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Athene Holding Ltd. (ATH) Q4 2018 Earnings Conference Call Transcript

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Athene Holding Ltd. (NYSE: ATH)
Q4 2018 Earnings Conference Call
Feb. 26, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Maria, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Athene Fourth Quarter and Full Year 2018 Earnings Conference Call and Webcast. All participant lines have been place in a listen-only mode to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I'll now turn the call over to Noah Gunn, Head of Global Investor Relations. Please go ahead.

Noah Gunn -- Vice President, Head of Investor Relations

Thanks, Maria, and welcome, again, everyone to our fourth quarter and full-year 2018 earnings call. Joining me this morning are Jim Belardi, Chairman and CEO; Bill Wheeler, President; and Marty Klein, our Chief Financial Officer.

As a reminder, this call may include forward-looking statements and projections, which do not guarantee future events or performance. We do not revise or update such statements to reflect new information, subsequent events or changes in strategy. Please refer to our most recent quarterly and annual reports and other SEC filings for a discussion of the factors that could cause actual results to differ materially from those expressed or implied. We'll be discussing certain non-GAAP measures on this call, which, we believe, are relevant in assessing the financial performance of the business. Reconciliations of these non-GAAP measures can be found in our earnings presentation and financial supplement, which is available at ir.athene.com.

And with that, I will now turn the call over to Jim Belardi.

James R. Belardi -- Co-Founder, Chairman, Chief Executive Officer and Chief Investment Officer

Thanks, Noah, and good morning, everyone. I'm pleased to report that 2018 was an incredible year of acceleration for Athene. We deployed capital into two inorganic transactions, representing more than $25 billion of liabilities. While growth is helpful, in the aggregate, these transactions will produce mid-teens cash and cash unlevered returns on the capital redeployed, substantially increasing future earnings power.

2018 also fostered substantial growth on the organic side in our retail and flow businesses. Again, the growth itself in these channels is not as important as the returns we were able to generate which was almost equal to our inorganic activity on an unlevered basis.

For the year, every core operating category across our business performed well. Net investment earned rates, cost of funding, G&A and our net spread margin. The primary driver of GAAP year-over-year trends was volatility in public equity markets, both on two public equities in our asset portfolio and in our other liability costs. Specifically, there were several notable themes in the past year that drove our business forward. One, in 2018, we grew adjusted book value by 19% to $45.59 per share, exceeding the trailing five-year compound annual rate of 16%. Two, we posted a consolidated adjusted operating ROE of 14% for the full year, achieving our target of at least mid-teens returns despite the drag created by the significant fourth quarter market volatility and excess capital that was held for most of the year.

Three, we continue to generate our top-tier investment performance and yield generation. Our consolidated net investment earned rate for the full year of 4.54% surpassed the 2017 level despite integrating $27 billion of blocked reinsurance assets that were onboarded with much lower earned rates as well as a significant market volatility we saw in the fourth quarter. Four, we continue to exhibit great discipline around expenses, which drove increasing operating leverage. As a percentage of average invested assets, our operating expense ratio declined more than 20% year-over-year to just 33 basis points.

And finally, our multi-channel models generated total deposits of more than $40 billion in 2018. This was driven by record activity in our organic channels and the first instance of closing two inorganic transactions in the same calendar year. Combined, this significant deposit activity resulted in 46% year-over-year growth in total invested assets to $111 billion.

In summary, these results illustrate the fact that we have built an enviable Retirement Services franchise, but we believe there is plenty more to accomplish. Along those lines, we have several strategic priorities for 2019.

First, we will continue to raise the bar by generating increasingly profitable growth across our organic channels with strong demographic trends and better market positioning in retail, new and expanding relationships in flow reinsurance, momentum in pension risk transfer and upside from funding agreements, we are well positioned to be able to pivot across channels and prudently allocate capital to grow profitably.

Two, picking up on 2017's upgrade by A.M. Best and 2018's upgrade by S&P, our next priority is that we will continue to pursue rating upgrades in hopes of achieving a rating of A or better from all the agencies which cover us. We already have a strong financial profile with low financial leverage, but we believe there is an attractive organic growth opportunity that can be captured through expanding product distribution and better spread-based economics in certain divisions.

Third, we will complete our asset redeployment strategy for the Voya and Lincoln assets to be more in line with our current asset allocation mix.

We estimate the Voya block will be completed by the middle of the year and the Lincoln block will be completed by the end of September. When fully redeployed, we expect these transactions will become more accretive to our portfolio yields and net investment income.

And lastly, we are fortunate to work in a business which generates over $1 billion of capital annually. Each year, we are presented with attractive opportunities to deploy that capital to generate attractive returns for our shareholders. As always, we will continue to be patient opportunistic stewards of capital and diligently evaluate the abundant opportunities we see across liability trades, strategic asset origination platforms, more traditional asset trades, bolstering for rating's upgrades, executing share repurchases and other accretive avenues of capital deployment.

We have historically generated significant shareholder value through such opportunistic deployment, and we intend to continue to judiciously evaluate the opportunities we see in 2019. Recall that in December, amid the tremendous equity price declines, we announced an opportunistic share repurchase authorization because our management team and our board believed it represented a very accretive use of capital. I'm pleased to report that in just the last few weeks of the year, we were able to repurchase 2.5 million shares at an average price of approximately $40 per share, totaling $100 million.

In the first quarter, we purchased another 1.2 million shares, totaling $47 million. Since these repurchases were executed at an average share price in line with our initial public offering price more than two years ago, when the size and earnings profile of Athene was significantly less than it is today, we believe this method of capital deployment will prove very accretive.

While we believe we are well capitalized with strong capital ratios and strategic flexibility, the recent bout of market volatility reinforced our view that there are plentiful deployment opportunities on the horizon. Adjusting for capital recently deployed or pending deployment, we have approximately $1 billion of excess equity capital remaining and over $2 billion of incremental debt capacity within our current rating levels.

