Great-West Lifeco Inc. (GWLIF) Earnings Call Transcript & Summary

All right. We will get the next session started here. First thing I'd like to do is thank John Nielsen for being here, CFO, Great-West. You all -- I know them better as Empower for my 401(k) plan, but fantastic to have you here. I can't wait to jump into the conversation.

I wanted to start with a broad strategy update type of question here. I mean you all hosted an Investor Day not too long ago. You provided a lot more disclosure on your business, which is very appreciated from the outside. What are the things you're most focused on as we think through this more medium-term plan? What are the things you're most focused on over the next 12 to 24 months? What is the beginning part of that execution look like for you all?

Yes. Well, first, thanks for inviting us, Alex. We really appreciate the opportunity to meet with investors here at this great event and really appreciate the opportunity you've given us to join you here today on the stage. So yes, we did host an investor event. It was a -- we call it across the waterfront view of all of our businesses. The composition of our portfolio over the last 10 years have changed quite materially. We went through a period of consolidation, so to speak, in terms of our focuses. We totally transformed our U.S. business by selling off our interest in Putnam, selling off our life insurance business and reinvesting into becoming the second-largest retirement provider in the U.S. And that was done both with a significant amount of organic investment to our U.S. business as well as some pretty strategic and large transactions that's given us this incredible position. So what we wanted to do at the Investor Day is rearticulate both the strengths and the market shares. What we like is develop markets, we know well, significant brands, deep penetration, top 3 market positions. So we wanted to bring forth the strength of those businesses. We thought a number of things were underappreciated and part of that was on us telling our story better, but also part of it was giving enhanced disclosure. We wanted our investors to know better just the strength of our capital generation, the strength of the positions in the market. And that then led to changing and reaffirming and upgrading some of our targets. So out of that came moving from 8% earnings growth to a range of 8% to 10%, raising our ROE target from 16% to 17% to 19% plus and reiterating our yield payout ratio of 45% to 55% and also introducing capital generation and really clear disclosures around how much capital we generate and the fungibility of that capital. So what we said is we're going to generate over the medium term 80% plus of capital as a percent of earnings. How did we get -- I mentioned the strategic positioning we like, but it's also a fundamental change in -- over time in our business mix. So we're about 2/3 capital -- what we call capital-light businesses now. That's Retirement. That's Wealth. That's Group Benefits. We have leading positions in our geographies in those businesses. They are the businesses that have the highest organic growth rates. And so we'd see those capital-light businesses becoming 70%, 75% without any inorganic deployment over the medium term. And that kind of leads to those higher targets that we've laid out. In terms of execution priorities over the next 2 to 3 years to get there, in most of our markets, all of our markets, we're in the position that we like to be in. We've disposed of market positions that we don't have leading franchises in. We have good deep customer bases. So many of those are continuing to execute very strong, growing with the market, taking market share organically. I guess, in terms of where do you see the most change, it would be Empower. And so over the next 2 to 3 years, I would say our biggest opportunities expanding our wealth business in the U.S. organically principally. Right now, we capture -- we've increased our capture rate at rollover by 30% over the last 3 to 5 years. Our targets anticipating increasing that by another 30%. That would take us to 20% rollover capture. That's a far distance from where we hope to get over time. In comparison, we see best-in-class being 40% to 50%. So a long road, it's a multi-year, multi-decade journey. But our principal focus in the U.S. is getting that rollover capture up over the next 5 years.

Great. Maybe I'll dig in there on Empower a little bit. I thought one of the positives from the earnings call was you all talked about potentially getting as much as $25 billion of flows into Empower. And this is an industry where it's not maybe overall industry positive flows. So quite a feat to be able to potentially do that in the back half. What -- what's the underlying driver there? What are the things you're doing that are working?

