Morning. Next presenter or next session is with MetLife. I'd like to introduce Met's CEO, Steve Kandarian, and CFO, John Hele. Steve's been with MetLife since 2005, where he first served as chief investment officer until 2011, then the CEO. John joined MetLife in 2012 after serving as CFO at Arch for three years, where I had the pleasure to work with him back then. Over the past several years, Steve and John have overseen among the most significant corporate restructurings in the insurance industry, probably the most significant, with the spinoff of Brighthouse Financial materially changing the risk profile of MetLife. Steve and John, thanks for joining us today. Let's start with a big issue, group annuities. A lot of focus on the issue related to group annuities.
Sure.
Let's take a step back. Describe the problem-
Sure
for us. What happened with this situation?
This relates to our pension closeout business, our pension risk transfer business. Can you hear me okay? Is it projecting? Okay. These are when private sector companies have defined benefit pension plans they seek to get out of. They've closed them down. They're transferring over to an insurance company, the administration, and the risk associated with those plans. These plans that MetLife have been involved with go back many, many decades. We began this business at least back in the 1950s. When someone would come into these situations with MetLife, and they were already receiving a pension check, it was pretty seamless. We'd go from the employer right to MetLife, where we would get the checks out to them on time. There was no issue for all those kinds of beneficiaries.
The issue that you've heard about, and that we've been talking about quite a bit lately at MetLife to the marketplace, relates to those people who have left their companies after we received those pension plans coming to us. Those employees were not yet at retirement age, and they may have been decades away from being at retirement age. They may have left their companies and moved to other parts of the country, et cetera. The question was, how do you find those people, sometimes decades after we've assumed these pension plans? Sometimes we had addresses that were quite old, out of date, et cetera. There were certain methods that were used and processes, and this goes back to, again, many decades ago, when we began this process.
Those methods may have been adequate, or at least some people consider them adequate at one point in time. As time goes on, we think of other ways you can find people, contact people. We simply didn't do as good a job as we should have in terms of tracking and trying to find those lost or missing potential annuitants. That's really the issue that we're talking about here. This is a very small percentage of this much larger group of people that we administer pensions to. Once this issue percolated up to the level of John, myself, Michel Khalaf, who runs that business. Michel has been running the U.S. business since June.
Once this issue percolated up to us in the fall of last year, we quickly dedicated a tremendous amount of resources to this to figure out how can we do a better job of finding these people, making sure they get paid the pensions that they've earned and deserve. That's what you've been hearing about from us recently. Now, there were some other issues involved, which was when we didn't find these people, we assumed that they were just lost or, in this case, were no longer alive, and we released reserves, the reserves associated with these pension payments. That was an error. We should not have released those reserves. That occurred again over decades, and in no one year was that number a material number. They were quite small numbers. They were inconsequential numbers.
When you add up those numbers over decades and you add interest, which we chose and decided it was right to add interest to that if we find these people, that adds up to a much bigger number in terms of a charge. That's a charge you heard us take, $510 million reserve strengthening pre-tax, $331 million post-tax.
Was there some trigger that highlighted the issue? How did someone realize it was an issue to begin with?
There were some things going on at the Department of Labor, which also got people's attention on this matter. The Department of Labor was sending out guidance and studying the issue with respect not to insurance companies, but with respect to employers. Employers retain these plans and administer them themselves. They were having the same kinds of issues of finding missing annuitants. Because again, people may have worked for them for 10 or 15 years, left at age 40, and you're trying to find someone 25 years later. DOL was offering some guidance, some suggestions as to how to find these missing annuitants. We took note of that within the business unit that I'm talking about here within MetLife. They ran a pilot project back in 2016.
They noticed by taking more aggressive measures and steps to try to find people, they're finding more than they found the first time, and that sort of triggered things within the business. The escalation of this issue to my level, John's level, Michel's level, did not occur on a timely basis. That's one of the issues we had in the company.
I'm assuming to some extent, this is a bit of an industry issue. I mean, each company must be challenged by this to some extent.
It's hard for me to know really what happens in the other companies in our industry, but I can't believe we're the only company that has this issue of trying to find people who have left their companies decades before. Oftentimes, the information we have received, not so much from recent pension plan transfers, but from the older ones that go back decades. People didn't have email addresses, for example, back then. Normal ways you think of contacting people simply didn't exist when some of these plans were transferred over to MetLife decades ago. In some cases, we didn't have good Social Security numbers. In some cases, obviously, the home address had changed many times.
