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EQUITABLE HOLDINGS, INC. – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of
operations should be read in its entirety and in conjunction with the
consolidated financial statements and related notes contained in Part I, Item
1 of this Quarterly Report on Form 10-Q, as well as "Management's Discussion
and Analysis of Financial Condition and Results of Operations" section contained
in our Annual Report on Form 10-K for the year ended December 31,
2021 ("2021 Form 10-K").
In addition to historical data, this discussion contains forward-looking
statements about our business, operations and financial performance based on
current expectations that involve risks, uncertainties and assumptions. Actual
results may differ materially from those discussed in the forward-looking
statements as a result of various factors. See the Note Regarding
Forward-Looking Statements and Information. Investors are directed to consider
the risks and uncertainties discussed in Part II, Item 1A of this Quarterly
Report on Form 10-Q, as well as in other documents we have filed with the SEC .
Executive Summary
Overview
We are one of America's leading financial services companies, providing:
(i) advice and solutions for helping Americans set and meet their retirement
goals and protect and transfer their wealth across generations; and (ii) a wide
range of investment management insights, expertise and innovations to drive
better investment decisions and outcomes for clients worldwide.
We manage our business through four segments: Individual Retirement, Group
Retirement, Investment Management and Research, and Protection Solutions. We
report certain activities and items that are not included in these segments in
Corporate and Other. See Note 14 of the Notes to the Consolidated Financial
Statements for further information on our segments.
We benefit from our complementary mix of businesses. This business mix provides
diversity in our earnings sources, which helps offset fluctuations in market
conditions and variability in business results, while offering growth
opportunities.
EQUI-VEST Reinsurance Transaction
OnOctober 3, 2022 , Equitable Financial completed the transactions (the "EQUI-VEST Transaction") contemplated by the previously announced Master Transaction Agreement, datedAugust 16, 2022 , by and between Equitable Financial andFirst Allmerica Financial Life Insurance Company , aMassachusetts -domiciled insurance company (the "Reinsurer"), a wholly owned subsidiary ofGlobal Atlantic Financial Group . At the closing of the EQUI-VEST Transaction, Equitable Financial and the Reinsurer entered into a Coinsurance and Modified Coinsurance Agreement (the "EQUI-VEST Reinsurance Agreement"), pursuant to which Equitable Financial ceded to the Reinsurer, on a combined coinsurance and modified coinsurance basis, a 50% quota share of approximately 360,000 legacy Group EQUI-VEST deferred variable annuity contracts issued by Equitable Financial between 1980 and 2008 supported by general account assets of approximately$4 billion and$5 billion of separate account value (the "Reinsured Contracts"). The Reinsured Contracts predominately include certain of Equitable Financial's contracts that offer the highest guaranteed general account crediting rates of 3%. At the closing of the EQUI-VEST Transaction, Reinsurer deposited assets supporting the general account liabilities relating to the Reinsured Contracts into a trust account for the benefit of Equitable Financial, which assets will secure its obligations to Equitable Financial under the EQUI-VEST Reinsurance Agreement. Equitable Financial reinsured the separate accounts relating to the Reinsured Contracts on a modified coinsurance basis.Commonwealth Annuity and Life Insurance Company , an insurance company domiciled in theCommonwealth of Massachusetts and affiliate of Reinsurer ("Commonwealth"), provided a guarantee of Reinsurer's payment obligation to Equitable Financial under the EQUI-VEST Reinsurance Agreement. In addition, the investment of assets in the trust account is subject to investment guidelines, and the EQUI-VEST Reinsurance Agreement requires enhanced funding upon certain capital adequacy related triggers. The EQUI-VEST Reinsurance Agreement also contains additional counterparty risk management and mitigation provisions. At the closing of the EQUI-VEST Transaction, ABLP entered into an investment advisory agreement with Reinsurer pursuant to which ABLP will serve as the preferred investment manager of certain general account assets transferred to the trust account. Equitable Financial will continue to administer the Reinsured Contracts.
Revenues
Our revenues come from three principal sources:
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•fee income derived from our retirement and protection products and our
investment management and research services;
•premiums from our traditional life insurance and annuity products; and
•investment income from our General Account investment portfolio.
Our fee income varies directly in relation to the amount of the underlying AV or benefit base of our retirement and protection products and the amount of AUM of our Investment Management and Research business. AV and AUM, each as defined in "Key Operating Measures," are influenced by changes in economic conditions, primarily equity market returns, as well as net flows. Our premium income is driven by the growth in new policies written and the persistency of our in-force policies, both of which are influenced by a combination of factors, including our efforts to attract and retain customers and market conditions that influence demand for our products. Our investment income is driven by the yield on our General Account investment portfolio and is impacted by the prevailing level of interest rates as we reinvest cash associated with maturing investments and net flows to the portfolio.
