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

Well, good morning, ladies and gentlemen. Very pleased to welcome back Garry MacNicholas, Chief Financial Officer of Great-West Lifeco. Garry, thanks for joining us again. Unfortunately, it's not live this time, but I guess this is what we have to do these days. Before we start, just wanted to mention to everyone online that if you do have any questions for Garry, please e-mail me, john.aiken@barclays.com, and we'll do my best to squeeze in your questions even though I've got a fairly lengthy list of my own.

Garry, I wanted to start off with what is obviously most topical for Great-West right now, your acquisition of MassMutual's Retirement Services business. I mean this is, well, not absolutely massive. This does appear to be a very significant event for Empower. Can you expand upon what your strategic rationale or your thinking was behind this? And what does this mean for Empower going forward?

Sure. Yes. I appreciate the opportunity. It's good to be here and no hassle at the airport. So there are some advantages. There are some advantages. And certainly, I mean, the transaction is a big deal. And it's not just a big deal transaction-wise for Empower but also for Lifeco overall, I think. And yes, last Wednesday -- or sorry, last Tuesday, was we announced the acquisition of MassMutual's Retirement Services business. In terms of Empower, it's a great transaction. Really, like it's at 9 out of 10, 10 out of 10 in terms of a fit with Empower. It's just a -- it's a really good fit. Number of perspectives. First is there's good business overlap, and that will drive synergy values, but it's important because a good chunk of the business is adviser-sold; small, medium corporate segment, which is right in the sweet spot for Empower as well. We're familiar with the advisers. A lot of the contracts would be more standard in that market, the more standardized contracts. So it streamlines the integration. So we see the integrations, the lower-risk integration, good synergy value. So certainly, a great fit there. And I think the customers will benefit as well through this. It will be a smoother transition for customers and the move to our platform where we've invested heavily and have a lot to offer. Second, just strategically for Empower, if I sort of step back. I mean, this now gives Empower over 12 million plan participants that they'd be dealing with in terms of I mentioned the small and medium segment, good margins there. On that participant base, that's where you get the growth in the IRAs, the individual retirement accounts. Those rollovers, that's a growing retail business for us, is having those rollover relationships, and we look to extend that. And again, the Personal Capital transaction recently, there's good synergies there to extend those retail relationships. And then third, just on the financials. It's an accretive deal, obviously, to Lifeco, very attractive financially. This -- because we're not buying an entity per se, it's you're buying a portion of MassMutual business, it's structured as a reinsurance transaction, which is very typical for these type of transactions. So the value metrics there you'd look at is really an IRR metric. You look at the embedded value, you look at the IRRs relative to weighted cost of capital. We're very attractive on that basis. It's accretive. And so yes, it's a strategic fit, good synergy potential and optimistic for a low-risk integration and financially attractive. Yes, very excited about the transaction overall. Plus it adds to -- that's about the Empower side of it. From Lifeco, this positions Empower really as one of our franchise platforms for future growth. I mean it's a -- it will take the U.S. segment to -- it should take it over 20% of our earnings once it gets fully integrated and fully synergized in the next 18 months or so. And that again would be very meaningful to Lifeco's overall portfolio. So yes, good all around.

Garry, Great-West has never been shy about making acquisitions. And this is one of the things that you've built your business up with. But I'm a little bit surprised in terms of the timing, particularly in the uncertainty with how the pandemic is unfolding. Why make the acquisition now? Was there a timing issue with the seller? Or are you quite confident that the business will not be necessarily be impacted by COVID-19?

Yes. I think there's a couple of ways we looked at this. And obviously, it's a very thoughtful decision on our part just to proceed. I mean in terms of the seller's motivation in this period, that -- it's hard to say, I don't think there's anything particular to the business. I think this has not been a core business for them for some time, at least that's my interpretation. They were looking to sell. It is a consolidating industry and a scale play, and they would have been in that sort of middle tier, which is a good size and, I think, a good franchise, but not quite at the top end of the market where, ultimately, after consolidation could be some pressures. If I look at us, from our perspective, in the COVID situation, I'd break it in 2 parts. One, there's the operational readiness. So as many companies, we were rapidly moving to a work from home, which for us, we were well prepared for. We've made the technology investments over the last number of years. And so we very quickly had high 90% of our employees very effectively working from home. So 85% in the office to 98% at home very quickly. So -- and what we found is that we can continue to run our business very effectively through this period. So when it comes to the additional operational challenges of doing due diligence, which we have done for quite some time through the last few months, to being able to carry out the integration remotely. We feel very confident that we'll be operationally ready to handle this. So from that side of it, very well prepared. From the financial side, that's the other interesting side. So first off, our own financial resiliency. So as we came into the COVID pandemic period, we came into it in a position of strength, good excess capital position, very strong balance sheet, high-quality investments. And so -- and then it's really running the stress test and saying, well, what if this, what if that, what type of recovery might there be from this, how long might it extend. Through that stress testing, we recognized that while, obviously, we gain -- we had a need to be thoughtful. We did have the capacity to continue our strategic deployments, whether they be organic or in the right cases, some of the inorganic or the M&A type opportunities. And this is -- so these opportunities don't come around all that often. So if we're ready and able and the seller was interested, it was good timing. And perhaps it kept some of the other potential players on the sidelines, perhaps it didn't. I don't know what others were thinking, but we felt very well prepared after thoughtful consideration and they're very pleased with the transaction.

