All right. We are going to get started. It's great to have MetLife back with us again this year. Up on stage with me is John McCallion. John was named CFO in May of this year. He was previously the treasurer from 2016 to 2018 and was the CFO of the EMEA region from 2012 to 2016, and in investor relations for a year or two before that. I also want to acknowledge John Hall and Charlie Douglas from IR in the front row. We will kick it off. I wanted to start with the cost save program. Can you review how much of the cost saves have been achieved so far, the additional savings that you're targeted from here, and also any timing considerations we should be aware of as you go through this process?
Yeah, sure. Good morning, everyone. Good to see all of you again. This unit cost improvement initiative that we have underway started back in 2016. Gross saves target was about $1.05 billion, and then when you adjust or net out the stranded overhead that we had as a result of the Brighthouse Financial spin, our net commitment is $800 million of expense margin improvement. We're looking to do that by 2020. In the first quarter of this year, we instituted a new metric. It's the direct expense ratio. We think this is a good reflection of our fixed cost relative to our revenue base ex pension risk transfers. We normalize for those. We think to get to the $800 million of net margin improvement, you should see about a 200 basis point improvement in that expense ratio.
The baseline year was 2015, which was a 14.3% direct expense ratio, we're targeting about 200 basis point improvement from there. Through end of 2017, we've gotten to 13.3%, so I'd say we're about halfway to where we need to get to. While we think the annual expense ratio is the best way to look at this, right, because the quarters can be fairly volatile, the first half of 2018, we've seen that ratio get to 13%. We are trending well. We would expect the second half of 2018 to trend up a little bit. There's some seasonality in expenses that we typically see, particularly in our group business, and oftentimes when we've had strong growth, which we've had, we'll see an uptick in that second half of the year.
On an annual basis, we do think we will be able to come in under where we were end of 2017. I'd just point out, we've mentioned too, that this is despite maybe some slightly higher expenses. Obviously, we're remediating some material weaknesses that's costing us some money. The acquisition of Logan Circle, which has a higher expense ratio, we've been able to absorb that today. I think it's a good trend. I feel comfortable with the progress we're making and feel comfortable with hitting our 2020 target.
Great. Can you go into a little bit more detail on some of the actual initiatives that you're working on to achieve the cost saves?
Yeah. I think it's important to realize this is not just your cost initiative, right? For us, this is really a transformational initiative. Granted, we are looking for $800 million of margin improvement out of this come 2020. I really see this as an opportunity to fund growth. We are looking to save money, to spend money, to fund growth in the platform that we now have. I think there's three ways we're thinking about it. One is, I'll call it kind of operating model efficiency and effectiveness. I'd say there's two things with that. One is you just look at your internal processes and streamline them and look to remove the waste. I think the second way is to look at outsourcing opportunities where you can immediately get scale.
I'd say the second broad category would be technology. I think, again, getting to the growth aspect of this investment. I really see that digital's important. We're not the only ones focused on that. Really focusing on that end-to-end process, distribution, servicing, as well as use of that technology in just your internal reporting processes. Then I think third is just kind of best in class on procurement and that vendor management and other discretionary spend. I think those are the three broad categories of initiatives that we have.
Great. Moving to free cash flow generation. Post tax reform as well as the group annuity charge, you had guided to the lower end of 65%-75% free cash flow conversion. Is lower end still likely at this point? As you move beyond that time frame, is there an opportunity to kind of move it back up within that range?
We tend to focus on the two-year average, as we've said, and it can be lumpy from any one year. We just think a two-year average is probably a better reflection of our kind of free cash flow trend. I think we'd stick with the low end of the range today because we think there'll be a little bit of pressure in 2018 and maybe offset in 2019 because of the timing of tax reform. Tax reform had an immediate benefit to GAAP earnings.
Yep.
