Aegon N.V. (NYSE:AEG) Q2 2022 Earnings Conference Call August 11, 2022 3:00 AM ET
Company Participants
Jan Willem Weidema – Head, IR
Lard Friese – CEO
Matt Rider – CFO
Conference Call Participants
Andrew Baker – Citi
Michele Ballatore – KBW
David Barma – BNP Exxon
Michael Huttner – Berenberg
Robin van den Broek – Mediobanca
Nasib Ahmed – UBS
Sudarshan Bhutra – Société Générale
Steven Haywood – HSBC
Operator
Good day, and welcome to the Aegon Second Quarter 2022 Results Conference Call for Analysts and Investors. Today’s call is being recorded.
At this time, I would like to turn the conference over to Jan Willem. Please go ahead, sir.
Jan Willem Weidema
Thank you, operator. Good morning, everyone, and thank you for joining this conference call on Aegon’s second quarter 2022 results. Before we start, you would appreciate it if you could take a moment to review our disclaimer on forward-looking statements, which you can find at the back of the presentation.
With me today are Aegon’s CEO, Lard E. Friese; and CFO, Matt Rider. After a brief update on our results by Lard and Matt, we’ll open the floor to Q&A.
Let me give the floor to Lard.
Lard Friese
Thank you, Jan Willem, and good morning, everyone.
The first half year of 2022 was challenging for investors with equity markets experiencing their worst start of the year in over five decades. Volatility remained as the war in the Ukraine continued and Central Bank’s increased interest rates to curb rising inflation. Against this challenging backdrop, we performed well, a testament to the strength of our strategy.
Despite the impact from lower equity markets, our second quarter operating result was strong. This reflects the receding impact of COVID-19 and the progress we are making on our operational improvement plan. We delivered further savings and continue to build on our growth initiatives. In our strategic assets, we maintained commercial momentum, even in a challenging market environment. Aegon’s net result was impacted by a onetime charge due to reinsurance rate increases in the United States. Nonetheless, we remain on course to deliver on our objective of growing returns to our stockholders.
Our balance sheet is strong with the capital positions of our three main units above their respective operating levels. Cash capital at the holding stands above the operating range. Together with the growth and free cash flow, this is a solid basis to raise the interim dividend to €0.11 per common share.
We also continue to make progress on our approach to sustainability. As part of our efforts to contribute to a climate-neutral world, Aegon Asset Management partnered in the launch of a US$600 million venture to acquire multifamily dwellings and transition them to low-carbon energy efficient buildings in the U.S. In the recent months, we moved over GBP 3 billion of assets from our U.K. customers into strategies that consider ESG credentials. This is part of the commitment to achieve net zero carbon emissions in the default investment options of our U.K. pension administration platform by 2015.
Based on the progress we have made on our transformation so far, we are comfortable increasing our expectations for cumulative free cash flow over the period 2021 to ’23 and from a range of €1.4 billion to €1.6 billion to at least €2.2 billion. We are also raising our expectation for operating capital generation in the units for 2022 to around €1.4 billion.
So let us move to Slide 3. You can see that we continue to progress with the execution of our operational improvement plan. We have now implemented 1,558 out of more than 1,200 initiatives as part of this plan. Just in the last three months, we finalized about 120 initiatives. Expense initiatives resulted in a reduction of our annual accessible expenses of €250 million in the trailing four quarters.
We continue to experience inflation headwinds that but so far, we’ve been able to absorb these and further reduce our expense base towards our goal of €400 million expense savings, and I remain confident that we will reach this target by 2023.
We are also increasingly seeing the benefits from our growth initiatives. The 240 growth initiatives that have been executed so far have had a positive impact on our operating results. Over the trailing four quarters, growth initiatives contributed €215 million to the result. We will, of course, maintain an intense execution rhythm to further implement our operational improvement plan in the coming quarters.
So let’s turn to Slide 4 to discuss the progress of our U.S. strategic assets. In Individual Solutions, we have the ambition to regain a top five position in selected light products over the coming years. As you can see, new life sales increased by 12% compared with the second quarter of last year. This was supported by the World Financial Group distribution channel, which benefited from a 12% growth in the number of licensed light agents compared with last year.
In the Retirement business, Transamerica aims to compete as a top five player in the new middle market sales. Britain sales were approximately US$850 million this quarter, while net deposits for the middle market increased to US$467 million, benefiting from strong written sales in prior periods.
