Ladies and gentlemen, thank you for standing by, and welcome to the MetLife Fourth Quarter 2016 Earnings Release Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. Instructions will be given at that time. As a reminder, this conference is being recorded. Before we get started, I would like to read the following statement on behalf of MetLife. Except with respect to historical information, statements made in this conference call constitute forward-looking statements within the meaning of the federal securities laws, including statements relating to trends in the company's operations and financial results, and the business and the products of the company and its subsidiaries.
MetLife's actual results may differ materially from the results anticipated in the forward-looking statements as a result of risks and uncertainties, including those described from time to time in MetLife's filings with the U.S. Securities and Exchange Commission, including in the Risk Factors section of those filings. MetLife specifically disclaims any obligation to update or revise any forward-looking statement, whether as a result of new information, future developments, or otherwise. With that, I would like to turn the call over to John Hall, Head of Investor Relations.
Thank you, Greg. Good morning, everyone, and welcome to MetLife's fourth quarter 2016 earnings call. On this call, we will be discussing certain financial measures not based on Generally Accepted Accounting Principles, so-called non-GAAP measures. Reconciliations of these non-GAAP measures and related definitions to the most directly comparable GAAP measures may be found on the investor relations portion of metlife.com in our earnings release and on our quarterly financial supplements. A reconciliation of forward-looking financial information to the most directly comparable GAAP measure is not accessible because MetLife believes it's not possible to provide a reliable forecast of net investment and net derivative gains and losses, which can fluctuate from period to period and may have a significant impact on GAAP net income. Joining me this morning on the call are Steve Kandarian, Chairman, President, and Chief Executive Officer, and John Hele , Chief Financial Officer.
Also here with us today to participate in the discussions are other members of senior management. After prepared remarks, we will have a Q&A session. In fairness to all participants, please limit yourself to one question and one follow-up. With that, I'll turn the call over to Steve.
Thank you, John, and good morning, everyone. Last night, we reported fourth quarter operating earnings per share of $1.28 and a net loss of $1.94. Capital market movements during the quarter, primarily the strong rise in interest rates, produced net losses in our derivative portfolio. We own derivatives almost exclusively to protect against market fluctuations in interest rates, equities, and currencies. An outsized post-election move in interest rates, characterized by the 85 basis point quarterly increase in the 10-year U.S. Treasury yield, affected the carrying value of our derivative portfolio to a greater degree than typical. Much of this is due to asymmetrical insurance accounting, which marks assets, including derivatives, to fair value, while related insurance liabilities follow an accrual-based accounting model. Despite almost all of our derivatives being used for hedging purposes, fewer than 15% qualify for hedge accounting.
A result, the change in the quarterly value of most of our derivatives flows through our income statement, while changes in the economically hedged risk do not. As in past quarters, the vast majority of our after-tax net income impact, approximately 94% in the fourth quarter, represents asymmetrical and non-economic movement that would reverse with a decline in interest rates. Despite these accounting related volatility, rising interest rates remains favorable for MetLife over the longer term. Included in our disclosure for the quarter is a slide that offers more detail on the fair value movements of our derivative portfolio, which John Hele will discuss later in our presentation. Adjusting for notable items in the quarter, operating earnings were $1.35 per share, which compares to $1.33 per share on the same basis in the prior year period.
The only notable items in the quarter were $58 million of net insurance adjustments spread across the MetLife Holdings and Brighthouse segments, and $28 million of spending in corporate and other associated with the unit cost initiative we discussed at Investor Day. Taking a closer look at operating earnings, we benefited from disciplined expense control, higher variable investment income, and a lower tax rate. Offsetting these positives were lower underwriting margins in our U.S. businesses and Brighthouse Financial. Our full year 2016 effective tax rate was 21.0%, mostly below the 22.1% estimate we provided on our third quarter call. In the fourth quarter, our effective tax rate was 17.3%. The reversal of a tax item and a timing of tax credits account for much of the difference in the quarterly rate. Our investment portfolio is starting to benefit from higher interest rates.
Our new money rate rose from 2.89% in the third quarter to 3.15% in the fourth quarter. In absolute terms, recurring investment income was flat compared to a year ago, as higher asset balances served to offset the roll-off of higher yielding securities. Variable investment income of $301 million came in just above the low end of our quarterly guidance range and was aided by another strong quarter of private equity returns. For the full year, VII totaled $1.16 billion, falling only modestly below our annual range of $1.2 billion-$1.5 billion. Looking back on 2016, MetLife took a number of actions that we believe will enable the company to perform well in a variety of macroeconomic environments. The year began with the announcement of our plan to separate a substantial portion of our U.S. retail business.
