Ladies and gentlemen, thank you for standing by. Welcome to the MetLife First 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 Ed Spehar, Head of Investor Relations.
Thank you, Greg. Good morning, everyone, and welcome to MetLife's first quarter 2016 earnings 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 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.
After their prepared remarks, we will take your questions. 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'd like to turn the call over to Steve.
Thank you, Ed, and good morning, everyone. Last night, we reported first quarter operating earnings per share of $1.20, which compares to $1.44 per share in the first quarter of 2015. The negative impact from market factors more than offset a benefit from volume growth. The combination of weak equity markets for most of the quarter, continued strength in the U.S. dollar, and low interest rates reduced operating earnings by $0.16 per share versus the prior year period. In addition, variable investment income, or VII, declined by $0.12 per share. Variable investment income can be volatile, largely because it is driven by the performance of alternative asset classes. We believe some earnings variability is an acceptable risk, as these asset classes have provided strong returns to MetLife shareholders over time.
To illustrate, VII was better than planned in seven of the past 10 years, with a cumulative positive variance of $505 million after tax. This Favorable performance to plan is noteworthy given that the time period includes the financial crisis. Despite the sluggish global economy, we estimate overall volume growth was 3% year-over-year, driven by 11% growth in our non-U.S. businesses. In addition, the value generated from new business written has improved as a result of our Accelerating Value strategic initiative. For example, in Japan, our second largest market, foreign currency denominated product sales were up more than 50% in the first quarter. We are focused on growth in this area because non-yen products have very attractive cash return characteristics. In contrast, yen whole life sales were down 60% in the quarter.
This sales decline was intentional, as it is difficult for this product to generate attractive returns and acceptable cash payback periods in a negative interest rate environment. Overall, top-line growth is a challenge in the current low rate environment. However, as I often tell my team, external factors are beyond our control, so we must focus on what we can control. In this instance, to combat the pressures of growth from low rates in a weak macroeconomic environment, we must address our cost structure. It is critical that we achieve a sustained reduction in unit costs, and our top priority is addressing elevated overhead expenses that will result from the separation of the U.S. retail business. It is too early to provide specifics on expense reduction, but we believe that the separated business and the remaining company combined will have a lower cost base than MetLife does today.
Now, I would like to provide an update on regulatory matters. On March 30th, Judge Rosemary Collyer of the United States District Court for the District of Columbia rescinded MetLife's designation as a systemically important financial institution or SIFI. In a carefully reasoned decision, Judge Collyer found that the Financial Stability Oversight Council's designation of MetLife was arbitrary and capricious. Her ruling said that FSOC had failed to, one, conduct a vulnerability assessment of MetLife as required by FSOC's own regulations and guidance. Two, adhere to any discernible standard in determining that material financial distress at MetLife could threaten U.S. financial stability. Three, consider the consequences and costs of designation as required by Supreme Court precedent. None of these is purely a procedural matter.
For example, the judge noted that FSOC defined a threat to financial stability as one that would, quote, "sufficiently be severe to inflict significant damage on the broader economy," unquote. Yet rather than apply its own standard, the judge found that FSOC, quote, "hardly adhered to any standard when it came to assessing MetLife's threat to U.S. financial stability," unquote. She said she could not uphold a finding for MetLife's distress, a finding that MetLife's distress would damage the broader economy when, quote, "FSOC refused to undertake that analysis itself," unquote. On April 8th, FSOC appealed the judge's ruling to the United States Court of Appeals for the District of Columbia Circuit. In MetLife's initial legal complaint filed last year, we offered 10 reasons or counts as to why our SIFI designation should be lifted. Judge Collyer ruled in favor of MetLife on three of those 10 counts.
She rejected our argument on one count, the technical question of whether MetLife qualifies as a U.S. non-bank financial company. She did not rule on the other six counts, including those based on constitutional grounds. On appeal, all 10 counts may be brought before the D.C. Circuit. Some of the commentary on our SIFI case has portrayed it as an effort to undermine the Dodd-Frank Act. We strongly disagree with this characterization. The right to seek judicial review of an FSOC designation is part of the Dodd-Frank Act itself as enacted by Congress. In seeking judicial review of FSOC's designation of MetLife, we are upholding the process established by Dodd-Frank, not undermining it. Let me be clear. MetLife supports prudent regulation of the U.S. life insurance industry. We make long-term promises, and consumer confidence depends on the ability of the life insurance industry to honor its commitments.
In MetLife's case, we have been keeping our promises since 1868, through wars, boom times, panics, and recessions. It is worth remembering that we came through the 2008 financial crisis in such strong shape that in 2010, we were able to buy Alico from AIG for $16 billion. Money that AIG used to help repay U.S. taxpayers. One of the questions we have received most frequently since Judge Collyer's decision is whether we still plan to pursue the separation of a substantial portion of our U.S. retail business. The answer is yes. As we explained when we announced the planned separation in January, the decision was driven by both strategic and regulatory factors. Strategically, the imperative of cash generation is stronger than ever, especially in light of a lower for longer interest rate environment.
