Hi, everybody. Thanks for joining us for our afternoon sessions. I'm Bill Hebel from Specialty Sales at Bank of America Merrill Lynch. I'm very pleased to introduce Steve Kandarian, Chairman, President, and CEO of MetLife. Met is the largest of the U.S. life insurers, with presence in Asia, Latin America, and EMEA, it truly has a global presence. With the recent announced acquisition of AFP Provida, a leading Chilean pension provider, Met is further expanding its presence in emerging markets. With that, I'm going to turn it over to Steve to walk you through the story. Steve?
Thanks, Bill. Okay. It's good to be here today with you. We just did our earnings call this morning. I imagine some of you may have listened to that. I have to go through the cautionary statement that we'll be talking about some non-GAAP measures and some forward-looking information as well. Okay. Let me kind of dive right into the first slide here. We had a good year in the year 2012 that we just announced today. Operating earnings up 22%, earnings per share at $5.28, above the high end of range we gave on Investor Day of $4.80 to $5.20. Premium fees and others up 5%. We put our operating expenses down. I'll talk about book value in a minute in terms of some write-off, which is why it went flat there.
In operating ROE, we had a good year, 11.3%, up from last year, 10.1%. Overall, I'd say MetLife was very pleased with 2012. It's still obviously a difficult environment for life insurers. When the 10-year treasury is below 2% for most of the year, it's just a tough environment. Given that the economy has improved but still hasn't snapped back to the kinds of levels that oftentimes you see after the conclusion of a recession, that also is a headwind for us. Our businesses overall performed well. We're working really hard on our strategy and our expenses. The book value per share, let me just kind of mention a little bit about that. We did have some goodwill impairments related to our VA book. It was about $1.6 billion.
We had some derivatives which were used for hedging purposes where there's no offset on the corresponding asset or liability, which is non-economic as well, that went into that number that brought down the book value number. We had some lapse assumption changes that dealt with the VA book that also resulted in some write-off of goodwill. That is why you see the book value number go sideways during a year we had good earnings. Okay. All right. As I mentioned, the macro environment out there is not wonderful, there are things that we can control, and we're working on that. This is a strategy that we have talked about before. I want to just refresh people's memories. In refocusing the U.S. business, that really means taking down risk, building out our global employee benefit business.
That's one of MetLife's real strengths historically is the group business in the U.S. We're really taking that now globally with our new geographic footprint post-ALICO, now operating in over 40 countries across the globe. Growing emerging markets, a big piece of that really is our growth story and driving toward customer centricity in a global brand, leveraging the MetLife brand, not just in the United States, but outside the United States. Let me kind of highlight some of the key cornerstones there that I just showed you. We'll start with the U.S. business. From this chart, you can see that our VA business peaked out at $28 billion in the year 2011. We discussed with the analysts and investment community at the end of 2011 that we're going to bring this number down. We did that in this past year, 2012, to $17.7 billion.
We announced that the number, the target we have, the range is $10 billion-$11 billion for the current year. This really corresponds to our strategy of moving away from the more capital-intensive products that we've been selling historically and moving away toward businesses that don't have that same level of capital intensity and more protection products going forward, lower risk. Let's drill down a little more on the VA business. The GMIB Max Variable Annuity is the primary variable annuity that MetLife sells. We introduced a new product on February the fourth. The roll-up rate went down from 5% to 4%. The withdrawal range went down from 4.5% to 5% to 4%. Essentially, we're really working our way down the risk curve on this product. Some people have said to me, "Why don't you just stop selling VAs?" That question does come up.
Our view is it's still a good business if we get the risk profile correct for it. In addition, there's other considerations. We have a large distribution force, both MetLife agents as well as third-party distribution. That's been selling this product and other products like this for a number of years. We are migrating them away from these riskier products we sold in the past to de-risk products going forward, and transitioning to other kinds of products that also can solve people's retirement needs in the future. We have things in the drawing board I can't disclose right now because they're still in the developmental stage, and they're still in the regulatory approval stage. They'll bring down this risk even further in this segment. The landscape really has changed, not just at MetLife, but throughout the industry. Our competitors are de-risking their products.
The distribution force understands it's a new day, that the kinds of products they once sold are no longer going to be available in the marketplace. I would say you'll be seeing further changes in the coming quarters. Here's a GMIB Max IV product on the left. That's the product that we sold until very recently. We've discontinued that, and the new product is on the right-hand side there. We ran stochastic models on this, 1,000 simulations for each of the two products. There you see a distribution of potential returns. The old product kind of averages out to about 16% return on investment for us on an economic capital basis, fully loaded, and about 18% on the right there for the Max IV product, the new product. Then you see the simulations.
What % of the time do the model indicate that there'd be a 15% or higher ROI on each of the two products? You can see it's 61% on the old product and 75% on the new product. Now, getting to a negative ROI is less than a 3% chance under these simulations. This is just an indication of the changes we're making and have been making over the last several quarters, to continue in this business, but to reduce our risk. A second cornerstone of our strategy relates to growing our emerging market exposure. The Provida deal that Bill just mentioned is an important component of that. We acquired AFP, or we're acquiring AFP Provida from BBVA for roughly $2 billion in cash. We're funding it with cash that's currently on the balance sheet.
The pricing is 10 times forward earnings, and we expect it to be accretive this year by about $0.05 a share and next year by about $0.15 a share. That's on a cash basis, I don't think that's the best of measures in terms of looking at a transaction to say, does it create shareholder value or not? We ran analysis on a 75/25 basis, 75% equity, 25% debt mix, which is roughly our balance sheet mix. The deal was essentially neutral on an EPS basis for the first couple of years, after that, it became accretive. The free cash flow, which is another key element of our strategy, increasing what % of free cash flow gets written off from our existing businesses, which now is around 40% or just over. This business is roughly 70%.
