The following discussion and analysis of our financial condition and results of operations should be read in its entirety and in conjunction with the consolidated financial statements and related notes contained in Part I, Item 1 of this Quarterly Report on Form 10-Q, as well as "Management's Discussion and Analysis of Financial Condition and Results of Operations" section contained in our Annual Report on Form 10-K for the year ended December 31, 2019 ("2019 Form 10-K"). In addition to historical data, this discussion contains forward-looking statements about our business, operations and financial performance based on current expectations that involve risks, uncertainties and assumptions. Actual results may differ materially from those discussed in the forward-looking statements as a result of various factors. See the Note Regarding Forward-Looking Statements and Information. Investors are directed to consider the risks and uncertainties discussed in Part II, Item 1A of this Quarterly Report on Form 10-Q, as well as in other documents we have filed with theSecurities and Exchange Commission ("SEC"). Executive Summary Overview We are one of America's leading financial services companies, providing: (i) advice and solutions for helping Americans set and meet their retirement goals and protect and transfer their wealth across generations; and (ii) a wide range of investment management insights, expertise and innovations to drive better investment decisions and outcomes for clients worldwide. We manage our business through four segments:Individual Retirement, Group Retirement, Investment Management and Research, and Protection Solutions. We report certain activities and items that are not included in these segments in Corporate and Other. See Note 15 of the Notes to the Consolidated Financial Statements for further information on our segments. We benefit from our complementary mix of businesses. This business mix provides diversity in our earnings sources, which helps offset fluctuations in market conditions and variability in business results, while offering growth opportunities. COVID-19 Impact During the latter part of the first quarter of 2020, the COVID-19 pandemic negatively impacted theU.S. and global economies, created significant volatility and disruption in the capital markets, lowered equity market valuations, dramatically increased unemployment levels and fueled concerns that it will lead to a global recession. In addition, the pandemic resulted in the temporary closures of many businesses and schools and the institution of social distancing and sheltering in place requirements in many states and local communities. The effects from the pandemic have continued intoMay 2020 and are likely to persist for months to come. Governments around the world have responded to COVID-19 with economic stimulus measures, including a$2 trillion emergency relief bill passed in theU.S. These measures are intended to steady businesses and consumers until economic activity and financial markets meaningfully recover. The timing and magnitude of any such recovery, however, remains uncertain. As a financial services company, factors such as the volatility and strength of equity markets, interest rates, consumer spending, and government debt and spending all affect the business and economic environment and, ultimately, the amount and profitability of our business. During the current economic downturn, the demand for our products and services and our investment returns could be materially and adversely affected. Action taken by state insurance departments, including the NYDFS, to require insurers to offer flexible premium payment plans, relax payment dates, waive late fees and penalties in order to avoid canceling or non-renewing polices may negatively affect our results of operations. Additionally, the profitability of many of our retirement, protection and investment products depends in part on the value of the AUM supporting them, which may decline substantially depending on any of the foregoing conditions. While our results for the first quarter of 2020 were strong, the ongoing economic impact and the potential for continued volatility and declines in the capital markets could have a significant adverse effect on our business, results of operations and financial condition, particularly if economic activity and financial markets do not recover or recover slowly. While the COVID-19 pandemic significantly affected the capital markets and economy, we believe the actions we have previously taken help assure that our economic balance sheet is protected from interest rate and equity declines. These actions include redesigning our product portfolio to concentrate on offering less capital intensive products and implementing a hedging strategy that manages and protects against the economic risks associated with our in-force GMxB products. In addition to our hedging strategy, we employ various other methods to manage the risks of our in-force variable annuity products, including asset-liability matching, volatility management tools within the Separate Accounts and an active in-force management program, 59 -------------------------------------------------------------------------------- including buyout offers for certain products. Our General Account was impacted both from declining interest rates, which had a positive effect on fair value, and sharply increased credit spreads, which had a negative impact on fair value. Due to the General Account's exposure toU.S. government bonds and credit quality of the portfolio, we feel that our balance sheet is well positioned to withstand the extreme volatility in the equity market. In light of the unprecedented decline in long-term interest rates in the quarter, we updated our long-term GAAP interest rate assumption to grade from current rates over 10-years to the 5-year historical average (currently 2.25%). This change resulted in an unfavorable impact to net income of$(2.5) billion and no impact to Non-GAAP Operating Earnings. For additional information, see "-Significant Factors Impacting Our Results-Assumption Updates and Model Changes." Operationally, we acted quickly and implemented our risk management and contingency plans as the COVID-19 pandemic evolved during the quarter. For example, among other things, we implemented travel restrictions, imposed self-quarantine requirements for employees and advisors who were exposed to someone who tested positive or had traveled to certain countries with active COVID-19 outbreaks and, finally, we temporarily closed our corporate locations and advisor branch offices. As a result, most of our employee and advisors are working remotely with only a few operationally critical employees working at certain of our facilities for business continuity purposes. The remote working arrangement has detracted from the ability of our advisors to sell our products in the normal course and, as a result, the demand for our products and services has been impacted and going forward could decline significantly as the pandemic persists. We are also mindful that an extended period of remote work arrangements could strain our business continuity plans, introduce additional operational risk, including cybersecurity and privacy risks, and impair our ability to effectively manage our business. While the COVID-19 pandemic has negatively impacted aspects of our business in the first quarter of 2020, the extent and nature of its impact is highly uncertain. For additional information regarding the potential impacts of the COVID-19 pandemic, see "Risk Factors-The novel coronavirus (COVID-19) pandemic has adversely impacted our business, and the ultimate effect on our business, results of operations and financial condition will depend on future developments that are highly uncertain, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic." Revenues Our revenues come from three principal sources: • fee income derived from our retirement and protection products and our
investment management and research services;
• premiums from our traditional life insurance and annuity products; and
• investment income from our General Account investment portfolio.