We have further expanded our suite of financial wellness solutions in the workplace business by introducing a product called Emergency Savings Account. The product enables employers to help our employees save for unexpected events and improved our financial well-being.
Let me turn to Slide 5, we’re looking at the performance of our Dutch and U.K. strategic assets. In the Netherlands, we are market leaders in both mortgage origination and defined contribution pensions and continue to attract new customers.
Mortgage sales amounted to €2.4 billion, a decrease compared with last year due to reduced financing activity in the market of increasing mortgage interest rates. Nevertheless, mortgages under administration continued to grow increasing over €3 billion compared with last year to almost €62 billion.
We also continued to consistently grow our workplace business. net deposits for defined contribution pension products amounted to €191 million in the second quarter of 2022, which is nearly on the same level as in the prior year quarter.
Moving on to the United Kingdom. We saw the platform business generated net deposits of GBP 317 million across the workplace and retail channels. Net deposits on the platform positively contributed to revenues, but were more than offset by revenues lost from the gradual runoff of the traditional product portfolio. Expense savings initiatives offset the impact from market movements on assets under administration, leading to a stable efficiency ratio of the platform.
On Slide 6, we see that our asset management business saw third-party net outflows on the global platforms amount to approximately €800 million, reflecting the challenging market conditions. Continued net deposits into the Dutch mortgage funds were more than offset by outflows in other asset classes as we saw customers freeing up liquidity in a rising interest rate environment.
The operating margin of global platforms decreased by around two percentage points to approximately 12%. On a constant currency basis, lower revenues due to adverse market conditions more than offset expense savings.
Our strategic partnerships in Asset Management continued to perform well with net deposits of more than €1.1 billion. Performance fees normalized from their exceptional high level last year. This is why you see the operating result from strategic partnerships decreased to €36 million.
In our growth markets, Aegon is investing in profitable growth. New life sales from these markets increased by 5% to €55 million and nonlife sales grew by 8% to €31 million, both mainly due to sales growth in the bancassurance channel in Spain. In summary, we’ve performed well against a challenging backdrop, which is a testament to the strength of our strategy.
Matt will now talk you through our financial results for the second quarter in more detail. Matt, over to you.
Matt Rider
Good morning, everyone, and again, welcome, and thank you for joining us.
Let me start with an overview of our second quarter financial performance on Slide 8. As you can see, Aegon’s operating result decreased by 11% on a constant currency basis to €538 million. Lower fees in part due to adverse market movements and lower investment income more than offset the benefits from favorable claims experience, growth initiatives and expense savings. Addressable expense savings for the trailing four quarters totaled €250 million compared with the full year 2019 expense base.
Operating capital generation before holding, funding and operating expenses was strong at €391 million and included net favorable claims experience. The decrease in operating capital generation versus last year reflects the impact of actions we have taken to both release capital and improve our risk profile. These actions have led to an improvement in the quality of our capital generation and support the growth in free cash flow to €318 million.
Cash capital at the holding decreased only slightly to €1.7 billion despite the more than €500 million in cash that we spend on deleveraging and the first tranche of the share buyback program during the quarter.
We have reduced our gross financial leverage to €5.7 billion or €5.4 billion based on a Euro-U.S. dollar exchange rate of $1.20, which is the rate at which we set our deleveraging target in 2020. This means that we have reduced our gross financial leverage to within the range of €5 billion to €5.5 billion, the target that was set to be accomplished by 2023.
Our balance sheet remains strong with the capital positions of all three of our main units remaining above their respective operating levels. The group Solvency II ratio increased by four percentage points over the second quarter to 214%.
Turning to Slide 9. We saw the second quarter operating result come in at €538 million. Lower results in the U.S. and Asset Management were partly offset by increases in the contribution from other units. The 16% increase in the operating – or decrease in the operating result in the U.S. was driven by lower fees due to adverse market movements and outflows in the U.S. variable annuity business.
Claims experience in the second quarter was favorable and broadly in line with last year. Mortality claims experience was a favorable €5 million in the quarter. This included €10 million adverse experience related to deaths that were directly attributable to COVID-19. This was more than offset by favorable experience from other causes of death. Next to that, favorable morbidity experience in the long-term care book amounted to €27 million.
This included the release of the remaining incurred but not reported reserve of €16 million.
In the Netherlands, our operating result benefited from provision releases in the non-life business. This was driven by both an exceptional level of recoveries and a low number of new claimants than expected in the disability income business. These items more than offset lower investment income in the Bank and the life business. which is in part driven by the sale of corporate bonds to protect our liquidity position in a rising rate environment.
