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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 the Second Quarter 2018 Earnings Call. My name is Sylvia and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.
I will now turn the call over to Alicia Charity. Alicia, you may begin.
Thank you, operator, and good morning. Welcome to Ameriprise Financial second quarter earnings call. On the call with me today are Jim Cracchiolo, Chairman and CEO; and Walter Berman, our Chief Financial Officer. Following their remarks, we'll will happy to take your questions.
Turning to our earnings presentation materials that are available on our website, on slide 2 you will see a discussion of forward-looking statements. Specifically, during the call, you will hear reference to various non-GAAP financial measures, which we believe provide insight into the company's operations. Reconciliations of non-GAAP numbers to their respective GAAP numbers can be found in today's materials.
Some statements that we make on this call may be forward looking, reflecting management's expectations about future events and overall operating plans and performance. These forward-looking statements speak only as of today's date, and involve a number of risks and uncertainties. A sample list of factors and risks that could cause actual results to be materially different from forward-looking statements can be found in our second quarter 2018 earnings release, our 2017 annual report to shareholders and our 2017 10-K report. We make no obligation to update publicly or revise these forward-looking statements.
On slide 3, you'll see our GAAP financial results at the top of the page for the second quarter. Below that, you will see our adjusted operating results, which management believes enhances the understanding of our business by reflecting the underlying performance of our core operations and facilitates a more meaningful trend analysis.
And with that, I'll turn it over to Jim.
Hello, and thanks for joining us for today's earnings call. I'm pleased to share that Ameriprise had a strong second quarter. Across our diversified firm, we're executing our strategy for growth and long-term value creation. This morning, I'll discuss the strength of the company and the progress we're making, both from a business and a financial perspective. And then Walter will delve into the financials.
As we reflect on the quarter, we're building on the growth and the momentum from the first part of the year, and that we've consistently delivered for many years. On an adjusted operating basis, revenue increased nicely, up 6%. We delivered significant growth in earnings, up 22%, with earnings per share also growing strongly, up 29%. And our return on equity was 31.1%, which is among the highest in the industry. In addition, our assets under management and administration were also up 7% to $891 billion.
In terms of our overall business, there are some important themes to take away. First, as part of our diversified firm, Advice & Wealth Management remains the growth driver of Ameriprise. As a segment, AWM generated 50% of our second quarter pre-tax adjusted operating earnings excluding corporate.
From a business perspective, we're serving clients' needs comprehensively with our advice value proposition and quality solutions. Our clients recognize the meaningful value that comes from working with Ameriprise, and importantly, we're attracting more clients and more assets.
Second, Ameriprise has a strong track record of generating profitable growth and shareholder value, while responding well to a changing operating environment.
And third, complementing our distribution, our Asset Management and insurance and annuity businesses provide strong solutions to serve our clients' needs. In addition, their ability to consistently generate free cash flow is excellent, which gives us further ability to invest for the future, as well as returning capital at a high level.
Like others, Ameriprise is also benefiting from a better operating environment. Equity markets globally are positive. We've seen a meaningful pickup in short-term interest rates, though long-term rates are still relatively low. The U.S. economy and employment levels are also improving nicely. However, global trade and geopolitical issues remain, and we're seeing that reflected in the higher equity market volatility. And in the UK, we're closely navigating Brexit and executing our strategy to adapt accordingly.
In Advice & Wealth Management, we delivered record business and financial metrics in the quarter. We continue to bring in strong client flows and are generating double digit revenue, earnings and productivity growth. We have a consistent growth plan in place. And with our focused execution and efficient use of resources, we're garnering strong results.
As we shared with you, key to our strategy is to grow our retail client base and serve more mass affluent and affluent investors with advice and to deepen relationships with our clients. I'm pleased to report that we're making good progress. Advisors are focused on client acquisition. We're serving more clients in financial planning relationships. We also continue to bring in clients with over $1 million of investable assets. This is a significant opportunity for us in an area where we're expanding our services. Ameriprise client assets grew a robust 10% to $566 billion.
We've built one of the largest investment advisory platforms in the industry. We continue to grow it and attract client assets. Net inflows into fee-based investment advisory accounts were up nicely at $5.3 billion, an increase of 18% from last year and the fifth consecutive quarter above $4 billion.
Client assets in these fee-based accounts, as well as in other solutions, are allocated across equities, fixed income and other asset classes. And because of our broad solutions and deep client relationships, assets can shift and stay at Ameriprise according to a changing market conditions and client preferences. And cash balances are over $24 billion. And with short-term interest rates up, we're generating additional net spread revenue, up 56% versus last year.
Our advisors are benefiting. Productivity growth is strong. With excellent client flows, as well as growth in assets and higher activity, advisor productivity was up 12% to $599,000 on a trailing 12 month basis. When you adjust for our 12b-1 fee change, Ameriprise advisors consistently grow productivity faster than many of our key competitors. And we continue to bring in experienced productive advisors. Another 76 joined us in the quarter. Ameriprise has a competitive attractive offering and the recruiting pipeline for the second half of the year looks good.
