. Again part of it is the overall market, part of it is – we’ve signed up some new relationships, some relationships have seen some expansion. People do value this, the services we provide in terms of flow reinsurance and how that can help position them in their fixed annuity business. So, we are seeing some good momentum there. I think that will continue as well.

Operator

Next we have Andrew Clurman of Andrew Kligerman.

Andrew Clurman

Hey good morning. I just want to follow-up a little on Elyse’s questions on investment income. So good on the 4.7% to 4.8% for next year. Cost of crediting, so we saw at 1.98 and recent guidance was 1.98 to 2.02 want to make sure that sticks. And then lastly on the tax rate. So year-to-date with the true up in the third quarter you're at 8.7%. And yet Marty you're saying next year you could be in the 9% to 10% range, and then you kind of followed up on the earlier question that Bermuda ALRe could bring it down a bit.

So I'm kind of wondering why you trued up to a year-to-date 8.7% if next year is going to be 9% to 10%. Could next year actually be a little below 9%.

Bill Wheeler

Well I think what happens as we head into next year Andrew is that the BEAT rate goes from what's been 5% this year to 10% next year. So, obviously we have to report tax for our years depending what the tax rate is for that particular year. So part of the pretty slight increase next year is driven by the increase in BEAT tax which is five points but a lot of that is offset by the mix of business that we expect to have next year and ALRe versus our U.S. tax payer subsidiary.

So there is two dynamics there but net, net we’ll probably go from mid-8s or so this year to year 9% to 10% next year and the next few years thereafter.

And on the investment income guidance, I think glossed over that. Yet we think that that guidance still holds.

Operator

Next we have Alex Scott of Goldman Sachs.

Alex Scott

Hey, thanks for taking another question. The excess capital I guess if I just look sort of at the equity allocated to the corporate segment. It's still roughly $2 billion but I guess just that allocated equity did decline a fair amount this quarter. Could you talk about why that occurred is that associated with the Voya transaction somehow or is there another dynamic.

Marty Klein

He Alex this is Marty. It is really a couple of things and you're right. You can look at QFS and if you look at corporate and other that is the excess capital number. It actually changed the kind of the way we thought it would, and that you think a couple of things, one is it put on a lot of volume in this quarter, and a lot of it was really in retail that tends to have a little bit more capital initially than some of the other businesses we’re in. So you should say funny agreements, where we didn't do anything. We priced for that and as we priced on a statutory internal rate of return basis we're fine with that.

But it does use some capital. And then the other aspect is, yes you're right on Voya as we're beginning to redeploy assets into some higher yielding assets over time that will use a little bit of excess capital in line with our anticipations. But we still think we're around $2 billion overall, along with $2 billion in debt capacity, untapped debt capacity.

Operator

Next we have a follow-up from John Nadel of UBS.

John Nadel

Sorry, excuse me again. Good morning. I want to go back to my earlier question about the increase in adjusted operating spread in 2019 versus 2018. So, we think about the moving parts there for roughly 10 or 20 basis points expansion in that spread. You've got some benefit from the lower fee arrangement with Apollo that should be beneficial year-over-year. You've got some organic expense leverage I assume built in there. You've got the full year of Voya accretion. I'm just wondering other than those three things are there any other key drivers of that expansion that you'd like to point out to all of us.

And then secondly just a quick follow-up to Alex's question. So in terms of the allocation of capital to retirement services no expectation that that changes much from the sort of historical target of 7.5%.

Marty Klein

Hey John it’s Marty. Thanks for the two part of your question and I guess it's typically two questions, a violation of the rule but is okay. So on the 2019 versus 2018. Yeah, I think you're thinking about the components right. I wouldn't, overplay initially the impact of the Apollo fee change. I don't think year-over-year unless there's a significant asset allocation change, which could certainly happen depending on the environment, it's going to have a material impact on earnings.

It does align interests still a lot better and if we get this environment, where we don't think we're paid to go into riskier assets and we pull back into high-grade corporate will have a little bit less in fees but we have less in investment income and in the reverse, if we think we are rewarded for going into higher risk assets, we'd have higher investment income, a little bit higher fees.

So, but I think year-over-year I don't think about having a big delta in that kind of basis point fee overall for Apollo. But yea, you are right there’d be some more expense leverage as we grow. And I think we’ll hopefully get a little bit more investment margin improvement over time as well.

