Next session is with MetLife. It is a real pleasure to introduce Steve Kandarian in what will be his swan song as far as conferences go. Steve has served as MetLife's Chairman, President, and CEO since 2011. Prior to that, from 2005 to 2011, he was the Chief Investment Officer. Over the past several years, Steve has led arguably one of the most significant corporate transformations in the insurance industry. You can include other industries in there, too, including the spinoff of Brighthouse Financial, which really materially changed the risk profile of MetLife. In January, Met announced that Steve would be retiring at the end of April. Steve, thanks for joining us. Congratulations, of course-
Thank you, Jay
on the next chapter. You were here last year, and I kind of felt bad because the first 10 or 12 minutes of the conversation was on sort of a negative issue, which was-
Don't say it.
Well, what I want to do, I'm going to get it out of the way right now.
All right.
The material weakness, your plans to remediate.
Right.
First question, can you confirm officially that you have remediated all of the issues? Maybe more importantly, any takeaways from that process?
Well, thanks, Jay, for inviting me back here, and it's a great conference every year. I enjoy coming here and see the great view. As to our material weaknesses, we have been speaking to investors since they were first disclosed about a year ago about the remediation plans and our efforts in that regard. We've been saying consistently that our intent, and we're on track to lift those material weaknesses with the filing of our Form 10-K later this month, and that's still our view.
Okay.
In terms of learnings, I'll start with the easier of the two material weaknesses. It was the Japanese variable annuity business. It was a modeling error. We have a partner in Japan, a bank that sells variable annuities. We were basically the guarantor behind those variable annuities. That business is no longer ongoing, but it's a runoff. We were getting feeds from them. It turned out the feeds were not correct. We didn't pick it up for a while because of some basis risk in our hedging that relates to the guarantees in those variable annuities. For a while, we just thought it was noise in the derivatives. When it finally started looking like out of the range of what would be normal for basis risk, we identified it, and we escalated it immediately.
It turned out to be, if you will, a good material weakness in the following sense. It was a positive, and we were not releasing reserves as rapidly as we should have. We actually released reserves that had positive earnings impact. That was a modeling issue. There's a partner involved. We've tightened up our policies around reviewing models, including information coming in from the outside. I think that one's in good shape. The tougher of the two was the material weakness related to our missing annuitants in our pension risk transfer business. It related back to pension risk transfers that we had taken on in many decades before. These weren't recent transactions. These dated back, in some cases, to the 1960s and '70s and '80s. Basically, the information we received at that point in time was incomplete for a number of the people in those plans.
That is the information that the plan participants, corporate employer type, gave to us back in the '60s, '70s, and '80s. Bottom line was we should have done a better job trying to find people where we had incomplete information. Some cases, you might have a common name, you might have an address. Address was no longer valid because the person had left the workforce or at least that company years before. We didn't look as hard as we should have for those people. I say that in the context of today's technology. When the system was put in place somewhere around 1990, in terms of looking for people, it may had been a fairly good system for 1990 technology.
It was one of those things where it kind of sat in a certain part of the company, just didn't get enough attention, and when people learned about it, they didn't act fast enough to escalate it to executive management people like myself and the general counsel and the CFO and so on. We declared a material weakness because of that, and we have worked extremely hard to find those people, to pay those people wherever they may be. In some cases, you still can't find them. This is not an issue that relates solely to MetLife. We've talked to corporations, even ones who have not done pension risk transfers. They're thinking about it. They have the same issue trying to find people who left their company decades ago.
Crossing off my list.
Thank you.
When you get a milestone like you're facing now, I guess it's natural to think about your legacy at MetLife and the CEO transition. When you think about MetLife today versus the company in 2011 when you took over as CEO, how do you view the differences?