As we continue to focus our resources for future growth, the U.S. wealth management opportunity today is larger, both in terms of households, as well as asset levels. We also know that our target market, investors with $500,000 to $5 million, want and need advice. In that regard, they're looking for a firm that will help them feel confident about their financial future. Confidence was and still is the outcome of advice in working with Ameriprise advisor. And as the long-standing leader in advice, Ameriprise is differentiated in the marketplace. Consumers need to plan and accumulate wealth for retirement and we're well positioned to serve this need and to continue to drive strong growth.
We've been conducting our other client satisfaction survey. I'm pleased to report that our results are best-in-class, with client satisfaction of an impressive 4.8 out of 5. Our clients are highly satisfied because the important work our advisors do every day, as well as the total experience Ameriprise provides. This complements our external recognition where consumers rated Ameriprise at the top of the investment industry for likelihood to recommend the firm to friends and colleagues.
The Ameriprise culture and the way we work with clients continues to be an important differentiator. We know that trust is the most important factor for clients, as well as our target market prospects, when they select a financial firm to work with.
During the quarter, in the Temkin 2018 ratings, Ameriprise was rated number one in trust across investment firms. And consumers were also asked how likely they would be to forgive companies if those firms made a mistake. Ameriprise was also rated number one for consumer forgiveness for the second consecutive year.
We're not stopping there and we continue to help our advisors satisfy client goals and grow their practices. We're further investing in our client experience, complementing it with the introduction of new digital advice tools; our new and enhanced customer relationship management capability, as well as enhanced goal tracking. We're beginning to introduce these capabilities in the coming months, and we'll be delivering focused training to support our advisor uptake through 2019 that will help us continue our journey and focus on growth.
We are also continuing our investment in the Ameriprise brand and getting our great story out to the marketplace. Brand awareness has reached a record 70%. We believe that this combination of strong client focus, recognition and results, as well as the investments we're continuing to make, positions us well for further growth.
As part of our asset accumulation approach, insurance and annuities are a part of our solution set and benefit both our clients, as well as generate appropriate returns for the company. They complement the other I&A manufacturers in our network and the broader range of solutions we offer clients; our I&A books are of high quality. We have good retention of assets and only sell in our network. And therefore, we generate good returns and cash flow for the company. Our results are in line with our plans. We aren't searching for growth and therefore, don't need to go out on the risk curve to compete.
Given that, we're seeing a good pickup in VA sales, up 16%. With 30% of our activity in products without living benefits, a continuation of growth we experienced in the first quarter. With regard to fixed annuities, since spreads are tight, we are not replenishing our activity. And in Life and Health, account balances are up 4% and sales are steady.
In Auto and Home, we continue to see improvement in our underlying results through increased rates and plan rating sophistication, product changes, underwriting advances and disciplined claims management. At the same time, we consistently earn high consumer satisfaction ratings, once again being recognized as a leader in California auto insurance, our largest state.
As you saw in our preannouncement, we, along with many other insurers, were impacted by wind and hailstorms in Colorado and Texas in the quarter. We are taking steps to further reduce our catastrophic risk profile including curtailing a homeowner's partnership with Progressive and putting more emphasis on the auto line.
As part of Ameriprise, our Asset Management business complements our Wealth Management strength. There are three key themes I want you to take away. First, we have a nice diversified base of assets that we manage with a good mix of equity, fixed income and alternative categories for both retail and institutional clients, distributed both domestically and internationally. And we're generating competitive profitability. Second, we're managing a strategic mix shift to more third-party assets. Third, we have a good diversified product line and distribution, and we're making the necessary changes to enhance the business further to improve longer-term flow results.
Let me take you through each of these themes in more detail. In the quarter, our assets increased slightly to $482 billion. Our teams are generating consistent competitive performance for our clients. At the end of the quarter, about 70% of our funds, equities, fixed income and asset allocation were above Lipper medians or benchmarks over multiple time frames. This has resulted in 110 four and five star funds offered globally. With the shift of assets, we maintained our fee levels, while we continue to manage expenses tightly, while making appropriate investments and managing regulatory changes. Our margins are strong at 38% and profitability was up a bit compared to last year.
And while near-term growth has been challenging, the percentage of lower fee former parent assets under management in largely closed blocks has gradually declined as a percentage of the total, as we have increased higher fee third-party assets under management.
Our strategic relationships with former parent companies provide an important base of our assets. Consistent with our plans, former parent assets under management levels have declined by about a half since 2010, while our total assets under management has grown to $482 billion.
In the quarter, while we remain in net outflows, we did experience improvement in total net outflows at $7.1 billion for the quarter, compared to $8.7 billion of outflows a year ago. Former parent outflows were $2.2 billion, compared to elevated outflows of $7.1 billion last year. Global retail, excluding former parent, was a net inflows of $2 billion in the quarter.
In the U.S., we are making progress with the top-eight wealth managers. For example, our funds, where we concentrated our wholesaling efforts, had inflows of nearly $1 billion for the quarter. And in EMEA, wholesale flows have moved from outflows last quarter to slightly positive in the quarter. Activity has improved, but isn't fully back, given Brexit and the political uncertainty in Europe that has increased volatility, particularly in June.
