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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to American Equity Investment Life Holding Company's Third Quarter 2020 Conference Call. At this time for opening remarks and introductions, I would like to turn the call over to Julie LaFollette, Coordinator for Investor Relations.
Good morning and welcome to American Equity Investment Life Holding Company's conference call to discuss third quarter 2020 earnings. Earnings release and financial supplement can be found on our website at www.american-equity.com. Non-GAAP financial measures discussed on today's call and reconciliations of non-GAAP financial measures to the most comparable GAAP measures can be found in those documents. Presenting on today's call are Anant Bhalla, Chief Executive Officer; and Ted Johnson, Chief Financial Officer. Some of the comments made during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. There are a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Factors that cause the actual results to differ materially are discussed in detail in our most recent filings with the SEC. An audio replay will be made available on our website shortly after today's call. It is now my pleasure to introduce Anant Bhalla.
Thank you, Julie. Good morning and thank you for your interest in American Equity. We remain steadfast in our focus on shareholder value and vigilant about the realization of value. Given the events of this month, including our Board of Director's unanimous rejection of an unsolicited opportunistic offer that significantly undervalued the company. I think it is important to spend some time outlining three themes on today's call. First, earlier this week, we posted a video with a slide outlining our new business plan which is dumped AEL 2.0. It highlights the recent commercial business arrangements with Brookfield Asset Management as a significant acceleration of our organic plan. I will take some time today to outline the key elements of that strategy. Second, I know this is a historic low point in terms of valuation for the life sector, and therefore the earlier of an all-cash potential offer even if opportunistic maybe compelling as a near-term trade for some investors. However, after following a very diligent and well-advised process, focusing on our fiduciary responsibilities, American Equity's Board concluded that the risk-adjusted intrinsic value of the company's organic business plan is significantly greater. To further emphasize this point today I intend to outline financial targets starting in 2021 to provide a sense of value that will be realized through the continued execution and scaling of AEL 2.0. Third, we'll cover the results for the third quarter. The third quarter of each year tends to be the time when AEL and the majority of the life insurance industry unlock actuarial models and assumptions. This refresh impacts balance sheet valuation and the trajectory of future financial results. Given the unprecedented drop in interest rates this year and expected continuation of macroeconomic uncertainty we believe it is prudent to swiftly move ahead and reflect the possibility of a sustained low-interest-rate environment for the foreseeable future as a new reality. While Ted will walk you through the details and impacts I would like to highlight that going forward we assume that the current low-interest-rate environment is sustained and rates rise only modestly over the next 8 years with the 10-year U.S. Treasury rate eventually rising from approximately 70 basis points as of September 30 of this year to 190 basis points over 8 years and remain under 200 basis points going forward. With that context let me get into the details of AEL 2.0, a strategic plan that specifically geared to this type of interest rate environment. We are extremely excited to share our plan going forward. For those who have been tracking us closely. Thank you for your patience as you may get some repetition from other previously made comments. We began to implement our strategy in June of this year after undertaking a thorough review of our current business, market dynamics, and the interest rate environment. Our strategy focuses on four key pillars; go to market, investment management, capital structure, and foundational capability. Let me elaborate on the key aspects of each of these pillars. Go to market. This area of focus is on how we raise long-term client assets through annuity product sales. We consider our marketing capabilities and franchise to be a core competitive strength. The liabilities we originate result in stable long-term attractive funding which is invested to earn a spread and return above the prudent level of risk capital. We have become a leading and proven player in the Independent Marketing Organization or IMO channel over our 25-year history and can tap into a core set of loyal, independent producers to originate new funding year in and year out. We are especially focused on growing the loyal producers with $1 million of greater deposits each year. The IMO market is dominated by the top 10 wholesaling organizations controlling around 90% of the $35 billion to $40 billion per year market. We want to deepen our share of wallet with these wholesaling organizations that actually call on the producers, and we also want to accelerate our expansion into the bank and broker-dealer distribution channel, through our Eagle Life subsidiary. Our strategy is to improve sales execution and enhance producer loyalty with product solutions-driven focusing marketing campaigns, distribution analytics to enhance both sales productivity and producer engagement, and new client or prospect engagement models like digital that complement traditional physical face-to-face interactions. The financial objectives of our