This decision to part with MetLife's original business dating back to 1868 was not made lightly, and we are confident that the separation will allow both companies to achieve greater success, with each offering a unique value proposition to investors. In March of 2016, MetLife achieved a significant regulatory victory when the U.S. District Court for the District of Columbia rescinded our designation as a systemically important financial institution, with Judge Rosemary Collyer calling the process fatally flawed. When MetLife announced its intention to seek judicial review of FSOC's decision, few gave us any chance of success. We believe our decision to contest the designation contributed to FSOC reform emerging as a key focus for policymakers. After announcing our separation plan in January, we achieved a number of additional milestones throughout the year. We chose a name for the new company, Brighthouse Financial. We appointed the company's senior leadership team.
We completed the initial filings with the Securities and Exchange Commission, and we began the process of seeking various state regulatory approvals that will be required. As you know, the separation of our U.S. retail business is central to a larger refresh of MetLife's enterprise strategy, which is part of our Accelerating Value Initiative. While strategy needs to continually adapt to the external environment, it is important to put stakes in the ground at key inflection points to show the direction the company is taking. We did this in May of 2012 and again in November of 2016. We believe the course MetLife is following toward less capital intensive and less market sensitive businesses is both clear and correct. As I said at Investor Day, capital is precious.
Our enhanced capital budgeting process ensures that we prioritize businesses with high risk-adjusted internal rates of return, lower capital intensity, and maximum cash generation. Another essential component of our refresh strategy is our commitment to operational excellence. From a cost perspective, this is driving a cultural shift at MetLife. Our expense targets are no longer absolute; rather, they are relative. If our revenues drop or our competitors become more efficient, our expense reduction targets will go up. The $1 billion target we announced in 2016 was a point-in-time estimate, and it has already moved higher to ensure we can deliver $800 million in run rate savings to the bottom line by 2020, net of stranded overhead. In conjunction with the rollout of our refresh strategy, we also launched our refresh brand. This was another pivotal decision that made 2016 one of the most transformative years in MetLife's history.
Our new logo is modern, fresh, and professional, and our new tagline, Navigating Life Together, embodies the trusted partnership our corporate and individual customers across the globe tell us they want from MetLife. MetLife closed out 2016 on a strong note with the announcement of a $3 billion share buyback program, the largest in our history. We are confident that our capital return plans will not face regulatory hurdles from the federal government. We repurchased $302 million in shares through the end of 2016 and remain an opportunistic buyer of our stock. Since year-end, we've acquired another $283 million of our shares. Looking ahead, we are encouraged that higher interest rates and the prospects for a more favorable regulatory environment, coupled with internal factors such as our new enterprise strategy, capital management, and expense discipline, will position us for value creation for both our customers and shareholders.
I would like to end this morning by thanking MetLife's employees for their tremendous effort, dedication, and focus over the past year. We are asking a great deal of them to ensure that MetLife's transformation is successful, and I very much appreciate their hard work. With that, I will turn the call over to John Hele to discuss our Q4 and full year 2016 financial results in greater detail. John?
Thank you, Steve, and good morning. Today, I'll cover our fourth quarter results, including a discussion of our insurance underwriting margins, investment spreads, expenses and business highlights. I will then conclude with some comments on cash and capital. Based on your feedback, we released additional disclosure last night labeled 4Q 2016 supplemental slides that addresses the large, more complex elements in the quarter, the large derivative loss and the low fourth quarter tax rate. I will speak to these slides later in my presentation. In the future, we will release additional supplemental slides when we have complex elements in a quarter. Operating earnings in the fourth quarter were $1.4 billion, or $1.28 per share. This quarter included two notable items, which were highlighted in our news release and disclosed by business segments in the appendix of our quarterly financial supplement, or QFS.
First, changes in DAC associated with the annual fourth quarter approval of an increase in the dividend scale for traditional life insurance policies, primarily in MetLife Holdings, along with other insurance adjustments, decreased operating earnings by $58 million, or $0.05 per share after tax. Second, severance expenses related to our unit cost initiative decreased operating earnings by $28 million, or $0.03 per share after tax. Adjusted for all notable items in both periods, operating earnings were up 1% year-over-year. On a per share basis, operating earnings adjusted for all notable items were $1.35, up 2% year-over-year. Turning to our bottom line results, we had a fourth quarter net loss of $2.1 billion, or $1.94 per share. Net income was $3.5 billion lower than the operating earnings, primarily because of derivative losses of $3.2 billion after tax.