Our fee income varies directly in relation to the amount of the underlying AV or benefit base of our retirement and protection products and the amount of AUM of our Investment Management and Research business. AV and AUM, each as defined in "-Key Operating Measures," are influenced by changes in economic conditions, primarily equity market returns, as well as net flows. Our premium income is driven by the growth in new policies written and the persistency of our in-force policies, both of which are influenced by a combination of factors, including our efforts to attract and retain customers and market conditions that influence demand for our products. Our investment income is driven by the yield on our General Account investment portfolio and is impacted by the prevailing level of interest rates as we reinvest cash associated with maturing investments and net flows to the portfolio. Benefits and Other Deductions Our primary expenses are: • policyholders' benefits and interest credited to policyholders' account
balances;
• sales commissions and compensation paid to intermediaries and advisors
that distribute our products and services; and
• compensation and benefits provided to our employees and other operating
expenses.
Policyholders' benefits are driven primarily by mortality, customer withdrawals, and benefits which change in response to changes in capital market conditions. In addition, some of our policyholders' benefits are directly tied to the AV and benefit base of our variable annuity products. Interest credited to policyholders varies in relation to the amount of the underlying AV or 60 -------------------------------------------------------------------------------- benefit base. Sales commissions and compensation paid to intermediaries and advisors vary in relation to premium and fee income generated from these sources, whereas compensation and benefits to our employees are more constant and impacted by market wages and decline with increases in efficiency. Our ability to manage these expenses across various economic cycles and products is critical to the profitability of our company. Net Income Volatility We have offered and continue to offer variable annuity products with variable annuity guaranteed benefits ("GMxB") features. The future claims exposure on these features is sensitive to movements in the equity markets and interest rates. Accordingly, we have implemented hedging and reinsurance programs designed to mitigate the economic exposure to us from these features due to equity market and interest rate movements. Changes in the values of the derivatives associated with these programs due to equity market and interest rate movements are recognized in the periods in which they occur while corresponding changes in offsetting liabilities are recognized over time. This results in net income volatility as further described below. See "-Significant Factors Impacting Our Results-Impact of Hedging and GMIB Reinsurance on Results." In addition to our dynamic hedging strategy, we have static hedge positions designed to mitigate the adverse impact of changing market conditions on our statutory capital. We believe this program will continue to preserve the economic value of our variable annuity contracts and better protect our target variable annuity asset level. However, these static hedge positions increase the size of our derivative positions and may result in higher net income volatility on a period-over-period basis. Due to the impacts on our net income of equity market and interest rate movements and other items that are not part of the underlying profitability drivers of our business, we evaluate and manage our business performance using Non-GAAP Operating Earnings, a non-GAAP financial measure that is intended to remove these impacts from our results. See "-Key Operating Measures-Non-GAAP Operating Earnings." Significant Factors Impacting Our Results The following significant factors have impacted, and may in the future impact, our financial condition, results of operations or cash flows. Impact of Hedging and GMIB Reinsurance on Results We have offered and continue to offer variable annuity products with GMxB features. The future claims exposure on these features is sensitive to movements in the equity markets and interest rates. Accordingly, we have implemented hedging and reinsurance programs designed to mitigate the economic exposure to us from these features due to equity market and interest rate movements. These programs include: • Variable annuity hedging programs. We use a dynamic hedging program
(within this program, generally, we reevaluate our economic exposure at
least daily and rebalance our hedge positions accordingly) to mitigate
certain risks associated with the GMxB features that are embedded in our
liabilities for our variable annuity products. This program utilizes
various derivative instruments that are managed in an effort to reduce the
economic impact of unfavorable changes in GMxB features' exposures attributable to movements in the equity markets and interest rates. Although this program is designed to provide a measure of economic protection against the impact of adverse market conditions, it does not
qualify for hedge accounting treatment. Accordingly, changes in value of
the derivatives will be recognized in the period in which they occur with
offsetting changes in reserves partially recognized in the current period,
resulting in net income volatility. In addition to our dynamic hedging
program, we have a hedging program using static hedge positions
(derivative positions intended to be held to maturity with less frequent
re-balancing) to protect our statutory capital against stress scenarios.
This program in addition to our dynamic hedge program has increased the
size of our derivative positions, resulting in an increase in net income
volatility. The impacts are most pronounced for variable annuity products
in our Individual Retirement segment.
• GMIB reinsurance contracts. Historically, GMIB reinsurance contracts were
used to cede to non-affiliated reinsurers a portion of our exposure to variable annuity products that offer a GMIB feature. We account for the
GMIB reinsurance contracts as derivatives and report them at fair value.