go-to-market strategy are to accelerate growth of new business and annuity funding origination in normal economic environments to levels that far surpassed our past peak sales levels and reducing cost of funds from approximately 3.5% to below 3% over time. For clarity let me elaborate on the term cost of fund. Cost of fund is a product economics term which reflects the total cost of originating the annuity funding or liability, including both the cost of money paid to the client and additional expenses like the cost of distribution and operating expenses of the insurance company. Investment management enables the return on assets to generate an adequate spread above our attractive low-cost funding. Put simply, while we seek to reduce the cost of funds on liabilities we simultaneously want to achieve a higher return on assets, thereby increasing the spread that is on. In an environment where risk-free rates are between 0% to 1% insurer need to invest for better risk-adjusted yield than what is available in traditional fixed income securities. The key to our asset strategy is to discover opportunities to invest in outflow producing specialty sub-sectors with contractually strong cash flows like real estate and infrastructure. One reason that we are so pleased with our partnership with Brookfield is because they are viewed as leaders in real estate and infrastructure investing. We have also been expanding our repertoire of asset classes to residential and agricultural loans as well as other privately sourced sectors in order to have new money yields that de-couple from pure spread to treasury and earn a 4% or higher risk-adjusted yield. The string of pearl's investment management strategy will see AEL from partnerships in which each pearl will provide unique access to a specific asset sector, resulting in a sustainable supply of quality alternatives to traditional fixed-income securities. This will result in solid spread earnings ROEs and growth even in a sustained low-interest-rate environment. AEL is approaching investment management partnerships, not as a simple vendor relationship but as a potential joint venture all taking equity interests in certain existing acted sourcing platforms. Making these minority investments will help create greater alignment across the insurance and asset management value chain and enable us to participate in the economics from scaling of the platform beyond our own initial investment mandate. Given the negligible allocation in our $50 plus billion dollar insurance general account to common equity, hedge fund or private equity investments we believe investing approximately 1% of our general account assets in asset origination platforms offers a significant upside for AEL. We continue to be in active dialog with multiple originators of privately sourced assets including specialty finance company and asset managers in order to build out our string of pearl's asset strategy. These discussions are at different stages of development and you can expect us to announce exciting new partnerships on a periodic basis. You may recall from our second quarter earnings call. I highlighted that AEL has started to so non-qualified mortgages from Pretium Partners which is enable both American Equity Life and Eagle Life to launch incredibly attractive single premium deferred annuity or SPDA products. Over the next year or two, we expect to originate between $1 billion to $2.25 billion of assets from Pretium. We have just finalized a $100 million of growth capital investment in Pretium from our general account, as Pretium grows its platform and $16 billion of assets under management over time we will participate in its earnings growth. I look forward to partnering with Don Mullen's and team in bringing Pretium into our string of pearl strategy. This demonstrates in action how AEL 2.0 is building the virtuous flywheel that expands the power of our new annuity origination platform. Capital structure. The goal of our capital structure improvement plan is to make greater use of reinsurance enabling AEL to free up capital and become a more capital-light company. Reinsurance allows for the transfer of liabilities to a jurisdiction with a principles-based reserve and capital regime, a key element of our recently announced partnership with Varde and Brookfield is the reinsurance of $5 billion of in-force reserves to each entity. These reinsurance transaction enable us to level the playing field with several key competitors who are domiciled in favorable regimes. Over time, we will set up our own reinsurer backed 100% with our own capital to maximize asset-liability management or ALM efficiency. Further, we will look to bring in third-party capital into our reinsurance vehicle, commonly known as sidecars to turn a spread business with our own capital at risk, that it is a ROE business into a more fee-like business back with externally source capital, something we described as an ROA or return on asset business. Our last pillar is foundational capabilities and its focus on upgrading our operating platform to enhance the digital customer experience, create differentiation through data analytics, enhanced core technology, and align talent. New investments in this area are likely to be fully self-funded through operating expense savings or capital generated through the financial benefits realized by executing the other three pillars. The virtuous flywheel of the AEL 2.0 strategy builds on an industry-leading at scale annuity origination platform. Adding in differentiated investment management capability attracts third-party capital to the business. Leveraging this capital will transform AEL into a more capital-light business as well as diversify earnings stream. The combination of differentiated investment strategy and increased capital efficiency