From a regulatory perspective, while we are pleased that our SIFI status has been rescinded, FSOC could attempt to redesignate MetLife at a later date. We are keeping open our options with regard to what form a separation could take, including an initial public offering, a spin-off or a sale. To prepare for the possibility of a separation in the form of a public offering, we expect to file a registration statement with the U.S. Securities and Exchange Commission sometime this summer. Regardless of the form, the separated business will be leaner and more focused. With the sale of the MetLife Premier Client Group to MassMutual, U.S. Retail will be only a manufacturer of annuity and life insurance products, not a distributor.
As I noted in my annual letter to shareholders last week, the expense of the advisor force was preventing us from clearing MetLife's hurdle rate on much of the new business written through that channel. By exiting proprietary retail distribution in the U.S., we anticipate run rate expense savings of approximately $250 million per year after tax, which would be split about evenly between the separated business and the rest of MetLife. I am confident that MetLife is taking the right steps to generate long-term shareholder value. We are changing our product mix to adapt to the external environment. We are separating the business on which the company was founded to strengthen the amount and timing of cash generation. We are focusing on expenses to ensure both the separated business and MetLife have a competitive cost structure.
Finally, this morning, I would like to discuss some changes to our finance team. As we announced in a news release a short while ago, Marlene Debel, our Treasurer, is becoming CFO for the U.S. This is a much-deserved opportunity for Marlene. Mike Walsh, our CFO for the Americas, will be retiring after 28 years at MetLife. Mike has been a trusted business partner to many of us. We thank Mike for his many valuable contributions and wish him all the best in his retirement. John McCallion, who is well known to many of you as our former Head of Investor Relations, will become our new Treasurer. Current Head of Investor Relations will assume John's role as CFO of EMEA. I told John he has done such a good job that he gets to come home from Europe.
I told Ed he has done such a good job, he gets to go to Europe. Congratulations, Marlene, Mike, John, and Ed, as you embark on the next chapters of your careers and lives. With that, I will turn the call over to John Hele to discuss our financial results in detail. John?
Thank you, Steve, and good morning. I would also like to recognize the contribution of Marlene, John, and Ed and wish them well in their new roles, and thank Mike for 28 years of outstanding service to MetLife. I am very proud of my finance leadership team. Today, I will cover our first quarter results, including a discussion of insurance margins, investment spreads, expenses, and business highlights. I will then conclude with some comments on cash and capital. Operating earnings in the first quarter were $1.3 billion, or $1.20 per share. This quarter included three notable items, which were highlighted in our news release and disclosed by a business segment in the appendix of our quarterly financial supplement or QFS. First, variable investment income was $109 million after DAC and taxes, which was $86 million, or $0.08 per share below the bottom end of our 2016 quarterly plan range.
Second, we had higher than expected catastrophe losses, which decreased operating earnings by $45 million or $0.04 per share after tax. Third, we had a one-time tax benefit in Japan, partially offset by a tax charge in Chile, which increased operating earnings by $10 million or $0.01 per share after tax. The tax rate in Japan decreased 60 basis points, resulting in a $20 million one-time benefit, partially offset by a $10 million charge from a 200 basis point increase in MetLife's tax rate in Chile. Turning to our bottom line results, first quarter net income was $2.2 billion or $1.98 per share. Net income was $866 million higher than operating earnings, primarily because of derivative net gains driven by lower interest rates and the financial impact of converting Japan operations to calendar year reporting.
Japan's results, including operating earnings for the month of December 2015, were reflected below the line in order to eliminate the accounting lag. The difference between net income and operating earnings in the quarter included a Favorable impact of $824 million after tax related to asymmetrical and non-economic accounting. Book value per share excluding AOCI other than FCTA was $53.31 as of March 31st, up 6% year-over-year. Tangible book value per share was $44.17 as of March 31st, up 7% year-over-year. With respect to first quarter margins, underwriting in the Americas was Favorable versus the prior year quarter after adjusting for notable items in both periods. Favorable results in Group Life, Retail Life, and Latin America were offset by less Favorable results in Nonmedical Health and Property and Casualty. Total company underwriting margins were essentially in line with the prior year quarter.