Gross GMIB reserves are calculated on the basis of assumptions related to
projected benefits and related contract charges over the lives of the
contracts. Accordingly, our gross reserves will not immediately reflect
the offsetting impact on future claims exposure resulting from the same
capital market or interest rate fluctuations that cause gains or losses on
the fair value of the GMIB reinsurance contracts. Because changes in the
fair value of the GMIB reinsurance contracts are recorded in the period in
which they occur and a majority of the changes in gross reserves for GMIB are recognized over time, net income will be more volatile. 61
-------------------------------------------------------------------------------- Effect of Assumption Updates on Operating Results Our actuaries oversee the valuation of the product liabilities and assets and review the underlying inputs and assumptions. We comprehensively review the actuarial assumptions underlying these valuations and update assumptions during the third quarter of each year. Assumptions are based on a combination of Company experience, industry experience, management actions and expert judgment and reflect our best estimate as of the date of the applicable financial statements. Changes in assumptions can result in a significant change to the carrying value of product liabilities and assets and, consequently, the impact could be material to earnings in the period of the change. Most of the variable annuity products, variable universal life insurance and universal life insurance products we offer maintain policyholder deposits that are reported as liabilities and classified within either Separate Accounts liabilities or policyholder account balances. Our products and riders also impact liabilities for future policyholder benefits and unearned revenues and assets for DAC and deferred sales inducements ("DSI"). The valuation of these assets and liabilities (other than deposits) are based on differing accounting methods depending on the product, each of which requires numerous assumptions and considerable judgment. The accounting guidance applied in the valuation of these assets and liabilities includes, but is not limited to, the following: (i) traditional life insurance products for which assumptions are locked in at inception; (ii) universal life insurance and variable life insurance secondary guarantees for which benefit liabilities are determined by estimating the expected value of death benefits payable when the account balance is projected to be zero and recognizing those benefits ratably over the accumulation period based on total expected assessments; (iii) certain product guarantees for which benefit liabilities are accrued over the life of the contract in proportion to actual and future expected policy assessments; and (iv) certain product guarantees reported as embedded derivatives at fair value. For further details of our accounting policies and related judgments pertaining to assumption updates, see Note 2 to the notes to the Company's consolidated financial statements and "-Summary of Critical Accounting Estimates -Liability for Future Policy Benefits" included in the 2019 Form 10-K.. Assumption Updates and Model Changes We conduct our annual review of our assumptions and models during the third quarter of each year. However, we update our assumptions as needed in the event we become aware of economic conditions or events that could change require a change in our assumptions that we believe may have a significant impact to the carrying value of product liabilities and assets and consequently materially impact our earnings in the period of the change. Due to the extraordinary economic conditions driven by the COVID-19 pandemic in the first quarter of 2020, we updated our interest rate assumption to grade from the current spot interest rate to an ultimate five-year historical average over a 10-year period. As such, the 10-yearU.S. Treasury yield grades from the current level to an ultimate 5-year average of 2.25%. The low interest rates environment and subsequent update to the interest rate assumption caused a loss recognition event for our life interest-sensitive products, as well as to certain run-off business included in Corporate and Other. This loss recognition event caused an acceleration of DAC amortization on our life interest-sensitive products and an increase in the premium deficiency reserve on the run-off business in the first quarter of 2020. Impact of Assumption Updates and Model Changes on Income from Continuing Operations before income taxes and Net income (loss) The table below presents the impact of our actuarial assumption update during the three months endedMarch 31, 2020 to our Income (loss) from continuing operations, before income taxes and Net income (loss): Three Months EndedMarch 31, 2020 (in millions)
Impact of assumption updates on Net income (loss): Variable annuity product features related assumption update $
(1,468 ) Assumption updates for other business
(988 ) Impact of assumption updates on Income (loss) from continuing operations, before income tax
(2,456 ) Income tax (expense) benefit on assumption update
516
Net income (loss) impact of assumption update $ (1,940 ) 62
-------------------------------------------------------------------------------- 2020 Assumption Update The impact of the economic assumption update in the first quarter of 2020 was a decrease of$2.5 billion to Income (loss) from continuing operations, before income taxes and a decrease to Net income (loss) of$1.9 billion . The net impact of this assumption update on Income (loss) from continuing operations, before income taxes of$2.5 billion consisted of an increase in Policyholders' benefits of$1.4 billion , an increase in the Amortization of DAC of$1.1 billion , an increase in Policy charges and fee income of$46 million and a decrease in Interest credited to policyholders' account balances of$6 million . Impact of Assumption Updates and Model Changes on Income from Continuing Operations before income taxes and Net income (loss) The unprecedented and rapid spread of COVID-19 and the related restrictions and social distancing measures implemented throughout the world have caused severe, lasting turmoil in the financial markets during the first quarter of 2020. The Company's accounting policy governing its Non-GAAP Operating Earnings measure permits adjustments to Non-GAAP Operating Earnings if certain criteria are met, which include if the proposed adjustment relates to a non-recurring event or transaction. Management concluded that all impacts on the Company from the COVID-19 pandemic and its effects on the economy meet the indicators of a non-recurring event. Therefore, management has determined that the items set forth in the table below should be included as adjustments to the Non-GAAP Operating Earnings measure so that investors can more clearly see the delineation between the operating results of the Company's core operations and the impact of the items specific to the current COVID-19 pandemic crisis. Management expects to continue to treat these items as adjustments to Non-GAAP Operating Earnings in the future. The table below presents the impact of COVID-19 related impacts on Income (loss) from continuing operations, before income taxes during the first quarter of 2020 by segment and Corporate and Other, and the COVID-19-related adjustments included in the reconciliation of Net Income (loss) attributable to Holdings to Non-GAAP Operating Earnings: Three Months Ended March 31, 2020 COVID-19 Impacts Impacts other than Interest Interest Rate Rate Assumption Assumption Update Update (1) Total (in millions) Net income (loss) from continuing operations, before income taxes by Segment and Corporate and Other: Individual Retirement$ (1,417 ) $ (44 ) $ (1,461 ) Group Retirement (51 ) 3 (48 ) Protection Solutions (955 ) (32 ) (987 ) Corporate and Other (33 ) (13 ) (46 ) Net income (loss) from continuing operations, before income taxes$ (2,456 ) $
(86 )