In institutional, we had $1.5 billion in outflows excluding former parent, which was mainly driven by CLOs. And with markets a bit more volatile, we experienced a slowdown in mandate fundings that we believe reflects current environment market.
And the third thing, we're making the changes necessary to evolve the business. With strong product lines, we're focused on further strengthening our third-party distribution both in terms of reach and productivity. That includes a stronger focus on driving sales of our key products, with the larger broker dealers. It also includes significantly expanding our CCAP product line in our Luxembourg fund range and launching new products such as our European Dynamic Real Return strategy that we introduced in Europe to complement the UK product line. We're also expanding our distribution reach in key European markets and expanding our marketing and sales activities there.
In addition, we're executing the Brexit transition, an important initiative that we're managing along with our growth initiatives. Importantly, we continue to invest to enhance our brand awareness in our key markets, as well as our website and in digital capabilities. In addition, we're enhancing our data analytics capability as part of our Ameriprise-wide initiative. It includes optimizing data to help identify and target sales opportunities and leveraging data within our investment research.
From an infrastructure perspective, we completed key deliverables to enhance our front, middle, and back office systems and operations, and we're realizing savings. These savings are helping to offset research costs we had to absorb due to MiFID, as well as cost to implement changes required for Brexit and new European regulatory requirements. This focus will continue.
So overall, in closing, we have a clear focus on client needs and a strong consumer value proposition. We continue to deliver excellent financial results and returns. We have a strong financial foundation, and we continue to invest significantly for growth, return capital and navigate the environment. In fact, as we invested in the business, we returned more than $400 million a quarter to shareholders for 25 consecutive quarters.
From our perspective, based on our consistently strong financial and financial results, and our ability to manage risk well and the quality of our business, Ameriprise is significantly undervalued today, especially compared to our competitors.
Now, Walter will cover the numbers, and I'll be back to take your questions.
Thank you, Jim. Ameriprise delivered strong results in the quarter. We continue to make significant progress in delivering our long-term shareholder objectives with strong 6% growth in revenue, 29% growth in EPS and a 31% return on equity.
Let me take you through the details, beginning on slide 6. Overall, Ameriprise delivered strong revenue growth, up 6% in the quarter, largely driven by Advice & Wealth Management. Asset Management, Annuities and Protection had stable revenue that was in line with expectations. Expenses continued to be well managed across the firm, with G&A up only 2%. I'll go into details on expenses in each segment on the subsequent pages.
We returned $532 million to shareholders through buyback and dividends. Given the lower share price in the quarter, we opportunistically increased the amount of share repurchase to the highest level over the past six quarters. In total, adjusted operating EPS was $3.60, fueled by Advice & Wealth Management, which now makes up half of our pre-tax adjusted operating earnings.
Let's turn to slide 7. As I just indicated, Advice & Wealth Management represents half of pre-tax adjusted operating earnings, demonstrating a significant trend, up from 44% last year. Advice & Wealth Management continues to drive growth at Ameriprise. And our Asset Management and insurance capabilities compliment and benefit from its strength. Combined with Asset Management, the fee-based businesses made up three quarters of our earnings for the quarter. This mix shift continues to generate significant free cash flow.
Turning to slide 8, Ameriprise's cash flow generation, balance sheet quality and capital return capability remained very strong. Ameriprise's excess capital is $1.4 billion, and our estimated RBC ratio is 532%. In the quarter, we returned $532 million of capital to shareholders, which was nearly 100% of our adjusted operating earnings. This demonstrated our ongoing commitment to capital return, as well as confidence in our risk analytics and future cash flow capacity.
Let's turn to AWM on slide 9. Advice & Wealth Management is delivering consistent strong financial performance that is underpinned by business fundamentals that support sustained organic growth. Revenues grew 12%, driven by wrap net inflows and higher transactional activity levels, as well as equity markets, and the benefit of higher short rates on cash suite balances. Expenses increased in line with revenues, and reflect higher distribution-related expenses.
G&A increased 8%, about half of which was related to investments for future business growth, including new digital capabilities and the addition of IPI advisors. Additionally, G&A was up due to higher volume-related expenses.
Given the revenue environment, and our future growth objectives, we expect G&A expenses to be up 4% to 6% for the full year. While we are investing substantially for future growth, we remain diligent in ensuring we are making the right investments that we will see the best payback, and that expenses are managed in line with revenues. Overall, AWM had substantial 20% earnings growth and margins reached a new record of 22.7%.
Let's turn to the elements that will drive sustained profitable growth on slide 10. Advice & Wealth Management has a strong track record of improving business fundamentals, which support good financial performance across market cycles. Total client assets increased 10% to $566 billion, driven by growth in wrap assets of 16%, reflecting client demand for fee-based products. In the quarter, wrap net inflows were $5.3 billion, which is our fourth consecutive quarter with wrap flows of over $5 billion. Brokerage cash balances remain substantial at $24.5 billion, down slightly as clients are putting money to work.
We are benefiting from short rates getting back to more normal historic levels, and we saw the spread rise to 1.57% in the quarter. While, we have retained a high percentage of the rise in short rates to date, we would expect to gradually pass along more of that to clients in the second half of the year and will closely monitor crediting rates offered by competitors. Advisor productivity also continues to steadily improve, reaching nearly $600,000 on a trailing 12 months basis.
