Good morning, everybody. I'm Yaron Kinar, the North America life insurance analyst here at Deutsche Bank. We're very pleased to have with us today John Hele, the Chief Financial Officer of MetLife. MetLife is one of the leading life insurance companies in the world, with a large presence both domestically and internationally. John, thanks for joining us today. Just as a quick reminder of the format, John is going to give a quick presentation. After that, we'll have a fireside chat and leave a few minutes at the end for our Q&A. With that, my great pleasure to introduce John Hele.
Thank you. This is our cautionary statement on forward-looking statements and not GAAP presentation. I'll let you read that for a second. This slide shows you our 2013 operating earnings and premium fees and other revenues by business. As you can see, we're quite well diversified by business and geography. About a third of our earnings and revenues today are outside the United States. Emerging markets comprises all of Latin America, 80% of Europe and the Middle East, and about less than 1% of Asia today. That's roughly 13%-14% of our total company earnings in 2013. We also purchased Provida in Chile, a large pension fund administrator, which, on a full year basis, would have gotten us up to 17% of our earnings from emerging markets.
We remain well on track to meet our target of 20% of our earnings from emerging markets by 2016. Driving these results is the diversification of our products as well as our distribution. In addition to being diversified by business, geography, products, and distribution, we're also quite diversified by risks. I showed this slide at our 2013 investor day. We've updated the results for our 2013 operating earnings. The takeaway is the same. Roughly 60% of our operating earnings come from businesses that are primarily driven by protection products. You will note that all of our businesses outside the U.S. primarily derive their earnings from protection or capital-efficient products. Therefore, in addition to having higher natural growth than in the U.S., they also have very attractive margins and returns on equity.
This slide shows you our operating earnings from growth from 2011 to 2013 following the acquisition of Alico at the end of 2010. We've had 16% compound performance over the time period. Our retail operating earnings were up nearly 40%, which were driven by favorable markets, quite a rebound from 2011. Asia is up nearly 20% due to strong recovery in the business from the impact of the tsunami in 2011. We also had additional mass marketing expenses, which were not deferrable, were much higher in 2011 compared to 2012 and 2013. EMEA was up strongly also at 15%, with good growth in the business and the benefit of an acquisition in Central and Eastern Europe. Currency weakness dampened some of these results in Latin America and Asia. Latin America's three-year CAGR is 6% on a reported basis, but 9% on a constant rate basis.
Asia's growth rate was dampened by 5%. The yen went from JPY 80, you remember back in 2011, to a mean of JPY 98 in 2013. The Aussie dollar went from AUD 97 to AUD 106. FX did not really have a material impact on EMEA's growth rate. This slide is a summary of what we communicated on our December outlook call. In the U.S., we expect operating earnings to grow generally mid-single digits, range within group voluntary on the high end at 6%-8%. Retail annuities is quite market dependent, while corporate benefit funding growth will depend quite a bit on the opportunities in pension closeouts. Outside the U.S., we expect to see double-digit PFO growth in Latin America in line with the overall market, while operating earnings growth is somewhat higher.
On this graph in the very fine print, the U.S. numbers are in earnings growth and the others are premiums, fees, and other revenues growth. In Asia, we expect Japan's revenues to grow 5%-7%, better than the market due to our unique multi-channel distribution for that country. Korea should grow about 8%-10% in PFOs. The rest of Asia, which is a blend of Australia, Hong Kong, and China, India, should grow 12%-15%. Overall, Asia earnings should grow faster than the top line. EMEA operates in both mature markets in Western Europe, where PFO is expected to grow 4%-6%, while the emerging markets in Central Eastern Europe and the Middle East will grow 12%-15%. Today, roughly 80% of EMEA's earnings are from emerging markets. We expect the profits from EMEA will grow faster than the revenues.
In summary, MetLife has operating earnings and PFOs are very well diversified by business, products, geography, and risk. We've delivered strong operating earnings growth. We have attractive long-term growth rates in our emerging markets. I think I've come to sit down.