COVID-19-related adjustments included in Reconciliation of Net income (loss) attributable to Holdings to Non-GAAP Operating Earnings: Variable annuities product features (1,468 ) (35 ) (1,503 ) Assumption update for other business (988 ) (51 ) (1,039 ) Net income (loss) from continuing operations, before income taxes$ (2,456 ) $
(86 )
_______________
(1) Includes adjustments to Non-GAAP Operating Earnings primarily due to non-variable annuity hedging impacts resulting from unprecedented volatility in equity markets. Adjustments related to Individual Retirement and Group Retirement segments are included in the "Variable annuities product features" in the reconciliation of Net income (loss) attributable to Holdings to Non-GAAP Operating Earnings. All other adjustments are included in "Other". This impact has been more than offset by hedging gains. 63 -------------------------------------------------------------------------------- Macroeconomic and Industry Trends Our business and consolidated results of operations are significantly affected by economic conditions and consumer confidence, conditions in the global capital markets and the interest rate environment. Financial and Economic Environment Although the first quarter started strong, uncertainties were prevalent at the end of the quarter, as the capital markets reacted to the COVID-19 pandemic. As the pandemic evolved during the latter part of the quarter, equity markets experienced significant volatility and declines, interest rates dropped to historical lows and many state and local governments ordered non-essential businesses to close and residents to shelter in place at home. This resulted in an unprecedented slow-down in economic activity, a related dramatic increase in unemployment and fears of a global recession. Stressed conditions, volatility and disruptions in the capital markets, particular markets, or financial asset classes can have an adverse effect on us, in part because we have a large investment portfolio and our insurance liabilities and derivatives are sensitive to changing market factors. An increase in market volatility could continue to affect our business, including through effects on the yields we earn on invested assets, changes in required reserves and capital and fluctuations in the value of our AUM, AV or AUA from which we derive our fee income. These effects could be exacerbated by uncertainty about future fiscal policy, changes in tax policy, the scope of potential deregulation and levels of global trade. The potential for increased volatility, coupled with prevailing interest rates remaining below historical averages, could pressure sales and reduce demand for our products as consumers consider purchasing alternative products to meet their objectives. In addition, this environment could make it difficult to consistently develop products that are attractive to customers. Financial performance can be adversely affected by market volatility and equity market declines as fees driven by AV and AUM fluctuate, hedging costs increase and revenues decline due to reduced sales and increased outflows. We monitor the behavior of our customers and other factors, including mortality rates, morbidity rates, annuitization rates and lapse and surrender rates, which change in response to changes in capital market conditions, to ensure that our products and solutions remain attractive and profitable. For additional information on our sensitivity to interest rates and capital market prices, See "Quantitative and Qualitative Disclosures About Market Risk." Interest Rate Environment We believe the interest rate environment will continue to impact our business and financial performance in the future for several reasons, including the following: • Certain of our variable annuity and life insurance products pay guaranteed
minimum interest crediting rates. We are required to pay these guaranteed
minimum rates even if earnings on our investment portfolio decline, with
the resulting investment margin compression negatively impacting earnings.
In addition, we expect more policyholders to hold policies with comparatively high guaranteed rates longer (lower lapse rates) in a low interest rate environment. Conversely, a rise in average yield on our investment portfolio should positively impact earnings. Similarly, we
expect policyholders would be less likely to hold policies with existing
guaranteed rates (higher lapse rates) as interest rates rise.
• A prolonged low interest rate environment also may subject us to increased
hedging costs or an increase in the amount of statutory reserves that our
insurance subsidiaries are required to hold for GMxB features, lowering
their statutory surplus, which would adversely affect their ability to pay
dividends to us. In addition, it may also increase the perceived value of
GMxB features to our policyholders, which in turn may lead to a higher
rate of annuitization and higher persistency of those products over time.
Finally, low interest rates may continue to cause an acceleration of DAC
amortization or reserve increase due to loss recognition for interest
sensitive products, primarily for our Protection Solutions segment.
For a discussion on derivatives we used to hedge interest rates, see Note 4 of the Notes to the Consolidated Financial Statements. Regulatory Developments Our life insurance subsidiaries are regulated primarily at the state level, with some policies and products also subject to federal regulation. In addition, Holdings and its insurance subsidiaries are subject to regulation under the insurance holding company laws of variousU.S. jurisdictions. Furthermore, on an ongoing basis, regulators refine capital requirements and introduce new reserving standards. See "Business-Regulation" and "Risk Factors-Legal and Regulatory Risks" in the 2019 64 -------------------------------------------------------------------------------- Form 10-K. Regulations recently adopted or currently under review can potentially impact our statutory reserve, capital requirements and profitability of the industry and result in increased regulation and oversight for the industry. • COVID-19 Impact. InMarch 2020 , in connection with the COVID-19 pandemic,
many
and guidance encouraging, requesting or directing licensed life insurance
companies to implement life insurance policy measures such as: providing
grace periods to policyholders for the payment of insurance premiums and
forbearing on the cancellation or non-renewal of life insurance policies
due to non-payment of premium. In addition, some states' governors have
issued emergency orders and state insurance commissioners have promulgated
emergency regulations requiring such actions. For example, the NYDFS,
which is the domiciliary regulator of our principal insurance subsidiary,
Equitable Life, promulgated a consolidated emergency regulation on March
30, 2020 requiring insurance company actions with respect to many lines of
insurance. Among other requirements, the
Regulation 216 provides that where a policyholder can demonstrate
financial hardship as a result of the COVID-19 pandemic, insurers
authorized to write life insurance or annuities in the state must, with
respect to group life insurance policies, extend grace periods for the
payment of premiums and fees to 90 days. With respect to any life
insurance policy or annuity contracts where the policyholder can
demonstrate financial hardship as a result of the COVID-19 pandemic, New
York licensed insurers are prohibited from imposing any late fees or
reporting such policyholder to a credit reporting agency or debt
collection agency in the event of a policyholder's failure to timely pay
premium and must permit policyholders who did not make a premium payment
due to financial hardship as a result of the COVID-19 pandemic to pay the
premium over a 12-month period. In connection with the NYDFS' emergency
measure, an insurer shall accept a policyholder's written attestation as
proof of financial hardship as a result of the COVID-19 pandemic.
