Jackson Financial Stock: Excellent Capital Position Can Support More Upside (NYSE:JXN)

Shares of Jackson National (NYSE:JXN) have been a tremendous performer over the past year, rising 70%. Elevated rates and rising equities continue to support results, and its capital position is now stellar. Since reiterating Jackson as a “strong buy” in December, shares have rallied a further 24%, bringing their return to nearly 60% since my initial piece in September. Shares now are within 10% of my $67 price target, and with additional financial results in hand, now is an opportune time to revisit the stock. I would stay long shares and am raising my price target given results.

In the company’s fourth quarter, Jackson had $2.53 in operating earnings, down from $3.39 a year ago. Its private equity investments underperformed by $28 million ($0.37/share) with its annual reserve adjustment an unfavorable $60 million ($0.79). For the full year, JXN earned $12.84 despite $1.65 in private equity and reserve headwinds. I would note that private equity returns often lag public market returns by 1-2 quarters; so given the late Q4 and Q1 rally in the S&P 500, I would expect to see private equity returns improve. GAAP earnings were hit by a $990 million net hedging unrealized loss. As a reminder, in Q3, JXN earned over $2 billion, so this represented an expected “give-back.” Over time, hedging costs will be minimal, but there can be timing issues within a quarter.

In Q4, we continued to see the trend of Jackson boosting sales of its lower-risk products as it slowly but steadily diversifies away from its legacy variable annuity exposures. Pre-tax earnings were essentially flat at $326 million at its core retail annuity business. Given the elevated rate environment, annuity sales continue to run strong at $3.3 billion, from $3.2 billion a year ago. Importantly, the mix shift is also improving. For instance, 53% of annuities lack a lifetime guarantee from 48% last quarter and 43% last year. This reduces the complexity and capital intensity of its new business.

Additionally, its RILA index annuity sales grew by 80% from last year with a $4 billion annualized run-rate. Total sales in 2023 were $3 billion. RILA account values are up to $5.2 billion, triple last year’s level. This is still a very small piece of Jackson’s business, but with fixed index annuities far easier to hedge, Jackson’s business is gradually becoming less risky. Overall, flows outside of variable annuities were quite strong. With rates still high in Q1, I expect this trend to continue.

Even with less of a sales focus, variable annuity account values rose to $228 billion from $206 billion a year ago. This was primarily due to the rise in the stock market, lifting account values. This higher AUM base will drive increased asset management fees in 2024, aided further by the ongoing increase in the stock market.

Elsewhere, institutional accounts continued to modestly decline; at $8.4 billion from $9 billion a year ago. Payouts of $2 billion exceeded $1.1 billion in sales. Earnings rose to $22 million from $17 million, given solid investment results.

The one area of weakness comes from its closed block, legacy VA business. As I’ve covered in the past, many variable annuities written prior to 2009 had very favorable terms and significant complexity. While Jackson stopped writing such policies, annuities can last 30+ years, meaning it takes a very long time for the unit to wind down. Due in part to market movements, reserves rose by $300 million sequentially. Additionally, the unit swung to a loss of $88 million given actuarial assumption revisions.

Based on actual results in its annual review, JXN needed to set aside a bit to cover this exposure. One reason why I believe shares trade (and likely always will) below book value is the risk that reserve adjustments will continue to be made. Indeed, adjusted book value ended the year at $136. We continue to see progress winding down this unit, but it will be a prolonged process.

Give strong full year earnings, in 2023, Jackson repurchased $255 million in stock and paid $209 million in dividends, returning $464 million to shareholders, in-line with its $450-550 million target. Its share count is down 7% and it raised its dividend by 13% to $0.70, giving shares a 4.5% yield.

One potential risk to highlight is that while JXN has a conservative $41 billion investment portfolio that is 100% investment grade, it does have commercial real estate exposure. Within commercial real estate, the 7.1 billion in assets have just a 51.8% loan-to-value with 2.2x debt service coverage. Impressively, there were no delinquencies as of year-end. Its office exposure is just $700 million with a 66.5% LTV. A sharper downturn could spark losses, but given the asset coverage and relatively small office exposure, I view this as a manageable risk.

The major positive I see for JXN in 2024, beyond my prior expectations, is how strong its capital position is. Risk-based capital (RBC) soared to 624% at year-end, well above its 425-500% target. JXN has $5.2 billion in statutory capital from $4.5 billion in Q3. The rising equity market is assisting its risk-based calculations, which should be a further tailwind in Q1. Now, in January, Jackson created a captive reinsurer, Brooke, which reduced Jackson’s RBC to 543%, which is the other major piece of news.

Statutory accounting for cash surrender values made JXN account for the possibility of 100% of plans immediately seeking cash, a non-economic outcome, which increased volatility of capital calculations and hedging requirements. This becomes more punitive as fewer plans have an economic incentive seek to take a cash surrender option, reducing the true statutory need, which gets overridden by the minimum floor.

By shifting this non-economic risk into a captive reinsurer, JXN should simplify its capital and hedging needs. This should also reduce quarterly GAAP earnings volatility. Jackson Life is sending $749 million of capital to Brooke Life Insurance Company and ceding $1.17 billion of commissions. This does not impact the holding company’s liquidity. Jackson’s separately managed VA business becomes a pure-play fee business by charging fees on AUM. By sending capital to Brooke, Jackson Life’s own capital falls to 543%, but the total company has unchanged financial resources.

Because earnings will be less volatile, Jackson Life will now aim to send dividends to Jackson Financial quarterly rather than annually. The holding company uses this cash to manage corporate expenses, pay shareholder dividends, and do share buybacks. The holding company also has $600 million in cash and equivalents, providing over two years of liquidity.

I targeted a $550 million capital return pace in December, which at a 10% yield, valued shares at $67. However, management is now targeting $550-$650 million in capital returns while maintaining a 425%+ risk-based capital position. This is underpinned by the operating company’s $1 billion in capital generation, which is about $700 million after holding company expenses and interest payments on debt.

With calm market conditions, I expect JXN to maintain significant capital beyond it 425% minimum; though I believe management is likely to maintain some buffer in case there is a downturn rather than return substantially more capital than targeted. However, given this, I expect capital returns to be the in the upper-end of its target or $600-$650 million. At $625 million, shares have a 12.5% capital return yield, and the share count can fall a further 7% via buybacks.

I continue to believe a 10% capital return yield is the appropriate target given perceived risk around its VA exposure. Still, that points to shares reaching ~$75-80 over the next year, for nearly 30% upside potential. As such, I continue to view Jackson as a compelling buy. It continues to de-risk its business, taking aggressive action to accelerate that via a captive reinsurer. While shares will likely exhibit a high beta to the market, JXN’s business mix continue to improve, and capital is strong. I would still buy JXN even after this run.