All right. We are going to get started. Thank you to MetLife for being with us again this year. Up on stage with me, we have John McCallion, the Chief Financial Officer, and I also want to recognize John Hall, Head of Investor Relations, and other members of the IR team in the front row. To kick it off, on the second quarter call, MetLife's new CEO, Michel Khalaf, stated that the company is in the midst of conducting a strategic review of the businesses. Can you talk a little bit about and provide a little more color on some of the key aspects of the review and some of the key things you're trying to accomplish with it?
Yeah, sure. I think I would probably start with and reiterate the point that Michel made on the call, which was that this is probably more of a evolutionary strategic review versus a revolutionary one. Obviously, we've done a lot over the years under Steve's tenure to kind of right-size the firm. I think we've kind of stuck to some of the key principles around just being very disciplined about capital allocation, generating strong risk-adjusted returns, and growing in a profitable way. I think those principles will be the underlying and underpinnings of our strategic review as we move forward. I think the other thing that we've been doing a lot of now and will become more of a muscle for us is expenses. We think that can be important, not just from an expense save perspective, but to fund growth.
We think it's vital, particularly as you move through kind of how the world is changing, technology and everything around that, and really innovation. Innovation is going to be a key component from a thought perspective there, but you need to fund innovation. I think expense discipline will become a key component of that. Overall, I don't see major changes on how we act or what we do. I think we've been optimizing the portfolio for some time, and I think he referenced maintaining that discipline around the portfolio, and that will continue.
It's somewhat related, but M&A has been fairly limited over the last five or so years for MetLife. I guess how are you evaluating M&A at this point in terms of things like key financial hurdles and business strategy, and how does this tie into the strategic review?
Yeah. M&A's always been an important muscle of ours, we believe. We believe it's a strategic asset of ours. M&A requires discipline. The volume of deals out there hasn't been zero. There's been quite a bit of activity, and we see all of it generally. We may choose not to bid or exercise any type of diligence there. It's been pretty active. We haven't been that very active from the buy side. When we think about M&A, it needs to be a good strategic fit. That's kind of the first thing we think about, and it has to have strong risk-adjusted returns. Those are kind of the bedrock principles how we would think about doing an acquisition, if that doesn't work then it doesn't make sense for us to do that.
Underlying that, the key metrics that are important for us to show that this is a good acquisition to our investors are kind of the, I'll say the top four priorities in terms of metrics. You think earnings per share, you think ROE, book value per share, and free cash flow. They can all have different tensions to each other, but you think about those and being accretive to those metrics as well. I think M&A will be an important aspect for us as well. We've actually done quite a bit of divesting over the last seven years. We've divested over 20 portfolios over that time. We've been pretty active, maybe more on the divesting side. We've been active reviewing the pipeline over those years as well.
We just haven't executed necessarily, and I think that just sticks with our philosophy around capital allocation.
I guess, are there any particular areas that would be of more interest from a strategic standpoint when you think about M&A going forward?
Yeah. I think for us, it would be where we can enhance our strategic and competitive advantages that we have in certain businesses. I think you could think in the U.S., we have a group business that's very strong. We have Mexico, we have some strong businesses in Asia. It would need to fit around kind of areas where we think we have good growth opportunities in the firm. I don't know if I can get any more specific than that.
Just beyond M&A, can you give an update on how you're thinking about the capital management strategy of the company at this point moving forward?
Yeah. I think capital management always starts with first you got to do a good job pricing your new business, right? You have to fund your new business at appropriate risk-adjusted returns. Then your excess capital above that is reviewed for M&A, potentially. Then in excesses, we generally return that to our shareholders, and you've seen us build a track record over the last several years. I think over the last three and a half years, we've returned over $14 billion through this first six months of 2019. I think that's our philosophy and certainly growing our dividend at a rate commensurate with, let's say, growth and earnings. Then the remainder being used for things like share repurchases. That philosophy is important for us.
We think it's part of Our business, the type of business we have, that's a good relationship that we've been, I think, building some credibility around over the last several years.
I think last year you talked about free cash flow being a pretty good proxy at this point for capital management. Is that still the case?
I think it is. Yeah. Now I take the two-year average. We often say the two-year average because it can get lumpy in any one year when you think about dividends from the operating entities. Over the two-year average, we think that 65%-75% of free cash flow is a good proxy for capital in excess of our needs to fund new business. That can be thought about as capital management to be returned to shareholders through dividends and share repurchases.
Shifting to MetLife Holdings, you assumed responsibility for that business earlier this year.
Yes.
Can you talk about if you think there are potential opportunities to accelerate the runoff over time?