The Group Life mortality ratio was 85.9%, Favorable to the prior year quarter of 90.7% and the low end of the annual target range of 85%-90%. We experienced lower claims severity versus the prior year quarter, while frequency was in line with our expectations. Retail Life's interest-adjusted benefit ratio was 54.8%, Favorable to the prior year quarter of 59.3%, and within the annual target range of 51%-56%. The year-over-year improvement was driven by a return to more normal average net claims. As we had highlighted, 1Q15 had higher than normal accidental death, particularly accidental falls, which we believe were related to adverse winter weather. In Latin America, underwriting was Favorable to the prior year quarter and relative to expectations, primarily driven by lower loss ratios in Mexico.
The Nonmedical Health interest-adjusted loss ratio was 83.2%, unfavorable to a strong prior year quarter of 77.0% and above the top end of the annual target range of 77%-82%. The key drivers were higher seasonal utilization in dental and higher claim severity and disability, as well as Favorable LTC underwriting in the prior year quarter. The first quarter is a seasonally weak quarter for dental and disability. This seasonality was not apparent in the Nonmedical Health interest-adjusted loss ratio during the past two years, largely because dental utilization was low due to adverse winter weather. In Property and Casualty, the combined ratio, including catastrophes, was 100.4% in retail and 102.9% in group. The combined ratio, excluding catastrophes, was 86.3% in retail and 93.0% in group.
The combined ratio, excluding catastrophes, was in line with expectations, but above a strong prior year quarter of 79.4% in retail and 89.7% in group. We experienced higher catastrophe losses in our homeowners business and modestly higher severity in our auto business. Auto results strengthened this quarter, and we expect further improvement throughout 2016 as a result of rate increases. Turning to investment margins, the average of our four U.S. product spreads in our QFS was 170 basis points in the quarter, down 41 basis points year-over-year. Approximately half of this decline, or 20 basis points, was a result of lower variable investment income. Pre-tax variable investment income or VII was $165 million, down $206 million versus the prior year quarter, mostly due to weak hedge fund performance.
Our allocation to hedge funds is approximately 40 basis points of the total investment portfolio, and we plan to further reduce our exposure. Product spreads, excluding variable investment income, were 161 basis points this quarter, down 21 basis points year-over-year. Lower core yields account for most of this decline. With regard to expenses, the operating expense ratio was 23.8%, Unfavorable to the prior year quarter of 23.5%. The higher operating expense ratio in the quarter was primarily driven to the write-off of a net reinsurance receivable. I will now discuss the business highlights in the quarter. Retail operating earnings were $532 million, down 19% versus the prior year quarter, and down 11% after adjusting for notable items in both periods. Life and Other reported operating earnings of $172 million, down 15% versus the prior year quarter. Up 7% after adjusting for notable items in both periods.
The primary driver was net Favorable underwriting as life mortality rebounded from an unfavorable prior year quarter. Property and Casualty non-catastrophe results returned to more normal levels. Underwriting improvement was partially offset by lower investment margins. Life and Other PFOs were $2 billion, down 1% year-over-year, as growth in the open block was more than offset by runoff of the closed block. Life and Other sales were up 1% year-over-year, as a 15% increase in P&C was mostly offset by a 5% decline in life sales, mainly in whole life. Whole life volumes were strong. We sold less high face policies versus the prior year quarter. Annuities reported operating earnings of $360 million, down 20% versus the prior year quarter. Down 19% after adjusting for VII below plan this quarter. The key drivers were less Favorable market impact, negative fund flows, and higher expenses.
The initial market impact reduced operating earnings by $5 million after tax, which compares to a $26 million benefit in the prior year quarter. Total annuity sales were $2.3 billion in the quarter, up 14% year-over-year. We continue to see good momentum in our index-linked annuity Shield Level Selector. Shield sales were $411 million in the quarter, or triple the sales in the prior year period. Up 14% sequentially. VA sales were $1.6 billion this quarter, essentially flat to the prior year quarter. Group Voluntary and Worksite Benefits, or GVWB, reported operating earnings of $174 million, down 24% versus the prior year quarter. Down 20% after adjusting for notable items in both periods. The primary drivers were less Favorable underwriting as compared to a strong prior year quarter. Lower investment margins. GVWB PFOs were $4.6 billion, up 4% year-over-year.
Sales were up 28% year-over-year, with growth in group and voluntary products. I know this segment's earnings were below consensus estimates, which I believe relates to seasonality that was not evident during the past two years. In terms of the full year outlook for GVWB, the near term guidance on the certain key items provided on our December outlook call still applies. Corporate Benefit Funding, or CBF, reported operating earnings of $295 million, down 20% versus the prior year quarter, and down 12% after adjusting for notable items in both periods. The key driver was lower investment margins. CBF PFOs were $508 million, down 6% year-over-year due to lower pension risk transfers or PRT. As we have noted before, PRT sales can be lumpy, but we continue to see a good pipeline and remain optimistic about future growth opportunities.