We believe 2019 will be a prudent time to show we are good stewards of capital. As management, it's our job to create solutions that allow us in a measured way, while enhancing our credit rating and maintaining our franchise to create capital to do to the most compelling inorganic transaction or initiate share repurchase activities in size.

Before I turn the call over to Bill, I'd like to make a few comments about the investment environment and how we are positioned. To recap what we saw on the macro front during the fourth quarter, there is obviously meaningful pressure on equity markets with the S&P 500 down 14%, the VIX doubled, one- and three-month LIBOR increased 25 basis points to 40 basis points, high yield and triple B spreads widened meaningfully to levels we haven't seen in over two years and treasury yields fell after five consecutive quarters of increases.

So how do we perform amid this backdrop? Not surprisingly, our portfolio is very resilient. At quarter-end, 94% of our available-for-sale fixed maturity portfolio was designated NAIC 1 or 2 and our annualized OTTI for the quarter was 4 basis points. We did not experience any material impairments or realized losses.

The weakness was mainly related to two non-core public equities within our alternatives portfolio, and even that weakness seems to be short-lived as those positions have rebounded materially thus far in the first quarter.

Back at our Investor Day in September, we emphasized our focus on downside protection and laid out a stress scenario detailing the estimated impact of a recessionary environment on our portfolio. We reran the same scenario as of year-end and that yielded very similar results, which gives us continued confidence that our portfolio remains well positioned and it's sufficiently constructed to weather a storm.

Over the past 12 to 18 months, we have been taking an active approach to selectively move up in quality, assuming a more defensive positioning in preparation for a turn in the cycle. We believe we have been rewarded for these actions, particularly, when we experienced bouts of volatility like we saw in the fourth quarter.

In terms of our investment activity, we invested approximately $27 billion over the course of 2018, which is more than 20% greater than the amount we put to work in 2017. The main categories where we found attractive risk return opportunities included residential and commercial mortgage loans, asset-backed securities and alternatives. We've also been active in the investment grade portions of aircraft whole business and container securitization markets, among others. That said, in line with our slightly more defensive positioning, we proactively managed our purchases of BBB-rated investment grade corporates, cutting our annual purchases by more than $1 billion year-over-year in favor of higher-rated securities.

As we stated in the past, we aim to invest in unique opportunities that enable us to generate sustainable, safe and attractive returns for our shareholders. We have learned from experience that the most attractive alpha-generating investment opportunities often surface amid periods of dislocation. By way of example, when the market was at its weakest in the latter days of December and early days of January, we purchased more than $350 million of investment-grade corporates at a yield of 4.6% with a 15-year weighted average life. As we've said previously, we believe market instability ultimately benefits our business, often resulting in heightened investment activity and heightened returns.

With that, I'll turn the call over to Bill to provide comments around our liability origination activities.

William J. Wheeler -- President

Thanks, Jim. Our fourth quarter results caps a strong year of organic and inorganic liability growth for Athene. We remained opportunistic, continuing to grow in a manner consistent with our desired levels of profitability.

In 2018, we generated total organic deposits of $13.2 billion, a record level and 15% higher than 2017, driven by broad-based strength across our channels. Importantly, we maintained our underwriting discipline by continuing to price our new business to mid-teens returns on an aggregate basis.

Our retail channel generated $7.5 billion of deposits, a 41% increase over the prior year. Wealth was driven by the introduction of new products and expansion in the financial institutions' distribution channel, which comprised 23% of retail sales in the year compared to 11% in the prior year. We expect this channel to continue to become a larger portion of our retail sales since we signed 26 new broker-dealer relationships and onboarded 30 during the year.

Turning to our PRT channel, after a slow start to the year, we were cautiously optimistic activity would pick up and that's exactly what happened as a handful of key wins drove a material increase in volume. For the year, we closed $2.6 billion worth of transactions and $1.8 billion of that total was in the fourth quarter. A notable transaction late in the year was a buy-in deal with Lockheed Martin, easily the largest buy in ever done in the US.

The 2018 transactions do not include the significant transaction announced with Bristol-Myers Squibb, which we expect to close in the third quarter. In addition, I'm pleased to report that we have closed two deals so far in the first quarter totaling approximately $2 billion in volume from two separate public companies, one of which is a warehouser.

Clearly, we are experiencing substantial momentum heading into the rest of 2019. While wouldn't expect this elevated pace to continue on a quarterly basis, we are encouraged by the increasing recognition we are receiving in the market as a preferred partner and an innovation solutions provider.

In our third-party flow reinsurance channel, we signed up three new counterparty relationships in 2018. For the year, we generated $2.4 billion of volume, more than double the 2017 total. The fourth quarter of 2018 was particularly successful with $1.1 billion of deposits, reflecting higher volumes from our new partners.

In December, we announced an $8 billion inorganic block reinsurance transaction with Lincoln Financial for which we deployed approximately $700 million of capital with an effective date of October 1. This transaction is a great example of how we are able to deepen our relationship with an existing business partner in our flow reinsurance channel. We believe we were selected as a partner on this block reinsurance transaction because we are a well-known, high-quality counterparty. We could conduct due diligence relatively quickly because we had existing insights on the block and because our strong capital position offered certainty of closing.

Through this reinsurance transaction, we were unable to unlock -- we were able to unlock capital for Lincoln, which was subsequently used to support their strategic priorities. As Jim mentioned earlier, we are in the early stages of repositioning the assets within the block and expect additional accretion to materialize once that effort is complete.