improves annuity product competitiveness, thereby enhancing new business growth potential and further strengthening the operating platform. AEL's recent partnership with Brookfield is a clear demonstration of this flywheel in action converting a spread business into a 90 basis points per year fee like earnings stream for 7 years. That is capital-light return on assets or ROA oriented as a business model, we believe that in a sustained low-interest-rate environment. It is imperative to switch the nature of our business from a historically capital intensive spread earnings business to a capital-light, fee-based business. This strategy successfully differentiates our business going forward and transforms it to increase shareholder cash distribution and ROE. This brings us to the second theme for today which is a targets that measure success and realization of shareholder value. We believe AEL 2.0 will be both a growth and capital return story. We intend to execute against the following targets. The first being capital return. We expect to annually return $250 million to $300 million of capital to shareholders through migration to a capital-light model releasing earnings to shareholders in lieu of retaining earnings to fund future growth in assets. Given the acceleration of AEL 2.0 business plan, we expect this to start in 2021. Second, return on equity. We expect to target operating return on equity or ROE in the 11% to 14% range over the next few years and above 15% on average over the long-term. Now turning to results for the third quarter. Gross sales of $574 million increased 3% compared to the second quarter of 2020 primarily driven by increased multi-year fixed-rate annuity sales at Eagle Life. We are starting to turnaround the sales battleship with new product introductions and engaging with distributors in new ways, despite the self-imposed limitations on face-to-face interaction with the fields during the current pandemic situation. In the quarter, we refreshed the income shield product making it very competitive. In September we introduced Eagle Guarantee Focus, a new single premium deferred annuity series at Eagle Life. We had 3 and 5-year products and our top 3 for crediting rates in the marketplace. At American Equity Life we introduced a similar product line a few weeks ago called the GuaranteeShield series. Our 3-year product over here is number 2 for crediting rates in the independent agent market, and we are already seeing strong application flow. As I previously mentioned, our new residential mortgage loan program fits well with the shorter duration products, once again showing the flywheel in action. In the third quarter, pending applications average 1,083 at American Equity Life and currently stand at 1,625. Pending average 104 applications at Eagle and currently stand at 975 driven by the new SPDA and FIA sales. For the quarter we reported net income of $661 million or $7.17 per diluted common share and a non-GAAP operating loss of $250 million or $2.72 per diluted common share. Both net income and operating income are significantly affected by the annual actuarial review. Ted will walk you through the effect of the annual actuarial review on operating results shortly. We ended the quarter with a book value per share excluding accumulated other comprehensive income or AOCI with and without the net impact of accounting for fair value of derivative and embedded derivatives of $35.97 or just shy of $36 and $33.39 respectively. Over time, we expect our AEL 2.0 business plan to deliver on financial metrics outlined, adjusted for here and all else being equal to grow book value per share. With that, I'll now turn the call over to Ted.
Thank you, Anant. Excluding actuarial assumption updates, operating income was $91 million or $0.99 per share for the third quarter of 2020 compared to $109 million or $1.19 per share for the third quarter of 2019. Third quarter 2020 non-GAAP operating results were negatively affected by $341 million or $3.70 per share from updates to actuarial assumptions. Third quarter 2019 operating income included a net benefit of $124 million or a $1.35 per share from updates to our actuarial assumptions. On a pre-tax basis, the effect of the third quarter 2020 update before the change to earnings pattern resulting from these updates increased amortization of deferred policy acquisition costs and deferred sales inducements by $148 million and increase the liability for future payments under Lifetime Income Benefit Riders by $286 million for a total decrease in pre-tax operating income of $434 million. The increases in deferred acquisition costs and deferred sales inducement amortization, as well as the increase and the liability for future payments under Lifetime Income Benefit Riders, primarily resulted from changes in assumptions due to the current macroeconomic environment, regarding investment spread and cost of money which we use as the discount rate in our models, as well as for lapsation. We have updated our assumption for aggregate spread to increase from 2.4% in the near-term to 2.6% at the end of an 8-year reversion period, with a near-term discount rate of 1.6% grading to an ultimate discount rate of 2.1%. Last year we had set our long-term assumption for aggregate spread at a steady 2.6%, with the near-term discount rate of 1.9% grading to ultimate discount rate of 2.9% over a 20-year reversing period. The average yield on invested assets was 4.1% in the third quarter of 2020 compared to 4.12% in the second quarter of 2020, excluding prepayment income of 10 basis points in the third quarter and 3 basis points in the second quarter and 8 basis points of mark-to-market losses on investment partnerships in the second quarter. Adjusted yield decreased to 4% from 4.17%. The decrease was primarily