Good morning, everybody. I will start today. I'm Yaron Kinar, Deutsche Bank's North America life insurance analyst. With me today, very pleased to have Steven Kandarian, MetLife's CEO. Met being one of the prominent life insurance companies worldwide with strong operations here in the U.S. and internationally. We'll kick it off with a few opening comments from Steve.
Thanks very much. I just have an opening statement to make before we get started with the fireside chat. I just want to inform you that we are accelerating a portion of our annual actuarial assumption review of the variable annuity business from the third quarter, which is when we typically perform this analysis, to the second quarter. Specifically, we're looking at policyholder behavior assumptions. In connection with the planned separation of a substantial portion of our U.S. retail segment, it is necessary to have a complete understanding of the financial condition of the company. In furtherance of this objective, we are reviewing these important assumptions one quarter early. As a result, I will be unable to answer questions about VA policyholder behavior and capital requirements for the VA business.
Thank you. I think it would be an understatement to say that things have been quite busy at Met the last few months. We have a very significant court ruling on your SIFI designation or your challenge of it, which the company won. We have the separation that you just mentioned. We have the Accelerating Value initiative. Hopefully, over the next 30 minutes or so, we can go over many of these items and still open the questions up for the floor later. Maybe we can start with the SIFI and designation court ruling. As things stand now, the court sided with your challenge. The government is challenging this. Will the circuit court rehear the case, or solely rule on whether there were errors or issues with the previous ruling?
As mentioned, MetLife contested its designation as a non-bank systemically important financial institution. We made that challenge under Dodd-Frank, which has a provision that enables a company that disagrees with FSOC's decision to go to the federal district court, either of your home district or the district court in the District of Columbia. We took our case to the District of Columbia District Court, and on March 30th, Judge Collyer ruled in our favor on three of the 10 counts that we brought in our suit. She ruled against us on one of the accounts, more of a technical issue, whether or not we qualified as a non-bank financial institution under the statute. But the other six counts she didn't rule upon. She didn't feel she had to. She already had other accounts which she felt were adequate to rescind the designation.
The federal government had 60 days to appeal that decision. They actually went to court very quickly after 9 days and filed their appeal, and that process has now begun. The briefing schedule has been set by the Circuit Court for the District of Columbia, which is, of course, one level above the district court. That court will hear de novo all 10 counts that we brought, including the 6 counts that the judge did not rule upon in the district court, and to review the 4 counts that she did rule upon. The briefing schedule is that FSOC's briefs will be filed on June 16th. MetLife will reply by August 15th. FSOC will have one last reply brief to our brief, which is due on September 9th. An oral hearing will occur at some point after that.
Typically, oral hearings are at least 45 days out from the final briefing of September 9th. The court will, of course, rule at some appropriate time after the oral hearing.
While this hearing is taking place, and while we're waiting for the final adjudication, can FSOC start a redesignation process of the company?
FSOC could do that. They could appeal the case as well as try to redesignate us with a new process. The process that we went through initially took over a year from the beginning of what's called phase 3, when they come forward to us and ask us for information that's not in the public domain. I think it's unlikely that the federal government would be appealing the court value, the lower court decision, while at the same time bringing forward a whole new process. My guess is they won't attempt to appeal and simultaneously try to redesignate under a process. The process, again, took well over a year from the time we were notified that we were in stage 3.
It is unclear how long the court will take to rule. They are on an accelerated schedule, probably more likely that the court case will be decided faster than how long at least FSOC went through the process the last time with us from start to finish.
Okay. While we're waiting for things to shake out, whether in the court system or for FSOC to make a decision on redesignation or not, were there any changes in your strategic view or view on capital, or will you continue down the path that you have been the last few years, and wait for that to finalize?
The uncertainty is still out there in terms of potential designation of MetLife. We feel very good about the judge's decision at the district court level. We think it's very well-reasoned. We think there's very strong facts on our side. That's why we brought the case in the first instance. There is an appeal going on, and there's also the ability, as long as the law Dodd-Frank exists, for this FSOC or some future FSOC to attempt to redesignate MetLife at a later date. We have to be mindful of that when we think about our capital.