A pipeline of M&A opportunities remains active, and we continue to explore potential transactions in hopes of providing unique solutions to the marketplace. There were numerous transaction opportunities that surfaced during 2018 and not surprisingly, we exercised our usual amount of rigor and discipline in evaluating all of them. While it's difficult to determine the likelihood and pace of additional transactions being consummated, we remain well positioned to navigate the current environment. We have a strategic partner in Apollo. We still have excess capital and we have untapped debt capacity if needed, all factors which provide us with the ability to be nimble and selective.

We still believe the industry is going through a significant restructuring and we are seeing continued evidence of that as companies seek to reduce exposure to complex liabilities, shed non-core businesses or like to hold businesses in the hopes of redeploying the freed-up capital in a more accretive fashion. While equity market pressure can certainly serve to be a catalyst to accelerate the industry restructuring, we believe activity will continue even in more benign periods because counterparties are generally making fundamental changes to their business models with a long-term focus rather than trying to time the market.

Now I'd like to turn the call over to Marty, who will discuss our financial results.

Martin P. Klein -- Executive Vice President and Chief Financial Officer

Thanks, Bill, and good morning, everybody. We delivered good performance in the fourth quarter in what was a strong year for Athene. This morning, I'll walk through our fourth quarter operating results and explain some of the volatility we experienced. And then I'll frame how we view our forward earnings power, including certain outlook items for 2019.

Turning to our results for the quarter, group reported a GAAP net loss of $104 million or $0.53 per diluted share. The loss was primarily driven by two non-operating factors, which are both non-economic. First, an unfavorable change in fixed indexed annuity derivatives due to equity market weakness and, second, investment losses on assumed reinsurance embedded derivatives due to credit spread widening.

With respect to fixed indexed annuity derivatives, the losses were the result of a timing mismatch and the marks between derivative assets and embedded derivatives in the liabilities due to GAAP reporting requirements.

With respect to investment gains and losses on assumed reinsurance embedded derivatives, these fluctuations are also non-economic in nature. As you know, GAAP accounting in the insurance industry is one-sided and that available-for-sale assets are generally carried at fair value, while associated liabilities are reported at book value. We don't believe they are consistent with our underlying profitability.

For direct written business, those fair value changes in underlying assets go through AOCI, but for business we source through reinsurance, GAAP requires fair value marked on the underlying assets, which are primarily fixed income, to be included in the net income line. So even though our reinsurance business has the same economic profile as our direct written business, the GAAP treatment of the underlying assets is different, i.e., there would be no net income impact from the asset marks that GAAP accounting for reinsurance were the same as for other business.

Moving now to operating results. We reported adjusted operating income of $240 million or $1.23 per share for the fourth quarter of 2018. Excluding notable items, such as volatility and other liability costs, adjusted operating income was $293 million or $1.50 per share. The significant equity market correction in the quarter increased other liability costs by $58 million and decreased investment income by about $41 million due to the depreciation of a couple of public equity positions. These offsets could be viewed as temporary in nature, as some of the quarter's decline already has been recovered in the year-to-date market rebound.

Sequentially higher net investment income in the fourth quarter was offset by the increase in other liability costs as well as somewhat higher crediting costs.

Let me provide some context for a few drivers within each of these areas. Within net investment income, we benefited from multiple positives, including new business growth, higher floating rate income, the Lincoln transaction as well as continued redeployment of the Voya portfolio. Collectively, these items drove a sequentially increase of more than $75 million versus the third quarter level.

It's worth noting that this improvement would have been greater if not for a softer quarter on alternatives, which again, primarily resulted from outsized depreciation in the couple of public equities. For additional context, approximately 40% of our alternative investments were marked on a real-time basis, but the rest on a one- or three-month lag. For the investments marked on a lag, we expect the widening credit spread backdrop we saw in December and in the fourth quarter more broadly results in a modest headwind in Retirement Services for the first quarter. However, that headwind would likely be offset by a tailwind from the sharp rebound in public equities so far this year, should it hold, which would benefit the Corporate segment.

Within our quarterly financial supplement, we provided a new reporting cable for alternative investments to provide more transparency around the composition of the portfolio. As I mentioned, other liability costs increased significantly quarter-over-quarter and this is driven by the impact of unfavorable equity markets on GAAP in rider reserves, resulting in a $58 million increase in those costs.

Rising institutional cost of crediting from our growing PRT channel also increased other liability costs, although of course, PRT growth is a positive for earnings as those crediting costs are more than offset by higher investment income on those deposits.

Lastly, cost of crediting rose nearly $50 million sequentially. The increase was partially driven by strong business growth resulting from the Lincoln transaction as well as growth in our retail and flow channel. Again, those crediting increases are more than offset by corresponding investment income on those deposits.

In addition, hedging cost in the quarter rose modestly from a sharp increase in volatility in higher short-term rates.

We'll try and move on to our forward earnings power, I want to cover a couple of accounting policy topics. First, late in 2018, we identified an error in a non-operating and isolated item, which had an immaterial impact in prior periods and certain actuarial balance is going back to the fourth quarter of 2015 and had no impact at all on adjusted operating income. Rather than make the cumulative correction in the fourth quarter, we revised our financial results for this and all other immaterial adjustments from prior periods as detailed in the appendix of our earnings presentation.

I'd like to note that as part of the review of this item, we identified the related material weakness and total control of our financial reporting, though we have remediated it with initiatives begun in 2018 and it is no longer outstanding.

Separately, as part of our annual unlocking process in the third quarter, we reviewed our process for determining the impact of the equity market movements and other liability costs, specifically deferred acquisition costs and rider reserves. As a result of that review, in the fourth quarter, we implemented a change in estimate, which will reduce the equity market-related volatility on those line items than our operating results. This adjustment will result in our operating results to be more closely aligned with our long-term economic view.

To give you some indication of the market sensitivity to expect, if the first quarter 2019 ended today with markets up approximately 10%, other liability costs would benefit by approximately $5 million to $10 million. This would be a much lower level of earnings volatility than under our prior methodology. And as before, the actual impact will depend on specific factors, such as the passive equity changes during the given quarter and during the previous quarters among other considerations.