Let's turn to Asset Management on page 11. Asset Management financial performance remained very good, as we transition the business during a period of industry change. Revenues were up 1% from strong market appreciation and the acquisition of Lionstone, which was partially offset by net outflows and lower CLO performance fees than the year-ago period. In addition, the fee rate was consistent with our expectations in the 52 basis point to 53 basis point range. Expenses continue to be prudently managed. Excluding the acquisition of Lionstone, G&A was flat, even with continuing investments in the business and elevated research and regulatory cost in the UK and Europe.
The investments we've made to enhance operational efficiencies are bearing fruit and helping to offset this additional expense. We delivered a 38% margin in the quarter. We continue to expect the margin to be in the 35% to 39% range in the near term.
Let's turn to Annuities on slide 12. Variable annuities earnings are $117 million, down from last year, and in line with expectation in this environment. Equity market appreciation increased account values year-over-year, but earnings were down due to lower mean reversion than a year ago and net outflows. Variable annuities continue to be in outflows, though at a slower pace than last year in both internally distributed block and the closed block that was distributed by third parties. We've also seen a 16% increase in our sales of our variable annuity product. Fixed annuity pre-tax adjusted operating earnings declined to $12 million, as lapses and interest rates continue to impact results as expected.
Turning to Protection on slide 13. Life and Health pre-tax adjusted operating earnings declined 7% from the pressure of continued low interest rates consistent with the industry. Total claims are in line with expectations, though there was less reinsurance coverage in the period. In the Auto and Home business, pre-tax adjusted operating results in the quarter were impacted by elevated net cat losses of $40 million concentrated in Colorado and Texas.
We continue to reduce home exposures and severe convective storm states from the termination of one of our affinity partnerships along with other actions. This has resulted in homeowners' policies in force declining 12% year-over-year and 7% in the quarter. We expect this to improve our risk profile going forward as will other actions being taken. We had substantially lower gross cat losses in the first half of 2018 compared to the first half of 2017. However, we realized little benefit from reinsurance, as year-to-date cats have not yet exceeded the retention of our aggregate cat treaty. Should we experience similar cat activity during the rest of the year, we will see the benefit of our reinsurance arrangement as we did last year.
Underlying Auto and Home results are benefiting from the improvements we've made over the past couple of years in product management, pricing, underwriting and claims. However, we have not yet reflected the favorable development from these changes and our reserve estimates to date.
Next, I would like to spend a few minutes on our Long Term Care business beginning on slide 14. In the quarter, Long Term Care had a pre-tax adjusted operating loss of $5 million, partially driven by lower investment portfolio yields. Claims were in line with expected ranges. As I spoke with you about last quarter, we believe we have a season Long Term Care book that is appropriately reserved, and we remain very comfortable with our exposure. We began writing the business in 1989 and sold our last policy in 2002, which gives us a substantial amount of experience to inform our reserve estimates.
I think about our Long Term Care business in two distinct blocks. First; our older generation policies that were written between 1989 and 1999, which is about half of our policies and 56% of our GAAP reserves. This block has been shrinking over the last few years, given the average attained age is now 80 and the average attend age of policyholders on claim is 87. We benefit from having substantial credible experience, so our actual results have deviated very little from reserves in recent years.
Next, we have our second generation policies that were written from 1997 until 2002. This block has a more conservative risk profile, specifically a smaller portion of the block has lifetime benefits and there are higher premiums per policy. This block has significant credible experience, and we follow the same reserving practices. The average attained age is 75 overall, with the average age of those on claim is 84 for this block.
Let's turn to slide 15. As I mentioned before, we utilized three primary levers to manage the Long Term Care business. First, we have taken an active approach to steadily increasing rates since 2005 with cumulative rate increases of 138% on our first-generation block and 63% on our second-generation block.
Second, we have a rigorous reserving process that reflects the policy features and risk characteristics of our blocks. I'd like to note that our statutory reserves are approximately $400 million higher than our GAAP reserves, and includes margins for key assumptions like morbidity and mortality, as well as $165 million in asset adequacy reserves that we voluntarily put up to build in additional conservatism.
Lastly, we have prudently managed our investment portfolio by maintaining a liquid investment-grade portfolio that is currently in a net unrealized gain position.
In the third quarter, we will add another year of experience and incorporate any deviation from our assumptions into the reserve calculation. To date, reserve adjustments have been small and manageable. I continue to believe that our Long Term Care business is adequately reserved and well managed. As such, I do not believe that Long Term Care will impact our ability to return capital to shareholders consistently.
In conclusion, Ameriprise delivered another quarter of excellent financial performance and demonstrated the sustainability of our business fundamentals and growth. The outlook for AWM is outstanding. We're managing a period of transition for Asset Management and our enterprise risk management program is very effective. And we feel confident that we will continue to execute on our strategy and deliver strong results and free cash flow generation going forward. The investment thesis for Ameriprise remains intact, and is particularly attractive at the current valuation.
With that, we'll take your questions.
Thank you. We will now begin the question-and-answer session. And our first question comes from Adam Klauber from William Blair.