Aegon U.K. and Aegon International both performed well. The increase in the operating result of the U.K. reflects a onetime benefit in fee income net of hedging and a reduction in addressable expenses. Growth in Spain, Portugal and Brazil as well as favorable claims experience across the region contributed to the 72% increase of the result of Aegon International.
Finally, the Asset Management operating result decreased by 31%, mainly driven by the normalization of performance fees in the Chinese asset management joint venture. The operating result from the global platforms decreased slightly, driven by the impact of adverse market conditions on management fees and lower other revenues, partly offset by expense savings.
Now let’s turn to Slide 10, where you can see that our net result amounted to a loss of €348 million in the second quarter. Nonoperating items totaled a loss of €450 million, driven by fair value items and realized losses on bonds. Fair value items were mainly driven by the interest rate hedges for the U.S. variable annuities with GMDB and GMIB riders. This program hedges the economic liability.
However, under IFRS reporting, the discount rates for liabilities are locked in, which leads to an accounting mismatch and resulted in a fair value loss as a consequence of the increase in interest rates during the quarter. These hedges continue to effectively protect Aegon’s capital position against market movements.
Realized losses on bonds amounted to €226 million. These were sold to protect the liquidity position in a rising rate environment. Other charges amounted to €522 million, primarily resulting from €192 million charge from reinsurance rate increases as well as a €159 million charge for various assumption updates in the Americas. Other drivers included a book loss of €84 million from the sale of Aegon’s business in Turkey and onetime investments related to the operational improvement plan, which added up to €69 million.
And now moving on to Slide 11. Here, you can see that the solvency ratios of our three main units ended the quarter above their respective operating levels. U.S. RBC ratio decreased eight percentage points over the quarter to 416%. The sharp decline in equity markets in the quarter reduced the ratio by 29 percentage points.
Furthermore, the previously announced adoption of a long-term implied volatility assumptions reduced the RBC ratio by four percentage points, in line with our previous guidance.
Management actions partially offset these items in the second quarter. We made updates to the modeling of indexed universal life reserves, which was possible due to a multiyear model enhancement program. This positive impact on the ratio was partly offset by the recapturing of liabilities from a captive reinsurance company.
In the Netherlands, the Solvency II ratio of the Dutch Life unit increased 200%. The increase was mainly a result of a reduction in required capital including from an update to our internal model and from the sale of bonds to protect our liquidity position in a rising interest rate environment.
Market movements had a neutral impact as the negative impact from higher spreads was offset by a positive impact from interest rates and other market movements. Interest rates had a more favorable impact than our sensitivities would have suggested. This is the result of the magnitude of the interest rate increase and cross effects with other market movements. The solvency ratio of Scottish Equitable, which is our main legal entity in the U.K., increased by one percentage point to 178%.
On Slide 12, you see that cash capital at the holding decreased only slightly during the quarter to €1.7 billion despite the successful completion of our €400 million debt tender. Next to that, we executed the first €100 million tranche of our €300 million share buyback program this quarter.
Gross remittances from our business units and the proceeds from the sale of the business in Turkey contributed favorably, keeping the cash position above the operating range. We will spend part of this cash on dividend payments and buybacks during the remainder of the year. Second tranche of our share buyback is underway, and we announced today that the third tranche is expected to commence in October of this year.
Slide 13 shows the results of our financial assets, where we continue to take actions to maximize their value. As we shared with you last quarter, we are now directly engaging with third parties to discuss a potential reinsurance transaction on parts of the variable annuity portfolio.
Let me remind you that the outcome of those external engagements and the trade-offs to be made as part of a potential transaction will be weighed against the alternative of continued full ownership and active management of the now derisked variable annuity portfolio. As soon as we have more to share on the outcome of this process, we will update you accordingly.
As part of the ongoing active management of this block of business, we adopted a long-term implied volatility assumption for the valuation of variable annuity guarantees. The adoption of a long-term volatility assumption will better protect Transamerica’s capital position against short-term market dislocations. Furthermore, Transamerica is taking actions to reduce the basis risk between underlying investment funds and hedge instruments.
To this end, enhancements have been made to our hedging program in the second quarter, which will further increase the predictability of cash flows from the variable annuity portfolio going forward.
We continued our track record of successfully hedging the targeted risks embedded in our variable annuity guarantees. The dynamic hedge program achieved a hedge effectiveness of 98% this quarter. On long-term care, we have progressed well on the in-force management of this book.