For more details about the difference between operating earnings and net income, please reference page three in our supplemental slide disclosure this quarter. Page four in the supplemental slides shows the attribution of the after-tax derivative loss. As Steve noted, a significant rise in U.S. interest rates this quarter primarily drove this result. The interest rate impact in the fourth quarter was a loss of $2.2 billion after tax on derivatives outside our VA program, as highlighted in the slide. However, more than this amount, $2.3 billion, is what we consider asymmetrical accounting driven by current U.S. GAAP. In addition, the change in fair value of the embedded derivatives in our VA program this quarter accounted for a loss of $854 million after tax, or the vast majority of the remainder.
More than half of this total, or $467 million after tax, was due to non-performance risk, also commonly referred to as own credit. We view own credit as non-economic. In total, $3 billion out of the $3.2 billion after tax derivative loss, or approximately 94%, was attributable to asymmetrical and non-economic accounting. Book value per share, excluding AOCI other than FCTA, was $49.83 as of December 31st, down 3% year-over-year, primarily due to the impact of the derivative losses. Tangible book value per share was $41.14 as of December 31st, also down 3% year-over-year. With respect to fourth quarter underwriting margins, total company earnings were lower by approximately $0.16 per share versus the prior year quarter after adjusting for notable items in both periods.
Underwriting in Brighthouse accounted for approximately $0.10 of the total decrease, primarily due to the previously disclosed quarterly impact of the loss of the aggregation benefit in Variable and Universal Life, or VUL, as well as unfavorable mortality. Excluding Brighthouse, underwriting earnings were lower by approximately $0.06 per share year-over-year. This was primarily due to less favorable mortality experience in Group Benefits and MetLife Holdings, as well as a one-time $14 million reserve adjustment in long-term care to update assumptions on 2016 claims. The Group Life mortality ratio was 88.2%, unfavorable to the prior year quarter of 86.8%, but within the annual target range of 85%-90%. We had a reserve refinement on a small block of claims this quarter. Adjusting for this refinement, the Group Life mortality ratio was 86.9%, essentially in line with the prior year quarter.
For full year 2016, the Group Life mortality ratio was 87.2%, below the midpoint of its targeted range. MetLife Holdings' interest adjusted benefit ratio for Life products was 63.5%, higher than the prior year quarter of 58.7% due to claim severity and less favorable reinsurance on some large claims. Finally, the group non-medical health interest adjusted loss ratio was 76.2%, favorable to the prior year quarter of 77.0%, and modestly better than the 2016 annual target range of 77%-82%. For full year 2016, the interest adjusted loss ratio for non-medical health was 78.3%, below the midpoint of the targeted range. Turning to investment margins, the weighted average of the three product spreads in our QFS was 165 basis points in the quarter, up 11 basis points year-over-year.
We believe a weighted average is the better measure for U.S. spreads in our QFS, as Retirement and Income Solutions represents roughly three-quarters of the total asset base for RemainCo. Pre-tax variable investment income or VII, was $301 million, up $192 million versus the prior year quarter, driven by strong private equity performance. Product spreads excluding VII, were 133 basis points this quarter, down three basis points year-over-year. Lower core yields accounted for most of this decline. Overall, higher investment margins in the second quarter accounted for approximately $0.05 of EPS improvement year-over-year. In regards to expenses, the operating expense ratio was 23.0% and 22.7% after adjusting for the notable item this quarter related to the company's unit cost initiative.
The ratio was favorable to the prior year quarter of 24.4%, which did not include any notable expense items, primarily due to the sale of Premier Life Client Group and expense efficiencies. Overall, better expense margins contributed approximately $0.11 of EPS improvement versus the prior year quarter. I will now discuss the business highlights in the quarter. Group Benefits reported operating earnings of $174 million, up 14% and 9% adjusted for notable items in the prior year quarter. Primary drivers were favorable expense margins and volume growth. This was partially offset by less favorable mortality experience. Group Benefits operating PFOs were $4 billion, up 5% year-over-year, driven by growth across all markets. Full year 2016 Group Benefits sales were up 24% over the prior year, with strong growth across most products and markets. In addition, we are pleased with the start of the 2017 sales and renewal season.
We are seeing continued strong persistency and solid sales across our market segments, as well as in both core and voluntary products. As a result, we expect 2017 PFO growth to be at the higher end of our target range of 3%-5%, excluding the loss of a large dental contract, as discussed on our outlook call. Retirement and Income Solutions, or RIS, reported operating earnings of $299 million, up 27% and 28% after adjusting for notable items in the prior year quarter. The key drivers were higher investment margins and favorable underwriting. RIS operating PFOs were $895 million, up 5% year-over-year due to higher pension risk transfers or PRT, which can be lumpy. We closed PRT transactions totaling more than $500 million in the quarter. We continue to see a good PRT pipeline and expect 2017 to be an active year for transactions of all sizes.
