In a prior note I penned in August, I suggested Jackson’s efforts to push regulatory change was perhaps more real and near term than one would normally assume when corporations think of government timelines.
In December the company announced that it had come to a preliminary agreement with the Michigan regulator for a new regulatory framework that would achieve the goals Jackson outlined, namely less RBC ratio volatility and less uneconomic hedge spend to defend against uneconomic RBC movements.
As the stock has not moved since the 8-K release, I thought I would put on paper what I expect the company will say with respect to the tangible outcomes for shareholders when it releases earnings this week.
Note: The below is a brain dump versus an article to capture eyeballs, so keep that in the back of your mind.
Capital Surplus
In the past, the company maintained an RBC ratio target of between 425-500%. However, it was comfortable with and often carried an RBC ratio above 500%, including when it last reported in November. Does that change with the new regulatory framework in place? I think that the company indicated as such on the prior call:
“So first on the Michigan solution, assuming you get it in early ’24, would that change how you think about your RBC target of 425 to 500%”
“I think that’s a likely outcome, Suneet, that we would want to revisit that, not indicating that how it would change. But I do think that when we set that 425% to 500% target range, we set a wider range purposefully, given the volatility in our business. And I think to the extent that some of that volatility was contributed to by the cash surrender value floor, a solution that mitigates that cash to undervalued floor solution could very well likely mean that we don’t need such a wide range to think about. And therefore, that’s something that we would be considering as we look forward and provide our outlook and targets for 2024.”
JXN 3Q22 Earnings Call
Given that the company was sitting above 500% in the prior quarter, it is not unreasonable to presume a return of something like 75 basis points (bps) of capital to shareholders (or a partial return) could be in the cards. Seventy-five basis points on total adjusted capital (TAC) of roughly $5 billion and 525% risk-based capital (RBC) would be something like $750 million, on a market cap of $4 billion.
However, I hesitate to presume anything like that will happen. If anything is clear about this management team, they have a track record of being conservative and disciplined. The odds they “stair-step” their way to an eventual resting place are very high, in my own opinion. So, say they want to likely settle on a range of 350-425% given the new framework, my guess is that they lower it to 400-475%, and then 375-450% the following year, etc.
In a different vein, the company has said it aims to maintain a minimum cash buffer of $250 million at the holding company. As of last quarter, the company had $900 million in cash equivalents and up to $1.5 billion in total assets at the holding level. Furthermore, the company generates something like $200 million per quarter, roughly speaking, in cash in the old regulatory regime, so that amount is likely higher now. So, will the company return a substantial amount of cash independent of a potential release of capital from the insurance entity?
Again, my gut feeling is likely no. The company had a target of $500 million returned to shareholders in 2023, and they were roughly at $350 million at the end of Q3. So, to get to $500 million, they roughly returned the cash they generated in Q4. But more importantly, the company is trying its hand at growing a new product category, RILA, given its distribution capabilities and differentiation of the product versus its core variable annuity (VA) product. It has grown the line of business (LOB) quickly, and if I were in the CEO’s shoes, I would consider this a “moment” in which, if the returns in RILA continue to clear a reasonable hurdle, it is a moment in time to put the foot on the gas and not be capital-limited in expanding RILA.
Call Buying
The company was buying roughly $500 million in calls in 2018 when the book was smaller and less “floored out” to the extreme. Given the book is far larger now, but more importantly, more floored out than prior, I would presume the call buying is somewhat higher than the $500 million figure. Since the uneconomic call buying may be “mitigated,” I presume this figure is now gone, a material cash saving on an annual basis. However, in the release, it also explicitly called out interest rate hedging in the new regime.
In the prior world, Jackson was clear that their hedging program was a more holistic economic approach versus a 1:1 “immunization” of macro factor risk inputs. Other insurers explicitly called out their immunization strategies to help investors focus and value the company based on the risks it is taking. With this wording, it seems, Jackson is moving closer to an immunization strategy with respect to interest rate risk. To that end, I would expect some portion of the prior call buying outlay to be utilized for rate immunization. How much? I have no informed view, and my hope that it is material is speculation. But if it does result in a net savings of around $250 million or 50% of the 2018 call buying budget, it is material against capital generation of $700-900 million per year.
Moreover, sustained annual savings are what I presume the board will overlay potential increases in returns of capital to shareholders. If cash generation increases 25% as a result of the new regime, I would presume that a material portion of this increase would apply to the dividend/buyback.
Crystal Ball
Altogether, while a more aggressive management team may initiate a one-time massive share repurchase paired with a substantial increase in returns to shareholders, I don’t think that will be the case at Jackson. I personally believe the management team prioritizes “consistency and discipline,” words that have been used ad nauseam in communications with shareholders. My best guess is the management team increases its budget for annual return of capital to shareholders from the current range of $450-$550 million to something like $550-$650 million, with guidance that any future increases in shareholder returns will continue to follow the prior framework of 40-60% of annual capital generation.