Move on to our next presenter. We got a fireside chat, obviously, with MetLife. It's a great pleasure for me to introduce Michel Khalaf and John McCallion up here. Michel has served as MetLife's President and CEO since May of 2019, so less than a year. He joined MetLife in 2010 as CEO of its Middle East, Africa, South Asian region through the company's acquisition of AIG's Alico. You were at Alico for 20 years?
Yeah, a little over 20 years.
In 2011, Michel joined MetLife's executive group when he was named president of the EMEA region. In 2017, he took on the added responsibility for the company's U.S. business, group benefits, Retirement and Income Solutions, and property casualty. You've seen everything in this company, basically.
More or less.
Glad you're the CEO now. John McCallion has been MetLife CFO since May of 2018. Prior to that, John had many senior leadership roles at MetLife since joining the company in July of 2006, going on a decade next year. No, actually
A little, yeah, decade plus we like to say.
Decade plus. Wow.
Yeah.
Including the CFO of MetLife's investment department.
We always round up and down, too.
He headed investor relations. As many of you know, he was CFO of EMEA and MetLife's treasurer. Within the financial world, you've kind of done it all as well. Both are graduates of Syracuse.
I'd like to say go Orange, but I was a UConn Husky.
Yeah.
growing up, so.
We had a tough night last night too.
Oh, yeah. Yeah. Tough evening, actually. In Bay Hong we trust.
Any Syracuse questions, field it to them, please. Michel, I want to start with you. In your December investor day, you outlined sort of the next horizon of your strategy. Just kind of walk us through that. Remind everyone of the core principles of this strategy. That'd be a great place to start.
Sure. We outlined three sort of pillars, if you like, that will help us accelerate value creation going forward, and those are focus, simplify, and differentiate. Those provide the blueprint as to how we're going to manage the company. For every decision that we make, for every investment that we make, we would ask ourselves, does this help us accelerate value creation? Does it allow us to simplify MetLife and improve the customer experience? Does it help us differentiate to drive our competitive advantage in the marketplace? Let me maybe just expand a little bit about on those three pillars. In terms of focus, we understand that capital is scarce, and we need to be very deliberate, very judicious in how we deploy capital to drive value creation. We believe that cash is the true measure of the economics of the life insurance business.
We've been using a cash lens for a number of years in how we view our business, and that's something that we're committed to continuing going forward. Focus is also about continuing to look at our footprint from a strategic fit perspective. Post the Alico acquisition, we had a presence in 66 markets. We're now down to 44. Last year, we announced the divestiture of our Hong Kong business. We're going to continue to look at our portfolio, but we would also be disciplined when it comes to optimization. Any sort of opportunity, any transaction must make sense from a MetLife perspective in terms of will it help us significantly reduce our risk profile or will it drive value for our shareholders in the long run. Those are the sort of lenses that we would use when we look at further optimization.
In terms of simplify, we're coming to the end of our unit cost initiative. We will exceed our target of a $900 million. Our target was $800 million margin improvement. We will achieve $900 million. Post that, we would like to move away from these serial expense initiatives, those tend to be complex to administer and difficult to explain, into a more of an efficiency mindset where we will maintain the margin that we have achieved through the UCI initiative and continue to drive efficiencies using our positive operating leverage to drive further efficiency to create additional capacity. Over five years, we expect to create over $1 billion of additional capacity to invest in innovation and in growth. On the differentiate front, we're a 150-year-plus company. We've built great relationships over the years. We have a very strong brand. We have scale in many of our businesses.
This is about continuing to leverage those capabilities so we can drive our competitive advantage and continue to win in the marketplace. I think group benefits is a great example of a business where we're a market leader, where we have the ability through the relationships that we have, the trust that we've built with our customers, to bring new capabilities to bear. An example of that are some of the announcement that we made in the fourth quarter of last year around introducing pet insurance, HSA, digital wills. Those are examples of how by bringing new capabilities to bear, we can further drive our competitive advantage.
At that Investor Day, you reiterated a number of financial targets, the 12%-14% guidance for adjusted EPS, 65%-75% free cash flow target. I want to focus on, there was two, I guess, new commitments that you provided. First, you mentioned generating $20 billion of free cash flow over the next five years. Let's start there. Where does that come from, and does this assume some additional acquisitions?