Sure. I joined MetLife in 2005 as a Chief Investment Officer. My background was investments. When I came to the company, after about a year or so, I was looking over the portfolio and looking at the financial markets. I became concerned about the risk associated with holdings on the securities we were holding on the investment side. By 2007, my concern was heightened. We de-risked that investment portfolio dramatically before the financial crisis. We sold our biggest real estate asset, Peter Cooper Stuytown, for $5.4 billion. People sometimes think of that as a top-of-the-market kind of trade. That really was a de-risking move because that one asset within our real estate equity portfolio was making up close to 50% of our overall portfolio, and that just wasn't good risk management. We also sold down most of our subprime mortgages.
We kept some of the older vintages that we felt were better underwritten. We took a number of other moves, sold about $8 billion of credit we thought would be hit hard by a consumer-type led recession, which we anticipated coming soon. We made that call in October of 2007 and sold most of that by the early part of 2008. That was my background before becoming Chief Executive Officer in 2011. In between, I also oversaw strategy and marketing. I came into my current role with a lens of let's make sure the risks in the company are appropriately measured and accounted for and at the right levels for us. I felt like the investment portfolio came through really well through the crisis. We have one of the lowest loss ratios of any company in our industry proportion to the size of our general account assets.
I was concerned about some of the liabilities we had written, and these weren't just liabilities MetLife wrote. The whole industry was writing these kinds of liabilities. Variable annuities with lots of guarantees on them, lifetime benefits, universal life with lifetime secondary guarantees, long-term care, and so on. Products that all of you are aware of have certain risks associated, especially in a low-interest rate environment. My initial thought was, we're going to be in this low environment for a number of years. My number was something like four years, five years, something of that nature. That proved to be not conservative enough. We came in as a team and said, we have to look at this, figure this out, make sure we have the asset side in good shape pre-crisis.
We have to address the liability side, then we can really move forward as a company. That is what we have been doing for the last several years. We've been de-risking the liability side of the balance sheet. That's a harder thing and a longer-term thing to do than the asset side. The asset side you can de-risk in a day, you can de-risk it over a few years, which we did before the crisis. Liability side, of course, stays on your books for a long time, and it wears off over years. You can't just go back to the person who bought the policy and say, "Let's take the policy back. We'll give you your money back." That isn't an option. We spent a number of years here in terms of redesigning our products.
We stopped selling certain products like VAs and USGs and long-term care. After a number of years, we looked at where we were and we said, okay, that prediction of four years or so, give or take, the economy get back to something more normal. More normal interest rates, not high-interest rates, but just more normal, call it a 4% 10-year treasury. Of course, that didn't happen. We said, okay, it's not enough. What else can we do to de-risk that side of our balance sheet? That's when we finally made the hard decision to sell what was our original business, our U.S. retail business, or basically spin off that business and sell it. Then it became Brighthouse.
The issue there was really we were hearing from investors and others that that part of the business they felt was clouding the story for the rest of the company. By then, we already owned Alico from AIG. We already had a good footprint outside of the U.S. Makes up about 40% of our business today. The view was that is weighing down other parts of the business. If you want more of a pure play on U.S. retail, you should have that separate and then have a different play related to MetLife diversified with the group business, in the U.S. with pension risk transfer business in the U.S., those kinds of more institutional businesses. Broadly across the world, exposure to both group and retail businesses.
We said it's time to give that serious consideration, which we did, and we spun out Brighthouse back in 2017. We sold down our last 19.2% last year. Now investors have really two choices, two different options there in terms of how to invest their monies in terms of different approaches. Basically, we spent a lot of time with the de-risking. We're now at an inflection point. I think much of this really is behind us, and we're now looking at the future very differently in terms of how we now grow again our business. We did other things over this period of time. It wasn't just de-risking. Our systems and our technology have dramatically been upgraded. For years, it wasn't just MetLife. It was really our entire industry didn't view technology as being central to the business model.
It was something necessary to do just to make the trains run on time. Oftentimes people buy a policy from us, they put it in a drawer. There's not a lot of interaction on a regular basis, unlike the banking industry or the mutual fund industry elsewhere in financial services, where there's a lot of interactions on an ongoing basis. I think our industry, and MetLife included, just didn't focus enough on that customer interaction, having technology in place to have a better customer experience and a more efficient operation, frankly. When I was Chief Investment Officer, people used to say to me when I asked these questions at the executive group level, when I asked them why aren't we upgrading our technology? Why do we have all these old systems?