It has a little bit of a delay benefit to us as a firm, given our tax position in terms of cash taxes. That's why we focused on the low end of the range. I think as we get more visibility into 2019, we could think about we would update that guidance, but I think sticking with the low end of the range at this point is still appropriate.
Got it. Then on capital deployment, you had guided to about $5 billion of total capital deployment in 2018 between buybacks and dividends. As we move beyond this year, is free cash flow the best proxy to think about your capital deployment capacity, or do you anticipate still having some level of excess capital beyond 2018 that you could draw down?
Yeah, I think at this juncture, that's a good proxy. I would say the average of the two years.
Yeah
is probably a way to think about it as opposed to any one year, is a good way to think about our capital deployment between dividends and stock buybacks. Obviously, M&A is obviously an opportunity, and there is other capital deployment opportunities. I think at this juncture, that's a good framework. It can vary from any one year, and obviously given that we have about $5 billion of deployment occurring this year as a function of just increased cash flow as a result of the Brighthouse spin-off. It could vary, but I think as a good proxy for modeling and thinking about our cash flow and capital deployment, those two match up well.
Got it. On the material accounting weakness, can you give us an update on your efforts to remediate that and thoughts around timing?
Sure. When they both were identified in the first quarter, we immediately started to create some improvements in the control environment and the processes. At the same time, part of this process, you have to find the root cause-
Yeah
to really make sure that you have the right fixes in place. We did that in a bit of a parallel state. We immediately fixed some things that just seemed obvious. At the same time, we went through an independent root cause on both of those, and the good thing is those are completed come the end of the second quarter, and they have confirmed our initial beliefs. There was not a lot of refinements that we needed to make. We made a few, but I would say we are now in this observation stage of the remediation. You fix the controls, you identify the root cause, and you enhance those procedures, and now you need a consecutive periods of observation to ensure that that control is effective.
We're in that stage, and some controls are much easier to observe and say that they're effective, and the frequency of those controls could be daily, as opposed to some others that could be quarterly. We're working through that. I think we're making good progress. I'd say relative to what our expectations and throughout the number of times that we've commented on that, they are on track. We continue to be optimistic about clearing these by end of year.
Can you just remind us, I believe you had disclosed the additional cost associated with this, and once you get them remediated, will that all drop off?
Yeah. I would say it's roughly $0.03, $0.04 for the year.
Okay.
Yeah.
Got it. Had to ask one on long-term care. Can't get through something without that. Can you review, I guess, some of Met's key assumptions at this point.
Yeah
just discuss your overall level of comfort with the LTC reserves?
Sure. Yeah, I think it's fair, just appropriate to say that we're in the midst of our annual assumption review, right? I wouldn't want to front-run that. We'll be able to give more updates on that come the third quarter earnings call. In terms of our metrics and our statistics, I'd say there's a couple things. First, just around the risk profile, right? We stopped selling this business in 2010. Only approximately 15% of that business has lifetime benefits. A high percentage of the in-forces group policies, so they tend to be a little less generous, smaller face amounts and things like that. The risk profile of this business I think is relatively good on a relative scale. That's one. Two, management actions is key in this business, and we've taken quite a bit of that in terms of rate actions.
Last year, we were able to get over 20% rate increases on a third of the business, and we're halfway through, I'd say, the actuarially justified rate increases for the block. In terms of reserves, our stat reserves are $14.5 billion and 20% above our GAAP reserves. We do not assume any rate increases, and we assume no morbidity improvement in those statutory reserves. On the GAAP reserves, they're $11.9 billion, and we've talked about our loss recognition testing. We have a cushion or margin in loss recognition testing. We said it's over 10% of our GAAP reserves.
I tried to frame this a little bit on the last earnings call because there's quite a bit of discussion around some firms removing morbidity and that, and I try to help frame it by saying, if we were to remove morbidity, it would be absorbed in our loss recognition cushion. I think those are the statistics we have. I think we've tested our assumptions rigorously on an annual basis. We're going to continue to do that in this quarter, and I think we'll give a more wholesome update on the third quarter.