Summing up on our results, we benefited from the continued execution of our strategy of profitable growth. The $40 billion plus in deposits in 2018 added $110 million of operating income over the fourth quarter of 2017. The scalability of our platform has certainly contributed to that result as operating expenses declined 8 basis points versus a year ago, equivalent to a savings of approximately $20 million.

While fourth quarter results were lower than earlier quarters this year, the reality is that our core earnings power is continuing to build meaningfully. As Jim mentioned at the start of the call, our business experienced strong acceleration in 2018 and that acceleration is expected to translate to earnings growth. From a simple timing perspective, approximately 90% of the $40 billion deposits during the year were added on the June 1 or later, which means the full benefit of all that growth is not yet reflected in our results.

When we consider the stair-step growth of our in-forced, the ongoing benefits of our organic growth engine, additional accretion potential from redeploying the Voya and Lincoln blocks as well as share repurchase accretion, we believe our forward earnings power, operating earnings power exceeds $7 per share. This level is more than 20% higher than the earnings generated in 2018 and is more than double the 10% rate at which we've been compounding earnings over the past few years.

Our current outlook for 2018 incorporates the following. Organic growth volumes that exceed or meet -- meet or exceed our 2018 levels, with in-force decrements of approximately 9% to 10%, an investment margin of 2% to 3%, increasing operating leverage driving lower expense ratios, modestly higher tax rate of 9% to 10% as previously communicated and continued opportunistic share repurchase activity. Collectively, these drivers support an attractive earnings growth trajectory for Athene. We look forward to updating you on our progress throughout the year.

With that, we'll now turn the call over to the operator and open the line to you for your questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions).

Noah Gunn -- Vice President, Head of Investor Relations

Great. Thanks, Maria. And we appreciate everyone's interest in question. Just to make sure, everyone receives a turn if you could just limit yourself to one question and one follow-up initially and then if you have additional questions beyond that just rehop in the queue. Thanks.

Operator

Our first question comes from the line of John Nadel of UBS.

John Nadel -- UBS -- Analyst

Hey. Thanks and good morning everybody. I guess, I'll start with this. I'm curious if we move through 2019 and, Marty, I appreciate the organic growth target and the in-force decrement. So if we leave that into your 2019 results and assume you didn't deploy any capital inorganically, how should we think about your capital generation under that kind of scenario? And I'm really thinking about it relative to the drop in your RBC ratio and maybe you could pull into that conversation target for RBC on a go-forward basis since there has been some formulaic changes?

Martin P. Klein -- Executive Vice President and Chief Financial Officer

Sure, John. I think there's a couple of questions in there. Let me try to address them. Yes, I think the way to think our business organically, we generally think about levering capital, say 13 times or kind of a 7.5% of capital has been put on a new business and it can vary a little bit depending on the channel. So if we had $1 billion of capital that we spend, that would probably put on $13 billion or maybe $13.5 billion, $14 million of organic growth, which I think is in line with the guidance that we suggested for 2018. So that will be kind of the capital use in 2019 organic. As far as sources of capital, our statutory earnings, as we talk about are quite strong.

I'd say, for 2019, our stat earnings are probably going to be a bit north of $1 billion, not only our existing in-force, but Voya and Lincoln contribute to that. We've got probably over $1 billion of stat earnings and then in addition on the decrement that you mentioned, that will release capital -- and that will probably release capital of about $700 million. So we're looking at close to $2 billion of capital either coming in from stat earnings or being released from existing in-force as it lapses versus putting to what may be $1 billion of give or take kind of organic. So the way from other uses of capital, we probably grow excess capital by roughly $1 billion.

John Nadel -- UBS -- Analyst

Got you. Okay, that's helpful, that's helpful.

Martin P. Klein -- Executive Vice President and Chief Financial Officer

On the RBC question, I'd say a couple of things. One -- and there is a slide in our earnings presentation, but we put a lot of capital to work to get very good returns in the fourth quarter. And the big part of that, as Bill mentioned, was the Lincoln deal where we used $700 million of capital. As we're redeploying some assets, we found some attractive alts and that was another, I think, $250 million capital and then, obviously, we had the share buyback, which to date is another $150 million. So a lot of capital put to work, that's coming pretty much all out of ALRe, the Bermuda company, and our capital is very fungible and we feel good about that.

We're trying to put capital to work for good returns, and we feel good about that. Our RBC has also impacted the quarter. Obviously, like everybody else, the new RBC factors post tax reform are in place and that did have an impact in our RBC ratios. I'd say that RBC ratios are about 8% less than they were before. In other words, post tax reform, RBC ratios are 92% of what they were, that makes sense. But I'd say that our view of excess capital has not really changed and that what we really have been managing to, as I said, and in the past is really rating agency models. Those models did not change for tax reform. They use pre-tax factors. So as we look at those models, we are at the same spot from a capital standpoint and that's kind of how we really measure excess capital now and I think going forward.

I'd say though, as a rough proxy for what that looks like, 370% RBC under the new rules is a pretty decent proxy for where we want to be with the rating agency models under -- for those single A thresholds. So we don't follow that religiously, but it's a pretty decent proxy, if that makes sense.

John Nadel -- UBS -- Analyst

That's perfect. And then as my follow-up, just thinking about the repositioning of the Voya and Lincoln portfolios, if you can maybe give us a sense even if it's just in round numbers, how we could think about the lift in investment income through 2019 or maybe even just thinking about the fourth quarter of 2019 if the entirety of the repositioning is completed? About how much of a lift relative to the fourth quarter of 2018 would you expect to be able to achieve?