Latin America reported operating earnings of $137 million, up 5% from the prior year quarter and up 32% on a constant currency basis. After adjusting for notable items in both periods, Latin America operating earnings were up 45% on a constant currency basis. The key drivers were volume growth as well as favorable investment and underwriting margins. US Direct, which is included in Latin America's results, had an operating loss of $14 million versus an $18 million loss in the prior year quarter, reflecting growth and lower expenses. Latin America PFOs were $966 million, down 4%, but up 14% on a constant currency basis. Excluding US Direct PFOs, which were up 35% year-over-year on a constant currency basis, Latin America PFOs were up 12% on a constant currency basis, driven by growth across the region.
Total Latin America sales were flat year-over-year on a constant currency basis. Excluding US Direct sales, which were down 18% year-over-year, LatAm sales were up 3% on a constant currency basis. This growth was primarily driven by direct marketing, partially offset by lower AFORE sales in Mexico in the current quarter, as well as large group case sales in the prior year quarter. Turning to Asia. Operating earnings were $305 million, down 7% from the prior year quarter and 5% on a constant currency basis after adjusting for notable items in the current quarter. Strong volume growth across the region was more than offset by lower fixed annuity surrender fees in Japan, as well as higher project costs and other expenses in the region. Asia PFOs were $2 billion, down 7% from the prior year quarter on both a reported and constant currency basis.
There were two factors that reduced Asia PFOs this quarter. First, as a result of a regulatory change, we are now required to use the equity method of accounting for the 26% ownership interest in our India joint venture. As a result, beginning in 1Q16, we are no longer reporting 100% of India PFOs in Asia PFOs. Instead, the financial results of our 26% interest will be reflected as net investment income in Asia. This accounting change is consistent with the treatment of MetLife's other joint ventures in Asia, which include China, Malaysia, and Vietnam. In addition, Asia PFOs were negatively impacted by the withdrawal of single premium A&H yen products in Japan. As previously noted, these products do not meet our hurdle rates in the current interest rate environment.
Excluding the impact of the deconsolidation of our India operations and the withdrawal in Japan of single premium A&H yen product, PFOs were up 2% on a constant currency basis. Asia sales were down 10% year-over-year on a constant currency basis, reflecting the impact of management actions to improve value creation and growth in targeted markets. In Japan, sales were down 1% year-over-year. We have seen a successful shift in sales to higher return foreign currency denominated life product, which were up 53% year-over-year, and away from low return yen life product, which were down 35% year-over-year. Japan third sector sales were down 29% versus the prior year as a result of exiting single premium A&H and the negative impact on package sales from a reduction in yen-denominated whole life products.
EMEA operating earnings were $63 million, down 10% year-over-year and down 3% on a constant currency basis. Earnings in the prior year quarter benefited from Favorable underwriting margins and lower expenses. Underlying volume growth in the first quarter of 2016 is consistent with our near term outlook of high teens on a constant currency basis. EMEA PFOs were $615 million, down 1% from the prior year period, but up 3% on a constant currency basis, primarily driven by the Middle East and the U.K. Total EMEA sales increased 3% on a constant currency basis, and 7% after adjusting for the conversion of certain operations to calendar year reporting in the prior year. The 7% growth was driven by employee benefit sales in the Middle East and Accident & Health products across the region. I will now discuss our cash and capital position.
Cash and liquid assets at the holding companies were approximately $5.3 billion at March 31st, down from $6.4 billion at December 31st. This amount reflects a capital contribution of $1.5 billion to MetLife Insurance Company USA in contemplation of the proposed separation, as well as regular cash flows, including subsidiary dividends, payment of our quarterly common dividend, and other holding company expenses. Next, I would like to provide you with an update on our capital position. Our combined risk-based capital ratio for our principal U.S. insurance companies, excluding Alico, was 513% on a reported basis and 537% on an NAIC basis at year-end 2015. For Japan, our solvency margin ratio was 936% as of December 31st, which is the latest public data. For our U.S. insurance companies, preliminary first quarter statutory operating earnings and net earnings were approximately $700 million.
Statutory operating earnings were down 38% from the prior year quarter, primarily due to low interest rates. We estimate that our total U.S. statutory adjusted capital was approximately $30 billion as of March 31st, up 1% from December 31st. In conclusion, first quarter operating earnings were below expectations, primarily due to market factors.
While the current environment remains challenging, we are confident that our strategy will drive improvement in free cash flow and create long-term sustainable value for 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 John Nadel from Piper Jaffray. Please go ahead.
Thanks for taking my question. Good morning. The first question is, can you give us some sense, at least based on what your legal representation might be advising you as to the timing around this appeal process?
Hi, John. Steve.
Good morning, Steve.