• Variable Annuity Capital Standards. In 2015, the NAIC Financial Condition
(E) Committee established a working group to study and address, as
appropriate, regulatory issues resulting from variable annuity captive
reinsurance transactions, including reforms that would improve the current
statutory reserve and RBC framework for insurance companies that sell variable annuity products. InAugust 2018 , the NAIC adopted the new framework developed and proposed by this working group. Following its
referral to various NAIC committees to develop the full implementation
details, the new framework became operational inJanuary 2020 . Among other changes, the new framework includes new prescriptions for reflecting hedge effectiveness, investment returns, interest rates, mortality and policyholder behavior in calculating statutory reserves and RBC. Once effective, it is expected to materially change the level of variable annuity reserves and RBC requirements as well as their sensitivity to capital markets including interest rate, equity markets, volatility and
credit spreads. Overall, we believe the NAIC reform has moved variable
annuity capital standards towards an economic framework and is consistent
with how we manage our business. The Company adopted the NAIC reserve and
capital framework for the year ended
• On
differ from the NAIC variable annuity reserve and capital framework. These amendments will not materially affect the Company's GAAP financial condition, results of operations or stockholders' equity. However, Regulation 213, as amended, absent management action, will require our principal insurance subsidiary, Equitable Life, to carry statutory basis reserves for its variable annuity contract obligations equal to the
greater of those required under (i) the NAIC standard or (ii) a revised
version of the NYDFS requirement in effect prior to the adoption of the
amendment for contracts issued prior to
issued after that date a new standard that we believe is more conservative
than the NAIC standard. Absent management action, we believe that the adoption of the amendments will materially increase the statutory basis reserves that Equitable Life will be required to carry and, will materially and adversely affect the capacity of Equitable Life to
distribute dividends to the Company beyond 2020. As a holding company, we
rely on dividends and other payments from our subsidiaries and,
accordingly, any material limitation on Equitable Life's dividend capacity
could materially affect our ability to return capital to stockholders
through dividends and stock repurchases. The Company is considering
management actions to mitigate the impact of Regulation 213. These actions
could include seeking further amendment of Regulation 213 or exemptive
relief therefrom to make the regulation's application to Equitable Life more consistent with the NAIC reserve and capital framework, as well as
changing our underwriting practices to emphasize issuing variable annuity
products out of subsidiaries which are not domiciled inNew York , increasing the use of reinsurance and other corporate transactions intended to reduce the impact of the regulation. There can be no assurance that any management action individually or collectively will fully mitigate the impact of Regulation 213. Other state insurance regulators may also propose and adopt standards different from the NAIC framework.
• Fiduciary Rules / "Best Interest" Standards of Conduct. In the wake of the
announced that it plans to issue revised fiduciary investment advice regulations. At this time, we cannot predict when those regulations will be issued, what form they may take or their potential impact 65
-------------------------------------------------------------------------------- on us. In addition, the NAIC as well as state regulators either have adopted or are currently considering whether to apply an impartial conduct standard similar to the DOL Rule to recommendations made in connection with certain annuities and, in one case, to life insurance policies. For example, the NAIC has amended its Suitability in Annuity Transactions Model Regulation to apply to a best interest of the consumer standard on insurance producers' annuity recommendations and to require that insurers supervise such recommendations, and inJuly 2018 , the NYDFS issued a final version of Regulation 187 that adopts a "best interest" standard for recommendations regarding the sale of life insurance and annuity products inNew York . Regulation 187 took effect onAugust 1, 2019 with respect to annuity sales and took effect onFebruary 1, 2020 for life insurance sales and is applicable to sales of life insurance and annuity products inNew York . We have developed our compliance framework for Regulation 187 with respect to annuity sales as well as our life insurance business. In addition, state regulators and legislatures inNevada ,New Jersey ,Maryland andMassachusetts have proposed measures that would make broker-dealers, sales agents, and investment advisers and their representatives to be subject to a fiduciary duty when providing products and services to customers, including pension plans and IRAs.Massachusetts has adopted such a regulation applying a fiduciary duty standard to broker-dealers and their agents, but it does not apply to insurance product sales, including variable annuities. Beyond theNew York regulation, the likelihood of enactment of any such state-based regulation is uncertain at this time, but if implemented, these regulations could have adverse effects on our business and consolidated results of operations. • InJune 2019 , theSEC released a set of rules that, among other things,
enhance the existing standard of conduct for broker-dealers to require
them to act in the best interest of their clients ("Regulation Best
Interest"); clarify the nature of the fiduciary obligations owed by
registered investment advisers to their clients; impose new disclosure
requirements aimed at ensuring investors understand the nature of their
relationship with their investment professionals; and restrict certain
broker-dealers and their financial professionals from using the terms "adviser" or "advisor". The effective date for compliance with these rules isJune 30, 2020 . Investment advisers to retail clients will also be
required to file new Form CRS, providing disclosures about its standard of
conduct and conflicts of interest, with the
Form CRS to its retail clients. The intent of these rules is to impose on
broker-dealers an enhanced duty of care to their customers similar to that
which applies to investment advisers under existing law. Two lawsuits, one
by seven states and the
firms, were filed in
vacate Regulation Best Interest. Former Rep.
former Sen.
supporting a lawsuit initiated by XY Planning Network against the
respect to Regulation Best Interest, arguing that the regulation violates
the rule-making mandate in the Dodd-Frank Act and, as a result, should be
struck down. We are monitoring these developments and evaluating the
potential effect they may have on our business. In addition,
currently focusing on how broker-dealers identify and manage conflicts of
interest.