In the second quarter of 2022, Transamerica obtained regulatory approvals for additional rate increases of US$23 million, bringing the value of approvals achieved as US$391 million. This means that we have achieved 87% of the US$450 million rate increase expectation.
Long-term care claims for the second quarter came in at an actual-to-expected ratio of 75%. This includes the release of the remaining incurred but not reported reserve that was previously set up for delayed long-term care claims.
Excluding this release, the actual to expected claims experienced for the second quarter of 2022 would have amounted to 88%. The claims experience mainly reflects increased claims terminations as a result of higher mortality while new claims returned to pre-pandemic levels.
As you know, our aim has been to term our Dutch Life business into a low-risk cash generator in predictable regular dividends. This quarter’s operating capital generation of €79 million comfortably covered the €55 million remittance to the holding. To reduce the sensitivity of the ratio to steepening of the interest rate curve at the longer end, NL Life updated its interest rate hedging program in the second quarter.
Now let me turn to my last slide. I’d like to briefly walk you through an overview of our achievements since the Capital Markets Day in 2020 that have strengthened our capital position. We have reduced our exposure to financial market risk. We have maintained the capital positions of our three main units and cash capital at the holding above the relevant operating levels despite market volatility.
We have reduced our gross financial leverage to within the targeted range, 1.5 years, ahead of schedule. The active management of our balance sheet and the overall progress we have made to transform Aegon allow us to increase our outlook for free cash flow.
Barring unforeseen circumstances, we now expect to achieve at least €2.2 billion cumulative free cash flow over the period 2021 to 2023, of which approximately will come in – one-third of it will come in 2022. This is well ahead of the €1.4 billion to €1.6 billion target range that we had provided at the 2020 Capital Markets Day.
This outlook is supported by operating capital generation from the units. Operating capital generation benefited from strong business performance, onetime items and more favorable claims experienced in the first half of the year. Following the strong performance in 2022 year-to-date, we now expect to achieve operating capital generation of around €1.4 billion for the full year. This compares to the guidance of around €1.2 billion that we provided at the fourth quarter 2021 results.
And with that final note, I now pass it back to you, Lard, for the wrap-up.
Lard Friese
Thanks, Matt.
On Slide 16, I’d like to end our brief update by repeating that while uncertainty in the financial markets and economic outlook is expected to remain, we will continue to stand by our customers and help them navigate through the challenging economic circumstances with our expertise and high level of service. I also want to thank our colleagues for their continued dedication, and I am confident that together, we will deliver on our 2023 strategic and financial commitments.
I would like to open the call now for your questions. And in the interest of time, I kindly request you to limit yourself to two questions per person. Operator, please open the Q&A session.
Question-and-Answer Session
Operator
[Operator Instructions] We will now take our first question from Andrew Baker from Citi. Please go ahead.
Andrew Baker
Thank you for taking my questions. So the first is on – I guess on free cash flow and dividends. So free cash flow expectations are now obviously significantly higher. Was there any thought of increase in the €0.25 EPS target by the end of 2022? And then secondly, just on OCT, are you able just to walk through a bridge on your thinking of how you get to the €1.4 billion obviously in the second half performance? And then really, has anything improved in your outlook for the second half? Or is it really just a effective strong 2Q performance? Thank you.
Lard Friese
Yes, Andrew, thank you very much for your questions. I’ll answer the first one and then hand over to you, if you don’t mind, Matt. On your – yes, we’re very pleased to see that the strength of our capital positions and the way we run is allowing us to increase our free cash flow outlook and also our operating capital generation outlook for this year.
The progress that we have made on strengthening the balance sheet and growing that free cash flow to date has allowed to accelerate our dividend trajectory compared with the expectations that we had at the time of the Capital Markets Day. For ’23, we expect a level of sustainable free cash flows that will allow us to further grow the dividend per share to around €0.25.
Matt Rider
Yes, I’ll pick up the operating capital generation for 2022. So the way to think about this is in the second quarter, we reported €391 million of operating capital generation. Now that included about €56 million in favorable claims experience and other onetime items in the U.S. and in the Netherlands. So if you deduct that, it gets you to a clean number for the quarter of about €335 million.
So if you kind of take €335 million times two quarters for the next two quarters, add that to the year-to-date operating capital generation that we reported of €776 million, and that gets you to a number that’s a little bit north of the €1.4 billion that we’re guiding off.
Andrew Baker
Thank you.
Operator
We will now take our next question from Michele Ballatore from KBW. Please go ahead.