It is an area where I think the entire industry has to find ways to do a better job and find these people and pay the benefits to these people that they're owed.
In your pre-announcement, you said you were undertaking a global review. What are you looking to find in this global review? What's the outcome going to be, hopefully, in your minds?
When this issue came to us, to the top of the house at MetLife, we realized once we wrestled it to the ground, took a couple of months because the data was hard to kind of gather. Once we got our arms around this one, we said, "Okay." We knew that we had an issue here, that we were going to address it head on, pull no punches, disclose publicly to the investor world, to our regulators, et cetera. We wanted to make sure that similar situations like this, people who are owed money but are hard to find, didn't cause similar issues elsewhere in the company.
We decided we would do a global search in all of our operations around the world, look for other Group annuity kinds of missing participants, other kinds of annuity or life insurance beneficiary, missing people, and so on, and try understand as quickly as possible if we had any other analogous or similar situations where we needed to do a better job finding people. It was a very intensive process of review. Each country manager and their team went out and looked and scoured their entire business. The good news when all that information came back to us was that while there are some areas where there could be some administrative processes that could be updated, improved, and so on, there were no material issues. We didn't know that until we went out and looked.
We figured that once we made this announcement, the logical question from our investor base and from regulators would be, is this it? Is this the only thing you have of this nature where you're not finding missing people who are owed monies? We wanted to make sure we scoured our entire operation at the same time as solving this issue.
Maybe this is a quick question for John, but the charge itself, what is it actually for? Is it the reserves that are getting reversed?
There's $510 in total pre-tax. It's $331 after tax. It's tax of $35 because it's a historical financial that you think about in the fourth quarter. Tax reform is a separate area. The financial, $70 million is an in-quarter charge after tax, and $261 is prior period, and that's recorded as an accounting error. Let me explain the $70 million. In the quarter is for the accrual for, Steve spoke about accruing interest on those that we find, and we expect to find, so we'll have an interest component to that. We also changed our estimate for a group that we had not fully released the reserves for. With these outreach programs, we expect to fully find these people, and so we're changing the changing estimate there. Those two together are an accounting change in estimate there in the quarter, $70 million.
The $261 is spread back to the periods on which the error had occurred when the reserve was released over these decades. We go back to the opening balance sheet that'll be in our 10-K, which is five years, which is 01/01/2013. You'll see we have supplemental slides that we published, the amount in prior 2017 was $20 million. Then it's like $20 million the prior years. It's very small each year, and we put a little table in, but it's quite immaterial, which gets at what Steve was saying about in the financials, the RIS business makes like $1 billion a year. This little amount wasn't noticeable but adds up to $261 after tax over this long period. We had to go back and figure out which period these go to, and recalculate all of our earnings and all of our segment earnings.
Also, when you do an accounting reclassification, as it's called, it's not a full restatement because we don't have to republish the prior 10-Ks. That would be a full restatement. This is a reclassification. You'll see it all detailed in our 10-K published toward the end of this month. You see all the numbers. We gave you a table there. You also have to go back and if you have any errors that were immaterial that occurred in those quarters, you have to fix those, too. There's tiny amounts you'll see from quarter to quarter being moved around that kind of add up to be not much at all. We had to go through the whole process of doing that. That's why when we realized that we had
An error here and leading to a material weakness, but the error to recalculate all this, we did delay the earnings by two weeks so we could make sure everything was well run, everything was recalculated, and that got us to giving the earnings release with the details that we had. It's unfortunate. We want to do the best, but the most important thing is we're really going to try to find these customers and give them their money and give them interest as well.
That whole accounting thing sounds like a pretty fun exercise. You look at the size of the charge relative to your balance sheet, it's not that big.
No.
Does it, however, impact your capital management strategies at all?
No. We have a solid cash generation in our company. We've got a lot of cash at the holding companies that we communicate. Our capital plans are fully ongoing and are not changed by this.
I guess the same thing is true for statutory earnings, risk-based capital.
Right. There will be an impact from this charge in our statutory companies. The charge will go through on a statutory basis as well in Metropolitan Life Insurance Company. About 13 points on our consolidated, our total RBC. We did announce on the call that we are above the 400% target on an NAIC basis, which is the key target that we run the company on.