Good morning. Thanks. A couple questions on Advice & Wealth Management. Franchise advisor productivity has been very strong in the last two years, up 10% this year, and really 20% over the next two years. Could you give us some sense, what's driving it? Is it more advisors having higher assets? Is it net new wins? And/or is it clients putting more money to work?
This is Jim. It's a combination of all of the above. So, our advisors have been focused in bringing in more clients and moving a bit more upmarket. So, the average clients they're bringing in have more assets. They're also deepening the relationship through the advice value proposition, which in fact serves the clients in a more deeper way against more of their goals and activities. And we're also supporting them so that they can become more efficient, so that their practices actually can drive more levels of activity, serving the clients well.
And so, it's all of the above. And we are continuing to focus on bringing that advice value proposition to life because even our best advisors don't necessarily give the full advice equation to all of their clients. And we want to help them do that because – in a more efficient way, so that they can serve them even more fully. And so, that's why we're bringing even more tools and capabilities to bear in an integrated fashion, so that they can engage all of their clients in the same deep value proposition that they provide.
Thanks. And then as far as the number of advisors, you've had good growth. It's up almost 3%, one of the better growth rates in a number of years. Now that's driven in part by bringing in new advisors, but also deals. As we think about the next couple years, is it possible to keep that growth rate in that low single digit range?
Yes. What we're more focused really on is bringing in highly-productive people, and really tenuring our group. And so, helping our practices even grow more fully by adding support staff, so that they can drive more activities within their own grouping of advisor activity – teams. So, it's not just the number. I mean, we could go and bring in independents and merge other firms like others are doing. What we're really looking for is strong, quality advisors that will run a really good practice, deliver a strong value proposition, build our brand in that regard, and serve their clients well.
So, we look for quality. We look for them to have a good level of productivity in serving the clients more fully, so that we get really strong satisfaction. We're a firm believer in that if we can offer a really strong value proposition, if our clients believe in us and trust us, and we can give them the confidence they need to make the right decisions, we're going have a strong franchise. So, it's less about number for us and it's more about what we can deliver that will grow the asset base and the productivity of the advisor.
Thanks. And then as far as still on Advice & Wealth Management, expenses were up in the first half, 10%. If I understand your guidance, you're talking about expense growth more in the 4%, 5% for the year. That would suggest expense growth really contracts in the second half. Is that correct?
The answer is that the expenses will be going down – or will be lower. But the issue is we'll still be investing in the basic product, and we will be getting some efficiencies as we go through. But it is – that is – our targeted range is in that 6% range.
Okay. Thanks a lot.
And it's geared towards your revenue growth, and we feel comfortable that that is the range within reasonable deviation.
Okay. Great. Thanks.
Our following question comes from Alex Blostein from Goldman Sachs.
Hey, guys. Good morning. A couple of strategic questions for you. So, I guess first, there's been increasing chatter from private equity firms to look at lifting out the combination of variable annuity, fixed annuity blocks, and then there's also some chatter around long-term care. So, any appetite from you guys pursuing something like that? And if so, what are some of the key considerations we need to be contemplating in assessing whether or not you'd be willing to do that?
It's Walter, Alex. Obviously, we've gotten more inquiries coming in. And certainly as interest rates or other situations improve, people are looking for earnings. But we have – again, the block is an excellent block, it generates excellent returns on the variable annuities side. So, it would have to be an offer that would create shareholder value.
On the Long Term Care, again, as we always said, we are preparing for and certainly would entertain offers that would basically give us a reasonable share of return, considering the counterparty risk that you'd be taking, and the fact of where we're leaving the interest rate capabilities. Because again, as they go up, and you know that we've been investing conservatively on that point. So, yes, we're certainly prepared, but it has to meet certain hurdles that provide shareholder return and the right protections from a contingency standpoint.
Yeah. Alex, as we look at it, I mean, we have a very strong VA and as well as an insurance book. And it's an ongoing business that has really good clients and advisor activity against it and a very good channel in a sense of that we have a financial planning channel where the products are really sold as solutions.
So, strategically, if there's an opportunity there, but it's more thought about not as a closed-book where we're looking to unload it in any fashion, as we said, it generates very good cash flow, it has very good risk management, and it's an ongoing business concern in a sense of replenishment of assets. We don't grow this externally. Someone can take our capabilities and use it if they want it in that regard. So, it's along those lines that we would consider, but not in a sense of just selling it as sort of closed wind down book. It's not that book. It's not that type of book.
Yes. Yeah, got it. Sticking with the strategic portion. So, thinking about the bank, you guys started talking about it about a year ago. On the last call, it still sounds like it's work in progress, but maybe an update there. Where you stand on launching a bank, and when and how you do it I guess also depends on where the interest rates are going be. But as you think about developing that – I think you talked about coming up with some consumer lending products on the back of it as well, what are the stages we need to be thinking about? So, would it be bank, like a cash sweep program at first and then branching on into lending products, and maybe as a follow-up to that, how do you feel about potentially getting into consumer lending product at this point of the cycle?