attributable to a 7 basis point decline and the decrease in yield on floating rate investments, a 3 basis point reduction from interest foregone due to the buildup of cash, and a 2 basis point reduction from the reversal of accrued interest on certain impaired securities. The drag on yield from new money investments below the portfolio yield was 2 basis points in the quarter, in line with general expectations. Cash and short-term investments and the investment portfolio average $1.7 billion over the quarter and stood at $2.2 billion as of September 30 as we build up cash to support the investment management and capital structure pillars of the AEL 2.0 strategy. Our plan is to work our cash holdings down this quarter, a much of this amount as well as new money and liquidations will be invested in highly rated relatively short-term public corporates as we prepare for the Varde, Agam, and Brookfield reinsurance transactions. The aggregate cost of money for annuity liabilities was 166 basis points, down 7 basis points from the second quarter of 2020. The cost of money in the third quarter benefited from 3 basis points of hedging gains compared to a 1 basis point loss in the second quarter. Excluding hedging losses and gains, the decline in the adjusted cost of money reflects a year-over-year decrease and option costs due to past renewal rate action. Investment spread for the third quarter was 244 basis points. Trendable spread, which we defined as excluding the impact of additional prepayment income, the effect of hedging gains and losses, and other non-trendable investment income items was 231 basis points in the third quarter compared to 245 basis points in the second quarter. In our analysis of trendable spreads, we have excluded the reduction and effective yield up 8 basis points resulting from mark-to-market investment partnership losses that incurred in the second quarter. The average yield on investments acquired in the quarter was 3.59% gross of fees compared to 4.58% gross of fees in the second quarter of the year. We purchased $213 million of fixed income securities at a rate of 3.28% originated $37 million of commercial mortgage loans at a rate of 4.48% and purchased $24 million of residential mortgage loans at a 5.02% gross of fees. Reflecting actions taken in June to produce participation rates on $4.3 billion a policyholder funds and S&P 500 annual point-to-point and monthly average strategies as well the decline in equity market volatility, the cost of options drop to 142 basis points from a 162 basis points in the second quarter. Should the yields available to us decrease or the cost of money rise, we continue to have flexibility to reduce our rates, if necessary, and could decrease our cost of money by roughly 63 basis points, if we reduce current rates to guaranteed minimums. This is down slightly from the 65 basis points we cited on our second quarter call. Excluding the increase resulting from the actuarial assumption updates, the liability for Lifetime Income Benefit Riders increased $68 million this quarter, which included a negative experience of $5 million relative to our new model expectation. Negative experience primarily reflected lower than modeled indexed credits and a number of other small items, partially offset by lower than models utilization. Excluding the increase resulting from the actuarial assumption updates deferred acquisition costs and deferred sales inducement amortization totaled $138 million, $10 million greater than modeled expectations. The biggest items driving the negative experience were higher than modeled interest margins and greater than expected lapsation over the entire book of business. Impairments totaled $26 million in the quarter, mostly reflecting CMBS allowances and write-downs of $19 million. Estimated risk-based capital as of September 30th was 382% down from 389% at the end of June. The decrease in the RBC ratio primarily reflected 8 points from ratings migration and 2 points from investment losses and impairment. Cash at the holding company was $350 million including $290 million from our June perpetual preferred offering. Now I'll turn the call over to the operator to begin Q&A.
Thank you. [Operator Instructions]. Our first question comes from Pablo Singzon with JPMorgan.
So the first question is for Anant. Regarding a goal to reduce the cost of funds by at least 50 bps, much of that is driven by the cost of money versus AEL's own distribution and operating expenses and to what extent where this COVID aided by the competitive environment?
Thanks for the question. Good to hear your voice again. The cost of funds would be primarily driven by product innovation and a good example is our Destinations product that we launched this June. That shows our ability to come with innovative new products indices for everyone on the call Destinations brings together, a risk parity like strategy where clients have the option between gold, interest rates, and equities. So products like that will be the primary driver of reduction also optimizing our distribution spend will be the second driver of that.
And then regarding absolute trade, I'm looking a bit but I was going to specific transactions. Would it be feasible to assume some amount earnings degradation as you shift from spread to fee earnings and obviously expect ROE to go up overall, so it seems like what will be a larger offset but is that the right way to think about that piece of strategy?
Could you repeat that Pablo? You're breaking up a little bit.
Yes, yes. So just on the capital structure strategy and without going specifics here. Would it be reasonable to assume some amount of earnings denigration as you shift from spread to fee earnings? You expect [Inaudible] to grow up over, so it seems like capital is a large [inaudible]? Thank You.