Martin P. Klein -- Executive Vice President and Chief Financial Officer

Well, I think, those two portfolios, I think, we expect that over time to put them on kind of where we are elsewhere in the portfolio. I would just sort of note that Voya and Lincoln, respectively, kind of dragged down in years by about 16 and 7 basis points, respectively, about 23, 24 basis points in total year-over-year. And we'd expect really, frankly, to kind of get that back in aggregate as we redeploy the company close to it.

John Nadel -- UBS -- Analyst

That's perfect. Perfect, thank you so much.

Operator

Our next question comes from the line of Erik Bass of Autonomous Research.

Erik Bass -- Autonomous Research -- Analyst

Hi, thank you. If you keep growing and deploying capital at the pace you did in 2018, should we think of debt being the primary source of additional capital or it sounds like you may be open to looking at other options? I don't know if things like side cars or other co-investment options provide more flexibility and more broadly, how do you balance current deployment with maintaining flexibility for stat pitch opportunity?

Martin P. Klein -- Executive Vice President and Chief Financial Officer

Right. As we talked about Investor Day and Jim has mentioned that several times, we do want to be well positioned for the bad debt. I don't think we're calling for recession anytime real soon, but couple of years out, hard to say, and that's when I think the really very, very accretive opportunities really comes and we're getting mid-teens returns, but the returns we've got in the wake of the financial crisis were far north of that and we're very mindful of that.

Look, I think, right now, we have $3 billion of deployable capital, so that's a pretty good place to be. And we'd expect that to grow by roughly $1 billion over the next year, for the reasons I mentioned when I was answering John's question. So that put us closer to $4 billion away from many incremental things we may do. But we're open to other ways to use capital, that's $3 billion, we have now, would include untapped debt capacity of $2 billion and we're certainly open to issuing more debt and we believe that we issue debt and contribute it into our subs to support our business that up to a level of 20% or 25% adjusted capital that's relatively straightforward thing to do, so we would certainly look at that.

We also would look at other options out there. There's other ways to get capital, whether it's would we issue a preferred at some point? We might depending on the conditions, if we can put the money to work in a way that's very accretive or other opportunities. The reinsurance way is also another opportunity.

And so we're looking at a variety of things, but we do want to be mindful of that pitch. One other things we're doing, I think, Jim touched on this, is we're being very mindful of how we deploy our capital. We've been getting mid-teens returns, the share buyback could be even better than that. But we're raising the bar because -- so we really want to make sure that we're putting our capital to work and allocating that in the best possible way. And while we have a lot, there's probably a lot more opportunities out there than what we have in mind for right now.

Erik Bass -- Autonomous Research -- Analyst

Thank you. And on that last point, you mentioned, I mean, being able to pivot on throughout your organic channels. Where are you seeing the best opportunity right now in terms of the returns you're getting for organic new business?

William J. Wheeler -- President

Look, retail is still very strong. Even though we're growing in that channel, our returns are superior and so we're very pleased. Flow is similar to retail. It really depends on the specific feel or the specific counterparty. As mentioned, close outs are interesting. Look, it's a very competitive market. We do hit our mid-teens target returns, but I think, there is potential as we get into, what I would call, more complex types of deals to expand our margins. So they all have good opportunities in them. But retail, which is the biggest actually, is especially the indexed annuities portion of it is -- the returns are excellent.

Erik Bass -- Autonomous Research -- Analyst

Thank you.

Operator

Our next question comes from the line of Alex Scott of Goldman Sachs.

Alex Scott -- Goldman Sachs -- Analyst

Hey, good morning. First question I had was just thinking through sort of the spread versus other liability costs. I was hoping you could provide just some color around how we should think about other liability costs? With the Lincoln transaction coming online, I think there's probably some DAC considerations there with sort of pension risk transfers ramping up I think. I think that impacts it as well. Could you help us think through and in this quarter, I think, wasn't terribly helpful from like a run rate standpoint because there was a little bit of noise, right? So I'm just trying to think through how that's going to look as we go through '19?

Martin P. Klein -- Executive Vice President and Chief Financial Officer

I think, what we tried in the guidance I gave for 2019 to give you kind of, we expect to be better than $7 a share in operating earnings. The line items really depend a lot on what we're putting on the books. And at the end of the day, what we do -- looking at pricing business was whether it's organic business or inorganic businesses is we really want to get mid-teens returns or better on net capital, but the line items can move around a lot. And -- but the main thing is what the bottom line impact is on operating income. So think about the Lincoln deal as an example, its line items look different than our existing business in many ways, but we're still getting what we think as mid-teens returns.

This is if we source other business. So coming on to books initially, it's got lower year -- lower investment income rate. We think that over the next few months, the next couple of quarters, that would get back to where everything else is, but it starts out lower. On the cost of fund side, it actually has higher crediting costs, but it has lower of the liability cost. So when you factor in $8 billion into the existing book, in does have an impact on those line items. But at the end of the day, the bottom-line return on net capital we're putting to work is the same kind of number, that kind of mid-teens returns.

William J. Wheeler -- President

Alex, look, this is Bill. I know this isn't quite answering the question, but the problem is when we start to try to give guidance here and the next quarter when our mix shifts around either if we get a deal or we sold a lot of MYGAs that quarter, because of the new flow reinsurance relationship, it moves the numbers around and people get, I would say, overly distracted by it. And so we're trying (inaudible). I know you have to build a model, but I think the idea is that you should try to solve for other liability costs and crediting costs a little differently.

Alex Scott -- Goldman Sachs -- Analyst

Yes, No, I appreciate that. I mean, is it fair to say that sort of on a consolidated basis, the way you guys have talked about ROA in the past is still intact and like we may be a little below that now, but we should get back up to that as you guys probably reallocate Voya and Lincoln?