Benefits and Other Deductions
Our primary expenses are:
• policyholders' benefits and interest credited to policyholders' account
balances;
• sales commissions and compensation paid to intermediaries and advisors that
distribute our products and services; and
• compensation and benefits provided to our employees and other operating
expenses.
Policyholders' benefits are driven primarily by mortality, customer withdrawals, and benefits which change in response to changes in capital market conditions. In addition, some of our policyholders' benefits are directly tied to the AV and benefit base of our variable annuity products. Interest credited to policyholders varies in relation to the amount of the underlying AV or benefit base. Sales commissions and compensation paid to intermediaries and advisors vary in relation to premium and fee income generated from these sources, whereas compensation and benefits to our employees are more constant and impacted by market wages and decline with increases in efficiency. Our ability to manage these expenses across various economic cycles and products is critical to the profitability of our company.
Net Income Volatility
We have offered and continue to offer variable annuity products with GMxB
features. The future claims exposure on these features is sensitive to movements
in the equity markets and interest rates. Accordingly, we have implemented
hedging and reinsurance programs designed to mitigate the economic exposure to
us from these features due to equity market and interest rate movements. Changes
in the values of the derivatives associated with these programs due to equity
market and interest rate movements are recognized in the periods in which they
occur while corresponding changes in offsetting liabilities not measured at fair
value are recognized over time. This results in net income volatility as further
described below. See "-Significant Factors Impacting Our Results-Impact of
Hedging and GMxB Reinsurance on Results."
In addition to our dynamic hedging strategy, we have static hedge positions
designed to mitigate the adverse impact of changing market conditions on our
statutory capital. We believe this program will continue to preserve the
economic value of our variable annuity contracts and better protect our target
variable annuity asset level. However, these static hedge positions increase the
size of our derivative positions and may result in higher net income volatility
on a period-over-period basis.
Due to the impacts on our net income of equity market and interest rate
movements and other items that are not part of the underlying profitability
drivers of our business, we evaluate and manage our business performance using
Non-GAAP Operating Earnings, a non-GAAP financial measure that is intended to
remove these impacts from our results. See "-Key Operating Measures-Non-GAAP
Operating Earnings. "
COVID-19 Impact
COVID-19 continues to evolve. We continue to closely monitor COVID-19
developments and the impact on our business, operations and investment
portfolio. Any future impact of COVID-19 depends on many unknown factors and is
highly uncertain, including as to the emergence and spread of COVID-19 variants,
the availability, adoption and efficacy of COVID-19 treatments and vaccines, and
future actions taken by governmental authorities, central banks and other
parties in
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response to COVID-19. Further, as COVID-19 has not yet subsided, it is not
possible to predict or estimate the longer-term effects of COVID-19 on the broad
economy or on our business, results of operations and financial condition,
including the impact on our investment portfolio and the possible need for us
revisit or revise targets and/or aspects of our business model previously
provided to the markets. For additional information regarding the actual and
potential impacts of COVID-19 and action we have taken to mitigate certain
impacts, see "Risk Factors-Risks Relating to Conditions in the Financial Markets
and Economy-The coronavirus (COVID-19) pandemic", "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Executive
Summary-COVID-19 Impact" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations-General Account Investment Portfolio" in the
2021 Form 10-K.
Significant Factors Impacting Our Results
The following significant factors have impacted, and may in the future impact,
our financial condition, results of operations or cash flows.