Thank you. Thank you very much, John. Seth? Justin?
Good. There we go.
Good. Before we dive into the financials and the growth opportunities, maybe we can talk a little bit about the regulatory environment. I'm sure it's not unfamiliar to you.
Not unfamiliar, no.
If you look at the non-bank SIFI situation today and your latest conversations with Washington, maybe you can give us an update as to where things stand. Do you have any better sense of if and when Met is designated a non-bank SIFI, when the rules would come out, what the rules would be like if and when they do come out? Any update on any of those factors or fields?
Sure. Those are three very simple questions with extremely complex answers. We are still in stage 3 under the FSOC process. We've been in stage 3 since last summer. It's a very long process. We've given them a great deal of information that they've asked for. We've also provided them with a lot of information, which we believe communicates that we are not systemic to the U.S. financial system. They're still evaluating that, and we haven't finished our discussions with them. At some point, how the process works under the Dodd-Frank Act, that process will finish, and then they will, at one of their meetings, vote on us. They attend those monthly meetings. They give you a preliminary designation to which you have the right during a time process to have an appeal with the FSOC members who voted on this.
Within a period of time after that, they give you the final designation. It's a bit of an involved process. I wish I could give you more clarity, but all I can tell you is we're still actively engaged with them, the record hasn't closed yet. We've done a lot of work and a lot of information back and forth with them. That's the FSOC that's chaired by the Secretary of the Treasury, and there's a voting member from different regulatory agencies within the U.S. federal government. If and once you're picked as a Systemically Important Financial Institution, you become regulated by the Federal Reserve. That has two impacts on an institution. Number one, you are subject to enhanced regulatory oversight.
They hire people, and they come and live with you, and you hire a lot of people and provide them a lot of information. I'm sure banks are quite familiar with the regulatory review and interaction. It's much more than the state review system. They tend to be quite active with you. MetLife has been, in the past, regulated by the Federal Reserve. We were a bank holding company up to last year. We are used to some of the interaction. I understand now, though, from speaking to other CFOs who are regulated as SIFIs, it is a higher level of attention. Dodd-Frank actually requires under the law to have a heightened level of regulatory work with the institution. That's actually all quite manageable. It's work and it's employees and a lot of back and forth.
We've had a lot of the infrastructure already in place because we've been a bank holding company, and there'll be work to do, but that's what we view to be manageable. The big question mark, the hardest question to answer is what will the capital rules be? That is a very complex area. It's a little more positive in our mind than it was a short time ago, let me just speak to that just for a minute. The Dodd-Frank Act requires the Federal Reserve to set capital rules for non-bank Systemically Important Financial Institutions, including insurance companies. We've had a lot of meetings with, it's up by the Washington Fed, and we and other non-bank SIFIs have had many meetings with them explaining how insurance works and how it is different from banking.
I think that recognition is generally better understood now, certainly at the Washington Fed and throughout the Senate and the Congress. The Federal Reserve, though, has an interpretation of the Dodd-Frank Act, something called the Collins Amendment, that they feel limits their ability to tailor the rules. It's how you read the amendment, but the Fed is reading it such that their interpretation is that if it's an activity done by a bank, you would have to follow the same rules as applied to a bank. That means Basel III type rules and all that comes with it and how they regulate a bank. If it's a unique activity to insurance, they would say they have the ability to tailor the rules to or have appropriate rules for insurance. What's an example of that? That would be a policy loan.
A bank does not have a policy loan, they could have a different risk weighting for a policy loan. A separate account. Banks don't have separate accounts. They would have the ability to tailor that. In discussions with them, we've presented ideas on how to tailor. Our peers at Prudential and AIG have also had many meetings to present how to tailor this. We've had no insight yet into how they will be thinking about this. They'd be great poker players, the Washington Fed, because they don't give much of a response. They listen, they nod, they ask a lot of questions, but it's hard to tell where they're going to come out. Until they give some guidance out, it's a bit unknown to us where they are.