Our approach will continue to balance growth with an efficient use of capital. Property and Casualty or P&C operating earnings were $43 million, down 2% and 23% after adjusting for notable items in the prior year quarter. Primary driver was less favorable auto results due to increased loss severity. Our claim frequency and average premium were close to expectations. We have been taking targeted rate increases over the last 12 months, and the fourth quarter 2016, the average premium increase on renewing customers was approximately 7%. We continue to take similar rate increases in 2017. We expect these price increases, along with other management actions, to move the auto combined ratio toward the upper end of our 2017 guidance range of 95%-100%. P&C operating PFOs were $887 million, up 1% year-over-year. Overall P&C sales were down 9% due to price increases and management actions to drive value.
Turning to Asia. Operating earnings were $354 million, up 22% from the prior year quarter and 8% on a constant currency basis after adjusting for notable items in the prior year quarter. The key drivers were volume growth, favorable market impacts, and a tax-related item in Japan. The stronger equity market in Japan and stronger dollar versus the yen helped earnings in the quarter to asset appreciation. Although Asia had a strong quarter, operating earnings excluding the one-time tax item and the favorable market conditions this quarter were in line with our guidance of $310 million ±5%. Asia operating PFOs were $2.1 billion, up 5% from the prior year quarter, but down 2% on a constant currency basis due to the deconsolidation of the company's India operations.
Excluding the impact of the India deconsolidation, PFOs were up 2% on a constant currency basis, driven by business growth in the life and A&H markets in Japan. Asia sales were essentially unchanged year-over-year on a constant currency basis, reflecting the impact of management actions to improve value in targeted markets. Sales in emerging markets were up 13%. Latin America reported operating earnings of $122 million, down 22%, but up 5% on a constant currency basis after adjusting for notable items in the prior year quarter. The key drivers were favorable one-time tax items in the current quarter and volume growth. Latin America operating PFOs were $913 million, down 2%, but up 5% on a constant currency basis. Total sales were essentially unchanged on a constant currency basis, as higher Group sales were offset by lower Afore sales. Excuse me.
EMEA operating earnings were $72 million, up 33% year-over-year and 44% on a constant currency basis. The key drivers were lower expenses through the unit cost initiative, a claims reserve release in the Gulf, and volume growth. EMEA operating PFOs were $622 million, essentially unchanged from the prior year period, and up 4% on a constant currency basis, driven by growth in employee benefits. We continue to see a favorable shift toward higher margin products. Total EMEA sales increased 5% on a constant currency basis. MetLife Holdings, which primarily consists of our legacy retail and long-term care runoff businesses, reported operating earnings of $199 million, down 25% year-over-year. Adjusting for notable items in both periods, operating earnings were down 3%, as unfavorable underwriting and investment margins were partially offset by lower expenses, including those related to the sale of MetLife Premier Client Group in 2016.
MetLife Holdings operating PFOs were $1.6 billion, down 9% year-over-year, mostly due to the sale of MetLife Premier Client Group, which included the company's affiliated broker-dealer unit. Brighthouse Financial, or BHF. Operating earnings were $330 million, down 15% and 32% after adjusting for notable items in both quarters. The key drivers were unfavorable underwriting and life reserve changes, including $44 million in the ongoing impact from the loss of the aggregation benefit for GAAP reserve testing associated with the VA and UL business, as well as lower separate account fees. The $44 million impact was consistent with our prior guidance discussed on our 3Q earnings call. However, ongoing higher universal life reserves following a previously discussed model change in Q2 were $20 million in the quarter. In addition to the $10 million guidance, there was a one-time reserve adjustment for another $10 million.
As a reminder, the Brighthouse Financial segment results within MetLife's financial statements do not match the financial statements of Brighthouse Financial, Inc. and related companies shown in the most recent Brighthouse Form 10 filing due to accounting timing differences. BHF operating PFOs were $1.3 billion, down 15% year-over-year. Excluding the impact of single premium income annuities and reinsurance recaptures, operating PFOs were down 8% due to lower fees for annuities as a result of continued negative fund flows. Excuse me. BHF continues to see strong sales growth from Shield Level Selector, which is up 45% year-over-year. Next, I would like to discuss the company's low effective tax rate this quarter of 17.3%.
As highlighted on page five of the supplemental slides, the key drivers were a revised estimate of U.S. tax on the dividend from Japan, which reversed the tax expense taken in 2Q 2016, increased tax credits, an intra-quarter catch-up adjustment, and favorable audit settlements. Excluding these items, the company's effective tax rate was 21.7% for the fourth quarter and full year 2016. The 21.7% is reasonably close to the prior guidance we provided of 21.1% in the third quarter. Going forward, the company's tax rate is projected to be approximately 23%, consistent with our outlook call guidance. I will now discuss our cash and capital position. Cash and liquid assets of the holding companies were approximately $5.8 billion at December 31, which is up from $5.6 billion at September 30.