• Derivatives Regulation. The amount of collateral we are required to pledge
and the expenses we incur under our derivatives transactions are expected
to increase as a result of the requirement to pledge initial margin for
non-centrally cleared derivative transactions ("OTC" derivatives) entered
into after the phase-in period, which will likely be applicable to us in
the Currency ("OCC"), the
Administration, and the
Futures Trading Commission of final margin requirements for OTC derivatives. Also, theSEC has finalized and adopted the final set of rules related to security-based swaps, which triggers the compliance date for security-based swap entities registration and compliance with previously adopted rules regarding margin, capital, segregation, recordkeeping and reporting and business conduct for security-based swaps. The rules became effective onApril 6, 2020 . The compliance date for registration of (i) security-based swap dealers that incur a registration obligation as a result of meeting certain thresholds to be set by theSEC onAugust 6, 2021 will beNovember 1, 2021 and (ii) major
security-based swap participants that incur a registration obligation as a
result of security-based swap activities in their quarter ending September
30, 2021 will be
are evaluating the potential effect these rules might have on our business. 66
-------------------------------------------------------------------------------- Impact of the SECURE Act OnDecember 20, 2019 ,President Trump signed into law the Setting Every Community Up for Retirement Enhancement Act of 2019 (the "SECURE Act"). The SECURE Act contains a number of provisions that affect the administration and operation of defined contribution plans such as 401(k) and 403(b) plans and IRAs, including provisions that encourage additional retirement savings and lifetime income options, promote the adoption of retirement plans by small employers, provide lifetime income portability, and accelerate the distribution of retirement benefits of deceased retirees. Many provisions of the SECURE Act become effective for plan years beginning afterDecember 31, 2019 . At this time, we cannot predict the impact the SECURE Act will have on our business, financial condition or results of operations. Impact of the CARES Act The Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed into law onMarch 27, 2020 . Several tax provisions were included as part of a broad economic relief package. These include the temporary allowance of Net Operating Loss carrybacks and the acceleration of Alternative Minimum Tax ("AMT") credit refunds. The Company is assessing the economic and financial statement impact of these provisions. Impact of the Tax Reform Act InDecember 2017 , the Tax Reform Act was signed into law. The Tax Reform Act reduced the federal corporate income tax rate to 21% and repealed the corporate AMT while keeping existing AMT credits. It also contained measures affecting our insurance companies, including changes to the DRD, insurance reserves and tax DAC, and measures affecting our international operations. As a result of the Tax Reform Act, our Net Income and Non-GAAP Operating Earnings has improved and the tax liability on the earnings of our foreign subsidiaries has decreased. InAugust 2018 , the NAIC adopted changes to the RBC calculation, including the C-3 Phase II Total Asset Requirement for variable annuities, to reflect the 21% corporate income tax rate in RBC, which resulted in a reduction to our Combined RBC Ratio. Overall, the Tax Reform Act had a net positive economic impact on us, and we continue to monitor regulations related to this reform. Separation Costs In connection with our separation from AXA, we have incurred and expect to continue to incur one-time and recurring expenses. These expenses primarily relate to information technology, compliance, internal audit, finance, risk management, procurement, client service, human resources, rebranding and other support services. The process of replicating and replacing functions, systems and infrastructure provided by AXA or certain of its affiliates in order to operate on a stand-alone basis is currently underway. These expenses, any recurring expenses, including under the Transitional Services Agreement, and any additional one-time expenses we may incur may be material. See "Risk Factors" in the 2019 Form 10-K for additional information. We estimate that the aggregate amount of the one-time expenses described above will be approximately$700 million . ThroughMarch 31, 2020 , a total of$564 million has been incurred, of which$32 million and$24 million was incurred in the three months endedMarch 31, 2020 and 2019, respectively. Productivity Strategies Retirement and Protection Businesses We continue to build upon our productivity improvements through which we have delivered more than$350 million in efficiency improvements from 2012 through 2017. Our productivity strategy includes several initiatives, including relocating some of our real estate footprint away from theNew York metropolitan area, replacing or updating less efficient legacy technology infrastructure and expanding existing outsourcing arrangements, which we believe will reduce costs and improve productivity. We anticipate that the savings from these initiatives will offset any incremental ongoing expenses that we incur as a standalone company, and we expect these initiatives to improve our operating leverage, increasing our Non-GAAP Operating Earnings by approximately$75 million pre-tax per annum by the end of 2020 since the date of our IPO. 67 -------------------------------------------------------------------------------- Investment Management and Research Business AB has announced that it will establish its corporate headquarters in and relocate approximately 1,250 jobs located in theNew York metro area to,Nashville, Tennessee . Beginning in 2025, AB estimates ongoing annual expense savings of approximately$75 million to$80 million . Key Operating Measures In addition to our results presented in accordance withU.S. GAAP, we report Non-GAAP Operating Earnings, Non-GAAP Operating ROE, Non-GAAP Operating ROC by segment for our Individual Retirement, Group Retirement and Protection Solutions segments, and Non-GAAP Operating Earnings per share, each of which is a measure that is not determined in accordance withU.S. GAAP. Management principally uses these non-GAAP financial measures in evaluating performance because they present a clearer picture of our operating performance and they allow management to allocate resources. Similarly, management believes that the use of these Non-GAAP financial measures, together with relevantU.S. GAAP