Impact of Hedging and GMxB Reinsurance on Results
We have offered and continue to offer variable annuity products with GMxB features. The future claims exposure on these features is sensitive to movements in the equity markets and interest rates. Accordingly, we have implemented hedging and reinsurance programs designed to mitigate the economic exposure to us from these features due to equity market and interest rate movements. These programs include: •Variable annuity hedging programs. We use a dynamic hedging program (within this program, generally, we reevaluate our economic exposure at least daily and rebalance our hedge positions accordingly) to mitigate certain risks associated with the GMxB features that are embedded in our liabilities for our variable annuity products. This program utilizes various derivative instruments that are managed in an effort to reduce the economic impact of unfavorable changes in GMxB features' exposures attributable to movements in the equity markets and interest rates. Although this program is designed to provide a measure of economic protection against the impact of adverse market conditions, it does not qualify for hedge accounting treatment. Accordingly, changes in value of the derivatives will be recognized in the period in which they occur with offsetting changes in reserves partially recognized in the current period, resulting in net income volatility. In addition to our dynamic hedging program, we have a hedging program using static hedge positions (derivative positions intended to be HTM with less frequent re-balancing) to protect our statutory capital against stress scenarios. This program in addition to our dynamic hedge program has increased the size of our derivative positions, resulting in an increase in net income volatility. The impacts are most pronounced for variable annuity products in our Individual Retirement segment. •GMxB reinsurance contracts. Historically, GMIB reinsurance contracts were used to cede to non-affiliated reinsurers a portion of our exposure to variable annuity products that offer a GMIB feature. We account for the GMIB reinsurance contracts as derivatives and report them at fair value. Gross GMIB reserves are calculated on the basis of assumptions related to projected benefits and related contract charges over the lives of the contracts. Accordingly, our gross reserves will not immediately reflect the offsetting impact on future claims exposure resulting from the same capital market or interest rate fluctuations that cause gains or losses on the fair value of the GMIB reinsurance contracts. Because changes in the fair value of the GMIB reinsurance contracts are recorded in the period in which they occur and a majority of the changes in gross reserves for GMIB are recognized over time, net income will be more volatile. In addition, onJune 1, 2021 , we ceded legacy variable annuity policies sold by Equitable Financial between 2006-2008 (the "Block"), comprised of non-New York "Accumulator" policies containing fixed rate GMIB and/or GMDB guarantees. As this contract provides full risk transfer and thus has the same risk attributes as the underlying direct contracts, the benefits of this treaty are accounted for in the same manner as the underlying gross reserves.
Effect of Assumption Updates on Operating Results
During the third quarter of each year, we conduct our annual review of the
assumptions underlying the valuation of DAC, deferred sales inducement assets,
unearned revenue liabilities, liabilities for future policyholder benefits and
embedded derivatives for our Individual Retirement, Group Retirement, and
Protection Solution segments (assumption reviews are not relevant for the
Investment Management and Research segment). Assumptions are based on a
combination of Company experience, industry experience, management actions and
expert judgment and reflect our best estimate as of the date of the applicable
financial statements.
Most of the variable annuity products, variable universal life insurance and
universal life insurance products we offer maintain policyholder deposits that
are reported as liabilities and classified within either Separate Accounts
liabilities or policyholder account balances. Our products and riders also
impact liabilities for future policyholder benefits and unearned
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revenues and assets for DAC and DSI. The valuation of these assets and
liabilities (other than deposits) is based on differing accounting methods
depending on the product, each of which requires numerous assumptions and
considerable judgment. The accounting guidance applied in the valuation of these
assets and liabilities includes, but is not limited to, the following:
(i) traditional life insurance products for which assumptions are locked in at
inception; (ii) universal life insurance and variable life insurance secondary
guarantees for which benefit liabilities are determined by estimating the
expected value of death benefits payable when the account balance is projected
to be zero and recognizing those benefits ratably over the accumulation period
based on total expected assessments; (iii) certain product guarantees for which
benefit liabilities are accrued over the life of the contract in proportion to
actual and future expected policy assessments; and (iv) certain product
guarantees reported as embedded derivatives at fair value.
For further details of our accounting policies and related judgments pertaining
to assumption updates, see Note 2 of the Notes to the Consolidated Financial
Statements and "-Summary of Critical Accounting Estimates-Liability for Future
Policy Benefits" included in the 2021 Form 10-K.
Assumption Updates
We conduct our annual review of our assumptions during the third quarter of each year. We also update our assumptions as needed in the event we become aware of economic conditions or events that could require a change in our assumptions that we believe may have a significant impact to the carrying value of product liabilities and assets and consequently materially impact our earnings in the period of the change.
Impact of Assumption Updates on Income from Continuing Operations before income
taxes and Net income (loss)
The table below presents the impact of our actuarial assumption update during the three months endedSeptember 30, 2022 and 2021 to our income (loss) from continuing operations, before income taxes and net income (loss). Three
Months Ended
2022 2021
(in millions)
Impact of assumption update on Net income (loss):
Variable annuity product features related assumption update $ 175 $ (91)
Assumption updates for other business 7 (17)
Impact of assumption updates on Income (loss) from continuing
operations, before income tax
182 (108) Income tax benefit on assumption update (38) 23 Net income (loss) impact of assumption update $
144
_____________
(1)The amounts for the three months and the nine months ended
each year represented the same amounts.
2022 Assumption Updates
The impact of the assumption update in the third quarter 2022 was an increase of$182 million to income (loss) from continuing operations, before income taxes and an increase to net income (loss) of$144 million .