Pablo, you broke out a little bit. I would say the question back and you tell me if I missed any part of it. After I give you the answer we can add on, okay. So what I heard was as we, as part of the capital structure strategy as we move to ROA business should we expect some earnings then in provision and then what the trajectory of that is something. And add on to be on that. Let me take the first question then. As we move to an ROA model, you can see from our slides that we put on the Investor Relations website around a week ago earlier this week. The $5 billion of Brookfield in-force reinsurance demonstrates this very well. We go from an earning a spread-based ROE in the 80 basis points of that area for a sustained period of time to earning 90 basis points for 7 years. What it will do is give us a more stable earnings stream, which is higher ROE because it's very little your equity, a risk capital that we need to put up, but it will be for a finite of time 7 year as the origination machine that we have that is a leading platform will have to keep originating because that earnings stream drops off in 7-year. So from a dollar and cent perspective absolute earnings may decrease. They're roughly in the same vector as from this illustration. The ROE is significantly higher, but this is no easy but the earning is only for 7-year.
Got it. Thanks Anant.
Thank you. Our next question comes from Erik Bass with Autonomous Research.
And so I think it will free up close to $700 million of capital from the two reinsurance transactions that you announced. So hoping you could talk a little bit about how you're thinking about redeploying this capital? I'm assuming that's part of the driver of the capital return you talked about for 2021?
Erik, yes. [indiscernible] Yes, part of the capital freed up is part of accelerating the return targets to 2021, so almost pretty immediate. As you know, we've also announced a buyback program right away, which we intend to start at the end of this call or shortly thereafter. And the capital the $700 million freed up I think of it three ways, we did add. First of all, we live in a pretty uncertain time with COVID-19 in the environment right now and live through a credit cycle which is unprecedented, so it's good to have more capital on hand. Already the excess cash of the holding company, which is around $300 million is spoken for the buyback program and financial flexibility even before the Brookfield proceeds come in, we're starting to buyback stock, so that's one. Always be prudent with the use of capital if you think of all stakeholders. The second is historically we refund -- we funded growth with earnings and not distributed capital. Now you hear us talking about returning to $250 million to $300 million. And then thirdly, as we invest in [ Alpha ] asset strategy the return on that capital is significantly high, and therefore holding capital for the right alpha strategy is very important before we distributed all out. So that's why -- that's how I think about the capital freed up which is a sustained ongoing capital return program, which frankly starts at $250 million to $300 million and we look to grow that number over time at probably a faster pace in the earnings growth.
Got it. Thank you. And just to clarify on the buyback. So the $500 million I think initially you're capped at repurchasing the $9 million or so shares you're issuing to Brookfield but once they get approval for their stake to increase then is the intention to utilize more of that buyback authorization next year?
That's correct. We intend to aim to fully offset any dilution from issuing new shares to Brookfield.
Got it. And just I guess one more, I mean you've talked about wanting to use more flow reinsurance on an ongoing basis to generate more of the fee like income and move to an ROA model. How do you think about the level of sales that you want to retain over time and how are you, arriving at that target?
Yes, it's a great question. It's -- having in the [ COC ] from 8 months we've outlined a fairly ambitious strategy. So a bit early to say a target for how much to flow to retail and how much to, so that your question, gets to a fundamental question of how much to be a sustainable ROE business with our own capital and migrate to an ROA business. I think the 2 part answer is we don't think it has to be only through reinsurance to third parties, setting up our own reinsurer maybe inviting the third-party capital is a way for us to be bridge that. And I think over time, you will see us use more and more third-party capital without actually having to reinsure to a third-party because we control the reinsurer. Ted, do you want to add anything to that?
Erik, I think there's going to be points in time, that will weigh in balance when it makes sense to grow our own business versus reinsurer to depending on the terms that we're able to negotiate with reinsurance counterparties. So I think that will have and flow some to depending on what market terms are and what we see as may be attractive ROE business to keep on our books versus leading off.
Got it. So basically right now third-party reinsurance is kind of a tactical lever until you have your own capability and then that would be, I guess the primary reinsurance vehicle use your own, but then you could tactically use third-party reinsurance if it made sense.
That's a very good way to think about it and we think, why the two strategic partnerships we've done a little more strategic and tactical is because a great alignment we have a process with them beyond our own business. Right? And with Varde that platform we have an economic interest in the platform and 20% interest in it, so we continue to benefit from that. And in the case of Brookfield we manage counterparty risk in a very elegant manner with alignment with Brookfield having an equity investment in us while we with the reinsurance the life company. So we really like economic alignment especially, so that there's counterparty risk mitigation with the reinsurer and there is no [inaudible] economics in the value chain when it comes to asset management fee.
And I think a big an important piece that is not that there before too was that the creation of our own platform offshore and the ability to bring in other third-party capital ourselves to be able to put up the risk capital to support business too.
