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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
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Good day, and welcome to the Aegon First Quarter 2021 Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jan Willem Weidema. Please go ahead, sir.
Thank you, operator. Good morning, everyone, and thank you for joining this conference call on Aegon's First Quarter 2021 results. We would appreciate it if you could take a moment to review our disclaimer on forward-looking statements, which you can find at the back of the presentation. With me today are Aegon's CEO, Lard Friese; and CFO, Matt Rider. Let me now hand over to Lard.
Thank you, Jan Willem, and good morning, everyone. We really appreciate that you are joining us on today's call as it is a busy day with many companies reporting results. So thank you very much for being here. In my part of the presentation, I will take you through the strategic highlights for the first quarter and through the progress we have made in our strategic assets. Matt Rider will then go through the details of the results and our capital position and presents the progress we have made in our financial assets. I will conclude the presentation with a wrap-up, after which we will open the call for the Q&A session. Let's turn to Slide #2. We have made early progress toward delivering on our strategic priorities, and I am encouraged to see this reflected in our first quarter results. Despite the pandemic, our employees remain committed to support our customers and business partners, and I continue to be deeply impressed by the energy that they bring to transform Aegon into a more focused, high-performance company. The first quarter of 2021 saw a 20% increase in the operating result to EUR 431 million, driven by improvements in the United States, the Netherlands and Asset Management. So far, we have reduced the addressable expense base across the group by EUR 136 million and are on track to deliver half of our 2023 target of EUR 400 million expense savings by the end of 2021. Our balance sheet remains strong with the capital ratios of all 3 main units and the holding around or above their operating levels. We have made steady progress managing our financial assets during the first quarter. In our U.S. business, we reduced the sensitivity of our variable annuities business to interest rates and so far have achieved 1/3 of the targeted long-term care rate increases. In our strategic assets, we continue to invest in new products, product distribution and customer service. In the first quarter, we gained momentum from improved sales performance in each of our core markets. A good example is in the U.S. Individual Solutions business, where we grew the number of licensed agents in our main distribution channel by 18% and saw increases in our market share there as a consequence of new product introductions. We've also taken concrete actions to improve our risk profit, already executing more than half of our plan to reduce interest rate risk in the United States. Furthermore, we took advantage of higher interest rates by implementing a new macro interest rate hedge. This is an important step towards expanding the dynamic hedge to our legacy variable annuity block in the United States. We have also further increased our strategic focus by divesting Transamerica Venture Fund and closing the sale of Stonebridge. We are working together with the Vienna Insurance Group to close the divestment of our businesses in Central and Eastern Europe. As disclosed earlier, the Hungarian Minister of the Interior united the intended acquisition by VIG as a foreign investor of the Aegon companies in Hungary on April 6 of this year. Based on VIG's statements, we remain confident that the current situation will be resolved positively in the near future. Let me now give you an overview of where we stand with the execution of our operating plan on Slide 3. Our ambitious plan comprises over 1,100 detailed initiatives designed to improve our operating performance by reducing costs, expanding margins and growing profitability. I personally chair weekly meetings with my management team to track the progress on these initiatives to ensure that we give a good pace and to remove any potential impediments to achieving our targets. In the first quarter of 2021, we completed another 160 initiatives, bringing the total to over 400. This means that 35% of all initiatives have now been fully implemented. That gives us confidence in the contribution from these expense savings and growth initiatives to our results in the coming months. Expense initiatives helped to drive down expenses by EUR 136 million, which is already about 1/3 of the 2023 expense target. The contribution from growth initiatives is still relatively small, but we expect this to build up over time. We will continue to rapid pace an intense organizational rhythm throughout the year, building on these first successes. Let's now turn to Slide #4 to discuss the progress we've made in respect of our strategic assets. Our priority here is to grow the customer base and expand our margins. In the U.S. Individual Solutions business, we have the ambition to regain a top 5 position in selective life products over the coming years. In the first quarter, we saw good momentum, resulting in a 27% increase in new life sales. Our market share in Transamerica main distribution channel, World Financial Group, or WFG, increased significantly following the addition of a new funeral planning benefit. In addition, the number of WFG licensed agents grew by 18%. Volume growth, a more favorable product mix and lower expenses resulted in an 88% increase in the value of new business. In the U.S. retirement business, Transamerica aims to compete as a top 5 player in the new middle-market sales. Transamerica is leveraging its strength in pool plan arrangements as attractive propositions for the middle market, and we see the momentum is building here with