So I think it goes back 10 years and the team that set out our strategy recognized that structurally, the U.S. retirement market was an outflow for a period of time with the baby boomers demographically exceeding new entrants into the into the retirement platforms into the 401(k) market, and they anticipated that. And they saw that as a strength to build on because it said this market is going to have to consolidate. There's going to be less providers as you go through that demographic change. And what they identified were 3 -- what I call almost 3 winning levers of the strategy. One is you have to have a top-notch tech platform that you own that delivers very cost-efficient processes, and you have to have a cost advantage. And through the transactions that we've done, I think we've proven that cost advantage. We're able to take out 30% to 40% of the cost base of books that we bring in onto our platform. There are some variable costs, obviously, you have more contact points with customers. But there's a lot of fixed costs that need to be maintained, brand, tech and so on. So we think we have a winning hand on the cost side, driven that we own our own tech. We're very efficient. We've been -- it took a long time to do this. And if we look at public traded comparables, you can -- we can see that cost advantage in the numbers. So that was one -- one part of the strategy. The second was to be open architecture. Do not rely on manufacturing asset management products to be, if you want to call it, the Switzerland of asset management and partner with best-in-class providers. We thought that played into the Department of Labor's fiduciary responsibilities very well. It didn't leave us dependent upon asset management margins to meet our targets, and it allows us to partner with the best-in-class asset providers. I think the third thing was we saw that the team that built this saw the advantage that digital would bring to wealth over time and knowing that mass affluent middle-class people need wealth advice as well, can't be provided only with human touch. We knew human touch would be both ends of our business for the long term, but you can enable advice to be provided to many, many more Americans on a hybrid basis, using a combination of human and digital. And that's our model. And our model is right now to attack those people with somewhere between $200,000 and $2 million in retirement assets and bring a wealth-based advice model, best-in-class asset managers and focus on asset allocation, financial planning and getting people to save more for the retirement and stay safe. So that's our model, and it's worked out well for us now. I would say we're in the early innings of that wealth build out. And those were the tenants that led us to where we are today and what we think is a winning hand.

Next, you discuss the earnings sensitivity to equity markets in that business. And the reason I ask is markets are clearly up a lot from at least where the average level was in 2Q. I would think that would be a reasonably good tailwind for the part of your fees that are AUM-based. And the additional question I want to ask is, well, what do you do with that additional flexibility? Is that something that you leverage it to invest more in the business? Is there some of it that will fall to the bottom line and benefit your capital base? Just trying to understand the way you approach it.

Yes. So we do like this profile of earnings that we have, and let me just dive into that. About 50% of our revenues are kind of asset-based fee linked revenues. Another 25% or so, 30% are, call it, fixed fee or transactional-based fees, so they're not dependent on any type of markets. And then the residual is spread based from our stable value products. So this is a very diversified set of revenues. Over time, what we really like is we found new sources within those categories of revenue to continue to diversify and build our revenue base. This provides, along with cost, a competitive position that allows us to really compete strong on organic growth in the retirement sector that you touched on. So very diversified, very broad-based set of fees that we like that profile. In terms of -- you're right, it should provide tailwind to continue to show great earnings growth. In terms of investment, I would say our principal investment is going into the wealth side of the business. You'll see that the margins of both businesses are quite similar, 30% type of EBITDA margins. In the long run, we'd expect our wealth margin to increase to be a higher margin than the retirement. Why is that the case? Well, we're about $100 billion of out-of-plan assets in the wealth. We're growing, net flows in the wealth business are $12 billion plus this year. If we increase that capture rate, that business is going to grow very nicely. That leads to the double-digit earnings guidance that we've given for the U.S. business. So wealth is growing at a very healthy rate to get to double digit. We would say our retirement earnings would grow at mid-single digits plus type of levels over time. So investment is going to be principally on driving up that organic rate. What we need to do and what we think is the winning hand is to build a deeper relationship with the clients while they're in plan. So if you look at best-in-class, why do they win at higher levels of rates? Will they have multiproduct relationships with clients while they're in plan? We've announced that we're moving deeper into the health care savings account business. There are other things that we can do, whether it's retail brokerage, education savings accounts that we think will deepen our relationship with clients while they're in plan. And that will give us the right to win and move up that capture rate over the medium to longer term. And that's where our investment is going.

Can you talk about the competitive environment in the Empower Retirement business. I guess I'm interested, what are you seeing out there in terms of pricing competition? And also maybe if you could opine on is price usually what wins for you? Or is it more on the capability side, like just how price elastic is that process?