A lot of this stuff got built over many years in different pockets of the company and through acquisitions. We have all these different platforms, very inefficient. The view was when we do the analysis, we just can't make the paybacks work out on paper. The returns just aren't there. I always felt in the back of my mind that that wasn't correct. Just analytically, that was not correct. When I became CEO, I was able to dive down a deeper level and brought in technology talent from the outside, brought in operational talent from the outside and said, "Let's really look at this hard," and not just in a narrow sense, what is the cost for a new system or re-platforming things, but look at it broadly. How many people do we have in finance?
How many people do we have in operations that we wouldn't have to have if we had new systems? Because so much of this was labor-intensive and manually intensive. We did that analysis. The payback periods became much shorter. We made the commitment to spend a lot of money, a lot of time, a lot of effort on upgrading our systems. That not only has made us much more efficient, but has also resulted in a much better customer experience. Our customer experience ratings have gone dramatically up. We've won J.D. Power Awards in several different cases, and the feedback we get from our customers is much better. The other thing I'd say that's changed over this period of time is that we look at new business, we have a different lens. We use a value of new business, embedded value of concept and approach.
It's something that's more common in Europe than it is in the U.S. Our view is that GAAP earnings can be not always the best way to look at an insurance business. You can see a lot of positive GAAP earnings for many years, but then if you give it back because your original assumptions weren't correct, then you really weren't making the money you thought you were making those early years. We saw that in certain products. We said, let's look at a much more cash flow-based approach notwithstanding GAAP. We have to deal with GAAP. We report in the U.S. We're a public company. We have to have GAAP.
We have to look at that, let's look at, as we write new business, a different lens, value of new business, and look at the cash flows and shorten up how many years outstanding before you hit the breakevens in our products. Make ourselves less capital intensive. Look at the tail risks on products, not just the GAAP earnings if everything goes right. That really has changed dramatically how we allocate capital across the entire company. I think finally, I would just say that we've become truly a global company. We've organized that way. That wasn't always the case. We're now able to attract talent from places that we used to not be able to attract talent from, frankly.
We've upped our game in terms of who we can bring into MetLife, I don't know the exact numbers, but roughly half of the officers in this company weren't there in those positions. In 2011, when I became CEO, we brought people in from places like major banks, major corporations like Pepsi, AT&T, others, and we didn't always have access to that level of talent. I'd say those are some of the things that I'm most proud of in terms of what the team has accomplished over the last eight years.
What you describe, obviously the de-risking, but it really is a transformation. I guess you could make the argument that that transformation, all else being equal, should result in a higher multiple. You're not getting it. The question to you, and maybe it's a better question for the audience, but why do you think the market hasn't rewarded Met for these achievements?
When we looked at this years ago, I said to the team, we have to do two things. Soon after becoming CEO, we did a strategy offsite, spent a few days offsite doing this, I said we have to do two things simultaneous, which is not going to be easy. One, we have to drive up our return on equity over time. Two, as importantly, maybe even more importantly, we have to drive down our cost of equity capital. That goes back to the risk side. You can have great returns in the short run, high ROEs, but if you're putting a lot of risky business on your books with big tail risk, your beta, your cost of equity capital is going to go up, and it's a delta between your returns and your cost of capital that you'll get rewarded for.
We believe we've driven down our risk factor, I think it's starting to show up a little bit in the numbers. I think the market's waiting to make sure that there aren't any negative surprises. We had a big reserve charge back in 2016, the variable annuity block. We knew that was coming. I would like to have taken that earlier. We couldn't take it earlier because under the accounting rules, you have to wait for experience to change your original assumptions when you wrote that business back in 2003, 2004, 2005, 2006. Those products had guarantees that kicked in 10 years after owning the product. You had to wait for that to happen and see how people actually use those guarantees and those options. Once we get that data, we saw the number, there's the reserve charge.