We have also been very active, as have the ACLI and Pru and AIG, to try to have this Collins Amendment clarified because Senator Collins said she never meant this to require bank rules to apply to insurance companies. The way it's written, the Fed is saying they believe it does apply. Therefore, there's a bill that Senator Collins has now co-sponsored in the Senate. There's a bill in the House that would clarify this, that would give the Fed the freedom to apply insurance-type rules to an insurance company. That's building some good support. It's spoken a lot about in hearings, in that regard, we're a little more positive. On the other hand, getting a bill through Congress, the Senate, the House, and signed by the White House is not an easy task we're finding today at all. Nevertheless, it is on the agenda.
It's being spoken about in Washington, that is a positive step.
Thank you for the comprehensive answer. You alluded to this a little bit in your answer just now. I think when we looked at the last stress test for banks, I think some of us were surprised by the level of qualitative input, or how much the Fed measures the qualitative side. In fact, we saw banks fail on that side. With that in mind, and given the fact that Met was already designated a bank SIFI at some point, are you active in improving the controls and procedures? Maybe you can give us some examples of where it is that you're strengthening, what areas you still feel may need more improvement today.
Sure. Since we've not been a bank holding company, we've still continued on to good prudent management of all these things, but with an eye, just in case we are picked, what it might be. An example of that is model validation. The Federal Reserve requires independent model validation of all the critical and high-risk models of the organization. As you can imagine, insurance company with actuaries have many calculations for reserves that go through it, and it's not that it's not good and well-controlled, but the federal level of documentation is a higher standard, and they want independent review, not just a peer review within the unit. We've embarked upon a whole system to categorize all of our models worldwide and are working through, with our board, a plan for improved model validation, independent model validation, and building a unit to do that.
That's one example of an area that, if your models are not well-validated, that could be a reason on the qualitative side that could be a potential issue. That's why we are spending some time on that. We've done things like speak to a risk appetite. We've always had one, but we've had it approved by the board now. Bringing this level of corporate governance that we expect the Fed to have. It's just good corporate governance anyway. I find a lot is a lot of documentation and getting the form documented because we've always had risk appetites. We've always managed the company that way. They like to see it all written down and quite documented. Those are some examples. I think it's an unknown how detailed they will expect an insurance company to be.
I think banks have been learning, as I've been watching over the past few years, just the level that is expected. It does seem to surprise them from time to time. I think you have to be cautious in all this, and you have to approach this all with some conservatism. It is a new world of being regulated today, and you have to recognize that and be prepared for that.
Great. If we move on to interest rates. I remember last year we sat here, and I was giddy with anticipation and excitement, and asked you about a 4% rate environment. Hasn't quite materialized yet. Yet, if I read the 10-K, I think you give a stress test scenario where an environment where the 10-year is at 2.5%, spreads remain relatively unchanged. You see a $75 million impact to 2014's earnings, $130 million impact-
Additional
additional impact to 2015 earnings. Lo and behold, we're pretty much in that environment today. How do you see the stress test playing out? How do you see results relative to your expectations?
Well, we hit the end of the year at 3%, that was quite nice, the 10-year Treasury being at 3%. We've come back again a bit. There's a wide range of views as to where it's going to end up. On the one hand, we may have the Federal Reserve keeping rates down, keeping them at a lower level in the 2.5% or 2% range. On the other hand, there is growth in the U.S. economy. It's a bit sporadic, we're getting a lot of noise with a very cold winter that impacted a lot of things. I wonder if it impacted retailing. I'm not an economist, I don't know. I think the recovery won't be smooth. It's a slower growth recovery, and will go in fits and starts, and the data will be contradictory from time to time.
We'll have to see what comes out. I think 2.5% is a lot better than 1.68%, where we ended the year in 2012. We gave the guidance in our 10-K as to the earnings impact. It's like $0.07 this year and maybe $0.20 relative to our plan and our forecast rolling forward as to where we might be. That's still very manageable in our overall earnings power of this firm. Let's not forget that over a third of our earnings is coming outside the United States, not in U.S. dollars, and with different growth rates and different impacts. In the U.S., we have the interest rate risk. In international operations, we have currency risk. We feel a very balanced portfolio over time will generate good earnings growth no matter what the cycles go through from time to time.