Yeah. I don't think a lot has changed. Certainly as the rate environment has changed, it probably puts a little more pressure on just finding that bid-ask spread and whether that ever narrows. It's been a bit wide for some time. I think capital has improved, although again, as rates and the environment has changed, I don't know if that's backing off enough. The supply of capital has increased to some degree. We continue to review. I think the principles remain. Our first job is to serve our policyholders and our customers. Second is how do we continue to build efficiencies from a risk and an expense perspective in that unit. The third is continuing to look at ways to optimize. We continue to look. I think it's important that we do that.
It makes us actually run the business better as we continue to analyze potential opportunities. I don't think there's been a big change or sea shift.
Got it.
With me taking over.
On the cost save program that you currently have, you're several years into it, the 2020 program. Can you give an update on how much has been achieved so far and what's left? Also help us think about seasonality a little bit because I think.
Right.
It did have some seasonal impacts as well.
Sure. We started this program in the 2016 timeframe and said that we would, by 2020, improve profit margins by roughly $800 million of pre-tax. Remember also, that was entered into as a part of our separation exercise because we wanted to use another $250 above that to absorb some of the stranded overhead. We've done that. Through end of year 2018, we're about a little over $600 million of the way there, and we show that through this direct expense ratio. The direct expense ratio at end of year 2015 was 14.3%. By the end of 2018, it was 12.9%, about 130 basis points, or 140 basis points, I should say. That's generated a little over $600 million pre-tax margin. I think we've shown good progress.
For the first six months of 2019, the ratio has looked too good, and market factors have helped that. We've talked about on our two earnings calls that you have to normalize for some of those market factors. We've been running, the first quarter, I think we posted a 12.1% ratio. It's probably 60-70 basis points too good looking underlying that is really what the real rate was. In the second quarter is around 12.3%, and we were about 20 basis points looking too good because of market factors and some of the impact of some of our employee benefits there. You have to normalize for that. Nonetheless, we're on a good path to meeting our 2020, which ultimately becomes about a 200 basis point improvement from 2015 would get you to around $800 million pre-tax margin.
The second half of 2019, in any year, to be quite honest, we typically have higher expenses, with the main seasonality item being Group. That's when a lot of the enrollment activity happens. Once a year, you have your group employee benefits. We spend quite a bit of time on enrollment activity. If you think about the sales process in Group, it's a two-sale process. First it's B2B, sell to the employer, and the second is how do you get the consumer or the employee to participate in the product. That tends to be a little higher in the second half of the year. Yeah, you would expect an uptick in, I'll say, the normalized direct expense ratio.
I guess the company's been talking more about a continuous mindset around expense improvement. Once you achieve the 2020 target, would you envision another cost save program, or is this something that is more of an ongoing effort that would be targeted at improving the expense ratio gradually over time?
Yeah. As I said in the opening around the strategy review, I think we really want to get to an expense DNA efficiency mindset that's built into a continuous improvement mindset throughout the firm so that we don't have these one-offs. My preference is really to fund the continued improvement. We're going to look not to have these one-offs. As you know, we have some one-offs now that's going to get us to this, and that was part of the expense initiative, and we would like that to now be just part of our run rate expenses. Our objective is to meet our target by 2020 and call that, let's say, it's roughly 200 basis points improvement from the 14.3% we talked about. Beyond that, continue to build efficiencies. Some of those efficiencies, I think, need to be used to fund growth.
Okay.
I really believe that the only way to really compete in this industry is to continue to invest. We've seen where challenges emerge when you try to. Some of our products are thin margin, and you try to just compete on price. We believe in some of our businesses that you really have to continue to invest and make that part of your run rate cost.
Everyone's favorite topic, interest rates. Obviously, they're down significantly this year and continued to go down in the quarter. Can you review the sensitivities that you've provided around interest rates? Also just help us think about if there's any nuances around non-parallel shifts in the curve.
Yeah.
Things like derivative impact.
Yeah. We gave some sensitivities as part of the outlook call, and we also put it in the 10-K. We show about a 100 basis point parallel shift in the curve when we do that sensitivity back in the beginning of the year. It shows, I think it was roughly $25 million impact to operating earnings in the, or adjusted earnings in the first year, and then it grows to about $200 million in the second year. That was relative to where we expected rates to be at the end of this year, which was obviously much higher. Through the second quarter, actually rates declined beyond that sensitivity, but we're down a little over 100 basis points from the spot rate at the beginning of the year. That's at the 10-year. LIBOR did not drop as much.
When we think of inversion, that's how we think of the inversion to us, is that LIBOR rate is only dropped maybe 70 basis points or so.
