Please introduce our next speaker, Steven Kandarian, Chairman, President, and CEO of MetLife. Steve's been CEO of Met since 2011. Prior to his role as CEO, Steve was the Chief Investment Officer, and his background as a CIO, to me, is clear in Steve's approach to the business, not only managing to maximize returns but manage to risk properly as well. With that as the backdrop, I'm going to turn it over to Steve for a few prepared remarks, then we'll get into Q&A.
Great. Thank you, Seth, and good morning, everyone. I thought I'd just share a couple of slides with you before we entered into our discussion here. Let's see. Click in here. Oh, that's it. I guess I don't see that. Let me take a look at this here. Okay. The slide you see here is our operating earnings per share, and you can see the progression since 2011. I picked that year because we closed on the Alico transaction in November of 2010. This is the first full year of the combined company of MetLife and Alico. You see a strong progression of 9.6% compound annual growth in operating earnings. I'm sorry, that's earnings per share.
On an operating earnings basis, it's a little bit over 12%. The difference was that we had some conversion of securities into equity over that period of time, and we were reluctant to do any share repurchases because of the uncertainty around our regulatory status. As you know, we decided because the capital rules, which we were anticipating coming out within a few years of the passage of Dodd-Frank, didn't actually come out for quite some time. In fact, they still haven't come out. They're still in draft form and haven't been released yet. We have engaged in some repurchases, but the earnings per share grew about 9.6%, operating earnings about 12%. Good progress there for the company. This is a slide I wanted to show you. This is operating return on equity.
This is operating ROE, and you can see the pre-crisis years, some pretty high numbers in that 12 to over 14% range. The average, when you go through cycles, is a little bit over 11% for MetLife since its initial public offering in the year 2000. While we're not back yet to the high water marks of the pre-crisis years, I should mention a couple of things. I believe the quality of our earnings are even stronger today than they were back then. I say that for a couple of reasons in the quality of our returns. That's because we have de-risked our product portfolio.
You know we've done a lot around variable annuities and universal life with second guarantees no longer being sold, the life insurance policies that we used to sell, and as well as no longer selling the long-term care product, which was a capital-intensive product. In addition, again, Alico was purchased, and we have a much bigger exposure to non-U.S. business, faster-growing markets, emerging markets. I think that the return side is improving and the risk profile is also improving. I think in those terms, as Seth was mentioning as a former investment person, it's both return on equity, but it's also your cost of equity capital. If you can get your risk profile down and your volatility down, it really is that differential between your cost of equity capital and return that's most important to drive shareholder value. Let me show you one more slide.
This is adjusting the last slide on a spread basis, operating ROE as a spread above 10-year Treasury yields. I think it's important to look at ROE in that context. I say that because when you think about any asset class, you're really thinking about what kind of return can you get above the risk-free rate. If the risk-free rate is declining, then you expect that the overall ROE of those other assets might be declining as well, and the spread is really the key in terms of providing value to investors on a relative basis between asset classes. If you look at our operating ROE compared to a spread over 10-year Treasury yields, it actually looks even better than the previous slide.
Not only are we closing in on the pre-crisis years, but we're almost back to where we were, and we're well above the 7.4% average ROE spread above 10-year Treasuries. Again, I'd reiterate that the quality of these earnings, I think, are meaningfully improved from the pre-crisis years where we were selling more capital-intensive products that produced more tail risk in certain environments, including environments of low interest rates and stock market volatility. We've done a lot over the last several years at MetLife to shift our risk profile, to have more exposure to non-U.S. businesses, and to get a better balance in terms of the kinds of products we're selling in terms of risk. With that, I'll turn it back to you, Seth.
Great. Thanks, Steve. Along the lines of low rates, and I appreciate the illustration of spread to risk-free rate. By our calculation, low rates have caused a 2%-4% headwind on earnings growth, and that's our attempt to strip out the impact on base yield over the last couple of years. If we're in a 2% forever scenario, is this growth headwind perpetual and permanent?