So, we're clearly evaluating that. We still have a bank charter. It's a trust bank charter that we would look to expand our activities. So, we're well on our work in evaluating what that would be for the latter part of this year, but it would be more of a bank serving our client needs. So, it'll be around wealth management-type of products, such as pledge activity. It would be on secured lending activities. It would be what we used to do in some home equity lines and some mortgages, and various products like that on certain loans activity. But it would be all to our client base, not looking to externally sell.
Got it. So, is there like a go/no go by the end of the year? Or is it just kind of ongoing?
We have already and installed base of credit cards that we'll be transferring over. And certainly as you indicated, sweep accounts will certainly come in and then we will be able to leverage on and play with the balance sheet then to provide the appropriate risk return.
Got it. Great. Thanks, guys.
Our following question comes from John Nadel from UBS.
Hey. Good morning, everybody. So, I really appreciate all the incremental data and disclosure you've provided, not only this morning, but over the last couple of months on the Long Term Care block, and I was hoping I could ask a couple of questions and get a little bit more specific here.
First, I think your disclosure from a couple of months ago had indicated that about 90% of claims have been closed within five years and about one-third of claims are closed within one year. I'm curious. If we think about the assumptions embedded in your reserves, are those assumptions very similar to the experience you've actually had with respect to claims that have already taken place?
Okay. Alex (sic) [John] (41:15). It's Walter. So, thank you for recognizing – excuse me, John. It's Walter. The answer to your question is, yes. And you're exactly on – in the one year it is about a one-third and in five years it's about 88%, closer to 90%, and those are the ones that we use. And, obviously, we're going through our unlocking now and updating our credible experience factors, but certainly the assumptions are based on our experience.
Okay. That's helpful. And then, second, you've also – you've shown us that statutory capital supporting the retained portion of your block is about $280 million. I'm curious. Can you speak to the level of statutory capital that resides within the trust that represents the portion of the block that is ceded to Genworth? And the reason I'm asking is in the unlikely event that you either decided to or at some point even had to recapture that block, I'm trying to understand what impact it might have from a capital perspective on you.
Okay. It's a fair question, John. The answer is, obviously, we don't call it a trust, but certainly we feel comfortable, and that's your term. So, I just have to make that point. But we certainly have the collateral Protection that we feel is appropriate, and the answer is that the Protection is in line with what we believe the liabilities are. And certainly, we work with Genworth and we certainly understand.
Again, it goes to our close relationship both on them doing claims, doing administration, other aspects that we work with that we feel that theirs is similar to ours. And so, it would not have to be a substantial denigration of capital if in the – like you said, we're not talking about recapture. But if it – and that event ever occur, there should be no capital. But we have no plans to recapture. I just want to make sure everybody understands that.
Oh! Very helpful. And then, finally, if I can just ask in general, if you looked across the block and you thought about the biggest sensitivities, where they exist with respect to – if actual experience did come in different from your current assumptions, which of those assumptions might have the biggest potential sensitivity? And how much risk do you believe still exist given how credible the experience is at this point, particularly with the first-generation portion of the block?
Okay. Good question. With the first generation, as we've indicated, we certainly believe that that has reached a stage where the impacts will be minimal. And certainly over the last several years they have certainly stayed within very manageable ranges and quite minimal.
I believe, it's probably going to be in the area of morbidity. But again, we do build in morbidity. And we've been tracking morbidity, building at about 1% a year. So, we feel comfortable with our credible experience analysis as we look at it, and especially as we go over to the second generation, we are certainly matching and feel comfortable with that.
But morbidity – and again, the problem with morbidity, you just can't look at it as a single event or a single variable. You have to start getting into mortality or other (44:28) implications of that. But I would say probably, morbidity is and we – as a reference point of sensitivity, a 5% increase in the course of claims would equate to about $130 million. Just to give you guys some sizing. Okay? But that relates to our GAAP reserve, which is our best estimate. Okay?
Okay. All right. That's all very helpful. Thank you, Walter.
You're quite welcome, John.
Following question comes from Ryan Krueger from KBW.
Hi. Thanks. Good morning. On the cash sweep, I think you mentioned that you'll likely pass along more to customers going forward. Can you help frame that at all? I know you've been keeping the vast majority of it so far. So, going forward, I guess, would you still expect to keep over 50% of the upside?
The answer is yes. Obviously, we track this very closely versus peers and competitiveness, but the answer is yes to your question.
Okay. Thanks. And then just a follow up on the bank. How should we think about potential capital requirements as you roll out the bank? Is that something that will have a material impact at all? Or should we not be thinking about that as really impacting your capital much?
No. I guess the short answer is no, you should not. It's in our basically risk appetite and tolerance analysis that we do, and we certainly make recommendations as it relates to the deployment of capital. And with its earnings characteristics, and so even with as we run risk elements, the capital – I think we've actually disclosed this, that, five years out, you're talking in the range of $400 million. And certainly, we're generating very strong returns on that. So, it is actually certainly manageable and certainly providing the right return characteristics with the right risk characteristics. So, no impact to our ability to continue to do and invest in our business and have other options as it relates to inorganic or return of capital to shareholders.
Okay. Thank you.
Our following question comes from Suneet Kamath from Citigroup.