I think the market's waiting to see is there more of that, and there's a little bit of a wait and see, I think, on MetLife, given some of the things that we went through in the past. I understand that. I think if we can keep performing as we have over the last year and keep delivering good results and produce those kinds of results for a period of time going forward, that we will be rewarded going forward.
Yeah, that makes sense. When there's a transition of power at the presidential level, the outgoing president writes a letter to the incoming president, leaves it in the desk. You're going to have to give Michelle-
I got to write that down and make sure I do that.
You're going to have to give Michel Khalaf some advice. What will you share with him as far as what he should expect and focus on?
Well, first of all, we've made a lot of progress on this place. Please don't screw it up, okay? Michel is really well positioned to move us forward. I think I did say on our last earnings call, which was a few weeks ago, that I felt like my skill set was the right skill set for the CEO of this company for this period of time where I was leading the company in 2011 to now. That is, I had a real risk strategy kind of background, and I applied that to the issues at hand at MetLife. We now are at an inflection point, and I think we are now at a point where we can start stepping out a little bit and not being so much in the position of fixing things from the past. Rather now, where are the opportunities?
How can we innovate? Let's bring back more entrepreneurial spirit to things. Let's not only meet the plan, let's beat the plan. These are things that Michel is highly qualified to do for us. He has a long background in insurance. He came out of school into the insurance industry. He's worked in many different parts of the world, not just the United States. He is very well positioned to take us forward from here. I'm very pleased with the transition.
Let's look forward a bit. One issue you focused on is expenses.
Yes.
You've made good progress in getting the direct expense ratio down to, I guess, a run rate around 13%. What are you targeting for that ratio in 2019?
The ratio to us is a little bit of an outcome from the save. If you step back a little bit, when we began this process with our, we call it the Unit Cost Initiative, the idea was to drive down our unit costs so that we can compete effectively in the marketplace and sell our products at a competitive price and give a good value to our customers and a good return to our shareholders. That was the concept. The view was, we need to save. As we looked at benchmarking, we had help from outside consultants. We benchmarked ourselves department by department within MetLife. Not surprising to me, one of the worst benchmarkings was the finance area historically, because again, our systems were so bifurcated and so many of them.
That was, again, the technology piece now is driving us to a much better place there and elsewhere in the company. We said, what can we do if we end up being top quartile type of performer in terms of our unit cost? Where should we be? We did numbers on that. We say, where are we now and what's the difference? The difference was about $800 million to get the point we want to get to in terms of overhead. You don't just say, okay, let's just cut $800 million of people or expenses willy-nilly. You got to go through item by item, department by department, system by system, so on and so forth, and figure out how you do this. That has been a couple year process.
We're about two-thirds of the way there now in terms of the save, the dollar save. This $800 million is a net number because when you think about separating out Brighthouse, just like if I were coming to you today and say we're doing an acquisition and we're going to get synergies and part of it's just scale, being bigger. You don't need two people to do the same job and two parts of these different businesses that we put together, you only need one. Those are synergies. Well, unfortunately, that works the other way, too. When you separate something out, sometimes you actually still need a person where it used to be two people, one person doing two things. Now it's one person still there doing the one thing, notwithstanding the separation of Brighthouse.
There's a piece of that overhead that we couldn't really get rid of, we still need. Not all of it. A lot of it we got rid of. That's about $250 million. We have to save essentially $1,050 million to get to the $800 million net, and we are on track to do that. Our promise to the street was by 1/1/2020, we'd have a run rate going forward for that year, 2020 where we'd save $800 million. That translates into a Direct Expense Ratio somewhere in the mid 12% range, somewhere in there. That depends, of course, on your revenues and a little bit of business mix and what gets reported as revenue versus not revenue. I can't really pin down that number as much as I can say $800 million net is what we're delivering.
We have about two-thirds in the bag already, the rest of the third is on the drawing boards with plans to be executed by year-end.
Can you give us an example, I guess, or some detail on some of these projects, including the investments in technology? Everyone invests in technology, it's helpful to hear something concrete you're actually doing.