Martin P. Klein -- Executive Vice President and Chief Financial Officer

Yes, that's right. I think one thing I know is in 2019, we grew a lot in the fourth quarter. I mean, not only did we do Lincoln, which on the Investor Day wasn't booked into our estimates, but we also grew a lot. We have $5 billion of organic deposits, including fair key deals. That's a good thing for Athene earnings overall, absolutely. It also means though that redeploying all those assets, we talked about Lincoln already and getting more alts, as said, the amount of alts we expect to have by the end of 2019, in dollar terms, it may be about the same but because our balance sheet is that much bigger, the percent of alts may be 1% or 1.5% lower over the course of 2019. So that will bring down the rate, if you will, but we'll expect that to catch up over the next couple of years. And again, as we're putting business on our books, we're pricing it to mid-teens over its lifetime.

Alex Scott -- Goldman Sachs -- Analyst

All right. That's helpful. Thank you.

Operator

Our next question comes from the line of John Barnidge of Sandler O'Neill.

John Barnidge -- Sandler O'Neill -- Analyst

Thanks. Scale is something that's certainly been reached over the course of the last year. It's not about other liability, but operating expenses. You guided to 24 to 26 basis points. Does this seem reasonable that maybe given the scale and the volume we've seen over the last quarter that it could actually come in somewhat lower than that range going forward?

Martin P. Klein -- Executive Vice President and Chief Financial Officer

Yes, I think, that's right. I mean, the bigger balance sheet, I mean, the way we grow our earnings basically is we get more business on our books, it may change returns and make more spreads and we get increased operating leverage. So those are the main drivers of our story, and we think it's important for folks to remember that. But you're right, I think, at Investor Day, we -- and I think in the third quarter, we gave some numbers on overall rate and invested assets. We put on lot more business at mid-teens returns, so that will be beneficial. And the associated expenses didn't go up very much at all. So yes, we'll get increased lift and it may be some upside from what we had talked about on the expense ratio at Investor Day.

John Barnidge -- Sandler O'Neill -- Analyst

Okay. And then a follow-up question. When you talk about transaction opportunities, would you have interest in whole company transaction? Or does it seem more likely to be focused on block, similar to what has been completed so far in your history?

William J. Wheeler -- President

Well, if you look at our history, just the last couple of years, there's definitely...

John Barnidge -- Sandler O'Neill -- Analyst

I mean...

William J. Wheeler -- President

Yes, there's definitely a lot of whole company deals. Look, there are just less whole company deals out there to do, but we don't have any bias against them. There are probably more block opportunities. The other great thing about blocks are depending on who does the administration of the products. They're really easy to integrate. I would say, it was never easy, but it's relatively easy. And I would say that if you look at both Voya and Lincoln, that's clearly the case. We added less than 10 people for both of those deals, right. And by the way, we're already back in business, right. We're already ready to do the next one. So block deals have some real advantages and you still get great economics, so -- but no, if the right whole company deal came along, we would obviously pursue it.

John Barnidge -- Sandler O'Neill -- Analyst

Great. Thanks for the answer and congrats on the quarter.

Operator

Our next question comes from the line of Tom Gallagher of Evercore ISI.

Tom Gallagher -- Evercore ISI -- Analyst

Good morning. First question, Marty, I just wanted to make sure I understood your comments on the net income volatility and what our expectation should be going forward. The change that you have made to, I guess, I'm assuming that's kind of a corridor approach to equity market return assumptions. So as it relates to equity market moves, we'll see less volatility. I guess, that was my understanding from what you said and if that's right, will we still continue to see volatility based on the reinsurance accounting as it relates to credit spread widening because I think that was the biggest driver of the net income volatility this quarter?

Martin P. Klein -- Executive Vice President and Chief Financial Officer

Yes, Tom. Actually the biggest driver was that mark on derivatives versus embedded derivatives, but the mark on the reinsurance assets was pretty sizable as well. So both those things drove net income pressure. The change in methodology we use will affect other liability costs, so it's up in operating income and it really will in fact -- what we're doing is really smoothing the impact in equity markets over time rather than making these abrupt adjustments if the market is down 14% or up 10%, we're kind of smoothing those impacts. So it's just kind of taking the good and the bad things quarter-by-quarter and averaging them out because that's really how markets move.

They don't go up levelly 1.5% a quarter, they kind of bounce around a bit. So I think, it's a much more -- a much better approach and will create a lot less volatility in the operating income in that other liability costs line, exclusively DAC amortization and rider reserves. We're still going to have equity volatility in the embedded derivative line, again that's totally non-economic. It's all just timing. We're economically hedged to the horizon of our equity guarantees, but the way the valuation works for GAAP accounting is the liability market's spread out over its life versus the market and the derivatives is right away.

On the reinsurance stuff, really, all that is, is that business we source to reinsurance, which looks identical in many ways to what we do in the retail, I mean we originate fixed index annuities and MYGA products in retail and we do the same thing via reinsurance in flow. The difference is, in flow reinsurance and block deals, we have to mark those assets through a net income, that's all it is. It's just, frankly, inconsistent GAAP accounting between reinsurance business and the direct written business we have. We have more of that than others because that is the big source of our growth.

Both in organic and inorganic, it's the reinsurance, but it's really not economic. We're managing assets and liabilities the same everywhere. And it's sort of one-sided mark, only assets and not the liabilities. But in reinsurance, that mark is taken through net income, rather than AOCI and that will continue. It's non-operating because it's really not economic.

Tom Gallagher -- Evercore ISI -- Analyst

Got it. Got you. That's helpful. And then my follow-up is just on how should we think about organic deposits versus surrenders for 2019? I mean, flow reinsurance picked up a lot. I assume or question is, is that a pretty good new run rate to think about on a quarterly basis or anything unusual there? I know there's going to be volatility in PRT, but retail's also had a pretty good level. So maybe -- I don't know, can you give us some indication for where you think total deposits shake out in 2019 and also I noticed surrenders picked up a bit in 4Q, a little over $3 billion in total. Is that a decent run rate as well when we think about surrender ratios? I think it's like 11% to 12%, and I think your previous guide was 8% to 10% for 2018 on surrenders.