The net impact of this assumption update on income (loss) from continuing
operations, before income taxes of
policy charges and fee income of
benefits of
account balances of
million
2021 Assumption Updates
The impact of the economic assumption update in the third quarter 2021 was a decrease of$108 million to income (loss) from continuing operations, before income taxes and a decrease to net income (loss) of$85 million . As part of this annual update the reference interest rate utilized in our GAAP fair value calculations was updated from the LIBOR swap curve to theUS Treasury curve to theUS Treasury curve due to the impending cessation of LIBOR and our GAAP fair value liability risk margins were increased, resulting in little impact to overall valuation as our view regarding market participant pricing of our guarantees has not changed at this time. 74 -------------------------------------------------------------------------------- Table of Contents The net impact of this assumption update on income (loss) from operations, before income taxes of$108 million consisted of a decrease in policy charges and fee income of$28 million , a decrease in policyholders' benefits of$62 million , an increase in net derivative gains (losses) of$200 million and a decrease in amortization of DAC of$58 million .
Impact of Assumption Updates on Pre-tax Non-GAAP Operating Earnings
The table below presents the impact on pre-tax Non-GAAP Operating Earnings of our actuarial assumption updates during the three months endedSeptember 30, 2022 and 2021 by segment and Corporate and Other. Three
Months Ended
2022 2021
(in million)
Impact of assumption updates by segment:
Individual Retirement $ (13) $ (47)
Group Retirement 34 35
Protection Solutions 7 20
Impact of assumption updates on Corporate and Other - -
Total impact on pre-tax Non-GAAP Operating Earnings $
28 $ 8
______________
(1)The amounts for the three months and the nine months ended
each year represented the same amounts.
2022 Assumption Updates
The impact of our 2022 annual review on Non-GAAP Operating Earnings was favorable by$28 million before taking into consideration the tax impacts or$22 million after tax. For Individual Retirement segment, the impacts primarily reflect updated mortality on our older payout business. For Group Retirement segment, the impacts reflect updated economic assumptions. The annual update for Protection Solutions segment reflects favorable economic conditions and surrenders primarily on the VUL line. This, in turn, creates future profits and lowers the accrual on our PFBL reserve. The net impact of assumption changes on Non-GAAP Operating Earnings in the third quarter 2022 decreased policy charges and fee income by$23 million , decreased policyholders' benefits by$9 million , increased interest credited to policyholder account balances by$1 million and decreased amortization of DAC by$43 million . Non-GAAP Operating Earnings excludes items related to Variable annuity product features, such as changes in the fair value of the embedded derivatives associated with the GMIBNLG liability and the effect of benefit ratio unlock adjustments.
2021 Assumption Updates
The impact of our 2021 annual review on Non-GAAP Operating Earnings was favorable by$8 million before taking into consideration the tax impacts or$6 million after tax. For the Individual Retirement segment, the impacts primarily reflect updated mortality on our older payout business. For Group Retirement segment, the impacts reflect updated economic assumptions. The annual update for Protection Solutions segment reflects favorable economic conditions and surrenders primarily on the VUL line. This, in turn, creates future profits and lowers the accrual on our PFBL reserve. The net impact of assumption changes on Non-GAAP Operating Earnings in the third quarter 2021 decreased Policy charges and fee income by$28 million , increased Policyholders' benefits by$22 million and decreased Amortization of DAC by$58 million . Non-GAAP Operating Earnings excludes items related to Variable annuity product features, such as changes in the fair value of the embedded derivatives associated with the GMIBNLG liability and the effect of benefit ratio unlock adjustments.
Macroeconomic and Industry Trends
Our business and consolidated results of operations are significantly affected by economic conditions and consumer confidence, conditions in the global capital markets and the interest rate environment.
Financial and Economic Environment
A wide variety of factors continue to impact financial and economic conditions.
These factors include, among others, increased volatility in the capital
markets, equity market declines, rising interest rates, inflationary pressures,
plateauing or decreasing economic growth, high fuel and energy costs, changes in
fiscal or monetary policy and geopolitical tensions. The
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invasion of Ukraine by Russia and the sanctions and other measures imposed in
response to this conflict significantly increased the level of volatility in the
financial markets and have increased the level of economic and political
uncertainty.
Stressed conditions, volatility and disruptions in the capital markets,
particular markets, or financial asset classes can have an adverse effect on us,
in part because we have a large investment portfolio. In addition, our insurance
liabilities and derivatives are sensitive to changing market factors, including
equity market performance and interest rates. During the third quarter 2022,
equity markets continued their decline, while interest rates continued to rise,
and are anticipated to continue to rise throughout the year based on statements
of members of the Board of Governors of the Federal Reserve System . An increase
in market volatility could continue to affect our business, including through
effects on the yields we earn on invested assets, changes in required reserves
and capital and fluctuations in the value of our AUM, AV or AUA from which we
derive our fee income. These effects could be exacerbated by uncertainty about
future fiscal policy, changes in tax policy, the scope of potential deregulation
and levels of global trade.