This increase reflects the net effects of subsidiary dividends, payment of our quarterly common dividend, share repurchases, and other holding company expenses. Please note that cash of the holding companies at year-end was roughly $1 billion higher than anticipated. This was due to higher-than-projected cash of approximately $625 million, mainly due to lower collateral for derivatives and taxes, as well as timing of retail separation costs of close to $375 million, which were shifted from 2016 to 2017. Consistent with our prior guidance, we expect MetLife to receive between $3.3 billion-$3.8 billion in dividends from Brighthouse Financial prior to separation, subject to regulatory approvals. In addition, our 2016 free cash flow ratio was 48% of reported operating earnings. However, the free cash flow ratio was 77% after adjusting for notable items, excluding the impact from actions related to the separation of Brighthouse.
This was significantly above our 2016 target of 55%-65%, primarily due to higher subsidiary dividends as well as lower operating earnings. Next, I'd like to provide you with an update on our capital position. While we've not completed our risk-based capital calculations for 2016, we estimate our U.S. combined RBC ratio, including Brighthouse, will remain above 400%. Preliminary full year 2016 statutory earnings, operating earnings, including Brighthouse, were approximately $6 billion, and net earnings, including BHF, were approximately $5.2 billion. Statutory operating earnings increased by $2.4 billion from the prior year, primarily due to the favorable impact of equity markets and certain variable annuities, partially offset by lower net investment income. We estimate that our total U.S. statutory adjusted capital was approximately $25 billion as of December 31, 2016, which is down 14% from December 31, 2015.
Dividends paid to the holding company, as well as both realized and unrealized losses, were partially offset by net earnings. In statutory accounting, there is a balance sheet accounting misalignment between hedge assets and the associated liabilities. Hedge assets are marked to market. However, statutory reserves are less sensitive to interest rate changes. This asymmetry causes a reduction in statutory capital when interest rates rise. For Japan, our solvency margin ratio was 991% as of the third quarter of 2016, which is the latest public data. At the core, MetLife had a solid fourth quarter. Higher investment margins and lower expenses offset underwriting weakness in the quarter. Our net loss was largely due to significant rise in interest rates in the quarter. In total, asymmetrical and non-economic accounting drove approximately 94% of the derivative losses quarter. As Steve noted, higher interest rates are an economic benefit for MetLife.
In addition, our cash and capital position remains strong, and we remain confident that the steps we are taking to implement our strategy will drive improvement in free cash flow and create long-term sustainable value to our shareholders. With that, I will turn it back to the operator for your questions.
Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star then one on your touch tone phone. You will hear a tone indicating you have been placed in queue. You may remove yourself from queue at any time by pressing the pound key. If you're using a speakerphone, please pick up the handset before pressing the numbers. Once again, if you have a question, please press star one at this time. One moment, please, for your first question. Your first question comes from the line of Suneet Kamath from Citi. Please go ahead.
Thanks. Good morning. I wanted to start with MetLife Holdings, if I could. I don't know if you've given guidance on this, but do you have a sense of what the free cash flow conversion is out of that segment?
Hi, Suneet. It's John. We haven't given details by segment yet. MetLife Holdings, the goal of that is to optimize value for the shareholder in MetLife Holdings, including cash flow. We have work underway at that. Over time, we'll give you some more guidance on that. Right now we give you the overall guidance for RemainCo is 65%-75% on average in 2017 and 2018.
Okay. I guess on the interest rate hedges, obviously some of those hedges are going to stay with OldCo or RemainCo, some of them are going to go to Brighthouse. Can you maybe give us a sense of how much you're benefiting from the interest rate hedges now and then what the trajectory is of that benefit over the next couple of years?
Suneet-
I'm just looking it up. We have about a couple hundred million of benefit right now from the, and about just under half of that is Brighthouse today. These hedges stay for a long time. They run well into 2020 plus 2022.
That's a couple hundred million in the quarter?
Yes, a quarter.
Okay, great.
Sorry, Suneet, that's also pre-tax.
Okay, great. Thanks, guys.
Your next question comes from the line of Thomas Gallagher from Evercore ISI. Please go ahead.
Good morning. Can you comment on the net income sensitivity to interest rates? We had the pretty big loss here, and I realize your view is it's uneconomical, but just curious, would the next 80 to 100 basis point increase in rates have a similar net income loss, or does the sensitivity change? Is it not symmetrical?