Okay. Another question on interest rates. Back in the outlook call, you had discussed the estimate of having about 35% free cash flow conversion from operating income. I think you'd also mentioned the counterintuitive impact of rising rate environment and how it holds back the free cash flow conversion. With the interest rate environment being actually a bit lower than what the base case or the underlying assumptions were when you came out with that 35% estimate, how do you see that playing out for the rest of the year? Where do you see free cash flows for 2014?
A large source of our free cash flow, which we define as dividends up from subsidiaries to the holding company, less any capital that we have to inject into a subsidiary around the world for growth, less holding company expenses, plus any increase in debt we might issue to keep the leverage constant. That's our definition of free cash flow. Just want to be clear on that. That's truly cash available for dividends, share buybacks, or acquisitions. It's unencumbered at the holding companies. We have a U.S. holding company, we have an international holding company as well, but it's freely available. What determines that, a great deal of that is determined by our U.S. subsidiaries, our statutory insurance companies. Your dividend capacity is defined for 2014 by what we earned in 2013.
Because you could pay a dividend out of the statutory entity based on last year's earnings. Last year's earnings were impacted by rising rates because it's a net income measure that reflects. We have all these derivatives we bought for long-term industry protection that are in the statutory entity. As rates went up last year to 3%, we had lower earnings, and it impacts the cash for 2014. If interest rates drop year-over-year in 2014 from the 3%, let's say we end up below that, we'd have increased capacity for 2015 from the U.S. statutory entity. It's always a delay of a year that impacts that.
Okay. With that, why don't we move on to the international front, maybe a little bit about capital deployment. Don't worry, I'm not going to ask you about buybacks. On capital deployment, we clearly see a lot of other opportunities besides buybacks. There's dividends. Clearly, we did the Provida deal a little over a year ago. There are pension closeouts, other purchases of blocks of business. Can you maybe talk about where you see opportunities, what your priorities within the different opportunities are?
Sure. We think in terms of capital deployment, we want to strike a balance between being conservative, potentially being a non-bank SIFI, and uncertainty over what those capital rules might be, and quite frankly, the risk of bank-like standards coming on an insurance company's balance sheet. We do need to strike a balance. We want to continue growing our business. We had the opportunity when we stopped being a bank holding company. We did raise the dividend dramatically last year. We've also raised again this year. We've almost doubled the dividend from that time period. We also did an acquisition of $2 billion in cash in Chile, and that's one of our biggest priorities is to deploy capital into the emerging markets.
We had planned to do acquisitions to help get to the 20% of our total earnings being from emerging markets. Not all of it. We are going to have organic growth as well, but that's a key component. Provida was a good acquisition. I have to add that we are very disciplined about how we approach these acquisitions. We want to ensure that we get good returns on these. We bought essentially Provida for 10 times earnings, which we're happy with, and that's coming through quite well. It's going to generate $200 million of earnings this year. It's well on track. That's gone quite well.
The other thing that we think about also when you think about the whole risk of being a non-bank SIFI and these bank capital rules, is when we buy something, how's that going to look if we get some form of bank-style rules on us? Provida comes out very well. It is a fee-based business. It's a pension fee. Your income is a percentage of salaries from Chilean workers mandated by government. It's not related to asset growth or anything else and doesn't have a big asset balance sheet. If there's some form of higher capital to asset-intensive businesses, that would look okay under it. That's another filter that we do. That doesn't mean we're going to eliminate it. It's really a question of how much risk that you want to take. We are looking at other acquisitions all the time.