Thanks. Good morning. So, wanted to go back to Long Term Care. I think you've said couple of times your block is different in that, it's older. But as we think about over the next several years, particularly as mortality kicks in, how should we think about the pace of reserves over time? In other words, should we get to a point where we start to see the reserves declining just because the underlying policyholders are starting to die off?
Obviously, the answer is yes. Listen, we are tracking and we do build in and certainly based on our credible experience that we have what we feel is demonstrating the claims cost increases. So – and then, of course, we still have the ability on price increases, which we certainly build in, that we feel we're quite prudent on that. So, the answer is we do see that, obviously, claims are going up, but certainly within what we expect, what we've seen, and building elements.
The other aspect of this, and we've gotten questions, Suneet, and I think just to be clear, we currently have built in to our reserves about $120 million worth of future price increases, of which 30% of that is already approved by the state. So, we're feeling quite comfortable with that element. Our reserves, as we look forward, we're comfortable with that. But, again, we're going through our third quarter, we have no reason to think it's going to change. But we feel quite good about where we stand with that, and certainly expect that it will be within ranges that we've seen or we will adjust as we've always said, but again, quite manageable.
And then on the credible experience, for the two blocks, can you give us a sense of what percentage of sort of covered lives are actually on claim at this point?
We have about, total policies on claims, around 7%.
For the two blocks?
Yeah, it's about 8% for the first generation. It's about 5% for the second.
Okay. And then is that reinsurance cover that you have, is that sort of 50% on the two blocks or does it differ by the two blocks?
No. It's – again, we've reinsured to Genworth – we're dealing – I'm talking about our block now and, obviously, they're setting up the reserves, and I just answered a question on that. But this is, again, they will be impacted by obviously the full amount, but the issue is with their share. But this is for us. We're talking about us.
He is just saying did they have a share of the total.
They have a share of the total. Remember, the total of reserves on this are $5 billion. We're talking about $2.5 billion. There's about 113,000 clients, they have half the clients or half the risk of it.
Got it. And then just lastly, on the morbidity sensitivity that you gave us, a 5% increase. I guess, one of the things we're struggling with is just to try to understand what's the base assumption for morbidity, and maybe how it compares to the industry overall. You had mentioned in your slide deck that you have this external validation. Do you have any sense of how your morbidity assumptions compare to industry standard?
Actually – we certainly, as part of a review look at, but it's very difficult to get something that gives you the comparability. We rely on our credible experience because candidly that is something that is tracked, and we certainly feel very comfortable with that. So, on industry, certainly we don't ignore it, but it is now building and it's not difficult to do – it is difficult to do a very precise compare considering when they stop their features, the way they manage it. But certainly, it's a data point. And that will be evaluated as we go forward, but we do rely heavily on our credible experience. And certainly, are not – we understand what goes on with the street, but the issue is drawing our conclusions about what reserves and what generates on reserves is really based upon our credible experience because we have not seen anything that would deviate us from that.
Okay. Thanks.
Our following question comes from Andrew Kligerman from Credit Suisse.
Hey. Good morning. On the tax rate coming in at 16.5%, and then guidance for 17% rest of the year, I believe guidance was 17% to 19%. And I know you've had – you've got benefits like the DRD and tax preferences on low income housing. But maybe you could touch on what's kind of keeping it a bit lower? And where you see it going beyond 2018?
Yeah, that's a good question, Andrew, by way. Good to speak to you again.
Yeah, likewise.
Right now we put that 17% to 19% out because there were still a lot of areas that were floating around that could impact that number. Those have subsequently been settled down. We also have the share purchase accounting, which comes in, and we're trying to manage that from that standpoint which has a big impact. As you saw in the first quarter, we took in under – 14 point some-odd percent. We think we have a good understanding of DRD. Our other elements are still in place. So, on that particular case, 17% looks good us. It's obviously dependent on, of course, your marginal tax rate. Because again, tremendous amount of generation and new profitability will give you a higher marginal rate of 21%. But I would say, you should be looking forward that that rate is a good rate and, obviously will increase in time, as we build the business and we get the marginal rate of 21% coming in. But it's a good problem to have, isn't it?
Absolutely. And then just lastly, Walter and Jim, on the property casualty business, I was kind of looking through the model and going back to 2011 and the combined ratio hasn't gotten below 100% since 2011. And I'm wondering, is that a business – and your rationale for staying in the variable annuity area and other areas of Protection make a lot of sense, but is this really a business that fits Ameriprise, and where you want to be?
Yeah, so as we said previously, the first thing we wanted to do is we did have – developed a very good business here, a good business model. It's a direct affinity business. So, it – it generates unbelievable client satisfaction. It's a low-cost operated in the way the business is run as a direct affinity type of model. And we have very good client activity and retention, so more of a mass affluent base. I think over the last few years, as we've grown through certain partnerships, like Progressive, et cetera, we picked up some undue loss activity there based upon the concentration.
So, now we're getting out of that type of arrangement, which would bring down a level of the cat activity that we experienced, that really got heightened over the last few years based on the number and type of storms that have been through the country, but you can see that across a lot of insurers.