Thank you. Our next question comes from John Barnidge with Piper Sandler.
Just on the ROE target, was that reported ROE or ex-AOCI?
It will be operating ROE ex-AOCI on an equity which is ex-AOCI.
Okay, great. And then on the Pretium stake, I believe the stake increases once you hit that $2.25 billion of invested cap or investments deployed. How much additional stake do you get to at that point?
The additional stake that we get, would be 1.9%.
Okay, great. Thank you for your answers.
Thank you. Our next question comes from Ryan Krueger with KBW.
I was hoping that you could provide more detail on how you and the Board determined that you believe your company is worth significantly more than the $36 offer that you received?
I probably would give you a multi-part answer here. The first being the Board process and the real careful review around it. So the bottom line is that the offer that we received and that was then publicly made available or leaked on October 1st. It significantly inadequate relative to the value realization from execution of our standalone plan of AEL 2.0, that is the core basis for the rejection. The offer was very carefully reviewed by the Board with input and analysis from financial and legal advisors as we noted in our press release, but I'll highlight for others who may have not read at the time, JPMorgan, Morgan Stanley, and Skadden over numerous Board meetings over the 5-week, 6-week period and done with the lens of fiduciary duties and the best interest of shareholders. Now the offers made an opportunistic time as I mentioned in my prepared remarks with the industry trading at all-time lows and it's therefore significantly undervalued the company when compared to the value realization from the -- for shareholders by the organic plan. The Board decision was unanimous and we, and I as a member of the Board, can also speak, as we strongly believe we are doing the right thing for all shareholders as the execution of the business plan dries up value. And frankly, the firm also retained the option to contemplate a change of control at a higher price at the right time by executing AEL 2.0, which is a metrics and return driven business strategy. As you can see the target outlined today with starting in 2021 will create significant value for shareholders, a capital return targets including the cash return is north of 10% of our current market cap, which is enviable for any company, even on in the life sector or the P& C sector, the insurance sector. And therefore with strong conviction and believe we stand firmly behind executing our plan while obviously we're a public company and are very keenly aware and advise of our fiduciary duties and we'll be open-minded about thing, but there is no better plan in front of us at this point than executing what we've outlined. Hopefully, Ryan that gives you a sense, and I'm happy to take any more questions you have on that or others.
Different question. I guess just given that you have quite a number of moving parts right now with kind of transactions and earnings and I appreciate the ROE target, though it is relatively wide for next year. Can you give us any sense of, is there any directional sense in 11% to 14%? How we should think about and where you'd start out in 2021?
Well, I think in 2021 obviously there is a lot of timing, that's going to happen related to execution of transactions, et cetera. So I think we'll probably be on the lower end of the 11% on that part, but obviously there is a lot of moving parts to that. But as you know, we certainly what's going to impact is what is the execution of those transactions in the timing and the mix of investments in cash that we transfer at that point in time, which will impact ROE once those are done.
Yes, Ryan. Ted covered it. I'll just add once again, we are really excited about our string of pearls asset management strategy. I mean just sharing Pretium with you is a great pearl. As we added more of that and move to the ROA strategy, so a sustainable ROE model at insurer with new a differentiated asset strategy that is going to see us increase investment yield from the 4% area, because it's going to be in the 4% or just up 4% area for as we do a transition. We're doing a significant portfolio migration with the reinsurance deal and bringing on the new asset strategy. So offer $50 billion. We are going to be migrating $10 billion, $15 billion of assets 20% to 30% of the portfolio in the next 12 months or less. There will be some noise from that as Ted just mentioned and then after that, we think the earnings power and the cash distribution power of this business is better than any out there. Getting back to the virtuous flywheel and the value of the origination platform what is there in this business in the industry is both having the ability to originate capital -- I'm sorry assets under management at a size and then have scale. We have that and therefore we are turning it to our advantage which is why you see these partnerships, where we can be speaking about the right partners to then generate this higher return business for shareholders. It will take us a few, it will take us a few years to get there.
Thank you. Our next question comes from Mark Hughes with Truist.
The benefit of your investment in these, these firms that are helping you to source your investment, the pearl, string of pearls strategy. How much do you benefit by making your own contribution, your own investment? How enhanced is your access to investment that I'm just, I'm interested in your, the fact that you're taking a piece of these relationships?
Just to make sure I get the question a piece of the equity of the relationships?
Correct. That's right.