We just did a transaction in Malaysia. We bought half of an AmBank bank's insurance company. That won't add a lot to earnings the next few years, but that's a great growth story for us with a joint venture in Vietnam. We're building some smaller acquisitions as well for the future. We're still actively looking in the emerging markets to see what else might be there. However, many of them have been quite highly priced, with a lot of cash up front and without a return for a long time. Those we're not quite as keen on.
Okay. With the pressure in emerging markets, do you see some of that pricing pressure abate or not yet? If so, would you see it more in Latin America, more in Asia?
We've seen a little bit. I wouldn't say a huge rush, but I think the emerging market story is still underway in terms of what's going on. We'll just have to wait and see. I think as I read, all of my competitors are also actively trying to grow in some of these markets. You have to be very disciplined at this, and we are quite disciplined at doing this.
Okay. One other question on emerging markets. I think Met, at least of the companies I cover, is one of the ones that has some exposure in Eastern Europe. With everything going on in Russia and the Ukraine, can you maybe give us some sense, can you quantify maybe what the exposures there are?
We are in Ukraine. We have a small business there. It's not significant profits. It is profitable, though. Our employees and people are located in Western Ukraine. We had some sales agents in Eastern Ukraine. Our business, even though all the turmoil is going on in the east, it's still going on, it's still fine. It's really not a very large contributor to profits today. The other area is Russia, which is roughly about 10% of our EMEA earnings today. That's growing well. That slowed down a little in the first quarter. We think that that still has solid growth potential, and we sell through a variety of channels and through banks there. A lot of health products. That has gone well, and we hope for a peaceful resolution to all these conflicts.
Okay. Maybe I'll ask one more question before opening it up to the audience. How can I stand here for 30 minutes with you without asking anything about variable annuities? When we look at the variable annuity industry, it seems like there's been some pullback away from guaranteed living benefits. As that pullback occurs, do you think that the proposition to the policyholder, from a policyholder perspective, does it become less attractive? Do the alternative products offered by banks or asset managers or the like become relatively more attractive at that point? How do you position yourself with that in mind while trying to protect your balance sheet?
Variable annuities have been around for a long time, without even very sophisticated riders. We in the industry are seeing some growth now in a more stripped-down version without the riders on, just to get tax deferral. As tax rates keep going up, it becomes a better benefit for people, and there are some more unique products out there. I think the race for guarantees got to quite a high level, and we have pulled back from that. We are not out of the business. We think variable annuities act as a very great product for a growing and important consumer need. It's really finding the right risk balance as a firm in how you offer these to make sure that you've got a good risk profile and have a well-diversified business. We expect to sell less than $10 billion this year.
As we indicated on our last call, this is sort of the bottom. We expect to be coming up a little from that. Does that mean we're going to go back to $20 billion plus? No. We do plan to grow, we hope to grow that business over time in a very prudent, well risk-adjusted, good way. The new business has an attractive ROE, but it is a volatile business. You want to make sure that the variable annuity piece is never really too much of the overall risk profile, that you can always absorb the fluctuations that might happen if bad things happen again as we saw in 2008.
Okay. With this, why don't we open it up to the audience? If you don't mind waiting for the microphone before asking the question and maybe also introducing yourself.
Hi. Lee Rosenbaum, Loomis Sayles. Can you talk a little bit about the 35% free cash flow conversion, understanding that in any one year, that can move up and down moderately, as you talked about earlier with the derivative positions. How do you think about that longer term, three, five, seven years? Are there opportunities to drive that closer to 100%?
Sure. If we were not growing in many of our emerging markets and using capital, you would slowly approach a more steady state, particularly with the U.S. business. Our guidance for 2015 and 2016 was at 45% to 55%, and there are statutory limitations in all these things over time. Japan is conservative accounting. The reason why it doesn't get higher in Japan over time is because we're growing. If you slow your growth rate, eventually you'll build up excess capital. Regulators do allow you to take special dividends if you get to the higher levels. It's not that it's trapped there forever. We were allowed to take a special dividend of $1.6 billion from Japan in 2012. We have been able to take out excess capital as it builds up.