Good morning. Yes, the Justice Department filed their appeal nine days after the original decision came down from the district court. We anticipate that the ministerial paperwork will be filed by June 6th. That's what the court has requested, the circuit court. There'll be a briefing schedule at that point in time, which we think includes sometime in the fall time period. That'd be followed by oral argument, which is likely to occur in late 2016 or perhaps spill over to early 2017. A decision would be forthcoming sometime after that.
Okay. We could see something wrapped up on the initial appeal by mid-2017, give or take, you would think is reasonable?
That's probably reasonable, but courts take their own calendar into account in terms of these kinds of things. There's no way to know for certain how long it's going to take once the case has been heard.
Okay. My second question is just as it relates to the likely filing in the summer of an S-1 related to the retail business. Is it your anticipation that the filing of that IPO document would be sufficient to clear the hurdle of providing the non-public information necessary to give you and the board the okay to reinstate a buyback program?
Well, we're certainly not going to discuss capital actions before the filing of the S-1. Once we know more about what direction we're taking here and file the S-1, we'll have greater clarity, and we'll make a decision at that point in time as to what we can or should say regarding share repurchases. Obviously, the form and timing of a separation impacts the cash flows and capital actions. All this is kind of coming together as we determine how the separation will take place. Again, at this point in time, we don't know enough to be able to speak to capital actions. After filing the S-1, we'll know more, and we'll then figure out whether we know enough at that point in time to give greater clarity.
Okay, last one real quick, only because I've gotten the question.
Let me just, one more thing. I think one thing that's important to remember here is that we at management clearly understand and have stated that we want to return excess capital to shareholders. We also are taking a very bold step here in terms of separating out a major part of our business, really what MetLife was founded upon 140, I guess, eight years ago. I think that really is our first and foremost consideration and focus for us right now. If we get all this executed properly, which is our intent and our goal, as we've said before, the predictability and the amount of free cash flow as a percentage of our operating earnings, we believe will go up. That really is kind of the long-term or even intermediate-term payoff for these actions we're taking.
I think that really should overshadow the near-term impact in terms of timings around share repurchases.
Yeah, I totally understand that. Thank you. Then I just had one more quick one, only because I've gotten this question a couple of times. You've pushed out the date for your Investor Day. I assume it's related to the timing in getting this stuff done as it relates to the retail business, is there anything more to it than that?
With the planned separation and with the work we're doing around Accelerating Value, we want to make sure we had sufficient information for our investor base to hear from us. We didn't want to have an Investor Day where we said we still haven't determined that, or we can't talk about that, and so on. Our initial plans around the Investor Day, in terms of timing, preceded some of these actions we were taking in terms of clarity around those actions. As we stepped back and thought about it more recently, we said, what's the timing of things that we're going to have to analyze and make determinations on. Some of those items weren't going to be done by the initial date that we had put out there for Investor Day.
We felt that it just made more sense for everyone if we had an Investor Day at a point in time where we could provide greater clarity about the direction of the company going forward.
Your next question comes from the line of Jimmy Bhullar from JP Morgan. Please go ahead.
Hi, good morning. I had a question first on just the weak sales in Asia and maybe Latin America as well. Seems like there was a major initiative to grow in Asia a few years ago, especially in Accident & Health, and now you seem to be pulling back from some parts of the market. How much of the decline in sales recently has been in response to macro conditions in Asia or Japan versus maybe a change in your view on the economics of the business?
Hi, it's Chris Townsend here. Let me tell you the stories for Asia for sales. Overall, the headline number is down 10%. The Japan sales are flat but with a very different mix, as both Steve and John referenced in their prepared remarks. The yen life portfolio is significantly down, driven by the economics, and I think both referenced the long payback period of that and the challenge of the low interest rate environment. This was offset by a significant increase in terms of the foreign currency life and foreign currency annuity products, both which our customers find highly attractive given the enhanced yield they can get from a foreign currency play. The A&H business is still highly attractive for us. We generate very good margins from that business.
There is a packaging issue there for us in terms of when we sell yen whole life, we package that often with A&H. As that yen whole life came down by 60%, the A&H business came down as well. We'll look to offset that going forward. For the rest of Asia, China was up 16% for the quarter. Hong Kong and Bangladesh had good sales, and emerging markets overall were up 16% for the quarter. The one challenge for us in the rest of Asia was Korea. Korea was down sharply this quarter. Again, because of the Accelerating Value action work that had been taken there, we basically changed commissions predominantly in the general agency channel to reward persistency and better customer behavior or better behavior for our customers.
Also we changed the crediting rate in terms of the macro environment there in terms of the lower interest rate environment. We'll be launching new products there in the second quarter, and we think we'll get the sales back on track for that business. That's been really a roundup of the sales for Asia.
On yen whole life, how much business is sitting on the books now, and what are your views on margins on that business, given what's happened with JGB yields?
