Good morning, everybody. I'm Yaron Kinar, Deutsche Bank's North America life insurance analyst, it's a pleasure to host MetLife and MetLife's CFO, John Hele, in what has become a tradition by now, I think. Very excited to have you here with us today. A lot going on, clearly, in the space and with the company. Maybe before we even dive into some of the aspects of what may still come, maybe we can talk a little bit about the business or MetLife as it will look after the separation. I think at the time that you highlighted the separation of the retail business, you talked about basically turning into a more group benefits-oriented business in the U.S., have a large international platform, and then still have a smaller runoff business as well.
You highlighted a few segments that would be growth aspects or growth segments in the business. Most particularly, I think there's a group benefits business, the P&C business, and some opportunities overseas as well. I thought maybe we can start off by talking about the growth opportunities for RemainCo. Why don't we start with the group benefits market? Talk a little bit about the market trends there and what the opportunity for Met is in that market.
Thanks. It's a pleasure to be here, it's a great pleasure to actually speak about our business with RemainCo going forward. The U.S. group benefits business that MetLife has is really its flagship business. We have over 40 million employees, over 50,000 employers. We're the largest in the United States in terms of market share. We have about over 25% market share in the large employer, over 5,000 lives. We have solid market shares in the medium and the small case markets as well. We've been growing this group benefits business slightly faster than the industry for the last few years, and we expect to do that going forward. We're doing it really two ways. One is in the very large case, over 5,000 lives, we are adding more products through employers. We sell supplemental voluntary products. Of course, we have the basics.
We have life, we have dental and disability, but we also have legal plans. We sell personal lines, P&C, to employees of major employers and Accident health. Accident health is a growing business for us there. This has helped us greatly in the large market. In the mid-size market, which we define from 100 to 5,000 lives, we are growing there too. We have some advantages in that market. We are national, and we have a very good dental plan across the U.S. with a dental network. We're number 2 in dental in the U.S. overall. We're number 1 in life. We're in the top five in disability. We really have a strong share. In the mid-size market, having more products, even the basic products, is an advantage in having better coverage. That's how we're growing in the mid-size market.
The small market is much more fragmented. We're investing in some technology applications that we expect in the next few years will bear fruit in even that small market. Overall, our growth in revenue, PFOs is about 3%-5%, is the outlook that we gave. We think that's beating the industry by a bit. We're very excited about that business. It's a good capital return business. We can put capital work with a good IRR and a reasonable payback period. It is competitive, but we do have some advantages as I've outlined, and we're very excited about this market.
Got it. If we look at one of the other businesses in the U.S. that you had highlighted, property and casualty or the auto and home business, I guess some would be surprised to see a life insurance company competing in that business. Can you maybe talk about what the competitive advantages for MetLife in that business are, and also maybe about the accretive value of growth there, given some of the challenges that the industry and company has faced in auto and home?
Well, it's a very good question because we get that question a lot from investors. Why are you in the auto and homeowners insurance against some of the big giants who clearly have some strong advantages? The real strategy here is to sell through employers. We are the largest employer sold through personal lines insurer in the U.S. We have about $1.6 billion of premiums. That's where our growth is coming from. We've always had good combined ratios in this business. This team has done a great job for MetLife for a long time. The auto industry was challenged the last year or so, year and a half. We put through price increases 7%-8%. We're doing that again this year. We have been more selective in certain regions.
We've improved our expenses and our claims handling. We've gotten the combined ratio in the first quarter less than 100. It's an improvement. We expect that to continue and improve all year. We're also investing in digital in this space with a direct auto and now a direct homeowners. It's being licensed up in states. It's small today, but we think this is going to be a big growing area. Again, the strategy is through those large employers and even the mid-size employers we're going to start marketing through offering this. It's a great business. Because we're selling to the employer, we can offer a pretty competitive rate. You sign up for payroll deduction, so renewals are easier and better. It's a great business. This is one of the powers of the MetLife brand.