Before I go there, just the 12%-14% was our ROE target.
ROE, sorry.
The answer to your question is no. This does not assume M&A, although we don't rule out the possibility that we would consider M&A transactions. We think that M&A is a strategic capability, strategic asset that we have. Really the $20 billion, I mentioned the sort of cash flows that we look at, and the focus on value creation that we have in the company. We also feel really good about our portfolio of businesses. We think we have a great set of businesses. Some of those businesses are strong cash generators today. Think about MetLife Holdings. Think about Japan Retirement and Income Solutions as examples of that. We also have a number of businesses where we have market leading positions that are strong cash generators today and will continue to be going forward. Think about group benefits, LATAM, for example, Mexico and Chile.
We have a nice set of also businesses that are generating cash today, but that we expect will generate cash going forward as well. Those are some of the sort of long-term growth markets. Think about China, Brazil, Turkey as examples of that sort of grouping. We think that those businesses will allow us to continue to generate strong free cash flow going forward. I think we've had a good track record so far, even if you look at 2019, where I think we had strong free cash flow generation. We think that the power of those businesses are going to enable us to continue to deliver strong cash going forward, and hence the $20 billion target over the five-year period.
The ability to do life insurance. The one lesson I've learned is cash is almost the only thing people care about at the end of the day.
Sure.
$20 billion, obviously, a significant number. I guess the other thing you talked about was the billion dollars of capacity, which you just addressed. Let's talk about 2019. You got on the call, you said we had a great year. I guess let's take a step back and just reflect on the year and kind of what you were proud of when you were there at the end of the year on the conference call.
Yeah, I think we were very pleased with our performance in 2019, coming off a strong 2018 as well. 2019, I think was a year where most, if not all of our business segments performed very strongly. At a high level, we delivered $5.7 billion in net income and $5.8 billion in adjusted earnings. One of the things that we had talked about is our drive to better align adjusted earnings to net income. I think we achieved that in 2019. EPS grew by 13%, 10% excluding notables. That was a strong performance as well, driven primarily by volume growth, capital management, which has offset some of the pressure that we saw in terms of investment spreads. In terms of business segments, group benefits had a very strong year, $1.3 billion in adjusted earnings.
If we look back three years ago, our earnings in that business have doubled, which is a testament to the growth that we've seen and to our market-leading franchise and group benefits. We also saw a strong performance in our RIS segment. We had $4.3 billion in PRT business in 2019. That was our second-best year ever. We continue to see a good pipeline when it comes to pension risk transfer deals. We expect to continue to win our fair share. We're also pleased that our investment spreads came in within the range that we had specified, the 100 to 125 basis points. We came in at 106 for the year. Our international segments also performed. Asia and LATAM both had double-digit growth, excluding notables and on a constant currency basis. Those were strong performances.
We had $1.2 billion in variable investment income, which again speaks to our capabilities when it comes to private asset origination, which helped us obviously achieve this result. This allowed us to deliver an ROE of 13%, which is a 20 basis point improvement compared to 2018. Our direct expense ratio improved from 12.9%-12.6% in 2019, a 30 basis point improvement. Book value per share increased by 10% in 2019. Again, a strong result. If you think about our capital management, we returned $4 billion in common dividends and share repurchases for shareholders. At the same time, we reinvested $3.6 billion in our business. Again achieving returns that are well above our minimum hurdle rates.
I think if we look at the year in its totality, we feel really good about 2019, it gives us a strong platform for 2020 and beyond as well.
Yeah, no, that's great. Just a couple questions on the fourth quarter. Maybe this is for John. I'm not a tax specialist.
You and me both.
When I see big tax items, my mind gets a little blurry.
Yeah.
If you could just talk about the sizable tax items you had in the quarter and explain it to us, or at least to me.
Yep
as if I'm sort of an idiot, which I am when it comes to taxes.