written sales increasing by 27% compared to the same quarter last year. Net deposits also turned positive in this market segment following targeted campaigns with our existing adviser network. Our Dutch strategic assets performed well, as you can see on Slide #5. We are market leaders in both mortgage origination and defined contribution pensions, and we gained momentum in the first quarter. We originated EUR 3 billion mortgages, benefiting from a strong housing market and increased demand for mortgage refinancing in the current interest rate environment. In our defined contribution pension business, we grew net deposits by 14%. We have a competitive offering in this space, thanks to the scale of our administration subsidiary, TKP and our leading asset management solutions. And lastly, our online bank Knab that we want to develop into a digital gateway for individual retirement solutions added another 11,000 customers. In the United Kingdom, our aim is to grow in the retail and workplace channels. In both channels, we had a number of notable proposition enhancements in recent months that have supported the positive development in net deposits. Market movements and expense savings have helped to further improve the efficiency of the platform. By growing the platform business and taking out expenses, we aim to mitigate the top line impacts from the gradual runoff of the traditional portfolio, which is the driver behind the revenues lost from net deposits for the quarter. Let me now turn to our global asset manager and our growth markets on Slide #6. In our Asset Management business, we have a long-standing track record of third-party net deposits from our strategic partnerships and global platforms. Net deposits and strategic partnerships were again strongly positive at EUR 3 billion for the quarter, driven by our joint venture in China. Increased performance fees and management fees from growth of the business led to a doubling of the operating result for the quarter to EUR 62 million. In our global platforms, third-party net flows were also positive, driven by strong deposits on the fixed income platform. The operating margin for global platforms increased by 4 percentage points, which was not only supported by net deposits, but also by expense savings initiatives. For instance, we migrated the administration of our fiduciary business from a dedicated platform to existing systems used in other parts of our business. We continue to invest in profitable growth in our growth markets, Spain and Portugal, Brazil and China. The new business value from new life sales increased by 23% despite lower sales in the bank channel. This was driven by a more favorable business mix in China. New non-life premium production in our businesses in Spain and Portugal increased as a result of new products launch. So in summary, we've made early progress in improving our performance and growth across our strategic assets. We will continue to drive efficiencies, while at the same time investing in products and services to our customers in the various core businesses. And with this, I would like to hand over to Matt Rider. Matt, over to you.
Thank you, Lard, and good morning, everyone. On the next several pages, I will take you through the highlights of our first quarter 2021 results. our capital position and the recent progress we have made in managing our financial assets. Let me start with the financials. Expense initiatives have so far delivered EUR 136 million of savings, together with higher equity markets, this drove the increase of our operating result by 20% to EUR 431 million. Our balance sheet remains strong with the capital positions of all 3 of our main units and for the group around or above their operating levels. Our gross financial leverage stood at EUR 6.1 billion at the end of the quarter, and we remain on track to achieve our 2023 deleveraging target. This capital position provides us with financial flexibility to execute on our transformation and navigate through the COVID-19 pandemic. One of our priorities is to reduce the economic interest rate exposure of our U.S. business by 1/3 to 1/2. We have now executed more than half of the actions of the interest rate risk management plan that we announced at the Capital Markets Day, primarily by lengthening the duration of our asset portfolio. Furthermore, we took advantage of higher interest rates by implementing a new macro interest rate hedge. This is an important step toward expanding the dynamic hedge to our legacy variable annuity block in the United States. During the remainder of this year, we plan to take additional actions to reduce our exposure to interest rates. I will come back on this in more detail later in this presentation. Let me turn to Slide 9 to go into more detail on the expense savings. At our Capital Markets Day, we announced our plan to reduce addressable expenses by EUR 400 million. In the last 4 quarters, we reduced addressable expenses by EUR 203 million compared with 2019. EUR 136 million of these savings are driven by the expense initiatives as part of our operational improvement plan. We will continue to execute on this plan and are confident that we will achieve half of the targeted savings by the end of this year. Expenses in the quarter again benefited from lower travel and marketing activities due to the impact of the COVID-19 pandemic. We expect these expense reductions to reverse as vaccines are being rolled out and restrictions are gradually lifted in the countries in which we operate. Turning to Slide 10, you will see that these expense savings, together with favorable equity markets were an important driver behind the increase in our operating results. In the first quarter of 2021, our operating result amounted to EUR 431 million, an increase of 20% compared to the same period last year. In fact, the apples-to-apples increase is 32% at constant currencies and when adjusting for the reclassification of the result for Central and Eastern Europe from operating results to other income. As I indicated, the operating result benefited from lower expenses and higher equity markets. These led to growth of fee revenue, mainly in variable annuities and in the retirement plans businesses in the United States. Improved investment margins in the Netherlands also contributed to higher earnings. This reflects an increased allocation to corporate bonds and lower interest credit. In the United States, COVID-19 obviously had an impact on our claims experience. In the life business, we experienced EUR 138 million of adverse mortality relative to our long-term expectations. 