measures, provide investors with a better understanding of our results of operations and the underlying profitability drivers and trends of our business. These non-GAAP financial measures are intended to remove from our results of operations the impact of market changes (where there is mismatch in the valuation of assets and liabilities) as well as certain other expenses which are not part of our underlying profitability drivers or likely to re-occur in the foreseeable future, as such items fluctuate from period-to-period in a manner inconsistent with these drivers. These measures should be considered supplementary to our results that are presented in accordance withU.S. GAAP and should not be viewed as a substitute for theU.S. GAAP measures. Other companies may use similarly titled non-GAAP financial measures that are calculated differently from the way we calculate such measures. Consequently, our non-GAAP financial measures may not be comparable to similar measures used by other companies. We also discuss certain operating measures, including AUM, AUA, AV, Protection Solutions Reserves and certain other operating measures, which management believes provide useful information about our businesses and the operational factors underlying our financial performance. Non-GAAP Operating Earnings Non-GAAP Operating Earnings is an after-tax non-GAAP financial measure used to evaluate our financial performance on a consolidated basis that is determined by making certain adjustments to our consolidated after-tax net income attributable to Holdings. The most significant of such adjustments relates to our derivative positions, which protect economic value and statutory capital, and are more sensitive to changes in market conditions than the variable annuity product liabilities as valued underU.S. GAAP. This is a large source of volatility in net income. Non-GAAP Operating Earnings equals our consolidated after-tax net income attributable to Holdings adjusted to eliminate the impact of the following items: • Items related to variable annuity product features, which include: (i)
certain changes in the fair value of the derivatives and other securities
we use to hedge these features; (ii) the effect of benefit ratio unlock
adjustments related to extraordinary economic conditions or events such as
COVID-19; and (iii) changes in the fair value of the embedded derivatives
reflected within variable annuity products' net derivative results and the
impact of these items on DAC amortization on our SCS product. • Investment (gains) losses, which includes credit loss impairments of securities/investments, sales or disposals of securities/investments, realized capital gains/losses and valuation allowances;
• Net actuarial (gains) losses, which includes actuarial gains and losses as
a result of differences between actual and expected experience on pension
plan assets or projected benefit obligation during a given period related
to pension, other postretirement benefit obligations, and the one-time
impact of the settlement of the defined benefit obligation;
• Other adjustments, which includes restructuring costs related to severance,
lease write-offs related to non-recurring restructuring activities, separation costs and impacts related to COVID-19; and
• Income tax expense (benefit) related to the above items and non-recurring
tax items, which includes the effect of uncertain tax positions for a given
audit period and permanent differences due to the Tax Reform Act.
Because Non-GAAP Operating Earnings excludes the foregoing items that can be distortive or unpredictable, management believes that this measure enhances the understanding of the Company's underlying drivers of profitability and trends in our business, thereby allowing management to make decisions that will positively impact our business. 68 -------------------------------------------------------------------------------- We use the prevailing corporate federal income tax rate of 21% in 2020 while taking into account any non-recurring differences for events recognized differently in our financial statements and federal income tax returns as well as partnership income taxed at lower rates when reconciling Net income (loss) attributable to Holdings to Non-GAAP Operating Earnings. The table below presents a reconciliation of Net income (loss) attributable to Holdings to Non-GAAP Operating Earnings for the three months endedMarch 31, 2020 and 2019: Three Months Ended March 31, 2020 2019 (in millions) Net income (loss) attributable to Holdings$ 5,410 $ (775 ) Adjustments related to: Variable annuity product features (1) (6,861 )
1,540
Investment (gains) losses (4 ) 11
Net actuarial (gains) losses related to pension and other postretirement benefit obligations
27 24 Other adjustments (2) (3) 634 40 Income tax expense (benefit) related to above adjustments (4) 1,303 (337 ) Non-recurring tax items 6 6 Non-GAAP Operating Earnings $ 515 $ 509 ______________
(1) Includes COVID-19 impact on Variable annuity product features due to
assumption update of
million for the three months ended
(2) Includes assumption update due to COVID-19 of
related impacts of
(3) Includes separation costs of
ended
(4) Includes income taxes of
for the three months ended
Non-GAAP Operating ROE and Non-GAAP Operating ROC by Segment We report Non-GAAP Operating ROE and Non-GAAP Operating ROC by segment for our Individual Retirement, Group Retirement and Protection Solutions segments, each of which is a Non-GAAP financial measure used to evaluate our profitability on a consolidated basis and by segment, respectively. We calculate Non-GAAP Operating ROE by dividing Non-GAAP Operating Earnings for the previous twelve calendar months by consolidated average equity attributable to Holdings' common shareholders, excluding Accumulated Other Comprehensive Income ("AOCI"). We calculate Non-GAAP Operating ROC by segment by dividing Operating earnings (loss) on a segment basis for the previous twelve calendar months by average capital on a segment basis, excluding AOCI, as described below. AOCI fluctuates period-to-period in a manner inconsistent with our underlying profitability drivers as the majority of such fluctuation is related to the market volatility of the unrealized gains and losses associated with our available-for-sale ("AFS") securities. Therefore, we believe excluding AOCI is more effective for analyzing the trends of our operations. We do not calculate Non-GAAP Operating ROC by segment for our Investment Management and Research segment because we do not manage that segment from a return of capital perspective. Instead, we use metrics more directly applicable to an asset management business, such as AUM, to evaluate and manage that segment. For Non-GAAP Operating ROC by segment, capital components pertaining directly to specific segments such as DAC along with targeted capital are directly attributed to these segments. Targeted capital for each segment is established using assumptions supporting statutory capital adequacy levels, reflecting the newly adopted NAIC RBC framework the company as of year end 2019. To enhance the ability to analyze these measures across periods, interim periods are annualized. Non-GAAP Operating ROE and Non-GAAP Operating ROC by segment should not be used as substitutes for ROE. The following table presents Return on Average equity attributable to Holdings' common shareholders, excluding AOCI and Non-GAAP Operating ROE for the trailing twelve months endedMarch 31, 2020 . 69 --------------------------------------------------------------------------------