Michele Ballatore
Yes, thank you for taking my questions. So I have two questions. The first one is on the RBC ratio. I don’t know if you can give us more details about the breakdown of what was the impact of the negative impact from the market volatility and the positive impact from management action and exactly maybe a little bit explore give a little bit more color on these actions. That’s the first question.
The second question is, it’s about the free cash flow. So of course, I mean, the way you determine the free cash flow depends on variety of factors. But to what extent free cash flow depends on your IFRS numbers. And if it does, therefore, we can – I mean you highlighted some level of confidence today about the effect that IFRS 17 may have on this factor in 2023. Thank you.
Lard Friese
Yes. Thank you, Michele. Matt, can you take both of them?
Matt Rider
Yes. Thank you for the questions. On the first one for the RBC ratio, I mean, we saw some big moves, obviously, because of markets during the course of the quarter. So if you look at just the effective markets, it ended up being about 33 percentage points negative. That’s mostly driven by equity market movements, and that was pretty much in line with our sensitivities that we had put out there. But there were some management actions that we had taken. They totaled about 25 percentage points during the course of the quarter that were quite important. And I would say that, that highlights our commitment to active capital management. This is what we are doing.
So there are – there were some puts and takes on the – mainly on the management actions, giving a positive to the RBC ratio. But actually, those management actions had very little effect on the operating capital generation outlook going forward. So on that standpoint, I think that we did a good job during the quarter managing the capital base.
On the free cash flow, I would just remind everyone that the free cash flow, it’s a very simple definition. It’s the remittances from the business units minus the holding and funding expenses at the group level. So when you asked the question about how much does it relate to IFRS or IFRS 17? The answer is not. These are simply the result of the solvency capital regimes in each one of the units that we’re doing business in.
Michele Ballatore
Thank you.
Operator
We will now take our next question from David Barma from BNP Exxon. Please go ahead.
David Barma
Thank you, and good morning. Just to come back on the – your answer just now that on free cash flows. So based on your revised targets, I think the remittance payout ratio over capital – operating capital generation moves up slightly to the high 60s. Can you explain what the remaining gap between the 2, where it comes from? And what do we need to see to improve this program in the future? That’s my first question. And then secondly, on the U.S. retirement plan business, so it seems like the margin level on this unit continue to be either pressure or flat versus previous periods. When do you think we’ll start seeing in the margin numbers, the efforts you’re taking in the – I think is a more profitable middle market segment?
Lard Friese
Thanks, David. Matt?
Matt Rider
So I’ll pick up the first one. Yes, right now, you’ve got the numbers right on the convergence between the operating capital generation and the free cash flow. There are a couple of things that we have to make sure that we take into account. One is we want to make sure that there is sufficient capital in the businesses, especially the U.S. business to make sure that they can execute on their growth initiatives because that’s our goal here is to grow the strategic assets.
So there are still some investments that we’re making in the operational improvement plan that is – that causes a little bit of that gap. We also want to make sure that we take into account future uncertainty with respect to credit risk. That’s a big deal. So in that free cash flow guidance that we have given for the three-year total, we are kind of factoring in a thought that credit risk could be heightened over the remaining period in that target. So we’ve assumed that roughly 1.5x our normal level of credit impairments. So those are some of the reasons. So we would expect that to converge operating capital generation and free cash flow.
Lard Friese
Yes. And so David on the retirement plan. So first of all, this is all about scale. We focus on the middle market in retirement plans. We do compete also in the large case market, but only on a more opportunistic basis. And the reason for that is that we believe that our ability to extract better margins is in the middle market, where actually also our existing market position is a very good one.
You have seen over the last quarters that we were able to grow continuously in our middle-market retirement plan space. And even in the quarter – this quarter, we were able to post net deposits again in that market segment. So this is going as we expect it to go, which is step-by-step improving and getting more scale in that chosen market segment, where we operate currently in a position of strength as a top five provider in terms of the number of new middle market retirement plan customers, and we’ve onboarded roughly 4,400 new cases in the last 12 months.
And of course, the flows of that will come through in the coming periods in full. So again, we’re doing well, but it’s a scale question. And we need to continue to drive our growth up in the middle market space, which, by the way, we have seen consistently over the last quarters improving.
David Barma
Thank you.
Operator
We will now take our next question from Michael Huttner from Berenberg. Please go ahead.