Okay. Looking at the actual CCFS framework, we've been hearing a few voices coming from the Fed recently that we may actually see some framework come out in the next few weeks. Specifically, we heard Daniel Tarullo talk about an insurance-oriented US GAAP-based consolidated approach to determine enhanced capital requirements. Could we hear your view on this consolidated approach, and specifically maybe on this being GAAP-oriented?
Well, we'll wait and see what the notice of proposed rulemaking actually says. My understanding is that they will be issuing that on Friday of this week. We have been putting forward an approach that we call aggregation and calibration. That means basically taking the systems that are in place already in terms of regulatory capital regimes and aggregating them and then calibrating them based upon differences between different regimes. For example, if you're like MetLife doing business in Japan as well as in the United States, you look at those two different systems, you aggregate them, and you calibrate for those differences between the systems. You kind of roll it up to the holding company as well. We'll see how the rulemaking comes out. We'll see that very shortly.
There have been some comments coming out of the Fed I think are overall fairly encouraging.
One set of comments I heard actually came from Tom Sullivan talking about more of a bank-like approach, at least to manage liquidity risk. How do you view that approach with regards to an insurance company like yourself?
There's major differences between banks and insurance companies on the issue of liquidity. You don't see the typical kind of run-on-the-bank scenario occurring with an insurance company. We do have some liabilities that are more liquid in the sense that our customers come back and ask for their money or cash and policies. There's many of our policies that are illiquid until there's some event such as death or disability or something of that nature. It's a very different business model between banking and insurance on the issue of liquidity. It's also very different in terms of how we capitalize ourselves and how we fund ourselves. I think it's important that whatever the Fed comes up with in terms of liquidity or liquidity stress tests, that's appropriate for the insurance business model and is not bank-centric.
Do you see any sources for liquidity risk specifically at MetLife, or are there any protections that you can take to mitigate that risk?
We do have some liabilities that are much more liquid, that can be, in essence, put back to us. We have a great deal of liquidity at the company. For example, we have over $55 billion of U.S. Treasuries in agencies. We have close to $25 billion of cash and short-term investments. In addition, we have normal flows of premiums coming into the company, as well as investment income. We have a lot of liquidity at MetLife, and we run our own liquidity stress tests on a regular basis, and we feel that we have more than adequate liquidity at the company.
I think maybe we'll move on to the next big theme, separation or the separation plan. I realize you're limited in what you can say about it, but maybe we can start off with one question on just the strategic view of this plan. Ultimately, the main entities that will be separated are the retail entities. With that, you will basically separate yourself from a lot of mortality business at a time that life expectancy keeps improving on a multi-year trend. Is that multi-year trend of improving life expectancy not compelling enough to remain in the retail life business?
The separated business will remain in the mortality business, but the reasoning around the separation was driven by other factors. There was a couple of key issues that we were focused on. As we did our Accelerating Value strategy work, we were trying to find where our business had the best profile in terms of both free cash flow generation relative to the less capital-intensive businesses, growth prospects, and the ability to have a higher return than your cost of equity capital. As we looked at that, and we looked at it in the context of the competition, the structural nature of the businesses that we're in, we decided that that U.S. retail business could best thrive and be sustainable long term as a separate unit.
With a much lower cost structure, a fair amount of outsourcing, spinning off the captive agency workforce to MassMutual which would lower our costs and still enable us to distribute through agents as well as third-party distributors, now the MassMutual-controlled agents. The other factor that we took into consideration was the regulatory environment. People have said to me, "Well, if you win your case and you're feeling confident about the appeal process, why is that still a factor?" The answer is that even if you win your case, if you win the appeal as no longer being designated as a non-bank SIFI, as long as Dodd-Frank exists as a law, a future FSOC can attempt to re-designate you at a later date.