2/3 of this was directly attributable to COVID-19 as the cause of death. We believe that the remaining adverse mortality experience is also mostly related to the pandemic. This was partly offset by EUR 65 million better-than-expected morbidity experience in the long-term care book. This is net of additions to the IBNR reserves. We have established these as we expect claims to be reported once the concerns of our policyholders with respect to assisted living facilities subside. In the U.K., the operating result declined by 11% to EUR 39 million, driven by a lower result from our protection and distribution businesses. Fee revenues were broadly stable as the favorable impact from higher equity markets was offset by net outflows in recent quarters. The decrease of the operating result in international of EUR 21 million is mainly caused by the reclassification of the result from our operations in Central and Eastern Europe to other income. On an apples-to-apples basis and at constant currencies, the operating result decreased by 6%. Business growth and improved claims experienced in Spain and Portugal and China were more than offset by a lower result from businesses that are not part of our core perimeter, including TOB. Finally, the operating result from asset management nearly doubled to EUR 75 million. This was mostly driven by the strong performance of Aegon's Chinese asset management joint venture, where performance fees, net of performance-based compensation contributed EUR 32 million. The operating result of the global platforms increased as well, mainly because of higher revenues from net deposits and favorable market movements. Let us turn from operating results to net result on the next slide. As you can see on Slide 11, Aegon reported a net result of EUR 386 million for the first quarter of 2021, a result broadly in line with the operating result after tax. Nonoperating items contributed a gain of EUR 50 million. Fair value gains amounted to EUR 3 million as losses on hedge programs due to higher equity markets and interest rates were offset by a reduction in the liability adequacy test deficit in the Netherlands. In the current low interest rate environment, we realized EUR 31 million gains on investments from normal trading activity. Once again, impairments on our bond portfolio remained very low and recoveries on investments, including the unsecured loan portfolio in the Netherlands and corporate credits in the Americas led to net recoveries of EUR 16 million. However, we remain cautious on the outlook for credit markets given the uncertainty around the potential short-term effects from reduced government support for the economy as well as on the potential long-term impacts from the pandemic. Other income amounted to EUR 1 million, largely driven by the favorable impacts from an update of inflation assumptions in the Netherlands and a onetime gain in the Americas related to the sale of an individual retirement account portfolio, offset by onetime investments related to the operational improvement plan and IFRS 9 and 17 project costs. I'm now turning to Slide 12 to go through the capital position of our main units. The capital ratios of our 3 main units are around or above their operating levels. The U.S. RBC ratio decreased by 4 percentage points since the end of last year. Market impacts had a slight negative impact on the RBC ratio. Higher equity markets and significantly higher interest rates, both of which are economically good for us, led to flooring on part of our variable annuity reserves. Flooring prevents reserves from going below 0 in case of favorable market conditions. The way to think about this is that reserve flooring leads to an additional buffer. This either serves to absorb future shocks or it gets released over time as capital generation. In addition, dividend payments to the intermediate holding company used for tax payments reduced the RBC ratio by 8 percentage points. We expect the remittance from the U.S. to the group in the second quarter. Operating capital generation had a positive impact despite being impacted by adverse mortality. In the Netherlands, the Solvency II ratio of the Dutch Life unit decreased by 10 percentage points to 149%, which is around the operating level of 150%. The decline resulted mainly from the reduction of the ultimate forward rate by 15 basis points as well as by rising interest rates and in particular, a steepening of the yield curve. This is a reflection of the fact that Aegon hedges on an economic basis. We expect to earn this reduction in the ratio back within 6 years through higher capital generation as a result of lower UFR drag. Operating capital generation was offset by a EUR 25 million remittance to the group in the first quarter. In the U.K., our main legal entity, Scottish Equitable increased its capital ratio to 158%. The increase was primarily driven by both operating capital generation and by management actions to reduce financial market risk. These positive impacts more than offset the impact of remittances to the intermediate holding company, which will be used in part to fund onetime investments as part of the operational improvement plan. Let us now turn to the development of cash capital at holding on the next slide. Cash capital at holding increased during the quarter driven by remittances from our units. Next to the regular quarterly remittances from the Dutch