Hi, Thomas. John. It depends both on the shape of the curve and how much it moves in the quarter, how these marks on derivatives move. We also have currency hedging and some other aspects to it. It's a little complex. We have instituted a plan, though. We are re-looking at our hedging in total, so we don't want to give any guidance on it now. We haven't decided how we're going to or think about it. It's kind of an interesting balance. Economically, we're better off even with these hedges from an economic balance sheet point of view, but you have this noise through the GAAP. How much do you want to spend money or change your hedging to protect GAAP.
We are examining various options because we are at these rates, and if rates go up further, we will be moving away from some of the more costly guarantees in our businesses that we may be able to modify our hedging strategy. That's still work underway.
Okay. I guess the way I would think about it is for these types of mark-to-market losses on derivatives to truly be uneconomical, I would have to think then it's not affecting your view of enterprise-wide capital adequacy, despite what sounds like some negative adjustments to statutory surplus. Can you kind of reconcile those two things and indicate whether there is at least an immediate negative impact on capital, and how you and the rating agencies would view that?
From a pure mark-to-market economic balance sheet, MetLife is better off end of the year than in the third quarter and second quarter. The accounting does have timing issues sometimes. There is, as you can see, there are some effects statutory capital, but we still have our guidance and reconfirming our $65-$75 free cash flow for 2017 and 2018 for RemainCo on average over 2017 and 2018. It hasn't changed that amount. Long term, it's very good for the business when you think about the net present value of cash flows.
Got you. Then just one final one related to that is, I get the rate hedges related to the VA business, can you comment a little more broadly, since most of the loss was outside of VA, at least the accounting loss, is it mainly universal life insurance related hedges? Is that related to your pension business? Can you provide a little more granularity for what exactly it is in terms of the liabilities that you're hedging there?
These were general interest rate hedges purchased over years to protect against low rates across the board. In particular, we do have some long liabilities, long-term care, for example, that these protect against and some other longer liabilities. That's what it's protecting against, we've had them for a long time, they've reduced the income for us in a very positive way. As rates go up, they produce less income now, they do have this mark-to-market to the balance sheet through this asymmetrical accounting. That's why it's a big piece of it and less in the VA book.
Okay, thanks.
Your next question comes from the line of Seth Weiss from Bank of America. Please go ahead.
Hi. Thank you for taking the question. I understand the balance sheet implications of the accounting asymmetry of the derivative book. Just want to see if you could kind of reiterate your view on the near-term earnings impact from higher interest rates and just want to double check that it's necessarily a positive with rates moving up and more specifically, could you categorize what the impact to earnings is from what you're losing of what's being kicked off on the derivative book from higher rates and how that is immediately offset by the earnings impact of the in-force business and how to think about any timing lag that may exist between those two forces.
Well, there is an impact. It depends on how rates go up and how the shorting goes up. The shorting can affect the derivative income. If we had a 100 basis points increase in rates affecting operating up right up from where we are now, you have the positive from rising rates and the reinvestment of the portfolio, and you'd also have less derivative income. If it spiked up today, the sensitivity would be kind of a wash in 2017 at about $100 million in 2018 and $150 million in 2019.
Okay, thank you. Then if we think about the book value basis, is there a way to separate out the value of the derivative portfolio from book value just to get maybe a cleaner sense, a more consistent sense of what book value is, sort of similar to what you do with maybe the FAS 115 adjustment or the FCTA adjustment?
That is complex. You have to go way back and where do you start and how do you do the calculation? I think unfortunately, the answer is you have to wait till the accounting is modified at some point in the future. It's been about 10 years we've been working on it, the hope is to have a better balance sheet for insurers and this work by FASB underway to move towards that.
Okay, thank you. You can't give just an EPS per share amount of what those derivatives, the net position is what today?
Well, the total values are disclosed in our balance sheet, you can divide by the number of shares outstanding. To try to equate to get to the true book value, the true economic value of the firm, you'd have to adjust the liabilities. That's what I mean. It's not a useful number because you don't know the true economic value of the liabilities to really figure out what is the true economic book value.
Okay. All right. Thanks a lot.
Your next question comes from the line of Jimmy Bhullar from JP Morgan. Please go ahead.
Hi, good morning. First I had a question just on your Latin America business, and specifically on Mexico. Your sales in the business were pretty weak, I think mostly related to weak Afore volumes. If you could just discuss how economically sensitive the business is, I think significant portion of it is group sales. How susceptible are you to potential weakening in the economy in Mexico?