Michael Huttner
Fantastic. Thank you so much. I have two questions. 2.5, so maybe you will cut it to two. The first one is on mortality. So – and I think in the budget, there was €75 million less in the second half, but the mortality trends at the moment are so positive. I just wondered if you can say the – how you see the balance of charges in the second half?
And the second is we have the one-off items in the net profit level, €192 million for reinsurance and €159 million for various assumption changes relating to the North America. I just wondered whether you can give a little bit more color as to what this relates to is it hedging costs or ex-rates or mortality or I don’t know, it’s just interesting. These are amazing numbers. And please, can we have more buybacks? Sorry, sorry.
Lard Friese
Thank you for the suggestion, Michael, and thank you for the compliment.
Matt Rider
You are right, Michael. So the mortality in the second quarter was actually pretty good. So we see that a reduction obviously in coated related claims down to about $11 million during the course of the quarter, and that was based on 34,000 U.S. population deaths in the second quarter. By the way, that number had reduced dramatically from more than 155,000 in the first quarter. So we really see the effects of COVID on real mortality coming down.
Our outlook for the balance of the year is perhaps something like 40,000 U.S. population deaths due to COVID that translates into about $20 million a quarter in adverse mortality. And for the rest of it, let’s see how the experience goes for the remainder of the mortality claims in the U.S. But again, for the second quarter, they were actually pretty good.
But maybe I touch on the two charges that you had mentioned. The first one, the €192 million that related to reinsurance was an action by one of our reinsurers to increase why our key reinsurance rates on a significant block of business that – or significant blocks of business that we had reinsured with them. So that’s where you’re getting that one.
That has very little impact on the RBC ratio or on the – in the – in our statutory books, but it does have an ongoing drag of about €40 million in operating capital generation per year. That will decline over time as the book matures. That was purely related to mortality experience. And this is going back on reinsurance agreements and policies that were written decades ago. And this was one where it was better, let’s say, mortality expectations now are very different than what they were back then.
The assumption charges or the charges related to the assumption update in the second quarter in the U.S., we’re actually quite modest. I think, on an IFRS basis, you mentioned €159 million number, it actually has very little impact on ongoing operating capital generation, very little impact on the solvency ratio for the U.S. business.
And it was a mix of things. I think we updated maybe 70-some-odd assumptions. They’re very small. One example would be, for example, premium persistency on contracts. We updated for, let’s say, universal life-type contracts where we saw that people were paying higher premiums when they had lower account value. So it keeps the contract in force for longer. So that would be one example of the – one example of one of the updates that we had made.
One thing that we did not do during the course of the quarter was we did not look at COVID-19 mortality experience during the experience that we’ve had during the pandemic. Most insurance companies don’t really know what to do with it. So we’re basically throughout the data set and the assumption was related to many other things, but not generally population mortality. I hope that answers your question.
Michael Huttner
That’s really helpful. Thank you.
Operator
We will now take our next question from Robin van den Broek from Mediobanca. Please go ahead.
Robin van den Broek
Yes. Thank you. It’s Robin van den Broek. A follow-up question on free cash flow. I think if you break it down over the years, it’s €2.2 billion. I think you’re sort of getting to an equal level per annum. So I appreciate the commentary you made on 1.5x normal level of the Craig impairments, which is a 10 bps impact on our €60 billion book. So that’s only €60 million, but it feels like you’re still holding something back. Can we assume that maybe at least is a level of conservatism? That’s the follow-up question.
Then on OCG, I was just wondering if you could give us a bridge for 2023 on moving parts so far. You mentioned the reinsurance repricing, which had a negative impact, I guess, on OCG next year that you look for falling out and of course, a lot of macro movements quarter-to-date so that will be very helpful to get some more visibility there.
And the second question is around secondary guarantee universal life. One of your peers in the U.S., I think on the back of a private study, made some assumption changes in relation to that book. I was just wondering if you could explain what that entails to and to what extent that could be a future action for yourselves? Thank you.
Matt Rider
Take the first one. So on the – let’s say, on the free cash flow guidance, I think your question was really, do we have conservatism built into that €2.2 billion number. One thing that I can say is that, so what do we have in it just to let you know, we have assumed that the Dutch Life business will pay a growing dividend. What we see is there their capital generation capacity is going up, and we would expect them to pay a bit of a growing dividend.
What we also would expect is that the U.S. remittances would remain stable, and this is an important one because we’re still trying to invest in the strategic assets part of the U.S. business to be able to propel organic growth. So that’s a key thing.