All right, I'll do my best. We did have some large, significant tax benefits come through. We identified the ones that were very large as notables. We had about $475 million of that. It was basically two different items. The first one, which was, I think, $317, it relates to tax reform in a way, and not in a way, it actually does. What happened was there was tax reform requirements have evolved and have continued to evolve post the date of reform. Our dividend that we paid offshore to onshore in 2017, which we accrued for appropriately under old rules, was getting sucked up in new rules, so we were getting double taxed. We knew that the intent was not to catch us. There was an intent to catch people that tried to accelerate just before the date of implementation.
That was not our fact pattern. Nonetheless, the letter of the law forced us to have to put up these reserves. We kind of knew ahead of time that more likely than not, we were going to be able to get an agreement with the IRS to release and just be taxed once on those dividends. We did that, and that was successful in the fourth quarter.
Was that a tough task? How hard was it?
Honestly, it was constructive, actually. I think once we gave them our fact pattern, I think they also recognized that's not what our intent was. Nonetheless, there were some technical details that we had to get through with them. I would say it was constructive, actually. Very. They were looking to get through with us first so that they could move on to other more important negotiations, I'll say.
That was the biggest item in the quarter. The second item was kind of the closure of an event that has happened over a number of years. We had put up a relatively significant reserve in 2015 relating to some foreign tax credits on some foreign investments that we have that serve the U.S. general account. Again, we put it up in totality, kind of 100% provision, just because of where the environment was headed, with the idea that we would get to a more reasonable number. We did that. Over a multi-year period, we have been negotiating. It's about a nine-year period of reviews that have been going on since 2000. This was the third tranche that we ultimately negotiated to the, I'd say, the appropriate settlement. Again, we had a net release come through in the fourth quarter.
There's no other issues out there that should go into 2020, either positive or negative.
Yeah
That you can see?
Yeah. These items are now closed.
Okay.
Particularly that last one is a closed item, and the first one with regards to those issues. I'd say the other thing I would just add, we did have above and beyond that $475, we did have some other positive items come through. There was a revision of the GILTI tax in the early part of December. We had baked that into our 20%-22% effective tax rate outlook. It did have a positive impact in the fourth quarter. We had some return to provision refinements at the end. Tax rates, tax was a pretty large positive in the quarter. Excluding those other items, which is about $65 million, you get to a run rate of something like 18.5%.
Okay. On the expense side, Michel, you rightly pointed out you brought the expense ratio down. You've been doing this over many years, but the fourth quarter expenses were elevated. You had mentioned seasonality, some one-time factors. Can you just get into this in a little bit more detail to make us comfortable that the trajectory is still on track?
Yes. We referenced that seasonality is really tied mostly to the group business. We tend to spend money for enrollment periods. That premium comes in the following year. There's just a disconnect between when the expenses come through and when the new premium comes through. We tend to see that get elevated in the third and fourth quarter. In the third quarter this year, we actually pointed out that those expenses actually probably didn't get incurred in the third, and it ultimately all got pushed to the fourth. We knew that there would be elevated expenses. Seasonality is typical. On top of that, we had another 50 or 60 basis points, we'd say, on top of that direct expense ratio expectation that we had for a variety of items. I'd say in two broad buckets. One was we had some elevated employee benefit costs.
Now, if you listen or you go back to the transcripts of the first three quarters, you'll notice that we talk about market impacts of on employee benefit costs having the opposite impact. On a full year basis, they've effectively neutralized themselves. We also had some corporate initiatives that were incurred in the fourth quarter, that I'd say that were opportunistic for us. Not necessarily planned at the time, but as we work through, when you think about the discussion Michel had earlier around our next horizon strategy and some of the thinking around focus, simplify, and differentiate, it was just an opportunity for us to spend that money in the fourth quarter. I go back ultimately to full year ratio, right?
Right.
We've talked a lot about there will be volatility in our quarters. We think focusing on a full year is appropriate because you'll have these fluctuations from one quarter to the next. As Michel mentioned earlier, we're down 30 basis points. That trend continues, and we feel very confident about the trend heading into 2020 and to meet our objective of 12.3.
People like me agonize over basis points per quarter.
Yeah.
It just doesn't work that way as you.
That's right.
As you point out.