Thanks. I guess on the second quarter call, Steven Kandarian seemed to emphasize growth more maybe than in the past. To what extent is growth a major focus of the company now that you've kind of got through some of the balance sheet de-risking initiatives over the last few years?
Yeah, I think that's the right way to frame it in the sense that over the last several years since Steve has gotten into the chairman and CEO position, there has been quite a bit of management attention on, let's say, right-sizing the ship, shifting our product mix to less capital-intensive products, focusing quite a lot more attention on free cash flow, and you've seen quite a bit of an increase in our free cash flow ratio over the years. Let's not forget SIFI.
Yeah.
There has been a lot of attention on things to kind of get the business in the right place for growth. That's not to say we ignored growth. I think we've actually had some great improvement in growth over the years, and we've seen that benefit come through in some of the disclosures we've shown, like in our value of new business, the return on that has improved annually. Our payback period has lessened on that new business. There's been good improvement on that mix of sales. I think the observation's probably fair. I think we now believe we have the platform that we think is the right platform going forward.
A lot of those value actions that we've taken over the years have been completed, I think you're starting to see the benefits of those come through of late, and we saw some very positive sales numbers over the last two quarters.
Can you talk a little bit about MetLife overall, where do you see the best growth opportunities?
Yeah. We have gone through as part of our evaluation of our businesses over the last several years, we did bucket businesses into different groups, we have a growth bucket. That includes right now our group benefits, P&C, Mexico, Chile Life, MetLife Investment Management, and Gulf. Right. I'd say those are generally what we believe to be the growth-oriented markets. It's a strong economic environment, a place where we typically have an advantage relative to our competitors, we believe, in terms of the market that we play in. Just focusing on a couple of those, let's focus on group. Group, we are obviously the market leader in the U.S., that has been developed over the years. It's a function of, I think, the investments that we've made in the servicing, obviously our ability to leverage scale.
Let's break that down into a little further detail. One is you look at national accounts. We have over 25% share, these are the employers with more than 5,000 employees. We have over 25% share in that. You might say, "Well, how are you going to grow there?" Well, we're trying to do a lot of that through our voluntary products, we have a suite of, say, 20 products, the average customer has three. We think there's a penetration opportunity in that group business despite our very large market share. You move down into the regional middle market area, which is 100 to the 5,000 bucket. There we have, call it 7%, approximately 7% market share. That is a $50 billion market.
Should grow at 4%-5%, we think we can, through leveraging some of our existing capabilities, outgrow the market. Thirdly, you have the small market, we've been making quite a bit of investment there in the technology space to really focus on an end-to-end platform, digital platform that can give us a competitive advantage as we start to look to grow our share in that space. Again, all of that, if you think about across the three, a lot of it goes back to voluntary, there's been double-digit growth in voluntary this year. We're very pleased and believe there's a good opportunity for us to grow in the group space. Obviously, LatAm has been another area of growth for us. Mexico, we're a market leader. Chile, we're a market leader.
Both of those, we've been able to leverage that advantage we have and the capabilities we have there. We think high single-digit growth in those areas is certainly consistent with our expectations. There's been a few headwinds in terms of tax reform this year in terms of earnings. If you normalize for that, I think the underlying trajectory is consistent with those expectations.
Thanks. On the U.S. group business, you've had pretty favorable underwriting experience recently, just particularly in the non-medical health area. Can you talk about what you're seeing there? You've given a 75%-80% benefit ratio target. Do you think the lower end is still kind of achievable at this point?
Yeah, I would start with one thing. Well, first, we had really good results, right? We had really good claim size, incidence rates, and the Social Security offsets were all favorable in the quarter. On top of that, the healthcare tax is actually a benefit to the expense ratio, negative to the, I mean, sorry, a benefit to the benefit ratio, negative to the expense ratio. It's about a little over a point. I think middle of the range is still appropriate maybe low end give or take. Look, we've seen some good performance there. I think the economy helps. I wouldn't necessarily model the second quarter benefit ratio-
Got it
in the rest of the quarters.