The other one is that I think I had mentioned that we had benefited from the first half of the year from special dividends that we’re getting out of the – out of some of the companies, primarily the U.K. and TLB, but we have not baked in any material kind of special things for the balance of the year. So I don’t know if you would call that conservatism or that’s just what we have baked into the north of the €2.2 billion guidance.
As far as operating capital generation for 2023 goes, so we tried to give you some guidance for 2022 to say that we would get to about €1.4 billion of operating capital generation in the business units. And there are a couple of moving parts that you need to take into account for 2023. So the first one is, and I think you’re familiar with this, the UFR, the ultimate forward rate under Solvency II is not going to decline in 2023 next year, that 15 basis point decline that we’ve been suffering from each year. And that ends up giving a benefit of about €100 million in operating capital relative to this year.
Additionally, we talk a lot about the operational improvement plan and a number of initiatives savings and all these things. But ultimately, it’s important that this stuff comes through in the operating capital generation. And that’s what we would expect for 2023 that we would have some tailwinds from those successful completion of those initiatives to the tune of about €100 million.
And then I previously mentioned with respect to the YRT rate increases on reinsurance, I mean, just round it just say that it’s maybe between all the management actions and whatsoever, maybe €50 million headwind, so negative relative to 2022.
One thing we would expect, though, is that we would get – we expect that there will be a normalization of U.S. claims experience that we’ve seen in 2022, but we expect that at this moment to be offset by the nonrecurrence of favorable experience in other units, like you saw, for example, in this quarter in the Netherlands, among others.
What we are not doing is providing a more detailed OCG outlook for 2023, given the fact that we have a lot of macroeconomic uncertainty, and obviously, we’re making a lot of investments to grow organically in the strategic assets part of the business. But what you can say is that the level of operating caption is really a good basis for the units to pay the planned remittances to the holding and to invest in creating competitively advantaged businesses if we see opportunities to accelerate organic growth.
The secondary guarantee UL. So for us, we review our assumptions in the second quarter, and we again reviewed lapse assumptions in this type of business. Based on our experience, we saw actually no reason to change them. And in fact, we have actually very low lapse rates among especially the sensitive blocks of business where lapse rates tend to really matter. I think most people on the call will recognize that this is particularly sensitive for: one, older age population; two, higher phase amounts; and three, if contracts are in the money, then you can have a very low lapse rates.
And that’s where we have actually quite granular modeling and have been routinely updating these assumptions over time so that for those sensitive blocks of business, we have – they’re very close to Europe, very close to salaries. So this is not – the last issue is something that we’re routinely updating, but this is not an issue for us.
Robin van den Broek
That’s great color. Thank you very much.
Operator
We will now take our next question from Nasib Ahmed from UBS. Please go ahead.
Nasib Ahmed
Thanks for taking my questions. So first one on the U.S. variable annuity book. I appreciate you may not be able to say anything more since 1Q, but if there’s any update on how your internal process is going in terms of preparing the book and how your conversations are going with the third party, that would be great? And then secondly, again on the €1.4 billion OCG. So Matt, you said €350 times that by 2, and then maybe there’s about €40 million of COVID excess mortality that you’re expecting, and that kind of in gets you to the €1.4 billion. Is that correct? .
Lard Friese
Thank you very much, Nasib. Let me take the first one of the VA book. We’ve been very transparent and updated regularly on the steps that we are taking on that than we have been taking. We said that we would look at all options ranging from potential reinsurance transactions to continue full ownership of this now derisked portfolio. And if we have more share about this, we’ll provide an update at this point. We’re working on it. And in general, we don’t comment on this in this period. So the moment we have something to share, we’ll get back to you. . Matt, over to you.
Matt Rider
Yes. On the – I think you have it right on the OCG guidance for 2022. The one thing I would mention is that COVID claims are actually coming in for the balance of the year, they’re going to be relatively small. And frankly, we would expect them to be more or less canceled out by continued good morbidity experience. So that’s not really a factor. You can get to something north of €1.4 billion quite easily without factoring in sort of mortality or experience for the second half of the year.
Nasib Ahmed
Perfect. Thank you.
Operator
We will now take our next question from Sudarshan Bhutra from Société Générale. Please go ahead.
Sudarshan Bhutra
Hi. Just one question from my side. On your cash at holding, all your excess cash, given your current levels and the upgrade in the FCF guidance, you are easily going to be above, you’re going to easily be above the €1.5 billion – $0.5 billion to $1.5 billion target range. So I mean how should we start looking at the surplus cash? I mean what are the actions that you could take? Any color on that? Thank you.