Life unit, we received remittances from Aegon International and our businesses in the United States and in the U.K. Total remittances in the first and third quarters of the year tend to be somewhat lower than other quarters as Transamerica pays the bulk of its remittances to the group in 2Q and 4Q. After holding and funding and operating expenses, this results in free cash flows of EUR 75 million. Proceeds from the divestment of Stonebridge were more than offset by capital injections of EUR 50 million, mainly to fund onetime investments related to our operational improvement plan. Cash capital at holding closed the quarter at EUR 1.2 billion, which is in the upper half of the operating range and provides the group sufficient financial flexibility. We expect to manage cash capital at the holding to the top half of the operating range in the near term, considering the current risks in the macro-environment. The ongoing restructuring of our business and in recognition of our targets. Let me now turn to our financial assets, starting with the U.S. variable annuities business on Slide 14. As of the end of March, we have stopped selling variable annuities with significant interest rate sensitive living and death benefit riders. Transamerica will continue to serve the retirement needs of individuals with products like accumulation variable annuities that have limited interest rate sensitivity. To this end, the company recently launched a new product that offers customers protection of their principal investment with upside potential of investment growth. Additionally, we have taken advantage of the higher interest rates in the first quarter and have put in place a macro interest rate hedge as a transition measure toward a potential full dynamic hedge of the legacy variable annuity book. This hedge covers part of Aegon's remaining economic interest rate exposure, representing approximately 1/3 of the interest rate exposure associated with the legacy variable annuity block with income and debt benefit riders. This measure will mitigate the potential capital impact from the expansion of Aegon's dynamic hedge to the legacy variable annuity block if interest rates were to decline from the levels at the end of March. We are making good progress on the expansion of the Dynamic hedge, and we'll provide an update on the planned implementation of the second quarter 2021 results. We also progressed well on our long-term care book, which is now closed for new individual stand-alone policies. To date, we have received approval for rate increases with net present value of USD 112 million or 37% of the targeted amount of USD 300 million. The rate increase program is a multiyear program, and we expect a more moderate speed on obtaining approvals from here. Long-term care claims for the first quarter came in at an actual-to-expected ratio of 43% as a result of higher mortality and discharges from long-term care facilities. Given the successful rollout of the vaccine program in the U.S., we expect new long-term care claims to reverse to normal levels over time. Let me now turn to Slide 16. Our aim for the Dutch Life business is to turn it into a low-risk cash generator paying predictable regular dividends. A newly established team is actively managing capital and risk exposures to achieve this. Our Dutch Life business remitted EUR 25 million to the group for the second quarter in a row. This remittance is in line with its quarterly operating capital generation. The Solvency II capital ratio of the Dutch Life business has decreased by 10 percentage points this quarter, largely the result of the annual reduction of the ultimate forward rate by 15 basis points and from the impact of increasing interest rates and in particular, curve steepening. These movements were in line with sensitivities and will lead to higher capital generation in the future. To summarize, we are progressing to maximize the value of our financial assets. Next to getting further approvals for long-term care rate increases and the expansion of our dynamic hedging program for the legacy variable annuity block will be central in the coming months. Throughout our transformation, we will maintain a strong capital position in our main units and at the holding. Furthermore, we expect to deliver on our commitment to reduce financial leverage by another EUR 200 million before the end of 2021. With that, I pass it back to you, Lard for the wrap-up.
Thank you, Matt. I would like you to take away from today's presentation that we have made early progress on our plans to transform Aegon. We have increased our operating result by 20% to EUR 431 million. We are executing on our operational improvement plan and are intensifying the organizational rhythm. We are on track to deliver on our expense savings target. We have significantly reduced our interest rate risk, and we'll take more steps later this year. We have made steady progress on optimizing our financial assets, including achieving the rate increases in long-term care. We continue to invest in new products, product distribution and customer service in our strategic assets, and we have further increased our strategic focus through the divestment of noncore businesses. Lastly, we are working together with the Vienna Insurance Group to close the divestment of our businesses in Central and Eastern Europe. In summary, I'm pleased with the results we announced today and how well we are progressing in our strategic commitments and financial targets, but the journey has only just begun. We will continue to drive our transformation and increase our speed of execution, and we will do that in a rational and disciplined way. Looking to the future, I'm confident in the strength of our business, our strategy and the unwavering commitment of our employees to continue delivering on our plans. I would now like to open the call for your questions. And in the interest of time, I kindly request you to limit yourself to 2 questions. So operator, please open the Q&A.