It's a big, diverse firm.
Yeah. No doubt. Let's talk about the P&C business, which did have a challenging quarter. The results seem to be a little different than what we've heard from others. Can you talk about there was some adverse underwriting results in the auto side specifically. Talk about that and also how do you get comfort that we're not going to see the same thing as we enter 2020?
You want me to jump?
Yeah. Let me maybe just say to open that we like P&C. It's a nice niche business for us. It's a nice complement also to our group business. We're the biggest distributor of auto and home in the group space. It's also a nice diversifier in terms of if you think about macroeconomic trends and correlation to those trends. It's a nice diversifier from that perspective. It delivers good cash for us in terms of dividends and has a mid-teens ROE. It's a business where we have the ability to reprice fairly quickly to adjust to certain trends that we see in the marketplace as well. I'll let John maybe talk more about what we've seen and what we're doing about it as well.
Yeah. We started to see this trend I'd say during the summer into the third quarter, where the severity around bodily injury was increasing. I think others are seeing that as well throughout.
Yeah.
We were seeing that begin in the third quarter. We put up reserves for current accident year in that quarter. Fourth quarter comes along, we see kind of an increasingly deteriorating trend come through. In the fourth quarter, we actually added to those current accident years and took prior development. We had a combined overall ratio for the entire book, home and auto, of above 100%, 101.6, I think, and we had about six points related to that on prior development. We are focused on it. I think there's pricing actions that we're instituting right away. We've actually already had some success in the first quarter. We're looking at other operational reviews around claims practices and underwriting to make sure that there's nothing there that's causing some leakage. We believe we're on top of it.
As Ramy said in the fourth quarter call, our view is that if you take current levels as today's loss pick going forward and pricing actions in 2020 that we have planned, that we'll be within our ranges that we provided at Investor Day.
Got it. Let's talk about the benefits business where obviously this has been a fantastic business, outperformed others, been a great generator of earnings. The question always comes that I get is the sustainability, because you're not alone. Others have had good results in this business.
Yes.
You have added size and scale relative to others, though. Can you talk about that issue of sustainability? If someone asks you, are these sustainable? How do you answer that question?
Okay. First of all, there's no question that a healthy economy near full or near full employment wage growth are tailwinds, right? Those are helpful to that business, no question about it. However, when we look at sustainability, we look at it in terms of three major areas, I would say. The first is the quality of our top line. Here, we feel really good about the discipline that we've consistently had in how we price this business, and how we renew the business, and our ability to get renewal actions when we deem those to be necessary. Very strong persistency in that business as well. I think that's important, and we don't compete strictly on price. There are other elements, other attributes that we bring to the table that help us retain and win business.
That's one area, and we feel confident in our ability to continue to do that. I think the other area is scale related, and it has to do with our ability to grow revenues faster than expenses. This is a business, and I think you see through some of the consolidation that's taking place in the industry that requires continuous investment because customer expectations are rising. The bar keeps getting higher. The ecosystem is also evolving and changing, and that requires investment on our part in technology and new capabilities and the like, investments that we've been making for a number of years and that we plan to continue to make. Again, from that perspective, we think that sort of advantage that we have in terms of continuing to drive scale while growing expenses at a lower clip is something that we can sustain.
Those are two important components. The third one, obviously, is underwriting. We've always said, and I'll repeat here, that when you think about underwriting and benefit ratios, you have to consider that those are going to fluctuate. They're going to fluctuate quarter to quarter, and that's why we always guide to the midpoint of the ranges that we provide. I'll give you an example. In the fourth quarter of 2019, we saw favorable underwriting when it came to life mortality, for example. Whereas in 2018, due to higher severity, we were towards the higher end of our range for that quarter. We're going to continue to see fluctuation when it comes to underwriting.
If we have a really good year, we're still going to guide to the midpoint of the ranges that we provide because we believe that it's possible, maybe even likely that the experience will revert towards the midpoint.
I would just add just to the point of ranges, recall in non-medical health range, we did adjust that downward as we did see product mix shift occurring in there. As Michel said, we think about those ranges and think about what the right outlook is, there's a reason why we ultimately guide back to the middle as we've kind of gone through and thought about our book and what we see in the future.