Well, I think if we're in a 2% 10-year Treasury yield environment, that also likely means that we're in a slow growth or sideways type economy. If that were the case, you expect earnings of an insurance company, any insurance company with a major business in the United States, you'd see some impact upon that. A 7% operating earnings growth rate that we talked about on our outlook call for long-term earnings growth for MetLife was based upon a more normal economy over time, a 4%, 4.5% 10-year Treasury. We came to that number of 4%-4.5% based upon two components. One, the Fed's announcement that they're seeking to get about 2% inflation on an ongoing basis on average in the economy. They think that's a healthy place for the economy to be.
Underlying growth of, let's say, roughly 2.5% on a real basis. That would suggest kind of a 4.5% or 4%, 4.5% 10-year Treasury yield environment. Our 7% expectation long-term for earnings growth will be dampened somewhat in an environment if you still have a very low 10-year Treasury, which again, I think would be suggesting a very slow-growing economy in our largest market, the United States. Now, I should mention that from a capital perspective, even with a 10-year Treasury at 2% indefinitely, the impact upon our reserving requirements isn't that dramatic. It's a little bit less than $1 billion. I give you that in the context of $6 billion of cash at the holding company in a company that threw off about $3 billion of free cash flow in the year 2014.
That $6 billion of cash at the holdco is inclusive of the reserve actions that you've taken year-end?
Yes.
If we think about free cash flow, you're projecting a free cash flow rate of 45%-55% for the next three years. You just closed a 44% rate this year, better than what you had targeted to start out. This is better than the last couple of years, where it had been sub 30 in some years. This improvement in free cash flow, is it due to change in business mix, or was there something artificially low about the prior years?
Let me go through the numbers. In 2012, free cash flow was 26%. In 2013, it got up to 36%, and this past year it got to 44%. The first two years I gave you probably need some normalizing because we were contributing capital to a captive of ours. 26% was more like 34% on an adjusted normalized basis. 36% was more like 38% on a normalized basis. Still, we jumped up to 44% this past year. Our expectation for 2015, 2017 timeframe is in the 45%-55% ratio of free cash flow to operating earnings.
That's driven by a number of factors, but one of the key factors is our shift away from more capital-intensive products to more capital-light products, more protection products, growing our emerging markets business that doesn't require a lot of capital, more Accident & Health kinds of products we sell in that marketplace in Credit Life and shorter term investment-like products they call endowment products. That shift, along with a shift we've engaged in around the domestic market, around variable annuities and the other products I mentioned to you, lifetime universal life, secondary guarantees, long-term care, getting away from those businesses has helped us drive that free cash flow ratio higher. We are continuing to take those kinds of actions to ensure that the trajectory of our free cash flow rises.
How should we think about the impact of low rates on free cash flow? You mentioned $1 billion of that reserve if we stay here forever. I imagine that has some depressing effect on the free cash flow conversion.
Right. Again, we have $6 billion of cash at the holding company, so I think we're in pretty good shape there in terms of any reserving requirements, which we mentioned was probably a little bit under $1 billion if you had a 10-year Treasury that stayed at 2% for a very long period of time. I want to throw one more caveat in, which is why we have still $6 billion of the holding company, which is we have been designated, as you know, as a systemically important financial institution by the Financial Stability Oversight Council, and we are awaiting the capital rules to be written by the Federal Reserve and we'll have to see how all that works out for us in terms of both the capital rules and, of course, again, the judicial appeal that we're engaging in.
On the capital level, I understand you're not going to talk about a capital buffer, about a required capital level given uncertainty that we're in, is it fair to say that free cash flow is fully deployable?
Again, with the $6 billion, the holding company, we really haven't made a pronouncement about how much of that is needed. Frankly, we haven't because we don't know the answer until we see the capital rules. Then in terms of what we do going forward with additional free cash flow generated by our ongoing operations, I would simply say this, we have made a strong commitment to return capital on a prudent basis to our shareholder base. We've dramatically increased our dividend over the last several years. It's now $1.40 a share. I think it was maybe $0.74 a few years back. The payout ratio, I think, was around 23% last year.
The Federal Reserve has kind of made a general rule in terms of a benchmark for the banks, again, they haven't given us any input on this yet for insurance companies, for banks, 30% of net income is sort of the cap they'd like to see for a bank payout. We're within that certainly on an operating earnings basis, which I think is a more appropriate measure for insurance versus net income. We're committed to providing a strong dividend to our shareholders. We have engaged in two capital actions around repurchases, $1 billion that we announced in 2014, that was completed in 2014, we announced late in the year, last year, another $1 billion share repurchase program, which we're roughly 70% along the way to completing that.