We have a brand in the U.S. that's extremely well known. In 1929, we insured one in five Americans. Everybody has a family member who has been touched or been part of MetLife. Probably in their families. We have a wonderful brand recognition and trust, and we think this is an area that we can differentiate on so I can pause. That's the key growth strategy for the P&C business.
At the time of your investor day, at the end of last year, you'd also talked about growth opportunities into international markets in Latin America, Chile, and Mexico in particular. It seems like there are a few headwinds in those markets, for the company in particular or the market in general. You can talk about those a little bit. Do those two markets still present a growth opportunity?
The underlying long-term growth, we think in our Latin America business is low double-digit growth. We did outline on our outlook call that we're probably going to be high single digits right now in these businesses. There's some challenges that have happened there, particularly in Chile. We're the largest pension provider there in a company called Provida that we bought a few years ago. There's an election going on this year in Chile. Pensions are a sort of hot political topic, and they're talking about. We think this will all get worked out okay, but it has caused some issues for us as the leading provider. We're down about 2% year-over-year in customers, so we've taken some actions to rectify this. We've improved our servicing and service across Chile, and we're in most local cities, to help people understand their pensions better.
We've also reduced our fees. There's 2 types of contributions in Chile. You have to contribute a mandatory contribution of your pay into the pension system. Our fee on that was just over 1.5%, and we reduced it to 1.45%. You can also make voluntary contributions. We've really reduced the fees on the voluntary. They were 50 basis points to 90 basis points. Now they're 20 basis points. We announced it in March, it's effective in May. We've seen things die down now with our customers and we think that's going to all work out okay. It will be a bit noisy this year with the election going on. We also have some other slight headwinds in some areas. That's why we're down to the high single digit growth. It's interesting because people ask us about LatAm and the international strategy quite a bit.
They say, what's going to happen? Because the U.S. dollar the last three years has risen against almost every foreign currency, the really strong underlying growth that we have in international operations, we haven't seen published as out to the market. It is there if you adjust for constant currency. The U.S. dollar cannot keep going up forever. The key strategy of RemainCo is that a very well-diversified international operations in good markets, solid positions, that we can get good growth from across the board.
Okay. If excuse me, we move on to our Retirement & Income Solutions, which I think will comprise of about a quarter of earnings after the separation. It seems like a very macro-driven business. Other than market conditions, are there specific growth drivers in this segment that you could point to?
Well, this whole segment, as we said on our outlook call, is we really are seeking to balance capital and growth in this business. It is a capital-intensive business. It has longer paybacks, a very nice business. Very stable earnings once you get it. If you write the business well, you'll have those earnings on an ongoing basis. Still it's a lot of capital locked away for a long period of time. This is where we try to balance how much capital we put every year, and we actually give this unit a capital budget every year. We say, "We're willing to put X amount of our capital that we're going to invest in new business in the year in this business and get as much as you can." The forces driving this are two major businesses of growth here.
One is the pension closeout market, and the other is a stable value market where we sell types of GICs into that. Stable value is used in defined contribution plans. The stable value is growing like 3% a year. Pension closeouts has always had an idea it's going to be growing a lot. It's a huge potential market. It is tricky because I think the average defined benefit plan is underfunded. I think in the U.S. it's about 80%. We're seeing employers do partial solutions to their pension closeouts because to do the whole thing, they'd have to pay more money and cash into it. Often they spin off the retired lives portion of it and they keep the current lives still in the plan. That's the opportunity for that market.
They're both good markets, growing, but again, capital intensive, so we really try to balance this growth.
With regards to the pension closeout market or pension risk transfers, what would it take, do you believe, to really see the pipeline materialize more into the actual deals? It seems like a huge market potentially, and yet we haven't seen a lot of deals, at least on the jumbo space materialize.