I think the 45 to 55 for the next few years, that's the guidance that we have with a steady state on interest rates. That assumes interest rates are slowly increasing up over that period of time.
Why don't I ask another question in the time being? Looking at the variable annuity portfolio, once again, I think you're in the midst of a structural change there, moving some of the offshore, or the offshore captive and some subsidiaries, consolidating them onshore. Can you give us a sense of where that process is today? What capital ramifications there may be? Are there any tax implications to that as well?
Last year we announced we are moving our variable annuity reinsurance company, a captive internal reinsurance company, and moving that onshore and then merging that back into our U.S. statutory entities. The reason why MetLife created this in the first place was we were running variable annuities from many different U.S. statutory companies. To run a hedging program in all four of those companies, we just couldn't do it that well. We created one central area that takes all the rider risk. The revenue to that company is the rider fees, and the assets are all derivatives to match the risk of that business. That worked very well for a long period of time. The Dodd-Frank Act requires collateral to be posted not only on a variation margin, but on an initial margin.
That'll be phased in starting last year, over the next five years. Many of the derivatives we have are not exchange traded derivatives. They're some custom derivatives, uniquely to the risk that we design for variable annuities. That has a much higher initial margin requirement that has to be posted as our derivatives wear off, and we have to buy new ones. That would've meant, had we not done this step, we'd have to be taking valuable cash from the holding company and putting it down to post margin in this company, which seems like a waste given we've got assets that can be posted in the statutory entities. We're bringing that captive back. It's now in Delaware. We had to fix this issue of having too many of these smaller statutory entities. We're merging three U.S. statutory companies.
There will be a large U.S. life insurance company when done. When that's done, the risks and the fees will be put back to the non, well, the non-New York company, and anything sold from the New York company will go back to New York. We'll be running two derivative programs, one in New York, one non-New York, but we've got lots of assets to post as collateral, given we have those entities. It's a very complex transaction to merge three statutory entities at once, requiring SEC refilings, product refilings. The project's underway. We expect to execute it all in the fourth quarter of this year. There is a bit of an initial cost.
We did give guidance last year at our investor day that we expect when this is all said and done, that the RBC ratio of our combined U.S. entities will still be above 400%. The calculations thus far have indicated that that's still a good outlook. We don't really have significant tax implications from this. These entities were all under the U.S. tax return already, so there's not a fundamental change in that tax profile. So far so good. It's a complex transaction, but we think it will also mean some efficiencies going forward in 2015 and others because we'll have less companies, less filings to do, and have a nice large non-New York company.
Okay. You have one question back there? I think that may be the last question of this session.
Thank you. You've talked about emerging markets, you've talked about Chile and Malaysia. I guess these two countries have a regulatory framework in place, so they are, in a sense, developed in your business. If we look at ASEAN, i.e., from Vietnam to Indonesia to in that zone, which countries would you consider? i.e., would you consider to go to Indonesia, Vietnam, because you've got a large population? Even if we look at closer to India, Bangladesh? Is there not enough regulatory framework in place so that you could actually develop a business?
We're in Bangladesh. I think we've been there for 50 years, if I remember correctly, this year. It's very profitable. It's small, but it's profitable. We're in India with a joint venture with PNB Bank. That's growing well this year now. We just started last year, this joint venture. We have started a joint venture with a bank in Vietnam. That'll be an organic growth. We're not in Indonesia. It's hard to enter this country sometimes. We would like to be, but we'll have to find the right partner and at the right price in order to do that. We have a broad base of organic growth, and we have experience.
One of the great things we got in the Alico acquisition was all these many countries that are very hard to get in today, the Middle East, profitable, and we have a very talented group of executives who are used to working in these types of markets, both its regulators and also the businesses. They're able to do business even despite some of the risks of emerging markets. We're in Egypt, and that business is profitable and doing well. The management team is experienced in doing this. That's one of the great things that we got with the Alico acquisition.
John, thank you very much. I think we're out of time.
Thank you.
I appreciate your insights.
Thank you very much.