I talked today on our earnings call that we're still cautious about returning much more than that in terms of capital this year on the basis of share repurchases, given the uncertainty around the capital rules that remains. Of course, we have an appetite for M&A transactions that make sense from a strategic point of view. We're very selective about M&A transactions. We see a lot of deals on a regular basis. Oftentimes, we don't even bid on them if we think the bidding will be out of a range that we think makes sense in terms of creating shareholder value. Other times we do bid, we are very disciplined about how we bid. Using free cash flow for all those three categories, dividends, share repurchases, and cash component of M&A transactions still is very much part of our philosophy.
That's also taken in the context of not knowing yet what the capital rules would be from the Federal Reserve. In other words, designated as a SIFI.
I think that's a natural transition to questions on regulatory. For those of you who are not aware, I'm going to go out on a limb and say every single person in the room is aware that MetLife has filed suit against FSOC for the SIFI designation. My understanding is that to successfully appeal an agency's ruling, the bar is quite high. Am I correct in that?
Well, the bar for our appeal is a standard that's referred to in the law as arbitrary and capricious. If FSOC can demonstrate before the court that their action in designating MetLife as a SIFI was not arbitrary and capricious, they would fulfill that standard. You hear those words, and it sounds like a very, very high bar for us to overcome. It's not as high as it sounds. There have been a number of cases where that standard has applied, where courts have reversed actions by regulatory bodies of the federal government. Let me just give you a little context of what that standard really means. It means that FSOC's determination that MetLife is a systemically important financial institution must be reasonably based in fact. Okay? It has to be reasonably based in fact. It can't be conjecture.
It can't be you have this big book of assets, you have this big derivatives book, and so on and so forth. You have to make the connections under the law, Dodd-Frank, to qualify to be a SIFI. What does the law say? The law says, could material financial distress at MetLife pose a threat to the financial system of the United States? That is the language laid out in the act. FSOC needs to demonstrate factually with analysis that there's parts of our business that if MetLife got into financial distress or failed, would cascade over to other companies in the financial system, potentially resulting in the need for a too-big-to-fail-type bailout that we witnessed back in the 2008 crisis. Let me make clear, I'm totally supportive of the intent of that law. I just don't think FSOC got the analysis correct in our case.
We have demonstrated through a great deal of evidence, in our judgment, a very strong case then that our failure, while big and messy and certainly causing problems for shareholders, bondholders losing money, even at the very margin of our biggest policyholders of MetLife not being given 100% back on every dollar. All those things could happen theoretically if MetLife were to fail, as unlikely as that is. That still would not cascade over to other financial firms in the system. We have a great deal of analysis behind that, and I can go through all that here today demonstrating analytically with our own analysis and third-party analysis of this position. In our judgment, that case has not been made on the other side that we are truly systemic under that standard.
We think we have a strong case, but even when you're before courts, it's unclear as to how things will come out. There's always room for interpretation by people. I can certainly tell you we would not have brought this case forward if we thought that we did not have a strong legal case.
Do you have an indication of who the burden of proof is on, if it's on you or if it's on FSOC?
Well, now you're asking me to play a lawyer. What I know is that the standard, as I said, was arbitrary and capricious. FSOC will be making the case that that standard was not met. We'll present our evidence that we already presented to FSOC, and FSOC, I'm sure, through the Justice Department, will present their case saying, "Here's why we believe MetLife, this system will be important and meets the standards of Dodd-Frank, and here's our evidence.
Do you have any indication of what the timetable of the case will be?
There's no way for us to know that. If you look at similar cases, it might suggest that by the end of the year, end of this year, we might hear something back from the courts, it's very difficult to predict. It's a complicated case. It's hard to say how long it'll take for the court to work its way through all the evidence and come to its determination.
Just to clarify, in the meantime, you are now regulated by the Fed, like the other SIFIs. That's correct?
That is correct. We are designated as a SIFI by FSOC. We are under the regulation of the Federal Reserve. We've already met with our regulators from the Federal Reserve of New York. As we do with all of our regulators, we cooperate fully. We have a respectful relationship with them, we will work in that spirit going forward with the Federal Reserve.