Okay. On P&C, you guys have done a nice job of improving the combined ratio over the last couple of years. Do you see further potential to improve from where you're at now?
Over the last 12 months, I think our rate increases have been slightly higher than industry. We don't see that continuing. That obviously is one area that's helped with the combined ratio. I'm not so sure I'd see further improvement.
Okay
in the combined. Certainly in auto, maybe home. We can get better in home, I think. I think we're trending towards the low end of the range that we gave at the outlook call for the year. We're at 91% this last quarter, a little above that. I'm not so sure I would expect a further improvement from here.
Do you still, in that business, see an opportunity for growth to improve over the next several years? I know you've named that.
Yeah
A growth area.
Yeah. It's interesting. Obviously, it's in the area we play.
Yeah.
Right? Particularly given our group chassis, we think we have an advantage there. The interesting fact there, going back to just the statistics of penetration, it's only a 3% penetration. One. Two, we've seen some great sales momentum. In the first quarter, I think we were 16%, in the second quarter it's above 20% in terms of sales growth. Yeah, I think there's a good opportunity. You'll see a little bit of a lag on premium growth and earned premium growth is not as great right now, but we expect that to increase in the next few years.
In Latin America, based on what you've seen in the first half of the year, do you still think you can achieve the high single-digit growth targets in both earnings and premiums and fees in 2018?
Yeah. There's a few things in terms of some fairly large cases on the premium side that did not renew, that weren't necessarily as profitable. If you normalize for that, you get to the high single digits, in both PFO and sales. Similarly, as I mentioned before on the earnings, we've had a negative impact as a result of tax reform, right? The tax benefit on the U.S. expenses allocated to LatAm is less. That has negatively impacted the trend. Adjusting for that, I think pre-tax earnings were up 9%.
Yeah.
So.
Moving to the retirement business, I think one thing that was a positive surprise in the second quarter was you saw a decent amount of improvement in the spread there, excluding variable investment income, which was despite LIBOR rising and the yield curve flattening. Can you talk more about what drove that and how to think about spreads in that business moving forward?
Sure. We did guide to a $5 million-$10 million impact for every 10 basis point rise in LIBOR. Negative impact, obviously. Since that time, LIBOR has risen 60 to 70 basis points above what the forward curve we used at the time for that sensitivity. As a result, there were some out of the money caps that now are in the money. There's an offset there. The LIBOR has kind of outperformed our expectations in terms of how high it's gone. I think the second thing that happened is there were some management actions taken to lessen our exposure on the liability side to LIBOR. Those two things have, I would say, mute or neutralized the exposure to LIBOR temporarily, though. These caps will roll off towards the latter half of this year and into 2019.
As a result, we would have to kind of rethink about our guidance. I think we need to be a little more holistic around that going forward and think about it's not just linear up to a point.
Yeah.
Right?
Okay. The caps will kind of gradually roll off over the next year or so?
Yeah. I would say the second half of this year and into the first quarter of 2019.
Got it. On pension risk transfer, you did a very large $6 billion transaction with FedEx earlier this year. Is this, I guess, a market that you're more interested in growing now than maybe you were the past few years?
I'm not so sure about more interested. I think we're still interested in growing. We think this is a good opportunity for us. We think there's some competitive advantage because of our size in certain pension risk transfers that will come to market. We think the supply is going to be high.
Okay.
Particularly if we get some increase in rates, equity markets have been positive. We think there's still a great opportunity here. We are very mindful of the risk profile that we want to accept, and I think FedEx was a great example of that. While these tend to be as well capital intensive, they are, but the risk profile of these are much more in line. We can match it much easier with hard assets and things like that. We think it's a good business and we're certainly pleased and opportunistic about what can happen in the next few quarters.