So these are some of the drivers I think as we head into 2018 and then obviously we just keep growing our balance sheet and it's the biggest way that we grow earnings. And again in 2019 guidance doesn't include any inorganic opportunities which we feel like were pretty good shape to hit on.

On allocation of capital, we've historically said publicly, we want to have we measure excess capital over 400% RBC and NAIC RBC in the 400% level that's kind of historically fit pretty well with also where we're been navigating with the rating agency models, and that has been S&P and Fitch.

But really it's the rating agency models that we've focused on the most, and as well as our economic models and the NAIC is making changes at the end of this year for the new tax rate, and in 2018 or 20 for expanded NAIC factors it's beginning to stray farther and farther from what those ratings agency models look like. So, well we're probably going to switch over to a different way to think about it away from any NAIC RBC.

But at the end of the day I don't think it's going to deviate a whole lot from that kind of 7.5% kind of number that you tossed out.

Operator

Next we have Mark Hughes of SunTrust.

Mark Hughes

Thank you. Good morning. I'm sorry if you touched on this earlier but are you seeing any pickup in FIA sales in the fourth quarter around the market volatility.

Bill Wheeler

Hi Mark it's Bill Wheeler. It’s probably a little too early to say. I would say as a rule of thumb we are – we generally our annuities do better when there's market volatility because consumers get a little more worried about the potential to lose money. And obviously in our annuity products your principal is protected, so that sort of weighs on their minds a little bit.

So, I would say the market volatility probably on the margin will help annuity sales. I'm just not sure if we've seen that big of impact yet.

Operator

Next we have a follow-up from Suneet Kamath from Citi.

Suneet Kamath

Great thanks for this follow-up. Just back on capital Marty I think in the past you’ve talked about being able to fund about 13 billion of deposits organically without dipping into the excess capital. Just wondering if that's still a good guide with both Voya but also the ramp up in the retail business particularly with the upgrade, should we expect maybe a little bit of dipping into the excess capital going forward.

Marty Klein

Yeah, I think it still holds. It's $13 million, $14 million it's not to be overly precise so it's kind of in that ballpark. Yeah, retail is a little bit larger consumer of capital but on the other hand as we would get ratings upgrades I think that it could also investment funding agreement backed note market recovers, we could get in the funding agreement game and there it actually doesn't really use much surplus. In fact in some environments it's surplus accretive when you issue. So, we still think that the overall guidance hold. It is going to move around quarter to quarter a little bit depending on the business mix with our multi-channel distribution but is at ballpark range of $13 million maybe $14 billion still holds.

Operator

And next we have Tom Gallagher of Evercore.

Tom Gallagher

Hi. Yeah just Marty coming back to my first question. The $20 million to $25 million lower run rate of NII for 4Q, can you just tell us what's driving that because rates have actually gone up a little bit from the time you made more than a little bit from the time you made that that gave that guidance. And then the other liability cost 117 basis points normalized should we expect that to move it back into the 125 to 135 basis points range or is that going to remain below that.

Jim Belardi

No, my expectation would be that other liability costs, which do move around a lot, so that 125 to 135 is sort of a normalized range. But, obviously if there's a very good or very bad equity market or some other things, or it can move around a little bit outside that but we should be within that – of the liability cost range.

Marty Klein

Yeah I think our best estimate right now is investment income is for the fourth quarter is that incremental to the second quarter $150 million, $155 million increase. And part of it, it’s just everything's kind of more back-end loaded than we had thought. We did close an alternative investment, that I mentioned in October. So, we'll begin to benefit from that in the fourth quarter.

But the volume being more back-loaded we thought would carry through. Again from an earnings standpoint the cost of crediting associated with that back-ended volume is also back-ended. So, it's not a huge overall earnings impact. It's pretty de minimis.

Operator

This will conclude the question-and-answer portion of today's call. I will now return the floor back to Mr. Noah Gunn for any additional or closing remarks. Sir?

Noah Gunn

Thanks operator and thanks everyone for joining us this morning. If you have any follow-up questions regarding our results or anything discussed on the call today please reach out to myself or Paige Hart. We look forward to speaking with everyone again next quarter. Thank you.

Operator

And we thank you Sir and to the rest of management team also for your time today. Again the conference call is now concluded. At this time you may disconnect your lines. Thank you. Take care and have a great day everyone.