The, 2012, the market was $35 billion, and there's some jumbo deals that year. Then, it was like $4 billion in 2013 and then $8 billion, and it's been $13 billion-$14 billion the last couple of years. The potential is a multiple of that if all the employers started to do it. I think it's a growing solution. We find each employer decision to actually do this is quite specific to their situation. It's not there's any common themes. Sometimes when interest rates were low, we heard people wanting to do it more, and they're waiting for interest rates to go up. Interest rates go up, maybe they want to go up even more. It's quite employer specific. We think it's a good market. We sold the last couple of years about $1.7 billion.
That's our share of it, and we like what we do. You may have seen, Sears just announced a $500 million deal with us. We like to focus on retired lives that we bid on. The reason for that is it's nearer cash flows. By having nearer cash flows, it's a faster payback in terms of return. We think it also reduces risk. The nice side of this business is if you lock in the cash flows, we get a big cash deposit, we match it against the cash flows. It's pretty stable for the nearer term or even the medium term. One of the risks long term is that you could have longevity improvements happening.
We try to keep the cash flows a more reasonable timeframe on retired lives, so the impact of longevity will be lessened than if you do on deferred lives. Which means someone 45, they're going to need the money 40, 50 years from now, and there could be some breakthroughs in terms of mortality by then.
Okay. If the spigot does open eventually, do you think there's enough industry capacity out there to handle that demand?
Well, there's a limited number of players because employers want a well-rated company to work with. So far, the capacity has been here and the capital markets and banks are very innovative in terms of raising capital for good demand. We've seen that in the P&C space with all sorts of innovative structures. I think there could be those ideas coming along here if the demand was there, it hasn't really opened up greatly yet. We're all waiting for it just hasn't really happened yet.
Okay. Maybe we can move on to Japan, which is another significant market for MetLife, all the more so after the separation. A lot going on there. Clearly a strengthening dollar, lower standard reserve rate there. We're seeing a pickup in non-yen-denominated product sales there. The company has chosen to move out of the single premium whole life yen products. Can you talk about the positioning of MetLife in Japan today, and most particularly, vis-à-vis of the market trends there?
I get asked this question a lot also by investors saying, "Why do I want to be in Japan?" You're competing against big Japanese insurers. It's an aging society. It's a very saturated life insurance market. That's true at the high macro level. There's some very fascinating demographics going on. It's a shrinking population. They are shrinking overall, and it's an aging population. You also have the government running fiscal deficits and all the stimulus and spending, so they are pulling back slowly on paying for healthcare, supplemental, and old age pensions. The Japanese are a wealthy nation, so there's a lot of money sitting in the banks, sitting in yen, earning zero rates. The banks don't charge negative rates on retail investors now. I think Switzerland does, but not Japan yet. They're getting no return on their money.
Against that backdrop, and the concern of Japanese consumers to have enough money for healthcare and their retirement, there's really great opportunity within these segments to really serve the clients. There's actually a growing market, even though it looks like a quite mature market in certain segments. These are the segments that MetLife has great advantages in and has had it. We've been in foreign dollar annuities, both U.S. dollar and Australian dollars for 20 years. The Japanese consumer takes the currency risk, but they get a higher return. They're market value adjusted, so if people cash out early, we don't take a market risk on it. We have great expertise, of course, in U.S. dollar and Australian dollar investing. We've been selling foreign dollar life insurance.
We sold far less of it in the past, then we sold accident health, which is a very strong business, supplemental accident health and cancer insurance. We sell it standalone, and we also sold it as riders to yen life. Let me talk a minute about the change we've done in Japan. I think it's a good example of how we've really transformed the company and transformed this business. The standard product that was sold by our agents, our career agents, our brokers, was they would sell a yen life product to the consumer, and then they would add an accident health rider on top. Together, these had an okay return in IRR when the yen was the 10-year, JGB was positive or higher.