Okay.
Since then, it's gotten a little worse.
Yeah.
I think LIBOR is catching up. It just takes some time for LIBOR to get there. LIBOR can be helpful to us. Obviously, rates down, it has some headwinds as we show those sensitivities. As LIBOR comes down, that provides an offset in a few ways. First, you have receive fixed pay float derivatives that we use to extend duration in some of our longer duration products in ALM exercise. As LIBOR comes down, that gives us a benefit. That's one of the reasons why you see a low amount in the first year, then it accelerate in the second year. Second, our margins on securities lending get better. That's another. There are a couple other places in our portfolio where crediting rates are tied to LIBOR, so that actually can help us. LIBOR can be an offset.
It's not a complete offset to a lower for longer kind of mentality, it certainly can give us some. The steepness of the curve, or I should say the inversion of the curve has provided additional headwinds this year. We've been able to, I think, offset some of them, you're not seeing. I think the sensitivity that we gave at the beginning of the year actually is holding.
Okay
Fairly well. With no management action.
Yeah
It's a little more of a headwind.
Got it. On free cash flow, you talked about a 65%-75% conversion rate for the next two years. I think you've said that holds for a 1.5%-4.5% 10-year. Can you help us think about the sensitivity there in terms of one, I guess if we actually are below a 1.5%, how meaningful is that? If we remain in this low interest rate environment, do you think that 65%-75% still holds longer term, or are there more negative impacts?
Yeah. We said 65%-75% with the 10-year between 1.5%-4.5%. I would say at the 1.5% range, it's at the lower end of our
Okay
free cash flow ratio. Just to put it out there, it's not a cliff after 1.5%, right?
Yeah.
There's just a gradual, I'd say, pressure there. I don't know if there's any nuances to point out. It puts a little pressure on us in the early stages. I don't know if it actually changes the % necessarily because it's a %.
Yeah.
We have to be careful about that. Just think that it probably has some pressure on, let's say, longer term growth.
Okay.
Right? If you think about interest rates, I think there's still growth. It just may be a little more pressure there.
Okay, thanks. Shifting to the business units, I'll start with US Group Benefits. MetLife has had very good underwriting results. A lot of peers in the industry have also seen pretty good underwriting results. Can you talk a little bit about what you're seeing there and how sustainable you think these types of underwriting margins are?
Yeah, we've had some very good results in Group. I think it's a function of one, a lot of the work that we've been doing over the years to develop strong partnerships there with our brokers or employers, the whole ecosystem that we have. Benefit providers, administrators. That doesn't happen overnight. So there's a big credit to, obviously, the economy does help, but our team has done a great job investing in this business for years to get to this position. I think we're reaping the benefits of that in a strong economy. I'd say Group Life is performing as expected, and we saw that last year. If you think about throughout 2018, we had a very strong mortality ratio. In the early part of the year, it kind of came back, but on average, we were right in the middle.
We've had a strong first half, so we tend not to get too excited over there. We try to be balanced because we've had a lot of experience in this business. It tends to revert to the mean there. Nonetheless, I'd say Group Life is performing well and underwriting has been consistent with our expectations. Non-medical health ratio, we actually dropped that ratio last year. We've seen margin improvement over the years, and we've said that that should continue. We reduced the range of ratios there for this year, and we're performing as expected so far. Economy does help disability to some degree there. A big driver of that also is some of our voluntary products. We've had some great success in voluntary through the year.
On the voluntary products, that's been a big initiative to increase the penetration of smaller businesses with voluntary products. Can you talk a little bit about how things are going with that initiative and the progress that you've had?
Yeah. We've had double-digit growth in voluntary now. We've had it this year, we had it last year. It's performing very well. A lot of the comments I made earlier around the investments we're making is around voluntary. We knew that this was where things were headed. It's across all of our markets as we think of markets, you got the national accounts, regional, and small market. The national accounts is how do we build penetration with existing customers. It's a mix in the regional, and I'd say it's new kind of growth in the small market. We have a great product set there. We're spending quite a bit of time with that ecosystem I'm talking about and making sure our technology is in sync with these HR technology providers who are elected to help administer some of these voluntary products.
How do we seamlessly integrate with that? Also, the benefit communications providers, and how do we describe financial wellness and help promote the benefits of these to the employees, which again, helps the employer. Those strong relationships and partnerships, being a strategic advisor to our partners, has really started to pay off, we're seeing some great results there.
On the pension risk transfer side, you won a big case with FedEx last year. How are you thinking about the growth outlook in that business and your appetite to grow that business? To what extent does the lower interest rate environment kind of impact the growth there?