Lard Friese
Yes. Thank you very much, Sudarshan. I’m going to take this one, Matt. So we have a clear policy for this, which is that if there’s surplus cash capital above and beyond what we need to execute on the transformation of the company, then our first priority remains to return to stockholders over time, and that’s most likely done in the form of buybacks. And as you know, we have a – we’ve given you guidance on how we want to keep the cash buffer between €0.5 billion and €1.5 billion.
We are active in buybacks. I mean – and we take this commitment seriously, as demonstrated by the fact that we have launched the buyback program announced earlier this year, and that underscores the commitment to return that surplus cash to stockholders. We will spend roughly €200 million, I think, on the last two tranches of this program, of which today, we announced that the third tranche will start on – in October and the balance of the year. And also, please don’t forget that we will return €400 million to stockholders through the payment of last year’s final dividend and the interim dividend that we announced today.
Sudarshan Bhutra
Thank you.
Operator
We will now take the next question from Steven Haywood from HSBC. Please go ahead.
Steven Haywood
Good morning. Thank you. On the Netherlands, you mentioned the sale of bonds to protect liquidity position in rising rates. Can you explain what’s going on here? Do you anticipate higher redemptions, so your liquidity had to be higher than it was at the end of the first quarter? Or is the Dutch business remitting too much upfront and waiting for actual cash to come out of the business over time? I mean selling the bonds will obviously lower your operating capital generation from the Dutch business. Is this material? Can you give us an indication? And obviously, selling that the bonds have increased your Solvency II ratio in the Netherlands. How much was that contribution to the Solvency II ratio increase versus other model updates here?
And then secondly, just a quick one, if you can? How much of the free cash flow and OCG increase in outlook comes from foreign exchange moves to the U.S. dollar increasing significantly? Thanks.
Lard Friese
Thank you. Matt, can you take that?
Matt Rider
Yes, let me take the first one. So the short answer on this is that the Dutch Life business has a lot of hedging positions out there against lower interest rates. We need to do that in order to protect the Solvency II position of the company so that when you have rising interest rates, particularly quickly rising interest rates to the tune by the way, in euro land is about 100 basis points during the course of the quarter. That means we have to fund collateral needs against the derivative position that we have to protect the solvency balance.
So in fact, during the course of the quarter, we sold about €6 billion worth of bonds. And as you mentioned, that did reduce the solvency rate or increase the solvency ratio because you lose the solvency capital requirement on those bonds. That had an impact of about eight percentage points on the ratio. Now in fact, we have so – this is a big deal for all insurance companies, by the way, is that the quarter was a story of managing liquidity and we have been able to incredibly successfully do that well. We have plans in place to be able to do this, and we manage it well. So that did reduce the solvency – or increase the solvency ratio because of the sale of those bonds.
Model updates had a positive impact of about six percentage points on the Dutch Life solvency ratio. It had mainly to do with having a certain infrastructure-related equity investments included in our partial internal model. So that was an important movement during the quarter. But otherwise, the big – the rising level of interest rates actually has done a lot to increase the operating capital generation outlook for the Dutch Life going forward.
Now at the end of June, I think the – basically, the interest rate curve on which we hedge is very close to the interest rate curve in which we do the solvency calculation. So that’s actually quite a benefit to us. And we’re actually looking at something like guidance of about €240 million operating capital generation in the Dutch Life business on a run rate basis. So we’ve been able to manage the liquidity needs very well. And in fact, the rise in interest rates have enabled us to increase the guidance on the capture.
Operator
Thank you. That was our final – sorry, please go ahead.
Lard Friese
Matt, he had one question on the U.S. dollar strengthening.
Matt Rider
Sorry about that. Yes. So the U.S. dollar strengthening on the operating cap gen is a factor in there. I guess for every 10% change in the Euro-U.S. dollar, it equates roughly to about a 5% change in the value of the remittance system that they give us in euro terms.
Steven Haywood
Could you just say again what the run rate of the Netherlands OCG was?
Matt Rider
€240 million is what this was.
Steven Haywood
Okay. Thanks very much.
Jan Willem Weidema
Thank you, operator. This concludes today’s Q&A session. So on behalf of Lard and Matt, I would like to thank you for the lively interaction. Should you have any remaining questions, then please do get in touch with us in Investor Relations. We’re happy to help. Have a good day, and thank you for your participation.
Operator
Thank you. That will conclude today’s conference call. Thank you, ladies and gentlemen. You may now disconnect.
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