[Operator Instructions] And we will take our first question from Andrew Baker with Citi.
So yes, so 2 for me. Are you just able to provide a quick update on the outlook for both mortality and morbidity for the rest of the year. And then just on the CEE disposal, if it is a drawn-out close process, does this have any implications on any of your usage of cash and your plans around that? And more specifically, your debt reduction plans for even your 2023 dividend step change.
So Matt, can you take the update on mortality and morbidity. And on VIG, yes, as you know, VIG is in the lead to obtain the required regulatory approvals to close the transaction in CEE. And obviously, we're supporting them with their efforts. They have run into an issue in Hungary. And they have -- they told us that, and they are in discussions with the Hungarian government and they hope to resolve the situation positively -- expect actually to resolve the situation positively in the near future.
On the mortality and morbidity, just to give us a little bit of a baseline. So for the first quarter, we had about EUR 138 million of adverse mortality and that was offset by approximately 50%. We had $65 million better morbidity in the long-term care book. What we're seeing is, I think we had given some guidance before that we would expect to see about a $50 million per year impact for 100,000 additional COVID deaths. What we're forecasting now, so we think that, that sensitivity still holds to $50 million per 100,000 deaths. So we're -- right now, we're expecting in the second quarter about 75,000 U.S. population deaths declining to about 25,000 population deaths in the third quarter.
And we take our next question from Michael Huttner with Berenberg.
I had 2 questions. One is the IBNR and long-term care. I didn't understand that effort. It sounded like extra reserving, but I'm not sure. And then the other thing, you said remittances from the U.S. in Q2. And I just wondered if you could give us a figure.
Matt, can you take both of them, please?
Sure. On the IBNR, what we're seeing is that people are not going into long-term care facilities. So they're afraid of contracting COVID. So there's probably a kind of a pent-up demand for this. So we are establishing an IBNR because at some moment in time, we are going to see an acceleration of people going into long-term care facilities. So it is a bit additional reserving, like the current reserve stands at $59 million, but we would expect that to be released as people go into the long-term care facilities. For the U.S. remittances, we don't specifically say anything about the individual countries, but what we are guiding for, for 2021 is the same thing that we had talked about at the Capital Markets Day, which is somewhere between EUR 600 million and EUR 700 million for the full year.
And we take our next question from Colm Kelly with UBS.
And just a question on the capital generation. It was in line with expectations today and on track versus the 2021 guidance, but I suppose, given the strength of the progress on the operating plan, given higher reinvestment yields in 1Q, there's some thought that, that should have been maybe a bit better, a bit higher in a similar way that the earnings was better than expected. So can you just take me through why we haven't seen maybe a better uplift in terms of capital generation in 1Q in that context? Second question, can you just update on U.S. reinvestment yields for 1Q, how that compares with the -- in the CMD plan? And if it remains at the current levels, what impact are you expecting it would have for 2021 capital generation? Those are the 2 questions.
Matt?
So on the first point on the capital generation, I would just remind you that capital generation is typically a little bit lower in the first quarter due to seasonality than it is in the rest of the year. But what we had seen was -- so we don't normalize for everything. So you do see the impact of the adverse mortality coming through the normalized capital generation or the operating capital generation in the first quarter. But the other one is a problem that we actually like to have, which is hire new business strain coming out of the U.S., which is going to result in higher capital generation in the future. For the -- let's say, let's stick to the U.S. in terms of investment yields. For the first quarter, new money yields were at 2.9% and the back book yield was at 4.21%. So we had seen a modest uptick in the new money yield from the fourth quarter given the rise in interest rates. But as we'll see, we are going to see capital generation go up as a consequence of the rising rates, and that comes through, I think, in the presentation quite well.
Okay. And maybe just one follow-up. I mean you have a very useful slide indicating 35% of the initiatives in the operating plan have been executed. In terms of the financial impact within capital generation, do you have an estimate of what proportion you think has flowed through or has been already realized within capital generation?
Yes. I would say -- so it was total addressable expenses down $203 million for the whole thing. That's not a 4-quarter rolling average, I would say, perhaps 25% of the $136 million.