The potential for increased volatility, coupled with prevailing interest rates
remaining below historical averages despite recent increases, could pressure
sales and reduce demand for our products as consumers consider purchasing
alternative products to meet their objectives. In addition, this environment
could make it difficult to consistently develop products that are attractive to
customers. Financial performance can be adversely affected by market volatility
and equity market declines as fees driven by AV and AUM fluctuate, hedging costs
increase and revenues decline due to reduced sales and increased outflows.
We monitor the behavior of our customers and other factors, including mortality
rates, morbidity rates, annuitization rates and lapse and surrender rates, which
change in response to changes in capital market conditions, to ensure that our
products and solutions remain attractive and profitable. For additional
information on our sensitivity to interest rates and capital market prices, see
"Quantitative and Qualitative Disclosures About Market Risk."
Interest Rate Environment
We believe the interest rate environment will continue to impact our business
and financial performance in the future for several reasons, including the
following:
•Certain of our variable annuity and life insurance products pay guaranteed minimum interest crediting rates. We are required to pay these guaranteed minimum rates even if earnings on our investment portfolio decline, with the resulting investment margin compression negatively impacting earnings. In addition, we expect more policyholders to hold policies with comparatively high guaranteed rates longer (lower lapse rates) in a low interest rate environment. Conversely, a rise in average yield on our investment portfolio should positively impact earnings. Similarly, we expect policyholders would be less likely to hold policies with existing guaranteed rates (higher lapse rates) as interest rates rise. •A prolonged low interest rate environment also may subject us to increased hedging costs or an increase in the amount of statutory reserves that our insurance subsidiaries are required to hold for GMxB features, lowering their statutory surplus, which would adversely affect their ability to pay dividends to us. In addition, it may also increase the perceived value of GMxB features to our policyholders, which in turn may lead to a higher rate of annuitization and higher persistency of those products over time. Finally, low interest rates may continue to cause an acceleration of DAC amortization or reserve increase due to loss recognition for interest sensitive products, primarily for our Protection Solutions segment.
For a discussion on derivatives we used to hedge interest rates, see Note 4 of
the Notes to the Consolidated Financial Statements in this Form 10-Q.
Regulatory Developments
Our life insurance subsidiaries are regulated primarily at the state level, with some policies and products also subject to federal regulation. In addition, Holdings and its insurance subsidiaries are subject to regulation under the insurance holding company laws of variousU.S. jurisdictions. Furthermore, on an ongoing basis, regulators refine capital requirements and introduce new reserving standards. Regulations recently adopted or currently under review can potentially impact our statutory reserve, capital requirements and profitability of the industry and result in increased regulation and oversight for the industry. For additional information on regulatory developments and the risks we face, see "Business-Regulation" and "Risk Factors-Legal and Regulatory Risks." in the 2021 Form 10-K. 76 -------------------------------------------------------------------------------- Table of Contents Inflation Reduction Act. OnAugust 16, 2022 ,President Biden signed the Inflation Reduction Act into law which introduces a 15% minimum tax based on financial statement income as well as a 1% excise tax on share buybacks, effective for tax years beginning in 2023. While neither the minimum tax nor the excise tax on share buybacks are currently expected to have a significant impact on the Company, we continue to monitor developments and regulations associated with the Inflation Reduction Act for any potential future impacts on our business, results of operations and financial condition. Climate Risks. InMarch 2022 , theSEC released proposed rule changes on climate-related disclosure. The proposed rule changes would require companies to include certain climate-related disclosures including information about climate-related risks that have had or reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to the audited financial statements. Among other things, the required information about climate-related risks also would include disclosure of a company's greenhouse gas emissions, information about climate-related targets and goals, and if a transition plan, has been adopted as part of climate-related risk management strategy, and requires extensive attestation requirements. If adopted as proposed, the rule changes are expected to result in additional compliance and reporting costs. Privacy and Security of Customer Information and Cybersecurity Regulation. InMarch 2022 , theSEC released proposed rules enhancing cybersecurity risk and management disclosure requirements for companies. If enacted, the proposed rules would, among other things, require disclosure of any material cybersecurity incident on its Form 8-K within four business days of determining that the incident it has experienced is material. They would also require periodic disclosures of, among other things, (i) details on the company's cybersecurity policies and procedures, (ii) cybersecurity governance, oversight policies and risk management policies, including the board of directors' oversight of cybersecurity risks, (iii) the relevant expertise of members of the board of directors with respect to cybersecurity issues and (iv) details of any cybersecurity incident that was previously disclosed on Form 8-K, as well as any undisclosed incidents that were non-material, but have become material in the aggregate. InJuly 2022 , the NYDFS proposed amendments to the New York Cybersecurity Requirements for Financial Services Companies promulgated by the NYDFS inMarch 2017 . The amendments, if adopted, would require new reporting, governance and oversight measures be implemented, enhance certain cybersecurity safeguards (e.g., annual audits, vulnerability assessments, and password controls and monitoring), and mandate notifications in the event that a covered entity makes a cyber-ransom payment. The pre-proposal comment period on these draft amendments ended inAugust 2022 , and an additional comment period is expected in the future. Fiduciary Rules / "Best Interest" Standards of Conduct. The NYDFS' amendments to Regulation 187 - Suitability and Best Interests in Life Insurance and Annuity Transactions ("Regulation 187") incorporate the "best interest" standard for annuity transactions and they expand the scope of the regulation to include sales of life insurance policies to consumers. InApril 2021 , the Appellate Division of theNew York Supreme Court overturned Regulation 187 for being unconstitutionally vague, although theNew York State Court of Appeals reversed this ruling onOctober 20, 2022 . We cannot predict whether any rules or rule amendments will be adopted by either theSEC or NYDFS, what form any such final rules may take, or what effect adoption of such rules or amendments would have on our business or compliance costs.