Let me tell you in terms of the sales, first of all. The sales this quarter made up 12% of our total sales in Japan. A year ago, it was a third, so we've made a significant reduction in terms of that business. Given the rate environment there at the moment, we believe that the current margin on that business, under a range of assumptions, meets our cost of capital for that business.
Your next question comes from the line of Erik Bass from Citigroup. Please go ahead.
Hi, thank you. I realize it's too early to get specifics, but was hoping you could expand a little bit on your comments that combined expenses for the remaining MetLife and the separated company would be lower than the current level. It seems a little bit counterintuitive, given that you may need separate infrastructure for two public companies. If you could provide any examples of where you see dis-synergies from size, that would be helpful.
I think, Erik, there are synergies from being one company. If you're going to separate the two businesses, by definition, there'll be dis-synergies, and there'll be, in some places, duplicative costs if you take no actions. What we're saying is that we're engaged in a very rigorous analysis around our cost structure. Part of it has to do with the separation with stranded costs, and part of it just has to do with this macroeconomic environment of lower rates for longer, tepid growth, and not just in the U.S., but globally. In that environment, we have to take a very close look at our cost structure and look at unit costs in particular, and that is what we're undertaking as an effort right now.
Got it. Does the $250 million of savings from the advisor sale, is that included in your comment when you say that combined expenses would be less than the current level?
No, we're saying above and beyond that.
Your next question comes from the line of Randy Binner from FBR. Please go ahead.
Thank you. I have a question, thinking ahead a little bit on the NewCo as it likely will be standing alone by April 2017 when the new DOL rule goes into effect. If that's purely a manufacturing entity, do you view that NewCo Met as being subject to legal liability under the best interest contract to the extent it's selling variable annuities?
Good morning, it's Eric Steigerwalt. Look, one of the primary things that we've done is the announced sale of our field force MPCG to MassMutual. Given the timing of DOL, our what we'd call tied advisor force will not sell any products under the -of MetLife or NewCo when the DOL regulation goes into effect. That sale will be done long before the DOL regulation goes into effect. Just to give you a little color on that, we think we're going to close in July. We're on track to close in July. The answer is, with respect to the biggest piece of the effect on MetLife, which is our own field force in the United States, it will be sold to MassMutual and closed in July.
To the extent you're a manufacturer, do you think that the distributor will sign the best interest contract in a VA or index annuity sale or would you also be subject to that legal risk?
It's hard to tell. I can talk about that in two pieces. One, obviously we will have a very important field force, which is our wholesaling force, going forward. You have to think about the DOL with respect to how wholesalers will operate. That's something that we have to work through over time here. Secondly, it's just too early to know where distributors are coming out with respect to the regulation. Maybe four or five months from now we'll have a better view of that. Right now, given the fact that this is almost 1,100 pages, we're just going to have to wait and see what a number of distributors are going to do.
Your next question comes from the line of Sean Dargan from Macquarie. Please go ahead.
Thanks, good morning. I have a question about the variable investment income, specifically, what your view of hedge fund investments is going forward, given some of the headlines about pension funds rethinking their strategy and some other insurers, just recent volatility in that asset class.
Hi, Sean. It's Steven Goulart. Certainly the first quarter was challenging for variable investment income. If you look at our miss, it was heavily because of hedge fund returns, which actually were negative for the quarter. I think if we look at the market environment that exists today, we can talk about a number of factors, I think it'll continue to be challenging for hedge funds. I think when you combine that with our capital and cash flow predictability objectives, we've decided that we're going to continue reducing our hedge fund portfolio, as John alluded to in his comments. Just to remind you of some numbers, the portfolio today is just over $1.8 billion, recall we did reduce it during the course of last year also. We actually ended up redeeming about $600 million worth of hedge funds last year.
As we look out from where we are today, we expect that we're going to redeem probably on the order of another $1.2 billion. Really take the portfolio down by another two-thirds from where it is today. Just given the way redemption provisions work in the industry, it'll take us a couple of years to do that, but I expect that we'll probably see 60% of those redemptions come in this year and 40% next year, and maybe even leaking a little bit into 20018. I'll also put it in the context of our total portfolio, though. Remember, this is actually a very small portion of our total portfolio. Our total alts portfolio is under 2%. As John mentioned, our hedge fund portfolio today is less than half of 1%, obviously it's going to become even smaller.
What we'll be left with is a small portfolio of really our most consistently performing managers in hedge funds. There'll be a small portfolio left over, but we think, overall, it doesn't need to be the size it is today.
All right. Thanks. When I think about the impact of variable investment income across the company, is it roughly split along the lines of what the separated business will be versus the go forward RemainCo Met?
Well, if you look through the segments, I think you can get some numbers from the QFS. It's roughly proportionate. I think you'd find that Retail has a higher allocation in some pieces of variable income and lower in other pieces of it.