I don't know the definitions around the term material weakness. It comes up every once in a while. Doesn't sound good, but you did identify it. Give us a definition. Why did you identify that material weakness?
A material weakness, it's over your control in financial reporting. You have to analyze under SOX, you analyze any sort of deficiency, any little thing goes wrong. You could have a deficiency, and that's a level that we work on. You can have a significant deficiency, which you report to the audit committee, and you have to have remediation plans for all the significant deficiencies. If it gets to a point in terms, and there's various techniques you categorize these as, there's a quantitative impact. This did discharge, this error did impact our quantitative threshold. Then there's qualitative factors. I mean, is there fraud? No, we said no fraud. We had some other factors that impacted this. It was the release of the reserve that our administrative practices were not sufficient to allow for the release of the reserves on an accounting basis.
It's an accounting error. That's one fact. The other fact that it wasn't escalated to us on a timely basis throughout the company. That's one of the factors in SOX that you have to think about. Those two together brought it to the level of a material weakness. When it's material, we have to say it publicly. Of course, we are working hard to remediate this as we would with any deficiency. When you have any deficiency like this, you need to really analyze not only what happened, but really why it happened, and because you want to prevent it from happening again in the future.
That's why as part of our remediation plans for this material weakness, as we announced, we're going to be hiring external advisors, overseen by our Chief Risk Officer, Ramy Tadros, to really do a comprehensive analysis of all of this. Understand in SOX lingo, it's called the root cause analysis, then we will fine-tune our remediation plans to make sure that that is executed appropriately. We've already taken steps to remediate. We've stopped releasing the reserves. We're doing new techniques to outreach across the board. We're using the internet, using certified mail, multiple areas. We phone people now. Some older people pick up the phone. They may not read their mail. That's working pretty well, actually. Doing a lot of techniques we can when, but it's not easy to find some of these people. Some of these contracts go back decades.
We're taking every step we can. We want to find these people or their beneficiaries and give them the money that they're due.
I definitely don't want to spend the whole time here, but just lastly on this, I guess. The reaction from the rating agencies.
We've informed our rating agencies, and our ratings have not changed.
Okay. You've had this kind of ambitious expense program. Will the cost of resolving this issue have an impact on that, or is it just too small to matter?
Well, this will be absorbed within the business itself. There will be some ongoing costs, but it's spread out over time. As I said, this business makes about $1 billion a year, so they do have some margins. It'll be slightly higher cost, but we don't expect it to be material to the business. It's much more really working to find these people. We've now accrued with the $510 pre-tax for finding people and paying them the interest that's owed to them. We've got it accrued for finding these people.
I'm assuming this wouldn't have much of an impact on your competitive position when it comes to pension risk transfer?
I'd say that MetLife has been a leader in this area for many decades and has built up a great deal of expertise in terms of asset management, liability experience, underwriting, and so on. We are one of a few firms in the country that people really look to when they want to close out a pension plan. Obviously, this administrative issue that we have announced and discovered ourself and announced to the public is not helpful. At the same time, we hope that people understand that our company takes very seriously these obligations and that we are doing everything we can to make this right and fix this for those missing annuitants. Our hope is that the marketplace will understand that we'll remain highly competitive in this business, and I believe we will.
It's a pretty sophisticated buyer we're talking about here.
It is. Look, a lot of these employers themselves are struggling with the same issue, which is why you have these DOL guidelines that are coming out because they're trying to find people as well who, again, as I mentioned, may have worked for them decades ago, and they still are having issues in trying to contact these people and find them themselves. I think it's a bigger issue than simply the one that we have at our company.
Ongoing impact to adjusted earnings for the RIS segment, I assume it won't be that material?
No, you see, we had in our reporting, we showed the fourth quarter in-quarter change is at $8 million after tax.
Okay. All right. Let's shift gears toward free cash flow and capital. On the call yesterday, you mentioned that you expect your free cash flow ratio to be at the lower end of the 65%-75% range. Why would it be at the lower end, do you think?