Yes. It's a great question. And it goes back to the original strategy. The strategy of being a cost leader where you can invest in the retirement business, while still maintaining strong margins. And what we would say is we viewed the smaller players what would force their hands on consolidation is the inability to invest into the retirement platform and make it best-in-class. If you have earnings guidance, you're a public company and you're in an outflow. It's a bit of a -- what do you want to say a treadmill that you're on. Ultimately, they would need to curtail investments. Most of those providers rent their tech from third-party software providers that are also unwilling to invest substantially in service and in integrating wealth into the retirement platform. We own our -- we own our tech, we can do that. We can invest and still grow. So we believe in order to make our inorganic strategy successful, we needed to win organically. And if you look at the last 3 to 4 years, we've taken $135 billion of planned flows from other providers. We would say us and the #1 company in the industry are the 2 that are taking market share at the expense of the remaining parts of the industry. So winning market share organically is a testament to the product that we offer, the service and standards that we hold and that we're providing financial wellness to companies at a time when financial issues are typically what keeps the workforce from being highest productive. So we continue to win market share. Is there some price compression? Of course. I guess our view would be we'll outrun that with continued enhancements on the back office and the ability to invest into better solutions for our clients. So do we feel price competition? Yes. Do we always win on price? No. I'd say more times than not, it's on the service, the broader offering that we bring to our clients than price.

That's helpful. One of the key topics at the Investor Day that you already touched on a little bit was just the cash generation, how much capital you're generating. You're returning some of it. There's also some buildup that's occurring, a good problem to have. But just listening to you talk about how fragmented it still is out there and some of these providers can't invest in their businesses, it seems rational that many of them would make the decision to sell. Is that accurate? Like how impactful could that be for you? I know it has been a big part of the strategy, but will it be as big a part of the strategy for the next few years?

We certainly want to be opportunistic and be prepared for those opportunities when they come. We will maintain quite strict price discipline and make sure that the transactions meet our financial strategy and our incremental where we allocate capital, and we want to be prepared for that. You mentioned that period of time. We obviously took advantage of our strong balance sheet, strong credit rating to lever up the balance sheet, make those transactions. And now we're back in really good shape. So we -- you typically see us around 30% leverage. We're down to 27%. We have really strong capital, regulatory capital levels despite the capital generation. So very strong there. And where we have more than $2 billion of cash sitting at the holding company. What we also have done actively while we wait for the right opportunity is we started to return cash through buybacks. And we've announced 2 buybacks this year. We have that capacity. And we will balance that return on capital with those financial opportunities, strategic opportunities that come up. We think the market needs to consolidate more. We think with our cost advantage and the ability to provide wealth services, which many of these retirement providers are nowhere near our capabilities, it makes industrial logic to consolidate the market more, and we think it will happen. It's a matter of when. So we're waiting, and we'll be ready to go when the right opportunity comes. We think it will consolidate down quite substantially from where it is over time, and we'll be there when the right transaction comes.

Maybe just probably a touch further. I mean, do you envision more of this industry consolidation or at the micro level where it's like smaller businesses that really can't invest? Or are there still pretty large opportunities out there where there's still a very big scale play for you as well?

Yes. Well, the good thing is we have -- I think the good thing is we're very successful in our integration. So if you look at the larger ones that we've done, Prudential, MassMutual, JPMorgan, those were the largest transactions that we did with very -- some of which have very large clients, Fortune 500 that are very picky about these transactions. It's never easy. So nobody actually wants to change 401(k) if you're in the HR because you've got to send out passwords to thousands of people, disrupt your employees. So it's a very sticky nature of business, only about 3% of plans. We have [ 97% ] retention rate. But when you do a transaction, you're at your weakest point, right, because you actually have to force all your clients to move platforms, send out new passwords, change what they do. We had priced those transactions at a level we're comfortable with and we way overperformed the retention. And we think that's, again, a sign -- you can see we disclosed revenue and participants. So you can see what revenue shrinkage we had to do to retain those, and it was both in excess of our targets. It was high 80s percent despite being disrupted. So we were very successful on that, much better than everybody else. So we have experience in the large integrations, but we've done smaller ones as well over time. So whether it's large or small, there's a lot of the things you do that are the same, meaning we see it as being easier to integrate 1 versus 3. But we can do it either way, and we've done it both ways. So what's our preference? Our preference would naturally be to do 1 versus 3 because there is some synergies from larger customer bases, but we could do either way. We think the pressure will be across the sector. I mean, if you think of -- let me probably lay out the market. If you think of the #1 provider, which I think everybody knows who it is. It's -- they're about 30 million lives. We're about 20 million participants. We're adding 600,000 to 700,000 new participants a year. They're adding proportionally a lot of participants every year. The next largest players are, call it, 5 million to 7 million lives. So -- so we're already 3x as large. And there's 2 or 3 of those, and then there's a whole host of people with 1 million or 2 lives. So we think that pressure is across everybody -- everybody but the 2 largest. The acute pressure will obviously be the smaller you are, the more cost pressure you're going to have. We suspect there's a lot of fixed costs.