As we were doing our work a couple years ago and the JGB was getting down to 30, 50 basis points, we realized that that base yen life contract with a lot of commission up front and with the squeezed margins in having lower investment returns became a very long payback. Now an okay IRR, but a very long payback. With the accident health rider on top, it still wasn't as attractive as it used to be, say, five years ago. We told that business, we're not going to do this anymore, we're going to limit your capital. We're just not going to invest capital with such long payback. You got to figure out how to transform. Now, this was the core product that the agents were selling. How do you transform your core product?
It took them a couple of years, because we started 2 years ago, and we're now a leader in foreign dollar, U.S. dollar-based life contract. Sales have been kind of flat for 2 years, but the value creation is dramatically different. The IRR is much better, and the payback is dramatically better in terms of getting that cash back. Because it's not just IRR, it's payback is also really important if you're running a company to have continued free cash flow growth. This business has really transformed themselves over the last couple of years. Not an easy thing to do, but now sales are growing in the foreign dollar. We sell almost no JPY whole life anymore. We sell JPY Accident & Health standalone, and as those are growing, we're doing more market segmentation there.
We've been doing market research with Japanese consumers, to find out what they really are concerned about, how to speak to them about it, and additional services on that packaging is going on much better in Japan. Really, quite a transformed company from a couple of years ago. In addition, Japan's taking cost saves. They've moved their head office, and they're doing more cost savings across the board and invested in technology to reduce and lower costs. One example, as Steven Kandarian, our CEO, wrote in his shareholders letter this year, we're really transforming MetLife, and transforming MetLife to be a company that does well really in all market environments with good cash flow.
If I hear you correctly, then it sounds like we've already hit the inflection point there, and we're moving to better year-over-year comparisons then?
Yes, absolutely.
Okay. Thought maybe we could talk a little bit about the runoff business next, about MetLife Holdings. That business will account for about 15% of earnings, I think, post-separation. If you maybe talk a little bit about the different blocks within that portfolio and maybe what the natural runoff rate of that segment would be.
MetLife Holdings is primarily the runoff of the retail business that was sold in MetLife Insurance Company. Brighthouse is a separate company, legal entity, and that's the one being spun off. There has historically been a retail business sold in MetLife Insurance Company. It includes the closed block from pre-demutualization, includes annuity business, and has some long-term care and some other runoff blocks. Total liabilities are about $150 billion. Makes just over $1 billion a year. It's pretty sizable. About half the earnings are from annuities, 40% life, and 10% from long-term care and some other runoff blocks. That's kind of how it breaks down. We expect 2017 over 2016 for PFOs, premium fees, and other revenues to drop just over 10%, about 12% year-on-year.
That's because we sold our MetLife Premier Client Group, which was the sales force, the career sales force, and the broker-dealer, the year-on-year comparison from revenues year-on-year is down. After this year, it should go down about 5% a year, and earnings should sort of follow that path. You can see it's a very long tail business. It'll be solid and have good cash flows to it. We'll be looking to optimize that in a variety of ways. It's really about a 5% runoff.
Okay. Speaking of optimization, one idea that's been floated is the idea of transactions, reinsurance transactions, or flat-out sales. Do you see those as having potential in this market, or do you need a higher rate environment? Are there other barriers that would keep third parties from pursuing this at this point?
Higher rates help, especially the outlook for higher rates, because third parties, if they bid for it, might have a better view for this very long-term business. Again, I want to stress this is a long-term business. We would have to ensure that any reinsurance company that we did a deal with has the right ratings and the right credit exposure to it. It is complex, and there's some aspects to it that we have to get through. We have a full-time manager in charge of MetLife Holdings. It's run as a business, and the job of that general manager is to optimize value for the shareholder. Whenever you do a reinsurance deal, of course, the reinsurer takes a profit. You have to weigh the profit the reinsurer takes versus just having those cash flows on an ongoing basis. They're very steady cash flows over time.
That's the weight we have to do, and it's complex to do meaningful reinsurance transactions. We could always do something small on the margin, that's not going to be that meaningful for our shareholders. That's the balance. We will always be looking at it, and if we find something, we'll be happy to announce it to you.