Do you have any caps on capital allocated to that business, or is it really just opportunistic at this point?
There's no hard cap. We obviously, just like anything, we don't want to put all our chips in one basket. We will be mindful of that, and it will depend on a number of other factors that go into this. Yeah, we have no hard cap.
In Asia, I think you've done a lot of repricing actions in the last few years. Growth is improving, but one thing that makes it a little bit difficult to see is you've had mix shift towards dollar-denominated retirement products, which doesn't come through the premium and fee lines. Can you talk about where growth is at in Asia now?
Yeah. Sales growth has been very strong in a place like Japan. The last two quarters have been very good, and I think us getting into the foreign currency products has put us in a great spot. Right? The strengthening of the US dollar has been the tailwind. Interest rates obviously have been in our favor for those products. It's really helped us, and it's a risk profile that we like it. As you said, it does not show up well in the premium, fees, and other line. Sales have been good. PFOs have been muted. If you look at maybe assets under management, you'll see a similar trend to what we saw in sales. There is growth, you just don't see it in the revenue line.
It is going to come through in our liability exposures and then ultimately, we think to the margin.
Got it. MetLife Holdings, the guidance has been mid-single digit annual decline as the business runs off. Do you see opportunities to potentially accelerate the runoff using reinsurance?
I would say we continue to look.
Yeah.
It's difficult with New York in that it would be a portfolio of a legal entity. Obviously, if you had a legal entity, that's a different scenario, makes things a little easier. This is a portfolio of a legal entity, you'd have to utilize reinsurance. Look, we continue to look at this. We get a lot of different ideas brought to us. Having said that, we are comfortable with the risk profile of that business. Obviously, long-term care is in there, and we just talked about that previously. It does generate close to 100% of free cash flow on a percentage basis. It is a cash flow generating business. We're mindful of the different scenarios that can occur, we look at those different scenarios, and we'll continue to evaluate. I'd say to date, the options have not been economically favorable.
Can you just remind us what the key New York-related considerations are that make it more difficult to do reinsurance transactions out of a New York entity?
Yeah. Look, it's just making sure you have a qualified reinsurer, right? Otherwise, on the other side, as a result, it's pretty onerous.
Okay.
Right? It's difficult finding that happy medium between the two, and so that's really been the struggle.
Got it. On M&A, I guess, what's MetLife's interest in M&A at this point, and what would be the key strategic priorities that you target?
I think M&A, we're probably consistent in the message here. If it's a strategic fit and it's above our cost of capital and we think on a relative scale, other uses of that capital, that would be something we consider. Having said that, I think there's quite a bit we're doing right now-
Yeah
in-house. There's quite a bit of attention to making sure that we have the house in order, and remediating the material weaknesses is number one priority. Ensuring that we meet our unit cost improvement program, and delivering on our earnings and our businesses. That's our number one priority. Obviously, we get a lot of things that come to us through M&A, and we have a pretty disciplined approach to that. We'll look at things, but I don't think anything's necessarily changed in terms of our view of inorganic versus organic growth.
Got it. Can you just give an update on your efforts to build out the asset management business within MetLife and how that's going so far?
I think it's going very well. Obviously, you could try to just grow through M&A.
Yeah.
That's not usually the most effective economic approach to building a business. The multiples are very high, right? I think Logan Circle has been a nice acquisition for us. It's really added some attributes to that business. I think the growth there is performing well, and I'd say above expectations in terms of the metrics that we had at the beginning of the acquisition. All in all, we're pleased, but we're mindful of that we're not going to be able to just go out and buy someone for a good price. That wouldn't be really the most effective way to grow that business. A lot of it will be organic growth at this point, leveraging our capabilities, our private asset origination, our commercial mortgage origination. We do think we have a competitive advantage there, and we're leveraging that.
All right. I think we are going to wrap it up there.
Great.
Thank you very much.
Thank you.
Appreciate it.
Thank you.