Makes sense. Okay. Can we have a similar conversation around the wealth side of the business? And I guess maybe just to add into the fold like are you -- is there still a focus on doing some M&A within wealth? How does that compare to maybe just doing team lifts? When I think about some of the publicly traded ones in the U.S. that have built our wealth management businesses, I think team lifts has been a really big part of it. How does that all fit into your strategy?

I think our wealth strategy is probably a little different than they the RIA roll-up strategy. Obviously, we're very familiar with that strategy in Canada, our home market, and in Europe, where we're also building independent financial adviser roll-ups. We're not pursuing the same thing in the U.S. today. Our advisers, there's 1,200 of them. We're growing that organically. They're principally salaried based advisers, the remote partial -- as I mentioned, there's a hybrid -- human digital hybrid advice channel. So we're not competing with other RIAs for team lift-outs or consolidation. It's really an organic strategy. And I would say, to build the business, there is a distribution component. We need to continue to attract salaried advisers. We're on track to do that. There hasn't been any -- let's say, we've been able to do that commensurate with the ability to deliver that rollover percentage upwards. I'd say the big investments are brand. Everybody has now seen Empower all over CNBC, but we're only about a 50% aided awareness of the brand right now. Big providers are 80% to 90%. So that's going to take time, right? It needs to become a household brand name. Number two, it's product. I mentioned, entering HSA market, we need to bring other products to our in-plan customers. We already capture more customers off our platform than anybody else. So we're already #1 of our platform. But if -- where we typically lose isn't to the RIA of the world because those -- they're looking for 2 million-plus accounts. We are losing to the big financial services providers, the Vanguards, the Schwabs, the Fidelities. So building that product suite and that deeper relationship, we think moves the dial on the rollover rate. And then the third thing is just customer experience. We are very good at this, but we need to become better. We need to make it easier to roll over to us. We need to be a one-stop shop in terms of the customer experience for other products. So I'd say in the medium term, are we going to buy distribution in the wealth side? Could be, but probably it's more likely we invest organically on the wealth side. Are there skills or products or complementary spaces that could accelerate that build probably? But pricing right now is quite aggressive. And we're not necessarily competing against RIAs for teams right now. So I'd say that's probably more likely organic and if we were to deploy material inorganic capital into the U.S., it would be further consolidation in the retirement sector.

Makes sense. We pivot a little bit over to Canada. I wanted to see if you could talk about the Group Benefits, specifically what you're seeing in terms of top line growth production, maybe if there's any initiatives that are going on right now that we should be thinking about? And how you're viewing the performance of the margins in the business as well?

Yes. So while we're a retirement wealth player in the U.S. and the leading one, our international presence, we're strong in retirement and wealth in Canada and Europe as well. But we are a leading Group Benefits provider, #1 in Canada. Our historical focus has been on the small, medium sector where we see the great margins. We've also started to move into larger -- the larger scale market. We have the heft and the scale to compete there stronger than we have in the past. The margins have been very strong. They've always been pretty strong in Canada. Competition is quite rational in Canada. At the edges, you see some heightened competition. Nothing that really gives us pause. Disability margins are very strong right now. That's driven by a good experience as well as higher rates. The higher rate environment at the medium term -- term structure of the interest rate cycle is helpful to us. Obviously, you're discounting present value back lower. Nothing that gives us real pause. The -- while unemployment is up in Canada, the economy is slow. We actually are hopeful that the future is more positive for the Canadian economy than we might have hoped 12 months before. The government is going to invest substantially in infrastructure, military spending. There is a lot of investment that will happen in Canada. And we're hopeful that, that will lead to better economic growth as we look out 2 to 3 years than where we are -- where we're sitting today. So there's nothing in that sector that says that -- it's really a battle of the 3 big companies there, but pretty rational competition. So nothing that gives us real pause right now.