Do you think it's something that's possible in this environment, or do you really need to move to another level of rates or other drivers?
I'd say we have to wait and see. We don't have anything to announce. We're looking at a lot of solutions, nothing that we can announce right now.
Okay. If we move on to talk a little bit about capital generation, capital deployment. Clearly, the profile of RemainCo will be a very different profile than Consolidated Met as we've known it. You're talking about roughly 70% free cash flow generation, about $3 billion of capital to be deployed through buybacks by the end of this year, a very high dividend yield. As we think of these different capital deployment avenues, how do you think about the prioritization of those?
Just to step back for a minute to put this into perspective, MetLife from demutualization to 2012 averaged 26% free cash flow divided by GAAP operating earnings. Some years were much higher, but there were some negatives in those years, so on average, not really high free cash flow generation. We've made it a priority to improve that over time, and we've gotten up every year, improvement every year. We were 77% last year, if you take out all the noise and transactions from the separation, and our guidance is 65%-75% going forward over the next couple of years. We think that represents some of the highest free cash flow generation in the business. Free cash flow, what we mean by that, just to be clear on the definition, it's money at the free cash flow to the holding companies.
That's dividends up from subs. If any subs need any dividends for growth, that's subtracted from it. Holding company costs, preferred dividends, and costs at the holdco, debt is all deducted. This is money that is free, that could be pay a common dividend, it could buy back shares, or it could be used for an acquisition. It's totally free. We actually publish this in our 10-K. We have a chart that you can see all the movement up to the holding companies, and if we call it free or not. We try to be very transparent on this number. That's a very important number for us, because if we feel we can generate this on an ongoing basis, it would really help overall our company.
In terms of our priorities right now, even though we'll be a smaller company post-spin, we decided to keep our dividend $1.60. We wanted to show the confidence we have in our free cash flow. We currently have a $3 billion share buyback underway. We bought back about $1.8 billion of that so far as of last Friday. In total, we're going to be near $4.5 billion return to shareholders in 2017, and we think it's a very solid return to shareholders. This is a very high priority for us, and we will continue to execute on this.
In terms of M&A, clearly we're seeing a few blocks out on the market or potentially coming out to market. Is that an area that you have appetite and capacity for today, or would we kind of have to get through the separation and look beyond that?
The separation is underway, and we'll be working on that. In the near term, any deals take a time to close anyway, of course, if you think about any life insurance transaction. We do have an appetite. We continue to look. We always look. We look for things that have to fit our strategy. We look at an acquisition no different from investing in new business. We look at the capital that goes into that, the IRR, and the payback period. We weigh how does that look versus what we can invest on our own organically. We are very disciplined in it. Our M&A team is always busy. You've seen we've only done a few deals since I've been here, and we'll continue to be very disciplined at it.
Our experience is that if you are patient, you will get some good deals come along. If you are in auctions and just pay the highest price, you may get deals, but you probably won't get a good IRR and a good payback.
Are there areas, whether geographic or business-wise, that are of our particular interest?
Things that fit our strategy. Fee-based businesses, like we bought AFP Provida S.A. in the pension space in Chile. Insurance, more insurance pure businesses. Less not market sensitive businesses. You won't see us putting in capital work for market sensitive businesses. Our goal is that MetLife, Inc. going forward will be less sensitive to the market. We think being less sensitive to the market with strong free cash flow generation and growth not only has benefits from a revenue point of view and a profit point of view, but should over time lower cost of equity. We haven't seen it as of yet, but we're absolutely convinced that over time, the cost of equity will come down. That will increase value to shareholders.
If we move to another subject that clearly has gotten some attention, derivatives. Clearly, first quarter, we saw some movement in derivatives. Last quarter and first quarter, you announced some changes in your derivative program for RemainCo. Maybe we can talk about the changes that you instituted last quarter for RemainCo.