Let me define how we talk about free cash flow. It's dividends up from our subsidiaries all over the world, less any capital injections they need for growth that have to go down, holding company expenses and preferred dividends. This is the amount of money each year that's truly free. It's free to pay a common dividend, free to buy back shares, free for new acquisitions or things we do. That's sort of the definition. You can see the denominator is our U.S. GAAP earnings, and the numerator is the sort of the cash that comes up, which is driven by statutory. Just the change in the tax rate on a GAAP basis takes about five points away from that ratio because with 21% taxes versus 35%. That's a big change right there.
That's one of the primary drivers of why if we were in the range, we'll be toward the low end of the range right now. There's also going to be some timing points in 2018, 2019 in how statutory works and pays dividends out. There's always a delay of a year. We got this risk charge, it'll be a little slightly less in 2018, it'll be better 2019. That's why we also give a two-year average of this number because you can get timing issues in statutory, we always give a two-year average. We have said that even with this change in the denominator, the GAAP changing, driving approximately a five-point difference, we're still going to be in the 65%-75%, but likely at the low end of the range.
Got it. You had indicated earlier that you intend to execute the exchange offer of Brighthouse during 2018. When you guys are thinking about the timing of it, what are some of the considerations that come up?
There are regulatory issues associated with when we can do an exchange offer. Certain information has to be out there in the marketplace, not just for MetLife but also for Brighthouse, shareholders have full information before an exchange can actually occur. The earliest that's able to occur would be the second quarter of this year. What we've said is that we are committed to executing upon an exchange offer in the year 2018, by the end of the year, subject to regulatory constraints and market conditions. We still stand by that statement. It is our goal to make that exchange occur in 2018.
I don't think everyone kind of understands what an exchange offer is. It doesn't come up every day.
Right.
Why is this the best way for you guys to divest the rest of the Brighthouse holdings?
We think it's the right way to do for a couple of reasons. One is it's the most tax-efficient way of doing it, both for those who are exchanging shares and also for the company, for MetLife, in terms of tax consequences. It'll be a tax-free exchange. That's beneficial. People who want to sell their stock will end up realizing whatever capital gain they may have at that point in time. They want to hold it, there's no tax impact, and the same for our company. The other reason really is that in terms of how this would be executed, it's probably the least expensive way for us to transact on our remaining piece of Brighthouse that we hold. Between tax and transaction costs, it's the most efficient way of doing this.
In these sessions, I usually start very big picture and drill down. We kind of started down low. Let me bring it, I guess, back up a little bit. When you talk about your goal of an ROE of 800-900 basis points over the 10-year treasury, maybe this is for John, but Steve, you can comment as well. Talk about the drivers that will help you move into that range.
A slowly rising 10-year Treasury and getting better returns, particularly on our portfolio will help. We, in 2017, saw a squeeze on our margins. What was the assets maturing were leaving at a higher yield than what we could put on the books last year. The 10-year Treasury is at 290, I think, today. That will help over time as we can reinvest at better rates that will lessen the margin compression. Maybe someday a little expansion, we'll see.
How high would it have to go for that to-
The crossover point is roughly 3% 10-year Treasury. It does depend on where spreads go, on what we invest in. A little over 3% or around that is probably kind of the break-even point. If rates really go up over time, the market will react. We'll have to be forced to raise our rates on what we sell as well, but within a smaller band. We've been compressed, and we'll get a little upside there. Also, over time, the impact of our cost-saving program will help on our margins. We've done about $400 million toward the gross $1 billion target we have, but we are spending money today to get there. Net net, the shareholder hasn't seen that much in 2016 and 2017 so far from this. We're approximately spending $1 billion over this whole time period to save $1 billion.
That's a very good IRR over time, if you think about it. You save $1 billion recurring a year, and you invest $1 billion. It is tricky to track these cost save programs because we are saving the money, we're tracking it, but we grow at the same time. How do you know what's right? In the first quarter, we're going to publish in our statistical supplement a measure that we use internally to track a cost ratio. You'll see, and we'll tell you the target we need to be at in order to get that full amount to flow through to the bottom line. The amount we want to flow to the bottom line is $800 million net pre-tax, and that's going to cover the stranded overhead that we have from the separation of Brighthouse. It's a very important program for us.
We are very dedicated to it and working very hard at it.
That'd be helpful disclosure. It's hard for you to track it. Guess what? It's even harder for us to track it, anything that shines some light on there would be welcome. Again, maybe even bigger picture, actually. Capital allocation. You got organic growth, buyback, share repurchase. When you guys are sitting in a room debating these issues, how do you think about it?