If we move over to the U.K., could you talk a bit about bulk annuities? I think that was something you highlighted is a good opportunity in the last Investor Day. So I just wanted to see if you could update us there on some of the things you're doing?

So as you think of Great-West, we talked a lot about Empower, #2 in retirement. Canada Life in Canada, we're 1, 2 or 3 in every sector of the insurance business, #1 in Group Benefits, obviously, very strong in the other. Our European franchise is really principally made up of a very strong position in Ireland, which is the strongest growing economy in the EU. It's benefited from Brexit, obviously. It's benefited from being very close to the U.S. and Canadian economies. So lots of employers make their European base in Ireland. So in Ireland, you can think of us as a 40% market share in almost all of the nonretail banking financial sector, but it's a small but growing population. U.K. is really the place where we're not top 3 in the country across all segments. It's more of a targeted position where we're one of the last foreign insurers in the U.K., but we have targeted positions. So we're #2 in Group Benefits. Again, we're very good at Group Benefits, life, disability and so forth. And we've always been very strong in the retail annuity market. So English, I think I heard on the last stage, the Department of Labor wants more retirement income products in the U.S. And I think that will happen at some point. The U.K. has been the opposite, very defined benefit, very fixed income retirement streams. So we've always competed very well and with good reasonable margins in the retail sector. The U.K. is going through -- corporates are going through a derisking of their balance sheets. Higher interest rates right now is helpful, but they are going to derisk $100 billion or $1 trillion of on-balance sheet defined benefit obligations to the private sector over the next 10 years. We know this sector both through our retail annuity. We've also been a big player through our reinsurance division and longevity transactions in Europe, more on an institutional basis by supporting other providers in this pension risk transfer business. So we know it well. We're only a couple of percent market share in bulk annuities or pension risk transfer. I wouldn't think that we're going to be a major player, but we think we can do better than we've done before. We think we can grow that market share to a degree and provide some growth given all the skills that we have in underwriting longevity. Why do we think it's attractive right now? A couple of things have happened. First, Solvency II limits the asset allocation through the capital structure, the options that you have. So it's not like pension risk transfer in the U.S. where you can kind of move it to Bermuda and invest any way you like, or let's say, in a really broad perspective, they limit the asset choice. It's pretty limited because of the high capital stream into more conservative investments, but illiquids provide some yield. And the second thing that's happened is they said, you can't move these assets offshore. And so you can't just do what the U.S. market has done, underwrite these pension risk transfers and move them to Bermuda. They allow maybe 20% offshore, but they're requiring a substantial amount of your risk to stay onshore. There's only half a dozen plus people in the market. So by limiting reinsurance in us being onshore, we think it makes the margins a little better than if they would allow offshore. And we're -- we typically compete in the small case market. So think of pension risk transfer of $50 million, $100 million, maybe $200 million. We're not competing in the $1 billion transactions at this stage. And we like the margins in that. And then I'll say that secondarily, our Reinsurance division benefits because it can be where you do take advantage of 20% offshore in this market, what the U.K. regulator said is you can't just place it all with one provider. You need to split your reinsurance, you need to have a diversification. So naturally, they have to come to us. It's a AA provider. So I'd say it's an opportunity. I wouldn't overstate it in terms of the equity story of our company. If we can underwrite that business at mid- to high digit IRRs, we'll do it in a limited capacity. If we don't see that good margin, we're not dependent upon it. We will pull back our capital. We'll reallocate it to other sectors. So it's a nice opportunity to have, but not something we're dependent on.

Got it. Next, if we could go to the productivity initiatives that you've got going on. Could you remind us of some of the things you're doing the efficiency ratio improvements that you're anticipating? And maybe even just sort of geographically, now that you've got this more thorough disclosure that you've laid out, where should we expect to see the benefits that they come through?