Right. There are a multitude of benefits from that. I'll maybe highlight 2 or 3. The first is take a Pretium as an example. $16 billion of asset management, a world-class team founded by a visionary founder with a proven track record over a decade. That platform is $16 billion of AUM. It's got a complete ecosystem and real estate, single-family rental business, and ready loans not just sourcing the loans through Deephaven but servicing the loans through Selene and then working them out when things don't go as well, it happens with investments. No one has a 1.0 batting average. And so that complete ecosystem beyond even residential assets is $16 million. We will grow from a $1 billion mandate to $2.25 billion. So even when we get to $2.25 billion we're not more than 15% or so 20% of their assets over time. As that platform grows, we take information into that business by having a seat at the table by being on the Board, by in being in constant dialog where they're not a vendor. So the information value of knowing what's happening in the specialty sub-sector forms the financial value. You add to that as the platform scales and we help it scale by bringing long-term funding to it that's what our insurance liabilities are through our origination platform, that's why I call it the flywheel of our strategy. Now we make our share of the entire platform economics. So both the information value and the financial leverage we get from it. It helpful. And this is the third point, it is additive to our ROA model because if we have a minority interest in the teens in terms of percentage in a platform that $16 billion and is on its path to be $20 billion, $30 billion, $40 billion, $50 billion over time that additional fee income coming to us or compounding of that investment capital as growth capital that's additive to our own earnings. Our earnings expand as this platform earnings expand as is the example of our asset management joint venture with Varde. Hopefully, that gives you a holistic enough answer. I'm happy to take a follow-on, Mark.
I think. Yes, please.
I'd say Mark remember too with Varde and the Agam structure they are scaling that can happen within the Agam reinsurance platform and then we are in partnership with Varde on the management of those assets and our sharing and the economic success of that joint venture together as Agam scales up on the liability side within their reinsurance platform with other books of business separate from what we have ceded to them.
Thank you for that. And then Ted on -- you'd mentioned lapsation we think about persistency of your policyholders when you went through this study and review the assumptions. Any observations about policyholder behavior, how persistent -- persistency has changed over time? I think you mentioned this quarter was maybe lapsation is a little higher. Any comment on that would be helpful.
So the lapsation assumptions that we change we're on, we're going to two different ways, if it was a policy that has a Lifetime Income Benefit Rider we slightly reduced lapsation. We're being persistent feed continue to be very, very strong with Lifetime Income Benefit Rider policies and so we adjusted lapsation down slightly on those. Now doing that, that has an impact on the SOP reserve and so that increased that slightly. In regards the policies without the Lifetime Income Benefit Rider we increased lapsation slightly on those. So we saw a little bit or are seeing based upon our experienced study lapsation come in a little bit above what our original assumption was or our assumption from last year and so we moved that up slightly. So higher persistency with Lifetime Income Benefit Rider business and we saw a little bit increased lapsation on business without a rider.
Thank you. Our next question comes from Tom Gallagher with Evercore.
Just a follow-up question on the rejection of the takeout offer. I hear you on the sector trading at a big discount to historical averages. But I think this is mainly due to interest rates being historically low and the Fed intends to keep interest rates low for another 2 to 3 years. So with that in mind. My question is, assuming sector valuations remain depressed and rates remain low for the next 2 to 3 years. How do you think -- how long do you think it will take AEL 2.0 to get your stock north of the $36 per share offer. Do you think that's a legitimate scenario that you see it playing out if we remain in kind of a similar macroeconomic scenario?
The short answer is yes. We do see it playing out. That's the and I'll go back to the core basis for the rejection of the $36 offer was the value even on a present value basis of the AEL 2.0 plan. So if you look at all the probabilities and then PVs of value of our plan. They far exceed what was a potential non-binding offer. And the reason for that is multiple but I'll give you a view. First of all the asset strategies, we are talking about decoupled from pure spread to treasuries. Case in point take real estate investments. Their minimum cap rates in the sub-sectors for real estate investments. When we are doing resi loans, there is a spread to the treasury when it starts to decouple. You sort of hitting minimum rates of 3.5%, 4%, 5%. So you start to now have a portfolio that can as you transition to Alpha assets operate added a D plus 250-300 area, not just at the D plus 1$50 million, 175 and $200 million because you're solving for investment-grade corporate bonds. When you look at the real estate sector and infrastructure sectors, in the real state we have worked over the last 6, 7 months on the work this team started a few years ago to start to explore with partners and found specialty sub-sectors where we actually have conviction that cap rates are going to hold in into the 4% to 6% range area which means in a low-interest-rate environment our asset strategy, basically is going from being a capital business that's originating spread earnings just purely on corporate bond spreads largely to investing in real estate, where we've got a more sustainable way to have D plus 250 and $300 million, that's one. The second part, which I think you eloquently put in your research piece over the last few weeks, is that the At Scale origination platform that we have can attract reinsurers all third-party capital to both the platform and these investment strategies at better valuation, then the public markets Trade Act, which means we can do reinsurance transaction and unlock value and transform into an ROA business at attractive levels and return capital to shareholders. So, we think both those dynamics make it very interesting for this company to return $250 million to $300 million of capital to shareholders each year. And then you tell me a farm that does that and has a high ROE where that should trade over time, especially if it grows its cash return. It was a long answer to your question, Tom, but I'm hoping to give you a few rather than the fire.