Your next question comes from the line of Suneet Kamath from UBS. Please go ahead.
Thanks. Good morning. Just to quickly follow up on VII. I think last quarter, Steve, you sort of indicated that you'd reassess the outlook for the rest of the year. I think your range quarterly is $300-$375. Any updates there in terms of what we should be thinking about for the balance of the year?
Sure. As I just mentioned, hedge fund returns were actually negative for the first quarter. I think if you look at the rest of the year, you have to make some assumptions, of course. If we were able to see hedge funds and private equity return to our plan expectations for the second half of the year, we'd probably end up around the bottom of the range that we had given for the full year. I will remind you, private equity continues to perform fairly well. I mean, it was slightly below plan, but again, still very positive. It really, again, most of the underperformance came from hedge funds. Like I said, it depends on your assumptions for the rest of the year.
Right now, we're not going to change anything. If we hit the plan for the second half of the year, we'll be at the lower end of the range.
All right. Then maybe for Steve, I know it's early days around the separation, but if we think about your consolidated ROE of, I guess, roughly 10% on a normalized basis in the quarter, and we think about this sort of separation, is there any directional guidance you can give us in terms of how you think the return profiles of the two businesses would be post-separation?
Suneet, because there's so many moving pieces right now, it's premature for me to give out ROE targets.
I would anticipate we'd talk about this certainly in Investor Day.
All right, maybe just to sneak one last one in. I think, John, you said the stat earnings in the quarter for the U.S. businesses were around $700 million. I think a year ago it was around $1.2 billion, and I think in the prepared comments, you talked about interest rates, but is there any more color you can provide on what caused that big decline year-over-year?
You have the statutory operating net income. Some of the derivative accounting goes right through to, it's not in net income, and statutory goes right through to equity. There's a lot of moving pieces when you get into the statutory accounting that we have, particularly in MetLife USA that has all the VAs in it. Everything's consolidated, remember, in our statutory statements, and you'll see the volatility flowing through here.
Your next question comes from the line of Eric Berg from RBC. Please go ahead.
Thanks very much. John Hele, I have a question about your comments related to dental. Are you saying that the seasonality that you saw in the past, that the claims that you experienced in the just reported quarter, the March quarter, were absolutely there in the past as well, but were somehow masked, is that what you mean, by other considerations? Is that what you mean when you say that this seasonality wasn't evident and that therefore, since this is, so to speak, normal seasonality, that the earnings were in line with your expectations, or should I be reaching a different conclusion? Thank you.
Sure. The last two years in the first quarter, we had pretty tough winter weather conditions, and we saw a decline of frequency of dental claims coming through in that quarter. If you looked at the first and second quarters of the last two years, it got caught up. People ended up going to the dentist, you had a higher frequency in Q2 for the last two years. This quarter, we were at just above the high end of our range of our expectations for dental. It's a little higher than what we had expected, but there is a seasonality to dental, and we just think that may have been missed as we looked at how a lot of analysts had done the numbers for the expectations for this quarter.
I just wanted to highlight that for you, that this dental is more close in line to what we do expect.
All right. Thanks very much. I'm all set.
Your next question comes from the line of Steven Schwartz from Raymond James. Please go ahead.
Hey. Thank you. Good morning, everybody, and congratulations to everybody. Just one more that hasn't been answered yet. Could we talk a little bit about U.S. Direct? I think, John, that you said that sales were down 18%. Maybe you could talk about that. Also, am I wrong? Wasn't that supposed to be moved from LatAm?
Hi, it's Maria Morris. Yes, sales are down this quarter, year-over-year, that's very purposeful on our part. You may have seen that media spending is quite high as a result of both the election and other things going on. We're very selective in terms of how we actually put media into the marketplace. That's been planned. You probably also noticed, though, that our PFOs are up 34% year-over-year because they've had very strong sales over the last 12 months. That gives us some optionality in terms of how we're really thinking about sales for this year. We will be moving the U.S. Direct business out of Latin America later this year, we'll obviously be disclosing that when we do so.
Okay. I guess my sense here is the election is taking up too much advertising space. Advertising costs have gone up, so you can't beat hurdle rates, I guess, with what you want to pay. Is that the deal?
Exactly. The way that we actually go to market, as you know, is through both a combination of direct TV, digital, and since the advertising spending is up, plus it's a cluttered space, we made the decision to delay some of that till future quarters.
Okay. Thank you very much.
As a reminder, if you do have a question, please press star then one. Next, we'll go to the line of Yaron Kinar from Deutsche Bank. Please go ahead.
Good morning, everybody. Thanks for taking my questions. I want to start with the alternative portfolio. I heard Steve talk about the added value of the portfolio and how it's actually generated excess returns over the course of a long period of time. Then I hear John talk about the interest of maybe scaling that portfolio down a bit, at least the hedge fund component of it. Would the thought be that you'd replace some of these hedge funds with other alternative investments, or should we just think about maybe a smaller benefit or boost coming from overall VII going forward?