William J. Wheeler -- President

Well, OK. So a couple of things. Let's start with new deposits. We did $13.2 billion in 2018. We do expect that to be higher in '19 modestly, but also keep in mind, that's going to account the big -- that's accounting the big burst of Myers' deal. So if you sort of adjust for that, we're kind of assuming flattish volumes and the reason for that is not -- obviously, we can grow, but what we're doing is raising our IRR target. And so we're keeping growth, putting a little bit of a governor on it, if you will, because we want to make sure that we get full margins. So I would say that with regard to flow, in particular, $1.1 billion in the fourth quarter is not a new run rate. It's going to cool off.

Fourth quarter is always strong. There was some unusual activity with one of our counterparties there, one of our flow partners that isn't going to keep at the same pace. So I think you're going to see that slowdown. I think flow will have a very good year in '19, but it's going to slow down a little bit. So that gives you a sense of the gross volumes. So with regard to runoff, so '18 and '19, we're seeing unusually higher levels of runoff in our base business and that's because a decade ago, the old Aviva sold a lot of business then and it's finally coming off surrender charge. So you're going to see a shock lapse and then in the old in-force, then after '19, the runoff actually declines, OK.

So we're in a little bit of a blip. Now the other thing going on here is that Voya and Lincoln are older blocks, especially the Lincoln block, and so the runoff in those blocks proportionately is a little greater and, obviously, we price for that and factored it in, but that's why you're going to see the runoff a little higher. I can't -- I don't want to give you a percentage of the in-force runoff in a given year, but it is going to be high single digits, maybe getting to 10% in 2019.

Tom Gallagher -- Evercore ISI -- Analyst

Got it. That's helpful, Bill. Thanks.

Operator

Our next question comes from the line of Andrew Kligerman of Credit Suisse.

William J. Wheeler -- President

Andrew, are you there?

Andrew Kligerman -- Credit Suisse -- Analyst

Yes, right here. Sorry about that. Just a follow-up a bit on what Tom was asking. Could you clarify what that Aviva shock lapse will be? And just kind of looking at the flows, you had net flows of about $2.1 billion. It was off slightly from the fourth quarter of next year. So for the year, you would expect kind of a comparable net flow that -- to what we had last year or does it even shrink a little bit going forward?

William J. Wheeler -- President

It's going to be -- so surrenders on the base business are going to be about the same. I'm thinking -- I hate quote a number off the top of my head. I think it's about for the old in-force about $6 billion, $7 billion and then it's going to slip down to like $4 billion, $5 billion again, OK. So it'll drop. Then a couple of billions after '19, but yes, net flows of $2 billion, $3 billion, well, it'll be probably a little more than that because obviously of deposit growth, but that's sort of what's -- that's what's going on.

Martin P. Klein -- Executive Vice President and Chief Financial Officer

Yes. The 9% to 10%, Andrew, that I mentioned is on the existing in-force at year-end, including Lincoln and Voya. So the book of business we have is like $107 billion, $108 billion reserves. On that overall base, in aggregate, we expect the decrement rate, I'd call it, 9% to 10%.

Andrew Kligerman -- Credit Suisse -- Analyst

Okay. And with respect to the other liability costs and I think it's really interesting that you've shifted the GAAP accounting to more smoothing, and I think, Marty, you said $5 million to $10 million positive impact in 1Q as a result versus, I don't know, it must have been more than 10 times the impact on the negative side in the fourth quarter of last year. So that's good. I mean, I think that's a great thing, but what's it going to look like in 2021 when you have the new accounting? Are we going to see a very smooth outlook? Or will noise come back? I know they're going to amortize DAC more flat line-ish. How do you see 2021 once we kind of get through?

Martin P. Klein -- Executive Vice President and Chief Financial Officer

Yes. So you're, Andrew, referencing, the long-duration targeted improvement. Some people use the term LDTI and that goes into effect, at least it's scheduled right now to go into effect in 2021, couple of years out. That changes the rider reserve calc for everybody. It's just basically a fundamental reworking of how rider reserves, for example, are going to be determined and it will be much more mark-to-market for GAAP accounting. So we've adopted this new framework or methodology, I should say, but it will change like it will for everybody all the variable annuity riders and fixed indexed annuity riders and so for the changes for everybody in 2021.

Andrew Kligerman -- Credit Suisse -- Analyst

And do you think that we'll see a lot of noise again? Or do you think it could be smooth with the...

Martin P. Klein -- Executive Vice President and Chief Financial Officer

Yes, I think that -- again, it's early days and everybody is trying to understand this and work with the FASB, but basically for the rider reserve aspect of it, that we're kind of talking about here, it will be much more of a kind of mark-to-market construct rather than what's -- and I think different companies view this different ways. We set up very high reserves. We think we feel very good about rider reserving, but it'll just create, I think, more volatility.

How companies end up doing it exactly, we'll have to see. We, and I'm sure all other companies, are in discussions with accounting firms on how they implement these things. But this more mark-to-market framework will create some more noise and we'll have to look at it, and I'm sure this is true for others, and say how much of it is true economics and how much of this is just timing or noise. And if we determine that some or a big part of it's just timing or noise, we'll try to call it out as non-operating if that makes sense. So we'll have to play that out over time. It doesn't really change anything on the fundamental economics of the business. Nothing has changed. It just may create a little more volatility and we'll just have to assess the methodology we use, and we think some of that volatility and call it non-operating, but more to come on that over the next year or two.

Operator

Our next question comes from the line of Humphrey Lee of Dowling & Partners.