Yes. So -- so we did indicate that we saw some efficiencies coming through the business, and we're making some investments into that. So we announced about $250 million to $300 million charge. Let me lay out where we see that coming geographically and how it will benefit us over the long run. Most of it is targeted at Canada. So if you think back, Great-West really consolidated -- or started the consolidation of Canadian industry into these 3 great companies that exist now. Obviously, there's -- I'd say 3 major companies that control 80% of the market share. There's other great companies in the market that have found their niches and grown really nicely too. They're quite a consolidated industry. When we did that, we maintained 3 brands up until about 3 or 4 or 5 years ago. We had Canada Life, we had London Life, and we had Great-West. That was the right strategy for a period of time. We always had the best -- we felt the best distribution. It gave affiliated people who affiliated one of the brand and brands higher, the opportunity to work with them. But we decided the best thing to do in the long run is leverage one of the best brands in Canada, Canada Life. So if you look at brand awareness in Canada, you know Tim Hortons, you know Air Canada and you know Canada Life, right? This was just the right decision at the right time. When we made that switch, we were quite focused on the U.S. integration and so forth. We've now turned our attention to leveraging that brand, building a better customer experience in Canada, trying to throw around our heft better behind the Canada Life brand being -- having a better customer experience and becoming more efficient in Canada. So most of that investment goes into Canada. It prepares us -- it puts in place a better platform to enable AI over time. So a lot of it is moving to the cloud so that we can enable AI over the longer term better. And it's really to modernize our tech platform and kind of integrate it into a tech-enabled environment. The U.S., that's already been done. Ireland, that's already been done. They are really prepared for the advent of the AI. They're on the cloud largely. So most of it goes there. There are some, I'd say, smaller investments into the U.S. and U.K. as part of that. If you look at our -- how we get from, call it, 56%, 57% efficiency ratio down to 50%, sub-50%, I'd call it, 75% just comes from revenue growth. The other 25% comes from efficiency initiatives that we announced. And we think over the medium term or towards the end of the medium term, AI will be a real enabler that we need to be prepared for that will potentially drive even more efficiency over the long run. And that's what we're getting prepared for with those charges.

Got it. That's helpful. So it looks like we have time for maybe one more here. So why don't we hit on the ROE target that you've laid out? And I wanted to ask you about this because you've got a more capital-efficient business. We could almost debate whether ROE is even the right way to think about it a little bit. And so the nice thing about that is you're generating all this capital. As you put that to work, does it just naturally continue to be upside to those ROEs that you've laid out? Could we end up seeing more actual earnings growth as a result of just the redeployment, whether it's -- you've been doing more buybacks but also some of the M&A. I mean I'm just trying to think through whether -- I mean, the ROE sounds great where it is, but is it also just sort of missing the point of like this thing is going to keep chugging itself into more redeployment, more earnings growth, too.

Yes. So I think the -- I mean, I think it's natural to continue to have an ROE target. And it's -- it really goes -- why is it increasing? Really goes to the nature -- fundamental nature of the redeployment of capital into inorganic growth, right -- or organic growth, excuse me. 66% of our business is effectively capital light, meaning mix dollar deployment of growth doesn't require additional investment that's not already built into their earnings. We're investing in tech and so forth in marketing, but that's in the earnings. It's not, call it, distribution costs to get that next dollar of growth, commissions and reserves that you need to set aside. These are capital-light businesses. So if you look at the return on next dollar deployed of capital to grow, it's very high because of the nature of the mix of our earnings and the growth rates of those earnings. So we moved the target up to 19% plus. We wanted to leave room for inorganic growth. We didn't want to not have the ability to consolidate the market or invest into things that were strategically important over the long run and financially attractive, that might, let's say, temporarily set us back on ROE, and we think we got the right -- we think we got the right place at 19% plus. If you look at our prior guidance, we said 16% to 17%. And by the time we changed it, it was where we are today about going on 18%. If you look at -- in the long run, we think our wealth business in the U.S. can be as big as our retirement business. And the wealth business is a high ROE business, much higher than the 19% guidance. And I wouldn't think that we would deploy capital into more capital-intensive insurance businesses as we look forward. Organically, we left aside 20% of our earnings to invest in those. But I don't think you'd see a change in strategy where we didn't organically reenter higher capital businesses. So just gravity and growth over time should get us to that 19% plus, and we'll continue to evaluate all our targets regularly. And if need be, and we're able to overachieve the 19% plus or we need to reguide, we'll do that in due time.

Great. Well, thank you for being here. It's been fantastic. Thanks, everybody, in the audience. And we'll see you back here tomorrow.

Thank you, and thanks for the time, Alex.