Productivity Strategies
Retirement and Protection Businesses
As part of our continuing efforts to drive productivity improvements, inJanuary 2021 , we began a new program expected to achieve$80 million of targeted run-rate expense savings by 2023, of which$43 million has been achieved as ofSeptember 30, 2022 . We expect to achieve these savings by shifting our workforce into an agile working model, leveraging technology-enabled capabilities, optimizing our real estate footprint, and continuing to realize a portion of COVID-19 related savings. 77
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Key Operating Measures
In addition to our results presented in accordance withU.S. GAAP, we report Non-GAAP Operating Earnings, Non-GAAP Operating ROE, and Non-GAAP operating common EPS, each of which is a measure that is not determined in accordance withU.S. GAAP. Management principally uses these non-GAAP financial measures in evaluating performance because they present a clearer picture of our operating performance and they allow management to allocate resources. Similarly, management believes that the use of these Non-GAAP financial measures, together with relevantU.S. GAAP measures, provide investors with a better understanding of our results of operations and the underlying profitability drivers and trends of our business. These non-GAAP financial measures are intended to remove from our results of operations the impact of market changes (where there is mismatch in the valuation of assets and liabilities) as well as certain other expenses which are not part of our underlying profitability drivers or likely to re-occur in the foreseeable future, as such items fluctuate from period-to-period in a manner inconsistent with these drivers. These measures should be considered supplementary to our results that are presented in accordance withU.S. GAAP and should not be viewed as a substitute for theU.S. GAAP measures. Other companies may use similarly titled non-GAAP financial measures that are calculated differently from the way we calculate such measures. Consequently, our non-GAAP financial measures may not be comparable to similar measures used by other companies. We also discuss certain operating measures, including AUM, AUA, AV, Protection Solutions Reserves and certain other operating measures, which management believes provide useful information about our businesses and the operational factors underlying our financial performance.
Non-GAAP Operating Earnings
Non-GAAP Operating Earnings is an after-tax non-GAAP financial measure used to evaluate our financial performance on a consolidated basis that is determined by making certain adjustments to our consolidated after-tax net income attributable to Holdings. The most significant of such adjustments relates to our derivative positions, which protect economic value and statutory capital, and are more sensitive to changes in market conditions than the variable annuity product liabilities as valued underU.S. GAAP. This is a large source of volatility in net income.