No, that was helpful Anant. And just to be clear, again the $250 million to $300 million you expect to get there within 3 years?
No, we expect to that make -- we expect that next year, 2021. And then over time....
You expect that in 2021? And that will be a run rate and you would expect to grow off of that?
Correct.
Got you. And then just one quick follow-up if I could. Just looking at your interest rate assumption, I would agree that the 10-year treasury assumption to call it around 2 that you're moving toward would make you put you on probably the most conservative level in the industry, however, the new money yield assumption of 260 basis points of credit spread would put you at the most aggressive end on assume credit spreads. And I guess my question is if you're planning on pivoting to this capital-light business model to get that kind of credit spread that's going to in turn carry much higher C1 asset charges I presume, which would be in contrast to your -- to the capital-light business model. So how do you view that trade-off?
Yes. The trade-off is the capital charges will go up, but we are looking to have -- we're looking to structure our Alpha assets in a manner. That's pretty consistent to what a lot of our peers have done in the industry. Therefore, we should have a capital charge, our investment return over the higher capital charge is still far greater than we can return those earnings to shareholders. Last using reinsurance take our Brookfield example whatever we transferred to the reinsurance platform is no longer our own capital. Those are the 2 levels that allow us to have higher investment yield while not becoming capital intensive. The absolute dollar of yield is very high that you recoup your capital investment in a very short period of time and we can use other people's capital for it.
Thank you. Our next question comes from Dan Bergman with Citi.
I guess somewhat related to Tom's question, but just in terms of the ALE 2.0 strategy, one aspect is lifting the yield on new investments, aided by the new asset management partnerships, new asset classes. Just given public market valuations of annuity companies are currently depressed at least partly due to the risk of credit deterioration. I just wanted to see if you could give any more color on how you're thinking of the impact of this strategy on your overall credit risk and whether there is any tradeoff between potentially higher risk assuming there is no free money or some offset to achieving that higher yield and the better profitability and growth that it allows, any kind of big picture thoughts would be great?
Great. Dan, I'll let Jeff Lorenzen, our Chief Investment Officer take that. Jeff's on the call.
Thanks, Anant. I think as we look from a macro or from a high level approach to our strategy. It's more about reallocating risk in the portfolio, rather than an increasing risk of the corporates have predominantly been a key piece of our strategy at over 60% of the portfolio going more into private -- private type credits, where you have more structure around the underlying recovery value or get to the table more quickly will be part of this strategy and there's ways that we can partner with key folks in the market to help us get access to those quality transactions. If I look at it and it's kind of a continuation of what we've tried to do over the last couple of years is going into and we've messaged this going into less liquid assets but having more structure around those assets. Typically on a public security, if it's a $500 million to $1 billion issue size, you're not going to have much credibility at the table to try and have discussions with management when you're in a private transaction, smaller club transactions with partners who are very strategic about the alignment of their interest to the issuers. It does create much less risk in the portfolio and much more stability and that's kind of where we look at the credit risk. When you look at real estate risk in some of the real asset focus that we're driving toward longer-term around residential real estate, these are very capital efficient asset classes that do give you a premium yield to what you can get to some public-rated securities in the corporate or in the structured asset market. And from that standpoint, I think we can get some lift by being very capital efficient with the types of assets that we selected. We move forward as we strategically aligned with these key third-party partners.
Got it. That's very helpful. Thanks. And then maybe just one quick clarification question, I apologize if you already said this, but the $250 million to $300 million annual guidance that you gave earlier. Was that just for share repurchases or kind of total capital return including common dividend?
That's the amount of capital that we're going to return to shareholders in some form, and that's our annual run rate, whether that's going to be in a special dividend or in a share repurchase et cetera.
Thank you. And I'm not showing any further questions at this time, I would now like to turn the call back over to Julie LaFollette for any further remarks.
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Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.