The key focus of the changes was to better protect statutory capital, to protect the free cash flow in any one year. As interest rates rise, if you have non-qualified derivatives, the derivatives are at market in statutory, particularly your liabilities are generally a book, so you get a hit to your capital. It doesn't flow through statutory net income. It goes directly to capital. Which in that year could reduce your potential for statutory dividends in the following year. Long term, rates going up is really good. You have the better cash flows over time. Economically, your economic balance sheet is in better place, but you could get this risk of the statutory being reduced. We wanted to make sure that we protected the 65% to 75% statutory guidance. We've restructured our derivative portfolio. We've reduced some non-qualified swaps. We bought some more swaptions.
We got some more statutory hedge accounting for some other aspects of it. Overall now, we expect to be within our band of 65% to 75% from the 10-year Treasury being 1.5% to 4%. Good protection within that timetable. We expect GAAP, you can't get as much, quite as much statutory hedge accounting in GAAP as you can in stat, so there'll be a little more noise in GAAP, but the GAAP should be reduced as well from doing these changes. We think we're better positioned for the chance of a rising rate environment.
Have you extended the duration of the program as well as part of the changes?
No, it's generally about the same. It's a multi-year program. We've had these hedges on to protect from low interest rates for a long period of time. We have another whole program on VAs, which is longer-term liabilities. The duration has changed more the type of investment. If you have a swap, you protect on the downside, but you give up the upside. You buy a swaption, you buy a set price, but you give more of the upside. We have a combination of both now that we are protecting on that.
With that, should one expect more upside to actual capital if rates move up? Or is it more about protecting the capital than?
It's more about protecting the capital, it'll be less of an impact than what we saw in the fourth quarter. The key focus with statutory here is really to make sure that we have the free cash flow.
Okay. Then we have about three minutes left. I think I would do a disservice by not asking a little bit about the separation or the timing thereof. Clearly, the company's going to go through a public hearing with the State of Delaware next week. My understanding is it takes about 30 days for Delaware to make a decision after that, whether to approve the separation or not. Assuming they do approve the separation, what are the next steps for the company? Are there other regulatory hurdles that still need to be crossed? Are there other transactions or actions that the company needs to take before they can actually execute on the separation?
As Steven Kandarian mentioned in our last earnings call, this is a very complex transaction to actually execute. You mentioned the Delaware hearings that have to happen for a change in control to move the ownership of these entities to Brighthouse Financial, Inc., the holding company. There's also the Massachusetts department. As part of the Brighthouse Group will be New England Life Insurance Company, a Massachusetts company. They had a hearing last week. We need their approval. There's also a New York company, and I'll call Brighthouse Life Insurance Company of NY, been renamed, but that requires New York approval. That does not need a hearing. We have the hearing next week with Delaware, where Brighthouse executives give testimony, MetLife give testimony, and independent advisors give testimony to that. When the record is closed, the Delaware insurer has 30 days to make their decision.
There's one other important one is the SEC, the Form 10 has to be made effective. When you get all that done, you can set a distribution date, usually a couple of weeks before the actual distribution date, the stock would start trading when issued, that would be when the Brighthouse management would start doing some road shows, have some meeting with analysts to really introduce the concept to them. We get asked if it still makes sense to still do this, we think absolutely. Although the regulatory risk is lessened, with Dodd-Frank still on the books, there's always that risk. Strategically, we always said there were two reasons when we announced it some time ago, we think Brighthouse will be a well-positioned, standalone retail life and annuity provider.
It will benefit from rising rates in equity markets, it's really a pure play. We have RemainCo or MetLife, which will be less market sensitive and can do well in a variety of economic environments with growth and good cash flow. We think both of these, the shareholders can decide which ones they want to own, we're really looking forward to this. It's been a great deal of work, we are absolutely convinced that this will increase total shareholder value.
Thank you very much.
Thank you.
John. Thank you everybody for attending.