Even if you're successful in not being designated or having your designation once again rescinded, if you go to court, that cloud still hangs over the company for the foreseeable future in terms of, what if you're designated and what are those capital rules going to look like, and how much of an impact will those capital rules have on that particular business, which tends to have longer assets and longer liabilities, which most people feel the most impact from the Fed rules that we're about to see for the first time. Given both strategic factors as well as regulatory factors, we felt it made sense to separate that business out. That business will continue in a separate form. We sell retail insurance products around the world, and in those markets, we certainly are involved in insuring against mortality.
We're still in that business, the mortality business. I just would add one last comment, which is, of course, we're in annuities and life insurance, and one benefits and one doesn't benefit from longevity, but we certainly take into account projections about extended longevity in both those businesses.
You had mentioned that you would continue selling this business around the world. Can we maybe focus a little bit on the around the world portion? I think post the outlined separation plan, about 40% of earnings will come from international business. Can you maybe talk about how you think about the growth of the risks in these businesses post-separation?
We made a decision at MetLife really back in the early part of the 2000 decade to expand outside the U.S., our home market. We did that both organically and through acquisitions. The first major acquisition that gave us a more meaningful footprint was the Travelers acquisition in 2005. After that acquisition, we were in 17 countries. After the ALICO transaction, a division of AIG that we acquired in 2010, MetLife ended up in many more countries. Now I think it's 46 countries that we operate in. As you mentioned, after separation, roughly 40% of the business will be non-U.S. Many of those markets are developing markets with faster growth rates, more nascent insurance businesses, largely protection-oriented kinds of products, lower capital intensity, less risk in terms of market sensitivity to things like interest rates and equity market levels, but more geopolitical risk.
Maybe in a country where changes in regulation or instability of some sort creates a different kind of risk than you have in the U.S. We do a lot of analysis before going into those markets. We do a lot of analysis even once we're in those markets, if we see changing conditions occur. We've exited markets based upon our assessment of desirability of doing business in various markets. We like being in faster-growing, protection-oriented markets that are still in the developing stage. We're mindful of the geopolitical risks, and we measure those all the time, and we take actions on an ongoing basis in terms of making sure that the amount of capital we put at risk in any one market is reflective of our assessment of the desirability of that market.
Speaking of capital, you had moved, I think, a billion and a half dollars of capital into MetLife USA, which is one of the entities that will be part of NewCo. Can you explain why you did that, and do you believe that more capital will be needed?
We had really earmarked with the holding company a billion and a half dollars of capital for that VA business for MetLife USA. As we announced the separation of that business, we felt it made more sense to drop that capital directly down into that subsidiary. The reasoning was twofold. One was to indicate to rating agencies that we intended to well-capitalize the separated business. Also to indicate to distribution partners the same thing, that the entity be well-capitalized and be a strong entity that have a sustainable and strong future. That was the reason for dropping the capital down into MetLife USA.
Do you believe that more will be needed down the road, or do you find it well-capitalized as is?
I'd have to defer on that and wait until we finish the work we're doing that I just announced at the start of our discussion. We're doing a lot of work with third parties to assess the business and making sure that the entity, when separated, is well capitalized.
Excuse me. Along with the announcement of the separation plan, you also announced that you were suspending buybacks for the foreseeable future because you were in possession of material non-public information. Are there any that may drive such a decision or would allow you maybe to deploy capital at a later date?
Liquidity as well as just making sure that we're well capitalized, both of the spun entity as well as RemainCo. The work is ongoing. We've engaged investment bankers. Our internal teams are working on this, and we hope to file an S-1 over the summer. We'll know more in terms of how these entities are going to be capitalized, and we'll know more late this year or early next year in terms of how the actual execution will occur, in terms of an IPO or a spin or an IPO of a split or a spin later. Various different combinations can occur. You'll have to see both in terms of the work we're doing about the adequacy of the capital for the different entities, as well as the work we're doing around the actual execution, the form of the execution of the entities.
As you're going down this process, as we think of buybacks, should we not expect buybacks to resume until the process is completed? Or are there way points along the way that would possibly allow you to resume buybacks earlier?