[Operator Instructions] We take our next question from Ashik Musaddi with JPMorgan.
Just a couple of questions. Actually, going back to the previous question again. When we think about capital generation for the year, I mean, your guidance is $800 million to $900 million, if I remember correctly. But on top of that, the way I think is -- I mean, credit losses are more or less 0. So that should have added reasonably plus the investment income would be higher as well based on your expectations plus the -- you're running ahead in terms of your cost saving as well. So EUR 800 million to EUR 900 million could go up a bit stronger than expectations. You mentioned that first quarter was impacted by mortality losses and typically, there is a bit of seasonality. So is there any possibility you can give some color about seasonality and the excess mortality in the capital valuation number so that we can think about what the normal run rate for a quarter could be and how we need to think about the full year? So that's one. And secondly, in terms of the interest rate hedges that you have done, I mean, what is the economics of that? What is the drag in terms of capital or capital generation? I mean, are all those embedded in the numbers in your planning? Or is there any additional positive or negative that we should be thinking in the future?
So I can take the first one on the, let's say, a normal run rate for the operational cash or capital generation. If you look at the quarter, we did about EUR 220 million of capital generation after holding in funding expenses. So if you add back the holding and funding expenses, that puts you at about $290 million before holding and funding expenses. Now if you add back the core claims experience in the first quarter, that gets you to about EUR 360 million of, let's say, a run rate clean quarter capital generation. And I think from that, you can deduce the fact that we are having that you can work through the numbers yourself, but it implies for the full year, something like $1.4 billion of operating cash flow generation for the year. Now I would remind you that operating cash flow generation is not equal to free cash flow. So importantly, we do have to be -- so we are running ahead of our expectations on operating capital generation. But we do still see some risk in terms of the credit markets, and we still do see some risk in terms of the COVID-19 development on mortality. So we still want to be, let's say, cautious with respect to our guidance on this. And I would just remind you at the Capital Markets Day, we guided for $1.1 billion on a similar basis. So I think, again, we're running ahead of our expectations, which is good, but we also want to be a bit cautious given the uncertainty in the financial markets and with respect to COVID-19. Now on the interest rate hedges, maybe let's divide it into 2 pieces. So the first piece is, you'll remember on the Capital Markets Day that we had an ambition to reduce our interest rate exposure in the U.S. by 1/3 to 1/2. And at this point in time, we have delivered approximately about 50% of those actions. Those were largely in the general account. Now in addition to that, we have the -- we've introduced a new interest rate hedge in the U.S. that relates to the variable annuity book of business. This is where we have taken approximately 1/3 of the interest rate risk for that VA business off the table. This is in, let's say, in preparation for implementing a full dynamic hedge. The cost of that -- the cost -- because we're using linear instruments, basically, the cost of the interest -- the additional interest rate hedge is 0, but we do see the volatility of that number that will come through our capital. So it's not so much of a capital generation thing. You see it more reflected in the sensitivities of the RBC ratio to equity markets and interest rates. Let me leave it there.
I mean just a quick follow-up on that. Actually, it's a request. I mean it would be great if we can cover up the interest rate risk in future in a session or something so that we understand where is the risk, what you're doing and what are the interest rate risks remaining in the balance sheet? Because clearly, I mean, you are progressing, but the problem is we are not able to see that in terms of numbers because sensitivity may not be the right way of looking at economics. So any help in the future on interest rate-related exposure risk hedges, et cetera, would help a lot. Just as a thought.
That's an entirely fair request, and we will come back when we do the second quarter results and our progress on implementing the dynamic program in the U.S., and that will be part of them.
And we take our next question from Fulin Liang with Morgan Stanley.
And I have 2 questions. So first one is actually coming back to that interest rate hedge. So you took on the macro interest rate hedge. I think the -- when you put on the hedge, the U.S. 10-year was 1.65% roughly. And does that mean that you -- I understand that as you essentially locked in that 1.65% for 1/3 of your VA book? But if I look at your ultimate, like so-called U.S. 10-year assumption at the end of the pack, you said you have ultimate U.S. 10-year assumption of 2.75 in 10 years' time. Does that mean actually when you're locked in a rate, which is actually lower than this 2.75, it will be reflected in your Q3 assumption review somehow and somehow flow reduce some of the economics? Is that the right way to understand it or the dynamics of these 2 assumptions? And then secondly is just one small confirmation. So you set up the IBNR for LTC and of the benefit we reported this quarter plus the previous quarter as well, that is already net of the so called IBNR reserves, right? So we shouldn't -- so basically, you're already based in the pent-up demands on the LTC in the number -- in the benefit to report it. So we shouldn't expect some reverse of this benefit to reserves going forward. Is that right?