Hi, it's Steve Goulart again. When Steve made his opening comments, he was referring to the full mix of variable investment income. Remember, that includes private equity, that includes hedge funds. There are some old real estate development JVs in there, as well as prepayments. He was talking about the whole mix. If we look at the hedge fund contribution to that, actually, it didn't contribute to it positively over 10 years. Really it's just too inconsistent, we think, in actual performance. That's our reason for pulling it out. As far as how to think about it going forward, because the way the redemptions come in, which are spread out over a long period of time, we're really going to look at reinvestment just as part of our overall ongoing regular asset allocation and optimization plan.
Okay. Would the VII component of the overall net investment income come in a bit over the next few years?
Well, as an example, for this year, again, if we looked at the planned VII, the hedge fund redemptions would have a very modest reduction to overall VII. It's under $30 million. Going forward, it'll depend on the mix that we achieve.
Okay. The other question I had was going back to the Investor Day. I'm assuming that given the delay and the interest in maybe sharing a little more color with the investment community, at that point come November, ultimately there will be more publicly available material data out there. Would it be fair to assume that buybacks could be back on the table by November?
Yaron, the separation of the U.S. retail business will be the driving force here. I think at the time of the Investor Day, my guess is it's probably not going to be completed. We'll know a lot more, but we won't have final clarity about our capital needs, et cetera, until the actual form is known through the execution of a separation. A lot of that's going to be determined not just by what we want to do. It's going to be determined by the marketplace, what we can do. A little bit of this is going to be a timing issue. If we're not able to execute by the time of Investor Day, we're still going to be not knowing some key components here of the picture that will enable us to be clearer on our capital plans.
If you are not able to execute or you don't have that clarity at that point, will you still be able to share enough material information with the Street? Do you think that at that point maybe you'd reconsider holding Investor Day in November?
No, we're not going to change the date of Investor Day from November. We'll still hold Investor Day, but we may not have all the answers at that point in time. In fact, I anticipate we won't have all the answers as to how the execution of the separation actually occurred because if I had to guess, it's less likely than more likely they'll be done by then.
Okay. I appreciate the color.
Your next question comes from the line of Humphrey Lee from Dowling & Partners. Please go ahead.
Good morning, thank you for taking my question. Just a question for Steve. In your letter to shareholders, you mentioned your interest in growing the fee-based earnings organically or through acquisitions. Can you talk about what type of fee-based business that you're interested in growing, either organically or through acquisitions?
Sure, Humphrey. As you know, we purchased Provida, a pension fund administrator in Chile a few years ago. That was a business that we found very attractive. We were able to purchase it at a very good multiple of earnings, and it was a business we think will grow over time. We also have started up our own internal third-party asset management business, and we're growing that. There's both organic and acquisition-related efforts to grow our fee-based business. The asset management space is attractive if we can find the right opportunities, both organically and by acquisition. We continue to look at opportunities as they become available.
In terms of the kind of pension business, granted you have the presence in Latin America, would you consider growing your pension business elsewhere?
You're referring to fee-based businesses like Provida?
Yes.
Yes, we would. If we find the right opportunities in other markets, we are absolutely interested in looking at those kinds of acquisitions.
Maybe just a follow on that a little bit. Would you prefer a pension market that has more of a mandatory component similar to what you see in Chile, or are you open to kind of more broader pension business in general?
I'd say broader. We are opportunistic investors in businesses that we think make sense given our strategy. We've mentioned before, including in the annual shareholder letter, that we would like to grow our fee-based businesses. It's not a big component of our top line or even our bottom line at this point in time. Just from a balance point of view, we think we could do more in that space.
Kind of looking ahead in an ideal situation, how much do you want the fee-based business to represent your total earnings contribution in your kind of longer-term outlook?
We haven't determined a specific percentage at this point in time.
Okay. Got it. Thank you.
At this time, there are no further questions.
Okay. Well, I want to spend just 30 seconds to go back to a question that was asked that we didn't answer. It was cut off. It was on Latin America sales. I'm just going to pass it to Oscar Schmidt.
Thank you, Ed. As we saw, LatAm year-over-year sales are flat. If you exclude the U.S. Direct, and as we know it's still included in LatAm at this quarter, it moves up to 3%. That 3% is affected by a decline in the AFORE sales in Mexico. That decline was originally in regulatory change. That regulatory change that produced lower sales is also producing better persistency, no impact in bottom line. If you exclude the AFORE sales, LatAm growth year-over-year is 8%, which is in line with our expectations.
Okay. Thank you all for joining. Have a good day.
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