We look at our cost of capital, and we look at the businesses that we can invest in terms of growing organically and the capital needs of those businesses. If they clear a cost of capital hurdle rate, then those businesses get additional capital. That's the organic piece of it. Whatever is sort of remaining after that piece of it, we look at choices between dividends, share repurchases, and those are two very important factors, obviously, to compare the two. Our view is that having a good, solid dividend that grows over time with our business is a good component of our value proposition to shareholders. We're not in a high-growth business. We think we provide an attractive yield on our shares that grows over time, that makes our stock more attractive.
At the same time, if we think our stock is trading in a range that perhaps does not fully value it, we think that share repurchases make sense, and we're opportunistic about our share repurchases. We don't buy the same number of shares where our stock price is higher versus lower. We buy more when it's lower. We're very thoughtful about how we spend our dollars around share repurchases. Of course, the remaining component is acquisitions. An acquisition has to make sense first strategically. It has to fit to our overall view of what we're trying to do as a company, which is, again, value of new business, free cash flow, kinds of concepts come into play very quickly. What markets we want to be in, looking at geopolitical risks, looking at diversification of our businesses and so on.
An acquisition has to clear a high bar, which is that it has to be more attractive than a share repurchase over time. Over time doesn't mean 10 years, because if you use that standard, then you can talk yourself into any kind of deal. It's got to be pretty quickly. It can't be probably, in most cases, year one. Once in a while, you find a deal with so many synergies you can make sense of it in terms of it being accretive year one. Oftentimes it takes at least a few years for those lines to cross. There's a balance there in terms of the acquisition side, but it's got to be a good fit strategically, and it has to look more attractive, at least in a relatively short period of time, than a share repurchase program.
That's helpful. Going, down to some of the businesses. The Group Benefits business, you had a very good year. I'm learning this business, but it looks like other companies did too. It's been a good business, which always raises the question how sustainable is it? When you look at that business, Steve, what's your outlook?
Our Group Benefits business had a good year. MetLife is the leader in the large case market. We have the largest market share, and we're very solid in the mid and small markets as well. We've had this position for 100 years. I think we helped start it. We just had a letter from a customer thanking us for 100 years of service. Good service is really essential to this whole business. We're large in dental. We have a lot of products that we offer across the board. We have probably the broadest suite of products, a lot of voluntary products for the employees. We've had good growth. We had a really solid year of growth in 2017. You get a lot of your business on January 1st in the year in the large case market. We had a very strong sort of business.
We also had good underwriting results for the year. Underwriting does fluctuate. You do see times it's up and down. You have a bad winter or flu season, we may be affected by that. Overall, things are within our range that we have, and we do give ranges around this, but we were toward the better end of our range in 2017 on many of our dimensions. We saw our growth toward the higher end of the guidance that we'd given
For 2017. We're very pleased with it. We're also investing a lot in that business. We are partnering with IBM for the smaller case to do better technology for that. That'll be for 2019 before that fully comes out. This is a great franchise for MetLife, and we're pleased that the team's doing well.
I wanted to touch on the international business. We're almost bumping up against the end. This is going to be a broad question. I'll try to zero it in. On the international side, key markets for growth opportunities.
We are in over 40 countries around the world. I'd say the parts of our business internationally that present the greatest growth opportunities are in places like Latin America, where we have a very strong position. We're the number one life insurer in that market overall. A very strong position in countries such as Mexico and Chile. We are growing those businesses, and have been for quite some time. We have a strong franchise in the Middle East, in the UAE, in Turkey. That's another part of our business that internationally is performing very well and we expect continued growth from. In parts of Asia as well, have performed well for us. We're in China. That business has been growing nicely. It's a relatively small business.
For those of you who have kind of followed the Chinese market, regulatory constraints made it difficult for the non-Chinese players to really have much of a foothold initially. That market is now opening up somewhat. The international players are getting more traction in the market, MetLife included. We are hopeful there in terms of our prospects.
Why don't we end it? Guys, thank you for being here. I know you're sick, Steve.
I am.
Some tough questions, but I'm glad you guys were here to address them publicly to everyone. Thank you very much.
Thank you.
Thanks, sir.