Trailing Twelve Months EndedMarch 31, 2020 (in millions)
Net income (loss) available to Holdings' common shareholders $
4,439
Average equity attributable to Holdings' common shareholders, excluding AOCI
$
14,094
Return on average equity attributable to Holdings' common shareholders, excluding AOCI
31.5 %
Non-GAAP Operating Earnings available to Holdings' common shareholders
$
2,390
Average equity attributable to Holdings' common shareholders, excluding AOCI $ 14,094 Non-GAAP Operating ROE 17.0 %
The following table presents Non-GAAP Operating ROC by segment for our
Individual Retirement, Group Retirement and Protection Solutions segments for
the trailing twelve months ended
Trailing Twelve
Months Ended
Individual Protection Retirement Group Retirement Solutions (in millions) Operating earnings$ 1,579 $ 415 $ 385 Average capital (1)$ 7,327 $ 1,271$ 2,820 Non-GAAP Operating ROC 21.6 % 32.7 % 13.7 %
______________
(1) For average capital amounts by segment, capital components pertaining
directly to specific segments such as DAC along with targeted capital are
directly attributed to these segments. Targeted capital for each segment is
established using assumptions supporting statutory capital adequacy levels,
reflecting the newly adopted NAIC RBC framework the company as of year end
2019. Non-GAAP Operating Earnings Per Common Share Non-GAAP Operating Earnings per common share ("Non-GAAP EPS") is calculated by dividing Non-GAAP Operating Earnings by diluted common shares outstanding. The following table sets forth Non-GAAP Operating EPS for the three months endedMarch 31, 2020 and 2019. Three Months EndedMarch 31, 2020 2019 (per share amounts)
Net income (loss) attributable to Holdings (1)
0.02 - Net income (loss) available to Holdings' common shareholders 11.65 (1.50 ) Adjustments related to: Variable annuity product features (2) (14.80 )
2.97
Investment (gains) losses (0.01 )
0.02
Net actuarial (gains) losses related to pension and other postretirement benefit obligations
0.06
0.05
Other adjustments (3) (4) 1.36
0.08
Income tax expense (benefit) related to above adjustments (5) 2.81 (0.65 ) Non-recurring tax items 0.01
0.01
Non-GAAP Operating Earnings per common share$ 1.08
______________
(1) Due to reporting a net loss for the three months ended
shares was used in the diluted earnings per common share calculation as the
use of diluted shares would have resulted in a lower loss per share.
(2) Includes COVID-19 impact on Variable annuity product features due to
assumption update of
the three months ended
(3) Includes assumption update due to COVID-19 of
related impacts of
(4) Includes separation costs of
31, 2020 and 2019.
(5) Includes income taxes of
three months ended
Assets Under Management
70 -------------------------------------------------------------------------------- AUM means investment assets that are managed by one of our subsidiaries and includes: (i) assets managed by AB; (ii) the assets in our General Account investment portfolio; and (iii) the Separate Accounts assets of our Individual Retirement, Group Retirement and Protection Solutions businesses. Total AUM reflects exclusions between segments to avoid double counting.Assets Under Administration AUA includes non-insurance client assets that are invested in our savings and investment products or serviced by ourEquitable Advisors platform. We provide administrative services for these assets and generally record the revenues received as distribution fees. Account Value AV generally equals the aggregate policy account value of our retirement products. General Account AV refers to account balances in investment options that are backed by the General Account while Separate Accounts AV refers to Separate Accounts investment assets. Protection Solutions Reserves Protection Solutions Reserves equals the aggregate value of Policyholders' account balances and Future policy benefits for policies in our Protection Solutions segment. Consolidated Results of Operations Our consolidated results of operations are significantly affected by conditions in the capital markets and the economy because we offer market sensitive products. These products have been a significant driver of our results of operations. Because the future claims exposure on these products is sensitive to movements in the equity markets and interest rates, we have in place various hedging and reinsurance programs that are designed to mitigate the economic risks of movements in the equity markets and interest rates. The volatility in Net income attributable to Holdings for the periods presented below results from the mismatch between: (i) the change in carrying value of the reserves for GMDB and certain GMIB features that do not fully and immediately reflect the impact of equity and interest market fluctuations; and (ii) the change in fair value of products with the GMIB feature that has a no-lapse guarantee, and our hedging and reinsurance programs. Ownership and Consolidation of AllianceBernstein Our indirect, wholly-owned subsidiary,AllianceBernstein Corporation , is the General Partner of AB.Accordingly, AB's results are fully reflected in our consolidated financial statements. Our blended economic interest in AB was approximately 65% and 65% for the three months endedMarch 31, 2020 and 2019, respectively. Effective Tax Rates For interim reporting periods, we calculate income tax expense using an estimated annual effective tax rate ("ETR"), with discrete items recognized in the period in which they occur. Consolidated Results of Operations The following table summarizes our consolidated statements of income (loss) for the three months endedMarch 31, 2020 and 2019: Consolidated Statement of Income (Loss) (Unaudited)
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