I'll give you a number of examples. Some are technology, some are other to get to $800 million. Over the years, like a lot of companies, we grew by either new businesses popping up under MetLife umbrella or acquisitions. You had a lot of locations all over the place. You had a lot of different platforms all over the place. We've done a tremendous amount of consolidating over the last several years, and we have picked two places in particular for a lot of the consolidation. One is in North Carolina, Cary, North Carolina in particular. We had actually consolidated a lot in Charlotte as well, more on the Brighthouse side, and in Tampa, Florida.
We are in places where the kind of talent we're looking for is available desirable places for people to come and work and live and have their children educated and so on, and state-of-the-art buildings. We're able to actually attract even higher levels of talent into our company based upon these consolidation moves, which also save money. It's been kind of a win-win across the board. That's one area. Procurement, another area. We had things being purchased from the same vendor in different parts of the company. We've consolidated all of that. Lots of wins there. Just looking at technology and driving a lot of savings through technology. I'll give you a couple examples in our property and casualty personal lines business.
We have a kind of end-to-end quote-to-claim digital platform in the omnichannel for all levels of distribution, and that's being rolled out right now across all 50 states. A number of other examples, we have an initiative that we've announced with IBM to develop a small business platform in our group business. As people know, I think in the room who follow us, MetLife has been the leader in large group insurance. It's a great business for us, a great market. We have been less effective in the small market, which is a different skill set, if you will, for a company to succeed in that marketplace versus the big marketplace, the calling on the B of A's, you have a team of people that come in, they meet other people, small business people, 10 people, 20 people, 30 people kind of firms, you can't do that.
You need a digital platform. You need ways to serve your customers that is a very different approach than the big market. Those are some examples. We've really driven a lot of efficiencies throughout MetLife.
I want to move on to kind of cash and capital management. One of the first lessons I learned when I picked up the life stocks was how important cash is. You give this guidance range of 65%-75% of your earnings that are deployable in cash. The last couple years, it's been really at the low end of that range on average. There's different issues I know that affect that, things like tax reform. What are the reasons you're seeing why your cash generation's been a little bit lower than the range or in the bottom of the range?
Okay. I'd say the cash generation is not below what we anticipated. The ratio is, I'll get into that. When we began this process back in 2012, and frankly from the years before that, all the way back to going public in the year 2000, our average free cash flow ratio of total earnings was around 25%-26%. Essentially, we were running a lot of really capital-intensive businesses, and that really slowed us down in terms of being able to return capital to our shareholders. Our dividends level was quite low for many years. Our share repurchases were pretty modest over those years and so on. Since becoming CEO, we've raised our dividend at a compound rate of something like 12% a year, the last year we bought back $4 billion of shares.
We've driven that up from that 26% ratio when we started back in 2011 to in that range over two years of 65%-75%, which is a major shift for this company. That goes back to things I said earlier about looking at things through that lens of embedded value of new business, cash generation, payback periods, how much capital intensity there is, and so on and so forth. That's how we got there. In terms of this specific two-year period that we just finished, we're at the low end of that range of 65-75. We're at 66 for those two years. It wasn't because cash flow was lower, it was because earnings were bigger. Let me explain. Under tax reform, your bottom line earnings are after tax at a lower tax rate.
Just given how our tax cash flows work, our actual cash payments for taxes didn't change. Free cash flow didn't go up. We didn't save on cash taxes. The cash piece didn't change, but the GAAP number got bigger. That's why we're at the lower end of that range of 66. If you adjust for that one issue, you're actually at 70%, dead in the middle of that 65%-75% range. Substantively, nothing changed in terms of dollars. We reported bigger GAAP earnings based upon the tax rate in that formula.
Got it. That's helpful. At year-end, the holdco cash was $3 billion. It was down in the fourth quarter. Again, the low end of your cash buffer that you talk about. How should we think about the holding company cash in 2019? I might as well throw in the RBC levels as well, if you could talk about that.