Well, we're still in the early days of assessing our capital needs. I don't have anything I can add to my earlier comments about working on this separation. Which to us is the most important task in front of us, to make sure we do this as well as possible, because there's a great deal of value to be created for our shareholders by executing properly. That's our focus right now. We have said for quite some time that excess capital belongs to our shareholders in the form of share repurchases, dividends, and then acquisitions that make sense from the point of view of both strategy and clearing a cost of capital hurdle. That is our philosophy, that excess capital will go to one of those three purposes. For now, our focus is on making sure we properly execute the separation.
As you go through the process, and we're still in the early stages, have you seen a negative impact on retail sales the last few months?
The retail sales are close to plan. I think we had some comments on this at our first quarter earnings call. We did have one major distributor that pulled back from distributing for the U.S. retail business based upon uncertainty around the separation in their mind. We're hoping that we can bring them back into the fold in terms of being a distribution partner. The MetLife agents that still remain agents as of now are working hard, making sales. Third-party distributors are still selling for us, with the one exception I mentioned. We will have an agreement with MassMutual that's acquiring our agent workforce to distribute products for us on a white label basis. They'll be getting our 4,000 agents. They have another 5,600 agents of their own. Those 9,600 agents become another channel for us to distribute through.
We feel good about our ability to sell through our existing channels and new channels.
Finally, on separation, did the rating agencies give diversification credit for the variable annuity business? If so, how much does the separation ultimately hurt the value of the company or RemainCo?
The diversification benefit for the business that's being separated, and that's largely from the variable annuity book that I think that is the key factor here, had some impact on the diversification calculations that are utilized. In my judgment, that's going to pale in comparison to separating out what many feel are market-sensitive tail risks associated with that business. Again, that was one of the factors that we looked at when we made the strategic decision to separate out the U.S. retail business, was that having a large variable annuity book seemed to result in a discount to our stock price more than if we didn't have the large VA book. I think the benefit of separating that out will outweigh any kind of diversification benefit that may come from the variable annuity business, really.
Excuse me. We'll move to the last theme, the Accelerating Value initiative and free cash flows. I think you touched upon this earlier, maybe you could remind the audience what the Accelerating Value is?
Sure. Accelerating Value is really the next stage of our ongoing strategy work, and it's much more micro than the original strategy that we rolled out in 2012. It really gets down to specific markets, market segments, customer segments, geographies, products, and looks at which businesses generate sufficient free cash flow, looks at payback periods, looks at clearing cost of equity hurdles, and makes judgments about what we should be doing in terms of capital allocation. One of the first outcomes of that work really was related to this separation of the retail business that we've been discussing. That was one of the key factors behind the decision to separate out the U.S. retail business, was the work around Accelerating Value.
It focuses on looking at your customers, taking care of their needs, providing them value for the products that they buy from us in this low interest rate environment, which is a key factor. It looks at the competitive landscape, where can you compete to win, and then looks at generating free cash flow, return to shareholders or to use to make acquisitions that are accretive.
Have you identified other businesses other than retail that don't necessarily fit the Accelerating Value framework, both internationally and in domestically?
Well, the Accelerating Value work has resulted in really all of our businesses making adjustments to what they do. For example, in Japan, we had a single premium accident health product that had a very long payback, relatively low ROEs. That got called out through the Accelerating Value work. We have stopped selling that product. There's other products in Japan that have been modified to have better cash characteristics in terms of how we distribute those products and how we reward agents and financial planners to sell those products. In terms of we're replacing our bets in as to capital, that's driving a lot of our thinking as well. Those businesses that have faster paybacks, more free cash flow, will get more capital allocation going forward.
There will be instances where you are providing a suite of products, and some products may have more attractive characteristics under these measures than others. Overall, the emphasis will shift in terms of capital allocation to those businesses, those products, those segments, that increase free cash flow, that have good growth characteristics, and that clear its cost of equity hurdles.
Domestically, is the capital markets-oriented corporate benefit funding business, does that fit the initiatives framework?