Hi, Jimmy. As we've closed the quarter, in general terms, revenues are 5%, fine. We have weaker Afore sales in Mexico, which you know is a fee-based business, impacting in lower sales are not necessarily directly correlated with the top line because it's fee business. In terms of the impact in the economy, obviously we're closely monitoring how the situation evolves, including discussions about NAFTA. I have to say that our business model in Mexico is totally unrelated to any trade agreement. It's just tied to the general economy and the evolution of the market. We normally grow in similar rate to the market growth rate.
Just on the Brighthouse business, if you look at your sales of the two major products, annuities and individual life insurance, they're both weak a lot and part of it's distribution, which isn't going to really change. How do you think about the growth outlook for that business down the road, given that it seems like annuity flows are going to be negative for a while even with growth in the Shield product and it's just the individual life book seems to be shrinking?
Hi, Jimmy, it's Eric. I really can't talk about outlook right now, but I can give you a little sense. Look, where we are in the fourth quarter is right around where we thought we would be. What I'd call the normal variable annuity business, obviously there has been an effect from DOL. You've seen that on other competitors as well. The life business we kind of expected as we sold off the MPCG field force, and they shifted to their new company. The Shield sales are fantastic, up 45% quarter-over-quarter. We're seeing some momentum in, I would say, what I'd call our normal VA business. We continue to see momentum in the Shield business, the life business was clearly weak in the fourth quarter and we'll have to work on that in incoming quarters going forward.
All right. Thank you.
Your next question comes from the line of Sean Dargan from Wells Fargo. Please go ahead.
Yeah. Thanks, good morning. I want to follow up on something John mentioned around the FASB proposals for long-term insurance contracts. If I understand them correctly, insurance liabilities would be fair valued every quarter. Is that something that MetLife supports?
Hi, Sean. We're very active with the FASB on this. The concept makes a lot of sense. The devil is in the details. The big question is what interest rate do you bring the liabilities back at? There's a lot of discussion with the FASB on that, and that work is still underway. A lot of the changes, though, would flow through, I think the proposals flow through AOCI and not give noise to operating earnings. You'd still be able to see kind of the operating earnings piece, and the noise would flow through the AOCI.
Okay, thanks. I have a question about proposed tax reform. If U.S. corporate taxes get lowered, how do you think the industry and regulators respond? Would you target an after-tax return and cut pricing, or do you think the industry would as a whole, or do you think regulators would require pricing cuts?
Sean, it's Steve Kandarian. It's pretty hard to answer a question right now about tax reform because it's so early stage. Chairman Brady of the House Ways and Means Committee has a blueprint out. We'll have to see where that goes. There's been some support for it. Now the reporters of the economy are concerned about the border adjustability component. Still a lot of knowledge has to be gained in terms of how that will actually work and what the details will be. It's really premature for me right now to say how it would affect those factors.
Okay, thanks.
Your next question comes from the line of Erik Bass from Autonomous. Please go ahead.
Hi, thank you. Can you comment on the expected earnings run rate for MetLife Holdings and if there's any residual impact from the items you highlighted this quarter?
Erik, this is John. The guidance we gave at our outlook still applies for next year. There was noise this quarter and some worse mortality than we had thought. We had two large claims that flowed through, but we would stick with the guidance we gave you at our outlook call.
Okay. On interest rates, you mentioned the rise in new money rates. How much more would rates need to rise to sort of get you towards where your portfolio yield is and eliminate the drag from spread compression?
You highlight one of the sensitivities, Erik, this is Steven Goulart by the way, the way we look at it is if you were to hold all spreads constant across asset sectors, what has to happen to the 10-year Treasury, which is the primary indicator for where we're investing. It's approximately about a 3% U.S. Treasury rate at 10 years. Again, it's assuming all spreads stay the same, that would be about where we would hit our break even on reinvesting.
Got it. Thank you. I guess when you hit that point, would you expect to get some spread benefit initially before having to share that with policyholders?
I think we'll have to wait and see. It'll be nice so to not have spread compression that we've been fighting for years. We look forward to dealing with that issue going forward.
All right. Thank you.
Your next question comes from the line of John Nadel from Credit Suisse. Please go ahead.
Hi, good morning. Just a question. I am thinking about the 2017 outlook and taking into account all the moving parts in the fourth quarter results at the segment levels. Are there any segments, where you would say the baseline that you identified six or seven weeks ago that you talked about back in December, where the baseline has changed materially on sort of a core basis, where we need to adjust our expectations for 2017?
Hey, John, it's John. That's a good question. No, we would not adjust our outlook and we would try to tell that to you if we had a change to our outlook. Thanks for the question.
Okay. Then, second one is just, can you give us an update on any asset adequacy reserve additions of any note for 2016 year-end?