We've said for a while, $3 billion-$4 billion of cash is the buffer we feel comfortable with to provide us enough safety in a bad market, so on. We're near that $3 billion level right now. One of the reasons we feel comfortable to be at the low end of the range is because of where we stand on things like our debt schedule in terms of maturities. In the coming year, this year, 2019, we have no debt to be paid outstanding. That wasn't always the case. We had kind of a ladder of how much we pay per year. 2019, zero. The next three years after that, only about $500 million a year. We had actually done some work on our balance sheet.
Part of it was the debt for equity exchange we did under Brighthouse, that last stub of the 19.2% I mentioned that retired some debt. We also extended out some debt at low interest rates, attractive rates here. We're in a place in terms of our normal kind of cash flow needs where we feel comfortable being at that $3 billion level.
Does the holding company cash, again, at the lower end?
Let me just say one other thing. I'd say also, we've de-risked the company, we feel better about kind of the volatility just of the underlying business. In that range of three to four, we feel pretty comfortable between those two things, the debt repayment schedule and the de-risking.
Does this affect the pace of buybacks, where the cash level is? How quickly do you expect to complete the current buyback authorization?
As I mentioned, we bought back about $4 billion last year. We frankly accelerated a little bit in the fourth quarter because the market overall was down, and we were too. We've said many times, we're opportunistic buyers of our stock. We thought that was a good time to buy it. Our stock now is meaningfully ahead of where it was back in the fourth quarter, that's worked out to date. We have $1.3 billion remaining on our authorization that we have outstanding. It's a $2 billion authorization. We've used $700 million. There's $1.3 billion left. We anticipate we'll finish that authorization, the $1.3 billion, before year-end, and we'll be back in the market telling people what we're doing next at that point in time.
I think how to look at it conceptually for MetLife now, there was a little of a catch-up in terms of our ability to buy back large amounts of stock. I mean, last year, $4 billion. Some of that related to Brighthouse and so on, some activities around that. I think going forward, we should think about more in terms of what free cash flow gets generated by the business overall. We're on pace for that kind of approach going forward for the next few years.
I hate to be political, there was this recent proposal for a buyback test. Any views on that?
Sure. You're referring to Senators Schumer and Sanders' op-ed in "The New York Times," I think a week or two ago, about companies should not be permitted to do share repurchases unless they satisfy certain things. Fortunately for us and many large companies, we actually already satisfy the things they listed. $15 minimum wage for anyone in the company, we actually check that box. An adequate pension for people, we actually check that box. We have a 401 with a 4% match, and we have a defined benefit plan, which many companies no longer have, with a 5% crediting rate for all of our employees, not just senior people. Another aspect was sick leave.
Even the most junior person has 22 days of leave and has short-term disability they can use in our system for family emergencies and so on, as well as bereavement leave and so on and so forth. We check that box. Adequate or good healthcare. Everyone in our company has company-subsidized healthcare. For us, even if that proposal were a law, and it won't be, certainly for the next two years. It wouldn't pass Congress, wouldn't be signed by the current president. Even if it were a law at some point down the road, we would be able still to do repurchases given what the requirements would be under that bill. I would say just more conceptually that in addition to making sure you take care of your employees, you have to also make sure you take care of your shareholders.
They have given you monies to invest for themselves and their families going forward, and we feel a strong obligation to provide a fair return to our shareholders and treat our employees well as we are. Let me just add that sometimes people perceive share repurchases as something that directly helps senior executives or people with high net worth. I suppose it would if that helps the stock price. Sure, it would. It also helps a lot of ordinary people who have their pension plans invested through mutual funds or institutional investors that invest in companies like ours and other big companies. There's a lot of people out there who are not high net worth individuals who benefit from our being able to provide a fair dividend and do share repurchases when we have no better need for that capital inside of our company.
I think what the Senators are saying, I'm empathetic to, which is if you're not providing for your employees and you're just giving back money to your shareholders, that's not a fair deal for your employees. I think my response is most of us, certainly in the large company world, are already doing the things that they're asking us to do.
I've got other questions. I'm looking at the clock, we are out of time. It's saying zero up there. We will have to end it here. Steve, thank you very much for joining us today.
Okay. Jay, thank you.
Appreciate it.