I would also add, one of the reasons that we adjusted the range was the fact that we continue to grow our voluntary business.
Yeah.
That's a business that tends to have a lower benefit ratio. We're continuing to see tremendous momentum when it comes to growth in our voluntary business. Again, I think that's the sort of a positive indicator in terms of sustainability in that business.
It also seems like this market is fairly rational.
Competitive, but you don't have a lot of irrational players out there. Again, speaking to.
Yeah
sustainability aspect of it. I guess in this business, you probably have a pretty good view into 2020 given the early year and the renewal season. Can you talk about kind of what you saw during that renewal season?
Yeah, I think sort of we're pleased with our sort of sales and renewals, I would say, consistent with expectations. In this business, jumbo cases influence sales in any given year. That's down to the number of cases. We define jumbo as cases over $20 million in premium. We're seeing less activity on the jumbo side this year. Given sort of our overall sales and our renewal actions, we feel confident in the range that we provided during the outlook that PFOs are going to grow between 4% and 6% in 2020.
Got it. I want to shift to interest rates. Obviously, rates have come down over the past six months.
They're up today.
Whoo.
Not that we're watching.
Back above 160, I think.
Yeah. Exactly.
It's pretty pathetic that we're cheering for that, obviously, this is a big issue for investors. I'd like to get a sense of how it impacts your statutory capital, your free cash flow. Can you give us an update on your N.Y. cash flow testing, John? That might be helpful.
Yeah. We're still working through, I'd say, the overall RBC capital and finalizing that, and that will come out at the end of the month. I can say that on cash flow testing, the work's been done. In our book of business, there's no reserve increase for year-end 2019. Actually, rates were higher at year-end. Actually, we do our testing as of September 30th, roll it forward. Even at those rates, which are very consistent with where we are today, we still had healthy margins. Look, I think a lot of that comes down to we're focused on that. We've been working through this for some time. Even the go back to the expense program that we have, that's also powerful when you think about cash flow testing, right?
The present value of expense reduction on your reserves is helpful when it comes to cash flow testing. We've been focused on it around ALM expense management. As a result of all of those actions, we still have pretty healthy margins from a cash flow testing perspective.
Got it. I guess we'll stick with the issue of capital and talk about buybacks. We think about the pace of buybacks in 2020. How should we be thinking about this?
I would go back to sort of our philosophy or approach, which is that excess capital belongs to shareholders, absent M&A opportunities that are a strategic fit and that are accretive. I think we've built a consistent track record when it comes to that. If you think about 2019, we returned $4 billion in common dividends and share repurchases. Share repurchases in particular, the fourth quarter was probably light in terms of we repurchased $250 million. We had indicated on our third-quarter call that we had opportunistically pulled forward some of the repurchase activity in Q3. For the year, we returned $2.3 billion in share repurchases. That's our philosophy, that's our approach, and we're sticking to it.
I guess just for me, last question. Arguably, your most important job is allocating capital, and so what goes through your priorities when you think about capital allocation?
Yeah, it's really the fact that we understand that capital is a scarce resource, and we have to be very disciplined, very judicious in how we deploy it, whether it's to support new business. If we look at how we're deploying capital in support of new business, we're doing it at returns that are well above our minimum hurdle rates. We're doing it with paybacks that are around seven years, so we feel good about that as well. Also disciplined in terms of how we deploy capital in force, continue to look for portfolio optimization opportunities that make sense for us. Then excess capital, again, we think that M&A is a strategic capability that we have, but we're very disciplined also in how we consider M&A opportunities. I go back to a strategic fit, accretive.
Does it help us grow in a market or a business that we like? What are some of the synergy aspects of it? We also compare that to other uses of capital to determine if that's the best use or not. Excess capital obviously belongs to shareholders. That's really how we look at capital. We look at it in terms of how do we maximize value creation for the firm and for our shareholders.
You make it sound kind of easy, it clearly isn't. We're running right up against the end of the session. Why don't we end it here? Guys, thank you very much. Great session.
Thank you, Jay.
Thank you.
Thank you. Thanks, Jay.