Well, actually, with interest rates going up, we've not had to add to asset adequacy reserves. We have better buffers now with the rise in rates, and look forward to a future of not having to add to those for a while. This has been, as I said, it's economically very favorable to MetLife with the rise in rates.
Last one real quick. You didn't give an update, and I suppose that means nothing's changed, but can you still confirm that the spinoff is expected to take place in the first half?
Hey, John, Steve. Yes, our target's still the first half of 2017 for the Brighthouse separation.
Thank you.
Your next question comes from the line of Ryan Krueger from KBW. Please go ahead.
Hey, thanks. Good morning. John, you mentioned $625 million benefit to the holding company cash position. Is that something that you would view as a permanent benefit or should we think about that as potentially reversing?
Some of that was tax, which we have. We have the cash. Another piece was collateral for derivatives. Depending upon what happens to currency and interest rates, the collateral postings can change. We'll just have to wait and see on that piece of it.
Okay. On Brighthouse, could you just quantify, I guess, for the quarter, how much weaker were the underwriting results relative to what you would have expected?
Hi, it's Eric. I would say about $19 million. I would say this comparison, fourth quarter of 2015 was a very good underwriting quarter for us. Whether you look at what we expected or maybe an average run rate over eight or nine quarters, it was a very good underwriting quarter. This quarter, fourth quarter 2016, while it is weaker maybe than we expected, slightly weaker than we expected, over the last eight quarters, it's right on the average. Similar to what MetLife experienced, a little bit of severity, and a little less ceded, but despite the fact that it cost us some earnings, not that far off of what we expect.
Okay, great. Thank you.
Your next question comes from the line of Kinner Lakhani from Deutsche Bank. Please go ahead.
Good morning, everybody. John, I think you reiterated the free cash flow target of 65%-75% for the next couple of years. Would it be fair to expect the free cash flow conversion to be a bit on the lower end for 2017 and then maybe more of a catch-up in 2018, just given where the statutory capital and earnings are today and then the separation costs?
I think I understand your question, free cash flow has a lot of moving parts to it, and it is a bit volatile from year to year. We give you an average over 2 years, and we are confident in our range of 65-75, I can't give you an individual year target.
Directionally, would it be fair to expect maybe free cash flow moving up as the year moves on?
Directionally, I'm reiterating our range.
Okay.
That's all I can do at this time. It is a bit volatile from time to time.
Okay. Then in RIS, if one excludes the pension risk transfers, I think PFOs were actually came under some considerable pressure this quarter. Can you maybe talk about that a little bit and maybe also add any color or any extrapolation that you may see for that into 2017?
Sure, this is Maria Morris. Obviously RIS has a number of different products as part of it. It was our institutional income annuities block that was down this quarter-over-quarter. We are in a process, as you know, of balancing kind of value and growth in this marketplace. We're comfortable with where we ended up and going into next year, we have focused plans on each of these markets. In the income annuities business, we are seeing some increase in different sponsors interested in this product line. We do believe that we'll go back to traditional growth in the future.
Thank you.
Your next question comes from the line of Randy Binner from FBR Capital Markets. Please go ahead.
Hey, good morning. Thanks. I wanted to talk about just expenses and confirm that the overall expense savings initiative of the $800 million is still on track. I think it is, but more specifically, I think that you talked about in December costs associated with the expense initiative, $300 million pre-tax in 2017. Is that still on course now that we're in 2017? Is there any update or color you can give us on how the timing of that $300 million of costs associated with the expense initiative is going to come in in 2017?
Hi, Randy. It's John. Yes, we are on track to the outlook we gave you for the cost saves. As you remember, we spent a lot in 2017 to get the savings later on, a lot of technology and investments. It is spread out throughout the year, perhaps a little more in the second half than the first half. We will isolate these for you each and every time so you can see these pieces of what the investments are to create the savings.
Okay, thanks. Just a quick one. I wanted to cover the long-term care. There's a little bit of an adjustment in holdings. Can you just give a quick update on what the behavior versus interest rate assumptions were there that changed? Was it mostly interest rates that changed?
No, in long-term care, we adjusted the claims we had in 2016. We updated at the end of the year for those claims what we were seeing. We were seeing a little less termination of those claims, so we had to adjust the reserves on that. It's a small amount relative to the total size of our long-term care. Remember, we have about $10 billion of GAAP reserves on this business, about $13 billion STAT. This is a small change within the total and only affecting the 2016 claims.
Perfect. Thanks.
At this time, there are no further questions.
That brings us close to the top of the hour. It's a busy morning. Thank you to everyone for joining us, and we look forward to speaking with you during the quarter.
Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.