Yeah. We obviously, I think, believe this is a good business longer term. It's competitive right now, though, and it has been for a few years. We've been staying disciplined. We tend to stay in the retired lives space mostly, just given the duration fit there and haven't felt comfortable to move to the deferred lives for our business yet. The pipeline has been strong. People are continuing to talk about it. That certainly is a headwind, I think, to the supply and the growth in that business. I think as we talk about M&A, I think it's a large capital decision-
Yep.
It can be. We use a similar philosophy that we talked about in the beginning of the discussion here. I think discipline's key for now. These are good returning businesses that we've taken on over the years. We like the business, we're going to stay disciplined.
Sticking with retirement on spreads, you've talked about the lower half of 100 to 125 basis points as being achievable this year. Given the drop in rates that we've seen.
Yep.
Do you think that's still realistic?
I think so. Yeah, we think so. We think the lower half is still achievable for this year. As LIBOR, and again, it goes back to, as we see even with these lower rates, what we expect the curve to look like in the outer part of this year, LIBOR will be a friend to us eventually.
Okay.
Where it has been hurting us as it's coming down, remember we had some caps. We actually have some floors that would kick in and help kind of offset and mitigate some of the lower rate pressure there. We think, and I'll reiterate what I said, we've kind of started to hit the bottom of that spread compression, at least in the near term, as LIBOR continues to come down, and I think some of the management actions that the team has taken. We'll still be at the lower half of that range.
Do the derivatives, I guess, how short-term are those derivatives? Can it still have a positive impact as we move further along?
Yeah. That's why I said near. When I say near-term, it's a few years, right? I'm not saying three months. I'm saying 2019, 2020, probably have to look beyond that for how things look.
Okay
after that.
In Asia, you've had a good pickup in growth over the last couple of years. On the call, though, you referenced some headwinds around things like FX annuity sales in Japan, I think being under some pressure. I was hoping you could review the growth dynamics in Asia and Japan and kind of what you're seeing going forward.
Yeah. I think the first thing to point out is we had outsized growth between 2017 and 2018.
Yeah.
Right? We're starting against a very difficult comparison, 2019 to 2018. That was one. Two, just with the drop in U.S. rates, since these are U.S.-denominated products, the market has come down. I think it came down maybe 9% in the quarter. The third thing we've found is we had a first-mover advantage. We've talked about that, and that showed up, I think, in 2018. As a result of some of the positive results that we've had, we've had newcomers come in. Competition has increased even from the domestic players who are getting into U.S. dollar-denominated products. We still think we have a competitive advantage given some of our private origination capabilities in the U.S., but we have to remain disciplined there.
A lot of focus is often on Japan, but outside of Japan, can you just remind us how big the other Asian businesses have gotten and the dynamic there?
Yeah. Japan's 65% of total probably.
Okay.
It's still a major contributor. As we've talked about, and like on our Asia Investor Day, we think that there's a very positive outlook in China. I know there's some pressures with China and stuff, certainly with the trade war and stuff, but we still believe there's a good growth, strong growth trajectory there for us, and we're pretty bullish about that.
On the investment portfolio, can you talk about any changes you've made to prepare for later cycle risks and anything you're doing to the portfolio?
Yeah. We, back in 2018, started to make some adjustments to the portfolio, particularly in the areas of syndicated bank loans and some of the BBB and high-yield assets. We took, I'd say, 18 months to kind of transition some of those assets out and move into different ones, primarily in the private space. Some of the private placements where we believe we have better covenants and protections there. That was quite a 18-month journey. Look, we still are, I think firm view is that the U.S. economy is still strong, although as we've seen, trade friction can put some pressure there, and it has. We're mindful of that.
I think the efforts that we've gone through between 2018 and first half of 2019 have really just been precautionary and being thoughtful about some of the leverage that's built up in some of the BBB space over the years. It's really individual underwriting of each security and taking into account what we believe the outlook could be, but also what's the fundamentals of the individual security that we hold. I think we have a great team out there. They've proven that for years. We underwrite all our own securities. We don't rely on any one rating per se, and it's really a security by security type of underwriting.
Can you give any sense of the new money rates that you've been achieving, I guess, in the investment portfolio relative to the portfolio yield?
Yeah. I don't know if we've updated
Okay
that number since the second quarter. I think we give it out in the second quarter. It depends too, right? In just what flows come in and what type of assets you're buying. I think we gave a number that wasn't too far off from the first quarter, if you remember. Even though rates went down, it was in the 4% range.
Got it. All right. I think we're going to wrap it up. Thank you very much, John, for being here with us today.
Thanks for having me. Great. Thanks, Ryan.