Garry, in terms of -- you mentioned the opportunity is not coming up all the time. And honestly, it is basically, you have to be reactionary to a certain extent. You've actually made, along with this acquisition, you mentioned Personal Capital. You've actually spent a fair amount of capital recently on acquisitions. Do you still have firepower left? And I guess, the corollary to this is, what happens if something comes up in the Putnam space? And do you still have the ability to add on? And I guess, to go lower down on my list of questions but bring this forward, what are you doing currently to try to extract more value out of the Putnam platform?

Yes. No, that's -- I think there's a couple of questions buried in. But just in general, on the -- I'll start with the firepower side of it because I think that feeds into the others. Yes, if I look at -- first off, to note that this is primarily done within the what I'll call the U.S. side of the house at Lifeco. And it doesn't really impact the Canada-Europe reinsurance, which is what we often call the LICAT side of the house, where a lot of our regulatory capital so for the audience, that's the life insurance capital adequacy test in -- for the Canadian companies. And so we still have excess capital on that metric. Our LICAT ratio or the -- we target 110% to 120%. It was 132% at the second quarter. So well above our -- the higher end of our target range. So there is still some excess capital there. Now obviously, at this point, with some flexibility reduced with not increasing dividends from operating companies through the OSFI, the Canadian regulatory environment. So there might be some flexibility there. But within the Canadian-European operations, certainly, that's -- there's LICAT room and firepower. In the meantime, it's just a strong regulatory capital ratio. So we've got -- there's some firepower there. Certainly, from a debt point of view, this is -- we've pushed the leverage a bit higher, and that's a conscious trade-off to ensure we maintain strong liquidity throughout this more uncertain period, if I'll call it that. And so -- and we've obviously worked with the rating agencies and they understand the plans that makes a lot of sense, and we've positioned ourselves to delever quickly. So our focus there would be on making sure we do carry out the deleveraging plan. So I don't see us adding a lot of debt in the short term as we look to delever rather than add more. So firepower, I said, we do have some capital capacity. And then, of course, there are other alternative structures I've seen more recently for potential funding as well that have -- that aren't necessarily just adding debt. So there are ways for the right opportunities to keep our eyes open. And when it comes to Putnam, that's -- this is one of the areas where we would be looking for the right opportunity. Certainly, in the short term, we will continue to work. We have been doing some good work on strengthening the margins at Putnam through -- just organically through strong expense controls, getting some good flows. I mean there was a setback in March, obviously, with some of the short duration funds, but we've been experiencing good flows. We reported them through Q2. And Putnam, I know in their external reporting, has reported good flows more recently. So we are seeing this good performance there. We're attracting some good flows. So there are some organic moves. Obviously, to add scale, we would like to -- whether it's through a tuck-in, a smaller acquisition that's more manageable size and given the funding situation, or perhaps merging in and having a majority share, that would be our preferred approach. So in terms of to have a majority, that is. So there are a number of alternatives there to continue to maximize value. And that's really our goal, it's to maximize value. We do think there's value in Putnam, and that's a good franchise. So we -- it's been challenged with profitability, that's been documented in the past. So we see there are things we can do, notwithstanding the higher leverage ratios. There are things we can do to maximize the Putnam value. So I think that's covered most of your waterfront questions there.

You actually did a very good job. That's my 4-part question, probably threw you a little bit. Garry, back to the transaction with MassMutual, can you talk about the valuation behind that? Because as you alluded to beforehand, it's a reinsurance structure to the acquisition. But you also mentioned PE multiples in terms of the call. Can you just expand upon what the -- how you view the valuation or the multiples that you paid and where -- why you feel that's appropriate?