The questions I got immediately after the suit was filed is why MetLife risking antagonizing their regulator? You have real interactions with the regulator. You're currently regulated by them.
Right.
Could you describe what your interactions have been like?
Okay. Well, first let me make a distinction. FSOC is the body that determines whether or not you're a SIFI. Our regulator will be the Federal Reserve. The Federal Reserve is one of 10 voting members of FSOC, but our suit is not against the Federal Reserve, our regulator. It's against FSOC. Let me also mention, I was a former regulator earlier in my career. I ran an agency called the Pension Benefit Guaranty Corporation in Washington, D.C., a federal government corporation. We took actions that from time to time the parties involved in the actions disagreed with. Those parties from time to time would exercise their due process rights, and they would go to court and challenge decisions that we made. I was running that federal government agency. I can certainly tell you from firsthand experience, we didn't take that as some sort of personal affront.
People respectfully exercise their due process rights in our system. That's the beauty of our check and balance system and being a democracy. I fully expect that our regulator, the Federal Reserve, would feel the same way I did when I was a regulator in Washington, D.C., that we were simply, in this case, MetLife exercising its rights for a judicial review of decision by FSOC that is basically early days of making these kinds of decisions by that agency. Seeking what Dodd-Frank lays out clearly in the law that Congress intended and put in the law of if you disagree with the decision by FSOC and you would like to have a judicial review of that decision, this is the path to take, and we are simply following that path laid out by Congress in the law.
I don't believe that this is something that would cause our regulator to treat us differently than if we had not appealed this decision.
Maybe moving on to the actual business. Emerging markets, part of the growth story long term for MetLife over the last 12, 18 months, geopolitical risk, currency, hasn't been great headlines. How do you think about emerging markets long term?
Let me start off by saying we are in a long-term business, and I think most of you who follow the life insurance industry over the years understand that anything that we do any one year in terms of sales really has a lag effect in terms of impact upon our income statement, even our balance sheet. This is a long-term business. Our strategy of having a balanced portfolio, not just in terms of products, which these emerging market businesses do as well, also in terms of geographies and currencies and so on. When you have that kind of a business model, you're going to get ups and downs in different markets. Some markets will perform higher than long-term trends in one year, and other years they'll perform lower. We have seen some choppiness in certain of our emerging markets.
All of us have read about Russia. Russia is a country that we have a very good business in. We're one of the larger insurers in that country. We've been there through the Alico transactions since the opening up of the Soviet Union. It's a market that is a very under-penetrated life insurance market, so great opportunities in terms of growth. It's a profitable market for us, and the kinds of products that we like to sell are well received in that market. Obviously, that market is not doing as well as we had planned a couple of years ago before some of the turmoil that we're seeing. On the other hand, we're doing quite well in markets such as the UAE, the Gulf region. Our business in Turkey is growing at a good clip.
Another fast-growing emerging market with demographics that are very attractive, both in terms of population growth and GDP growth, and GDP per capita growth, which is important to us in terms of when people start buying insurance products. We're in a number of markets across the globe, including Latin America, Asia, that are growing rapidly, that will see some modulation and some vacillation in their growth rates based upon geopolitical events. We understand that. We don't have concentrations of capital that are significant in these markets, and we believe as stewards of a long-term business, that these are good markets for us to be in.
I want to take a sec to pause to see if there are any questions from the audience. There's one in the back.
Yeah. I think on slide five, you talked about how you're trying to make the case that, or you're making the case that your ROE should be judged as a spread to the risk-free rate. How are you finding that argument resounding with equity capital providers, in a sense, essentially saying your ROE should go from kind of a fixed to a floating rate?
Well, since I think today was the first time we talked about this, it was on the earning call, it's early days. I don't know. The reaction is we got a couple of questions on the earnings call, and I responded to it. I think that is the right way to look at things. Look, I oversaw the general account portfolio at MetLife for a number of years before taking on these responsibilities, and we were buying largely fixed income securities, and we'd think in terms of spreads over risk-free rates. That's just a normal way for someone in the bond world to think about returns. Oh, okay. I think it's going to be a little bit of an education process and a little bit of use the bully pulpit, not just myself, but hopefully others on my side of the table with the equity buy-side community.