Humphrey Lee -- Dowling & Partners -- Analyst

Good morning and thanks for taking my questions. Regarding the guidance or at least the earnings power outlook for '19, you've talked about the Retirement segment. Just for Corporates, I think, previously you talked about plus or minus $10 million would be the normal run rate for Corporate. Obviously, first quarter, you look at the recovery of the two public equities, that should be an uplift. But I guess, for the remaining quarters, should we still think about that plus or minus $10 million given the lower excess capital that you have in Corporate relative to when you first talked about the guidance back at Investor Day?

Martin P. Klein -- Executive Vice President and Chief Financial Officer

I think -- Humphrey, I think that's right. It probably still averages out around zero, but with some volatility. The things that are in the Corporate and Other now are excess equity capital and, obviously, with it being in some of the more volatile outfit we have, that's going to bounce around more than our alternatives portfolio and Retirement Services, then our debt servicing costs and some other expenses run there. So I think it normalizes around zero, and I think in any given quarter, it could be $5 million or $10 million different than that. Obviously, in extreme markets, zero is more volatile, it could be different than that, but I think, kind of a base run rate in Corporate and Others, basically close to zero.

Humphrey Lee -- Dowling & Partners -- Analyst

Got it. Okay. And then question for Bill. So you've talked about some of your outlook for retail, for reinsurance and PRT. You've done a couple of transactions in funding agreement kind of after the hiatus in the third quarter. I think you previously talked about the markets are competitive, that's why you've kind of pulled back from the market. Do you see something change in the fourth quarter? And do you think the overall environment continue to be, I mean the overall environment in 2019 being a little better than when you kind of pull back from the market in 2018?

William J. Wheeler -- President

So I do think the funding agreement-backed note market is getting a little better. But just to be clear that the issuance we've done this year has pretty much been all Federal Home Loan Bank issuance, especially in the latter part of the year. So that's a little different market dynamic and it's not -- you're limited on how much of that business you can actually do. So we, obviously, do what we can because it's very good return business, but it's -- but for us, we have not issued funding agreement-backed notes.

Humphrey Lee -- Dowling & Partners -- Analyst

Okay. All right, got it. Thank you.

James R. Belardi -- Co-Founder, Chairman, Chief Executive Officer and Chief Investment Officer

Yes, Humphrey, this is Jim. I'll just add to that. One impetus that could give rise to more issuance is a rating upgrade. So we'll see about that.

Operator

Our final question comes from the line of Suneet Kamath of Citi.

Suneet Kamath -- Citi -- Analyst

Thanks. Good morning. Just on the Retirement Services alternative return, I think, it was 11% in the quarter, which held up pretty well given the challenging macro backdrop. So can you just give us some color around what worked well there? And, in particular, what the marks were on AmeriHome and MidCap?

Martin P. Klein -- Executive Vice President and Chief Financial Officer

Sure. Our alternatives portfolio, as we've said, is really kind of designed to probably work very differently than other companies' alts portfolio, which it might be in hedge funds or private equity and we really look for more cash flowing businesses and we generally expect them to not necessarily do as well in super rah-rah bull markets, but we expect them to be in more steady state and perform better in downturns and we certainly saw that. I think I mentioned in my remarks about 40% of our portfolio is marked on a real-time basis and about the rest of it, roughly 60% is on a one- or three-month lag. AmeriHome and MidCap though are both on a real-time basis, I think, the return in the quarter for AmeriHome was close to about 12% -- a little over 12% and then for MidCap, it was I recall about 13%, 13.3%. So again, a very solid performance for both those investments.

Suneet Kamath -- Citi -- Analyst

And is there something that we can look at externally sort of on a real-time basis to get a sense of how AmeriHome and MidCap might be marked, just as we track it going forward?

Martin P. Klein -- Executive Vice President and Chief Financial Officer

It's tougher to do that. They are kind of unique businesses. I think that when we look at them on a discounted cash flow valuation methodology and really Apollo does that and we obviously review it. I think, AmeriHome is one market comp out there, Freddie Mac, but I think the characteristics of the AmeriHome business aren't exactly the same as that. And obviously, the mix of mortgage origination versus MSRs that will retain, kind of impact evaluation and without knowing that mix, it's hard to really come up with that evaluation unless you are privy to that. So the Freddie Mac is kind of the one public market comp out there for AmeriHome. Otherwise, there's really nothing outside there. And MidCap is the middle market lenders who is really pretty unique and there's no real market comp out there. So it's just a matter of kind of understanding its business and how it originates and what risk it retains.

Suneet Kamath -- Citi -- Analyst

Okay. Thanks.

Operator

Ladies and gentlemen, that was our final question. I will now turn the floor back over to Noah Gunn for any additional or closing remarks.

Noah Gunn -- Vice President, Head of Investor Relations

Great. Thanks, everyone, for joining this morning. If you have any follow-up questions on anything on the call this morning, feel free to follow up with myself or Paige Hart. Thank you.

Operator

Thank you. This does conclude today's Athene fourth quarter 2018 earnings call and webcast. Please disconnect your lines at this time, and have a wonderful day.

Duration: 61 minutes

Call participants:

Noah Gunn -- Vice President, Head of Investor Relations

James R. Belardi -- Co-Founder, Chairman, Chief Executive Officer and Chief Investment Officer

William J. Wheeler -- President

Martin P. Klein -- Executive Vice President and Chief Financial Officer

John Nadel -- UBS -- Analyst

Erik Bass -- Autonomous Research -- Analyst

Alex Scott -- Goldman Sachs -- Analyst

John Barnidge -- Sandler O'Neill -- Analyst

Tom Gallagher -- Evercore ISI -- Analyst

Andrew Kligerman -- Credit Suisse -- Analyst

Humphrey Lee -- Dowling & Partners -- Analyst

Suneet Kamath -- Citi -- Analyst

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