Non-GAAP Operating Earnings equals our consolidated after-tax net income
attributable to Holdings adjusted to eliminate the impact of the following
items:
•Items related to variable annuity product features, which include: (i) certain changes in the fair value of the derivatives and other securities we use to hedge these features; (ii) the effect of benefit ratio unlock adjustments, including extraordinary economic conditions or events such as COVID-19; (iii) changes in the fair value of the embedded derivatives reflected within variable annuity products' net derivative results and the impact of these items on DAC amortization on our SCS product; and (iv) DAC amortization for the SCS variable annuity product arising from near-term fluctuations in index segment returns;
•Investment (gains) losses, which includes credit loss impairments of
securities/investments, sales or disposals of securities/investments, realized
capital gains/losses and valuation allowances;
•Net actuarial (gains) losses, which includes actuarial gains and losses as a result of differences between actual and expected experience on pension plan assets or projected benefit obligation during a given period related to pension, other postretirement benefit obligations, and the one-time impact of the settlement of the defined benefit obligation; •Other adjustments, which primarily include restructuring costs related to severance and separation, COVID-19 related impacts, net derivative gains (losses) on certain Non-GMxB derivatives, net investment income from certain items including consolidated VIE investments, seed capital mark-to-market adjustments, unrealized gain/losses associated with equity securities, certain legal accruals; and a bespoke deal to repurchase UL policies from one entity that had invested in numerous policies purchased in the life settlement market, which disposed of the risk of additional COI litigation by that entity related to those UL policies; and •Income tax expense (benefit) related to the above items and non-recurring tax items, which includes the effect of uncertain tax positions for a given audit period. In the first quarter 2022, the Company updated its Non-GAAP Operating Earnings measure to exclude the DAC amortization impact of near-term fluctuations in indexed segment returns on the SCS variable annuity product to reflect the impact of market fluctuations consistently with the long term duration of the product. For the three and nine months endedSeptember 30, 2022 , Non-GAAP Operating Earnings was favorably impacted by this change in the amount of$24 million and$94 million for the three and nine months endedSeptember 30, 2022 , respectively. The presentation of Non-GAAP Operating Earnings in prior periods was not revised to reflect this modification, however, the Company estimated that had the treatment in 78 -------------------------------------------------------------------------------- Table of Contents the Company's Non-GAAP Operating Earnings measure of the Amortization of DAC for SCS been modified in 2020, the pre-tax impact on Non-GAAP Operating Earnings of excluding the SCS-related DAC amortization from Non-GAAP Operating Earnings would have been an increase of$7 million for the three months endedSeptember 30, 2021 , and a decrease of$7 million ,$16 million and$34 million for the nine months endedSeptember 30, 2021 , and years endedDecember 31, 2021 and 2020, respectively. Because Non-GAAP Operating Earnings excludes the foregoing items that can be distortive or unpredictable, management believes that this measure enhances the understanding of the Company's underlying drivers of profitability and trends in our business, thereby allowing management to make decisions that will positively impact our business. We use the prevailing corporate federal income tax rate of 21% while taking into account any non-recurring differences for events recognized differently in our financial statements and federal income tax returns as well as partnership income taxed at lower rates when reconciling Net income (loss) attributable to Holdings to Non-GAAP Operating Earnings.
The table below presents a reconciliation of net income (loss) attributable to
Holdings to Non-GAAP Operating Earnings for the three and nine months ended
Three Months Ended September Nine Months Ended September
30, 30,
2022 2021 2022 2021
(in millions)
Net income (loss) attributable to Holdings $ 273 $ 672 $ 2,574 $ (693)
Adjustments related to:
Variable annuity product features (114) 172 (2,639) 3,632
Investment (gains) losses 333 (164) 890 (767)
Net actuarial (gains) losses related to pension and
other postretirement benefit obligations
19 27 57 87 Other adjustments (1) (2) (3) 39 141 407 672 Income tax expense (benefit) related to above adjustments (59) (35) 270 (761) Non-recurring tax items 7 5 13 6 Non-GAAP Operating Earnings$ 498 $ 818 $ 1,572 $ 2,176 ______________ (1)Includes Separation Costs of$25 million and$62 million for the three months and nine months endedSeptember 30, 2021 , respectively. Separation costs were completed during 2021. (2)Includes certain gross legal expenses related to the cost of insurance litigation of$2 million and$0 million ,$168 million and$180 million for the three and nine months endedSeptember 30, 2022 and 2021, respectively. Includes policyholder benefit costs of$0 million and$75 million for the three and nine months endedSeptember 30, 2022 stemming from a deal to repurchase UL policies from one entity that had invested in numerous policies purchased in the life settlement market. (3)Includes Non-GMxB related derivative hedge losses of($28) million ,($4) million ,($68) million and$140 million for the three and nine months endedSeptember 30, 2022 and 2021, respectively.