I do hear this kind of mantra of, "Where's your 15% ROE?" I kind of go, "Well, I think you're talking 2007," that was a different world, that wasn't always the most stable world. I think people have to kind of recalibrate a little bit in terms of what the expectations should be. They should be fair returns. The slide I showed you in terms of spreads above risk-free, I think was a helpful slide to say that we've done well post-crisis in terms of getting our spread above risk-free rates back to levels that should be attractive to shareholders.
In our business, again, being a long-term business, the easiest way you can get yourself in trouble is to take actions in the short term that may show some good GAAP earnings growth, a number of years down the road come back and bite you pretty hard, both from a capital perspective, reserving perspective, and even an earnings perspective. We're not going to do that. We're going to be disciplined. If we have to take a few lumps in terms of people saying that, "Boy, that's not high enough, we don't think, compared to what we're expecting." We're prepared to take those lumps because, again, we're committed to creating shareholder value over the long run.
Maybe we could talk about variable annuities. You know what? I'm sorry. There's a question up front. Why don't we go with the question up front?
Sure.
Hi. Earlier in your presentation, you noted that a 2% 10-year Treasury yield would indicate a slow growth or sideways-moving U.S. economy. However, that may have been true in the past, currently what we're seeing is due to geopolitical risks or central bank manipulations of rates globally, the U.S. Treasury, 10-year in particular, might look very attractive versus, say, a 10-year Italian sovereign or negative German yields or yields around the world. It's becoming less of just a pure economic call, but kind of a capital flight coming to the U.S. This is kind of important because as a long-term investor, I think where 10-year rates are and your outlook on rates kind of important.
How are you managing, how are you thinking about that new world order of the 10-year and rates in particular, and how are you managing your interest rate risk maybe differently around that?
I take your point about, at this point in time, you could have faster growth and still a low 10-year Treasury yield. I accept that. I still do question whether that would be the case over a longer period of time, because I think we're still pretty connected in this country to other markets, and if Europe really is in a terrible place where they have the Swiss 10-year yield being negative, that tells you a lot about the world economy. I still think that if you see long-term 2% 10-year Treasury yields, that's signaling something about the world economy, and MetLife does have exposure outside the U.S., as I mentioned. It would dampen, to some degree, our growth. I think there's no way around it.
My hope is that Europe takes the measures that they need to take, not just in terms of monetary policy, but in terms of structural reforms. We've seen some of that in places like Spain, in Ireland, other countries I think need to do more as well to get that part of the world economy back in a better place in terms of the potential growth rates that they could achieve If they have the right kinds of fiscal and impact policies, frankly. I'm hoping that the policy outlook here in the U.S. improves as well. I don't think we have hit perfection in terms of policy in the U.S. I think we're going through still a difficult economic period. It directly impacts our business in a couple ways. Growth overall, certainly.
Low rates affect the life insurance business by nature of our assets and our liabilities. The liabilities, we try to match up with assets of the same duration, but we have some long liabilities that there are not long enough assets to match up against. When those assets roll off and those liabilities don't roll off, you're reinvesting at lower yields, and those margins get squeezed. That's impacting us, even though we had a lot of hedges in place for a number of years, but eventually those hedges roll off. In the near term, at least, a very strong dollar is impacting us because we do now have more exposure to non-U.S. earnings, and we've seen a number of currencies weaken against the dollar, and that's provided a headwind for us in the short term, in that regard.
You've seen other companies, even outside of the life insurance business, make announcements recently about shortfall in earnings expectations based upon currency fluctuations. We do some hedging of currencies, particularly in Japan, our second biggest market, but we don't hedge across the board. We feel that to do that really gives up too much income over time because of the cost of hedging and a view on our side that these things do fluctuate. We'll have years when the dollar will strengthen, we'll have years the dollar will weaken. We think it does balance out over time, and our strategy is to do some selective hedging of currencies when we have a strong point of view or try to preserve certain components of our earnings for any particular year, but not across the board hedging philosophy. That's how we view it.
I think we're going to have to leave it there. Steve, thanks for joining us on what is a very busy day for you. We appreciate it.
Okay. Thank you.