So on the first point, there is a difference between the, let's say, the statutory treatment of that interest rate macro hedge from that long-term rate assumption. That long-term rate assumption that we have, Fulin, is strictly related to IFRS. So the interest rate macro hedge doesn't -- it doesn't -- it's sort of an apples-to-oranges comparison. The only place that you're going to be seeing the results of that macro hedge is going to be in market volatility. So you have it exactly right. We executed the trades at approximately with a tenure of 1.65% and to the extent that markets move around there, then we're either going to be reporting IFRS gains if interest rates decline or IFRS losses if they increase. But the main reason for this, of course, is that we do it in the -- that we do it for capital management purposes. Now on the IBNR point, yes, indeed. So we have a low actual-to-expected ratio now for long-term care morbidity. And really, this is relating mostly to the mortality side, not so much in terms of people entering long-term care facilities. So I would expect that -- so that amount that we have now on the balance sheet, the USD 59 million IBNR, we would expect to release that to the extent that we see additional entries into long-term care facilities that are running above our long-term expectations. So we would expect to release that as we come out of the pandemic.
[Operator Instructions] And we take our next question from Farooq Hanif with Crédit Suisse.
On the macro hedge, you seem to be implying that it's obviously a stepping stone to a full dynamic hedge. So my question is, firstly, are you implying that the RBC impact of moving to 4 dynamic hedge now is more limited? And secondly, are you now quite clear because you were thinking about what approach to use for dynamic hedge. Are you clear now -- more clear about the structure of that hedge, therefore, does that imply this is going to happen quite quickly.
So maybe to correct one thing. You had mentioned that the -- we're talking about putting 1/3 of an interest rate macro hedge on implying that it's a stepping stone to fully dynamic hedging. We're not implying we're saying. So we are going to be moving to a dynamic hedging strategy, and this is indeed an important step to be able to get there. Again, we were able to lock in interest rates when we saw them rise in the first quarter. It's a little bit too early to tell you about structure and implications of the dynamic hedge. But we are going to come back at the second quarter and be able to update you on now.
But you can confirm -- I mean, you do say in the presentation that it limits the impact of moving to dynamic hedge. You do not say that. I just want to be clear about what that meant.
It -- ultimately, when we do move to a dynamic hedge, you will not see that, let's say, the capital sensitivity asymmetry to equity markets and interest rates, it will be somewhat muted. But we'll come back with additional information in 2Q.
And we take our next question from Robin van den Broek with Mediobanca.
Just one question last from me is on the reserve flooring that you seem to introduce this quarter. Can you just explain the reason behind the dynamics and potentially also the reduced volatility when we see reversal of raised equity markets and interest rate.
Sure. I guess the first thing I would say is that this concept of reserve flooring is -- it's new to people, but it is a bit of a luxury position to be in. And the reason is that effectively, if you look at reserving for guaranteed benefits and VA portfolios, to the extent that you see rising equity markets and rising interest rates, those would actually imply that reserves should turn negative. Now you're not allowed to do that under statutory reserving and accounting. So effectively, you're flooring the reserve at 0. What does that mean? Well, it really means that you're building a bit of a buffer to the extent that you do see rises in interest rates and equity markets. You're going to build a bit of a buffer to -- in the case where you have lower equity markets. You can see and if you look carefully at the sensitivities, I think in the last quarter, our sensitivity to down equity markets at 25% shock was 34 percentage points on the RBC ratio. Now it's 32%. And the reason for that is that we are starting indeed to build a little bit of a buffer there. So you can think of that buffer as either a buffer against future negative implications in the markets or if markets stay at those kind of levels, then that gets released as additional capital generation over time. So really, this is -- as I say, it's a luxury issue, even though the equity sensitivity looks a little bit funny in an upmarket situation, it really does improve capital generation over time and protect you fundamentally in the RBC ratio against the future equity market declines.
Thank you. That concludes today's Q&A session. I would now like to turn the call back over to our host today for any additional or closing remarks.
Thank you, everyone. This concludes Aegon's first quarter 2021. Thank you.
Thank you. Bye-bye.