Sure. You're right, I said at the outset it's a reinsurance transaction. And so there's a ceding commission involved that you pay across to the vendor. And then you have to set up the capital yourself. It doesn't come with the deal. They release their capital and you set up your capital. So -- and again, the main valuation metrics in those type of deals, you would typically look at -- the vendor will produce an appraisal value and then you put your own assumptions in and get comfortable with those, and then you look at it over an overall embedded value perspective and an IRR perspective. So those are key valuation metrics. But as a sense check, you do look at PEs. But when you look at PEs in a reinsurance transaction, I have to say, okay, if you're acquiring a company, it would come with its own capital. So obviously, you have to add the capital to the ceding commission, but it also would come with an equity and debt structure. You'd be acquiring some equity and debt structure. So when we look at this, we say what's the P for this, we'd say it's the ceding commission. You have to adjust for that transaction cash tax benefit as just part of reinsurance deals. You take that out. You'd take the ceding commission and the capital we're setting up, and that was at a very healthy 400% RBC proxy. And then say that's about $3 billion. And then say, our debt and equity structure, typically a 70-30 equity-debt. So $3 billion of purchase price, 70% equity, that's $2.1 billion, divided by -- and we had them in our slides, the synergized earnings that you're getting in 2022, the fully synergized post-integration earnings. And that gave you about an 8.5x multiple. And we said, okay, that's a levered multiple, 8.5x. That has a good sense check. So it wouldn't be the primary valuation driver, but it's good to keep in mind. And then obviously, we can look at similar transactions externally that are for reinsurance deals and say, okay, it was in line, our sense for similar growth-oriented transactions, it looked in line from that perspective as well. So checked all the boxes from a valuation point of view. Obviously, accretive. And the way we finance it is, I always like to say, the way we finance it, the PE was actually 0x, made 0x earnings because there was no equity in the financing. But no, on a sensible basis, we feel that -- and I think I quoted high-single digits on the call as people try to do the math. But that's how we looked at it.

Fantastic. And then in terms of -- you mentioned just in terms of the synergies, I know that Great-West historically has been very conservative in terms of what it's put out there. But can you talk to the degree of confidence that you have in terms of obtaining both the expenses as well as the revenue synergies? Because one of the factors in play here is that, well, because Empower has been built up from 0 through acquisitions, you actually have done integrations before. And I'm assuming that there's a reasonably high degree.

Yes. And so I think the synergies we quoted, I think we quoted the 20 -- the post-integration ones, the synergy expectations there in 2022, and that's -- I mean, the expense ones don't change much over time, but the revenue ones we expect to keep growing. So we quoted $190 million of synergies. But of that, $160 million is expense related and just $30 million were on the revenue side. You're right. We've done integrations like this in the past. This would be on the -- given the nature of book of business, which is skewed more to the small, medium corporate segment, I mean, there are some big-sized plans in there as well. But there is more of a skew to the small, medium where we have strong adviser connections, so you get good retention through that. We see a lot of standard contracts, so ease of integration. We have teams. A lot of the teams that worked on the JPMorgan Retirement Plan Services integration are still there. They're still in place. As you know, we've been looking to -- once we finish that integration, we have been looking to make a transaction like this for a couple of years. And so we've been ready to do this. So they're set to go. They have a clear plan. We're coming off 3 systems. It adds a bit more work, but not a lot more complexity because we're familiar with at least 2 of the 3 systems. I think we've had familiarity within our teams already in the integration work. So we're in a good position to deliver those. So I'd give that -- from our perspective, we have a high confidence on that side of the house. And again, we started with quite a cost advantage. Empower was almost 4x as many participants to start with and on one system. Relative to MassMutual, they were spread across 3 systems. So we had quite a cost advantage to start with. So we're not making heroic assumptions in terms of the average cost of bringing them on to our platform. I think it's -- they're appropriately prudent on the expense side. And on the revenue side, this is one, again, I've mentioned IRA rollovers earlier. The individual accounts. This is something where Empower has really put a focus on assisting people as they come out. It's probably $30 billion a year comes out of those retirement plants as people leave employment, change employers or retire and they're looking for something on the individual side. And at Empower, we've really put an effort into capturing those -- some of those flows. I think we've quoted our rollover book crossing a $10 billion threshold a few quarters back. Whereas at MassMutual, this is something that's largely been untapped. I think it's an area that we're starting to think of. But really, there's a real opportunity to expand our IRA rollover offering into this book. And just move not all the way to the Empower penetration rate, but even if we just move the needle upwards, that drives a lot of the synergies. We haven't counted a lot on the Personal Capital synergies even in the 2022 metrics although we do see real potential there. So again, I'd say the synergies, we've taken a more cautious view on the synergies, just the nature of those. But we see real upside on the synergy front as we go through time, get the business fully integrated, have full access to the Personal Capital tools and capabilities to augment the Empower side. So yes. Good profile for the expense synergies. And I think real opportunity to perform well and beyond as time passes on the revenue side.

Fantastic. And I think as part of the transaction, you mentioned the strategic relationship with MassMutual. Can you give us a sense in terms of what you're thinking and what the impact may be on Lifeco overall?

Sure. Yes. In terms of -- if you think about the Empower business, let's just sort of step back there, it's largely a digital business. We're dealing with the plan participants, the financial wellness solutions are, we're dealing with them on a digital basis. And so what we're working with MassMutual on is a strategic partnership to provide products and services through the Haven Life Insurance Agency of MassMutual, which is a digitally enabled insurance offerings from MassMutual and some of the other voluntary products and more on the life side to complement the financial wellness tool. So that partnership we see as having real potential there is to get that Haven Life, those offerings across the -- what is it, the over 12 million plan participants that could benefit from those just as part of an overall financial wellness offering. So we see benefits to the customers and to the 2 organizations.