Non-GAAP Operating ROE
We calculate Non-GAAP Operating ROE by dividing Non-GAAP Operating Earnings for the previous twelve calendar months by consolidated average equity attributable to Holdings' common shareholders, excluding AOCI. AOCI fluctuates period-to-period in a manner inconsistent with our underlying profitability drivers as the majority of such fluctuation is related to the market volatility of the unrealized gains and losses associated with our AFS securities. Therefore, we believe excluding AOCI is more effective for analyzing the trends of our operations. The following table presents return on average equity attributable to Holdings' common shareholders, excluding AOCI and Non-GAAP Operating ROE for the trailing twelve months endedSeptember 30, 2022 . Trailing Twelve Months Ended September 30, 2022 (in millions) Net income (loss) available to Holdings' common shareholders $ 2,748 Average equity attributable to Holdings' common shareholders, excluding AOCI $ 8,844 79
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Trailing Twelve Months Ended
September 30, 2022
(in millions)
Return on average equity attributable to Holdings' common shareholders,
excluding AOCI
31.1 %
Non-GAAP Operating Earnings available to Holdings' common shareholders $
2,141 Average equity attributable to Holdings' common shareholders, excluding AOCI $ 8,844 Non-GAAP Operating ROE 24.2 %
Non-GAAP Operating Common EPS
Non-GAAP operating common EPS is calculated by dividing Non-GAAP Operating Earnings by diluted common shares outstanding. The following table sets forth Non-GAAP operating common EPS for the three and nine months endedSeptember 30, 2022 and 2021. Three Months Ended Nine Months Ended September September 30, 30, 2022 2021 2022 2021 (per
share amounts)
Net income (loss) attributable to Holdings (1)
$ 6.72 $ (1.64) Less: Preferred stock dividends 0.03 0.03 0.14 0.12 Net income (loss) available to Holdings' common shareholders 0.69 1.59 6.58 (1.76) Adjustments related to: Variable annuity product features (0.31) 0.41 (6.89) 8.58 Investment (gains) losses 0.87 (0.41) 2.32 (1.81)
Net actuarial (gains) losses related to pension and
other postretirement benefit obligations
0.05 0.07 0.15 0.21 Other adjustments (2) (3) (4) 0.12 0.35 1.06 1.59 Income tax expense (benefit) related to above adjustments (0.16) (0.08) 0.71 (1.80) Non-recurring tax items 0.02 0.01 0.03 0.01 Non-GAAP operating common EPS$ 1.28 $ 1.94 $ 3.96 $ 5.02
______________
(1)For periods presented with a net loss, basic shares are used for EPS . (2)Includes separation costs of$0.06 and$0.15 for the three months and nine months endedSeptember 30, 2021 , respectively. (3)Includes certain gross legal expenses related to the cost of insurance litigation of$0.01 ,$0.00 ,$0.44 and$0.43 for the three and nine months endedSeptember 30, 2022 and2021, respectively. Includes policyholder benefit costs of$0.00 and$0.20 for the three and nine months endedSeptember 30, 2022 stemming from a deal to repurchase UL policies from one entity that had invested in numerous policies purchased in the life settlement market. (4)Includes Non-GMxB related derivative hedge losses of ($0.07 ), ($0.01 ), ($0.18 ) and$0.31 for the three and nine months endedSeptember 30, 2022 and 2021, respectively. Assets Under Management
AUM means investment assets that are managed by one of our subsidiaries and
includes: (i) assets managed by AB; (ii) the assets in our General Account
investment portfolio; and (iii) the Separate Accounts assets of our Individual
Retirement, Group Retirement and Protection Solutions businesses. Total AUM
reflects exclusions between segments to avoid double counting.
AUA includes non-insurance client assets that are invested in our savings and investment products or serviced by ourEquitable Advisors platform. We provide administrative services for these assets and generally record the revenues received as distribution fees.
Account Value
AV generally equals the aggregate policy account value of our retirement
products. General Account AV refers to account balances in investment options
that are backed by the General Account while Separate Accounts AV refers to
Separate Accounts investment assets.
80
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Protection Solutions Reserves
Protection Solutions Reserves equals the aggregate value of policyholders'
account balances and future policy benefits for policies in our Protection
Solutions segment.
Consolidated Results of Operations
Our consolidated results of operations are significantly affected by conditions in the capital markets and the economy because we offer market sensitive products. These products have been a significant driver of our results of operations. Because the future claims exposure on these products is sensitive to movements in the equity markets and interest rates, we have in place various hedging and reinsurance programs that are designed to mitigate the economic risk of movements in the equity markets and interest rates. The volatility in net income attributable to Holdings for the periods presented below results from the mismatch between: (i) the change in carrying value of the reserves for GMDB and certain GMIB features that do not fully and immediately reflect the impact of equity and interest market fluctuations; (ii) the change in fair value of products with the GMIB feature that have a no-lapse guarantee; and (iii) our hedging and reinsurance programs.
Ownership and Consolidation of AllianceBernstein
Our indirect, wholly-owned subsidiary,
General Partner of AB.
consolidated financial statements.
Our economic interest in AB was approximately 64% and 65% during the three months endedSeptember 30, 2022 and 2021, and approximately 65% during the nine months endedSeptember 30, 2022 and 2021. The slight decrease in economic interest was due to the issuance of AB Units relating to AB's 100% acquisition of CarVal. OnJuly 1, 2022 , AB issued 3.2 million AB Units (with a fair value of$133 million ) and recorded a$419 million liability for the issuance of additional AB Units onNovember 1, 2022 . AB also recorded a contingent consideration payable of$227 million (to be paid predominantly in AB Units) based on CarVal achieving certain performance objectives over a six-year period endingDecember 31, 2027 . The issuance of the AB Units is not expected to have a significant impact on Non-GAAP Operating Earnings and Net Income.
Consolidated Results of Operations
The following table summarizes our consolidated statements of income (loss) for
the three and nine months ended
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