I think it does. All parts of our businesses are getting a lot of scrutiny. There'll be parts of corporate benefit funding as well as any of our businesses that will have to make adjustments to meet the criteria that we now have in place. Certainly capital markets businesses have been very attractive. The returns are high. They're in the mid-double digits overall, teens, I should say, mid 15%, 16% kind of range. In addition, those businesses are relatively short in nature. They roll over fairly quickly, so you can make adjustments. Even in a low interest rate environment, as long as you have a spread, you still can do quite well in those businesses. Much of the corporate benefit funding, I think, will continue on as it has pretty much in the past.
Internationally, I think the Asia segment generates a low teen ROE. The EMEA segment generates a mid-single digit ROE. Do you think that the initiative will ultimately help with improving the ROEs in these two segments? Are there other maybe structural issues that prevent that from happening?
We find there to be very attractive markets in both those regions, EMEA and Asia. There's other segments that we are pulling back from. Already mentioned some things around the Japanese business. In the EMEA region, we pulled out of some traditional variable annuity products in the U.K. a few years back. We pulled out of the pension transfer business in the U.K. a few years back. There's other segments that we think are attractive in those regions, and we've begun a lot of work around driving new products into those markets. The EMEA and Asia regions also are impacted in terms of ROE by the intangibles related to the acquisition of ALICO. For example, EMEA's operating ROE is 7.2%, but on a tangible basis it's 13%.
EMEA has a lot of leverage to it in terms of these new products coming on stream we think could be quite successful, and we could see those ROEs go up significantly. Asia has an ROE of 12% on an operating basis, 20% when you take out the intangibles. Both regions have attractive markets and have segments where we think we need to pull back, we have. Overall, we're committed to both those regions.
Why don't I take a little break and open up the questions for the audience. You can just raise your hand if you have a question. All right, I'll continue then. As you look at the Accelerating Value framework, what impact, if any, does it have on your investment decisions and asset allocation?
Accelerating Value, as you mentioned, has a real focus on predictable free cash generation of our businesses, and investments also is looked at closely in that regard. We have taken a look at optimizing our portfolio with that in mind and looking at how much capital is allocated to certain parts of the portfolio. Obviously, the riskier parts of the portfolio require more capital being put aside, and some segments within those higher risk, higher potential returning asset classes have had some choppy results. We've talked about this before, hedge funds, even parts of the private equity portfolio. We like the real estate equity business, but we have to decide how much of that we have in the portfolio, given our Accelerating Value metrics. We've decreased our allocation, about $5 billion roughly in those segments.
We reallocated largely into other segments that require less capital and have more predictable income streams to us, including structured finance, mortgages that we originate, real estate mortgages. Those kinds of assets now are kind of picking up a little bit of the slack of what we sold off, and it's really more of a rebalancing. It's not an exit from some of the higher returning, higher capital intensity asset classes.
I think I'll have time for one last brief question. I think the company reentered the third-party active management business, which seems to be a good fit with the Accelerating Value initiative. What is the size of the business today? Where do you see it going? Do you think M&A will be one avenue for growing that business?
We call our third-party asset management business MetLife Investment Management. It has $43 billion as of end of last quarter under management. It relates to a couple of different asset sectors where MetLife has significant expertise and excess capacity to be able to run third-party monies without negatively impacting our work on the general account investments. That would be real estate equity, real estate mortgage origination, private placements, and index funds, which we've had internally for quite some time. That business is growing. It's a fee-oriented business, obviously, and low capital intensity business. It's a business we like to do more of to balance off the other risks we have in our portfolio. A related business that we acquired in 2013 was the pension fund administration business in Chile called Provida. Again, that's a fee-oriented business, low capital intensity.
It was a very attractive asset that we were able to pick up at a good price that generates very good returns to us. We are always looking out for potential acquisition opportunities that would meet our thresholds in terms of returns in excess of our cost of capital and generating fee income that we feel is predictable and sustainable going forward.
Thank you very much, Steve. I think we're just out of time. Very much appreciate you coming.
Thank you very much.