In this certain part of the equation, we had to enhance a lot of our modeling capability as the industry continued to make adjustments. And there are different things occurring in the Auto section, and so we've been able to do that now. And I think over the next year or so, you're going see improvements that are going to work its way through in what we're putting in place on the underwriting, the modeling, the pricing, the claims management activities, the policy adjustments that we're making and the partnership arrangements that we're adjusting.
So, I do believe we'll get back to a good state. But to your point, strategically, it is not as integrated into our proposition in a sense of it's all our core client activity. But we have very good relationships. We have very good client base. We have a consistent retention of clients based on how satisfied they are with Ameriprise. So, strategically, we'll be able to evaluate that with our partners and figure out if there are things that we should consider. And I will do that. But we want to really continue to bring this back to the state that we think it can be in, and it's well on its way.
Thanks a lot.
Our following question comes from Kenneth Lee from RBC Capital Markets.
Thanks for taking my question. Just want to focus on the Continental Europe growth plans for Columbia Threadneedle. Maybe you could expand upon some of the key opportunities there within products or distribution, and given the challenges stemming from regulatory changes in that region. Thanks.
Yes. So, what we're doing is we're going to replicate a lot of our OIC (56:08) line and build on our CCAP line across the continent. It's a combination of – we're doing it both for a combination of Brexit activities, but also we do want to expand more fully in the key markets across Europe. And we've already started to put our extra resources, build the brand, introduce some of these product lines more comprehensively in the fourth quarter of this year.
And so, we'll be building out in places like Germany and Italy and Spain and places like that where we see a good opportunity, where we already have a good initial level of client activity, and that they're looking for our product. And we feel there is an opportunity for us to further expand and go deeper like we are in the UK. So, we feel good about that. We think it's a good opportunity and one that we can have some good success with – with the product line that we have.
Great. And just one follow-up. In terms of what you said in the prepared remarks, began to slowdown in mandate fundings within Asset Management. Want to know if you could expand upon that? Maybe comment upon what you're seeing in terms of institutional client demands? And maybe also stepping back, just from a longer-term view, how do you think about the potential to grow that institutional side? I know that the Asset Management business is skewed more towards the retail side right now. Thanks.
Yes. So we have been able to put together both a good product line, more fully and comprehensive than we've ever had before in the institutional basis. We have longer term track records in a number of areas. In some of the areas that we've been a bit stronger in, things like high yield, et cetera, as you would imagine the markets has tightened a little bit. People aren't putting as much money into it. And also, just based on market evaluations, people have slowed down a little bit on the equity side as well.
So, we don't see this as a permanent thing, but we do see – and I think you'll see it across the industry where the institutional activities have slowed a bit in a number of the areas, particularly in the areas that we have a bit more strength in. So, that's really what we're seeing. But we have been expanding our relationships. We are growing them globally. And we do feel there's more opportunity for us to continue to get some of our product line in, including some of our solution activity.
And so, we're building that out as well. We want to get a little more customized than what we can deliver for institutions. We're also building out our infrastructure business out of the UK and Europe. And we're trying to also with Lionstone start to build that activity even further there. So, we have some things in the hopper. But as I would tell you, I think if you look across the institutional activity in the first half of the year, it slowed a bit.
Got it. Thanks.
Our final question comes from Humphrey Lee from Dowling & Partners.
Good morning, and thank you for taking my question. Just in AWM, can you remind us like what portion your G&A costs are fixed versus variable? Like just how to think about the potential margin expansion there as the experienced advisors continue to ramp up going forward?
So in our G&A, we both have, first of all, support across the entire network for what we do from our branding to our capabilities that we offer and the services we provide. It also is volume-related in various activities. From trading activities and the platform clearing and, et cetera, et cetera. So, all of that is part of our G&A expenses that go up with volume and down with volume, as well as some what we would call our staff and support and servicing.
From an advisor perspective, we bear the cost of our employee advisors for their G&A-fixed costs like offices, et cetera. And our franchisee channel, they bear the cost of their real estate and their services and their support staff, as part of their activities and they have a higher payout to do that. So, it's a combination of where we have the asset, both fixed and variable, that we serve. And then our advisors, if – they're a franchisee pick up some of their overhead from managing their own in-office operations.
I guess assuming we're just looking at the second quarter, if you bifurcate the G&A cost in AWM, like what portion of that would be fixed versus variable?
The variable expense in that – again, it's looking at what we've said as it relates to vendors and other elements as it relates to the activity level is about $4 million or $5 million on that increase.
Okay. Got it. And then regarding to your recruitment of advisors, can you talk about the pipeline in the second half? My understanding is the changes in the protocol disrupted the recruiting in the first half, but things have picked up since June. Do you think you can get to a similar level as the second half of last year in terms of the recruiting for this year?
Yeah, the recruiting did slow a little bit at starting the year activities. There's a combination of factors including market volatility. But I think some change in the protocol for some of the firms. But I think our pipeline looks good. We're seeing a bit more activity come back again. As you saw, we picked up the 76 or roughly similar in the first quarter. But we do feel good about the pipeline, the people we're bringing in, and people are interested. And so we feel good about that.
Okay. Got it. Thanks.
We have no further questions. This concludes today's conference. Thank you, ladies and gentlemen, for participating. You may now disconnect.