The reason we did the deal really was it fit our strategy, and it was a good financial deal both. Some have asked, "Why are you doing this?" Because right now, as part of being under the Fed oversight as a bank holding company, you can't buy back shares. You can't increase your dividend right now. Are you doing this deal simply to utilize your cash reserves? The answer is no. This deal really did pass all the measures that we'd have it pass, whether we can buy back stock or increase our dividend or not. I pause right now and just give you some new news that we just got after the earnings call before coming here, which is we did get final approval from the FDIC to debank and from the Fed. We are now no longer a bank holding company.
A little more on Provida. As I showed you before, our strategy about growing in the emerging markets when you look around the globe and say what markets are attractive because not all emerging markets are necessarily attractive to us. Chile is a place we've been for a number of years. We have a number 1 market position in the life insurance space. We have a very strong team down there that has been in place for quite some time, and it's really one of our leading non-U.S. markets. It's a country we feel very good about in Latin America in terms of stability, in terms of growth, in terms of rule of law, political risk not being high, and so on.
That was one of the key reasons why the Provida deal was attractive to us, the country, specifically Chile, and the fact that it's a growing economy. The pension market is one in which employers, excuse me, employees must contribute a fixed amount of their salary every year. That's where the fees come in that we garner from this business. It's based upon the contributions from their salaries. It's not based upon assets under management. When you have assets under management as the key element of your fee structure, when you see the ups and downs of the market, you're going to see your fees really become quite volatile. Here really is the contributions from those salaries, which is a much steadier number than the assets under management. Provida is a leader in the market in Chile, 29% market share.
It's a fairly concentrated market at four or five. The key players really have the lion's share of the market. It's about $160 billion mandatory market right now in Chile. That will grow over time with their economy in the accumulation of those assets. In addition, there's a voluntary component that people now can contribute to in Chile if they want to increase the amount of money they're putting aside out of their salaries. That's still in the early stages, but we're very focused on that market. It's only $6 billion. We think that's going to grow dramatically in the coming years. We see this as a real growth opportunity in a fee-based business with relatively low risk. This is kind of the analysis that we went through at MetLife before we moved forward with the Provida deal.
Does it meet, does it align with our goals, our strategy? On an operating ROE expansion basis to get our ROE numbers up, it does. We think it's around 15% ROE on a levered basis, 75/25 basis. It doesn't click off one goal here, which is expense saves. There's no real synergies here to speak of. A little bit in Chile, but it's minor. Shift from market sensitive products, interest rate sensitive products to a product that really is much more fee based, again, based upon salaries, not assets under management. Then grow the emerging markets business, which has been about 14% of our bottom line, and we said we want that to be above 20% by the year 2016. This transaction takes us about 17% on top of what we have already. A real move forward along the progression for that goal of ours.
When you look at the alignment of those goals with the Provida transaction, you look at being creative a few years out, even on a levered basis. You look at in terms of bringing down our overall risk profile and getting into fee business in a more significant way. You look at in terms of just what we believe to be a relatively safe transaction outside the United States. All those things we clicked off, which is why regardless of our status in terms of being able to buy back stock or not, we thought this was a good transaction for us to consummate. All right. I want to talk a little bit about how we think about creating shareholder value.
When my team and I sit down and talk about our business, and we talk about what things we're going to be doing going forward, what things we shouldn't be doing going forward, this is a lens that we use to determine our actions. What we look at is what's the return on equity of something we're doing, a business we're in or getting out of, or a business we may acquire or expand, and what's our cost of equity for that business? Our expectations for the year 2013 is somewhere in the 10.2%-10.9% range for ROE, not where we want to be. Our target for 2016 is 12%-14%, even if rates remain low. Part of that plan that we laid out in May of last year at Investor Day assumed $8 billion gross of share buybacks.
We don't know whether that will actually come to pass or not. That's going to be determined by a number of factors, including the regulatory landscape. People have asked us the question, what if you couldn't do any buybacks hypothetically? What would that 12%-14% number turn into? It turns into basically 11%-13%, takes off about 1%. I'm not suggesting we're not going to do any share buybacks. I'm simply saying to answer that question, how impactful are the share buybacks on this ROE projection? Those are the numbers. There's certain things we cannot control, but there are things we can control, and that's what we're working on. We've done some analysis.
We've taken a look at MetLife's return on equity since we went public in the year 2000 and our cost of equity capital, and we're using third-party sources to determine our cost of equity capital, not an internally driven number. You can see that during the early years of our existence as a public company, we were returning well above our cost of equity capital, which we traded at a premium to book value. At certain points in time, a significant premium to book value, which you'd expect with those kinds of numbers. The crisis came in 2008, and all of a sudden, our cost of equity capital skyrocketed. Our beta was typically around just over one, 1.1, say, on average during that period pre-crisis. At one point spiked up to around three times, three, a beta of three. What drove that?
One of the elements obviously is very low on a historical basis interest rates, which impacts our industry longer term. We were well hedged because we worried about the possibility of low rates for some period of time, and that's why our earnings held up even through this period. Still, in the out years, if one assumed you had a long period of time in the U.S. with very low rates, it put pressure on life insurers in general, including us. That helped spike up that number in terms of beta. Certainly during the midst of the crisis, there was all kinds of concern about financial institutions. That certainly threw up the beta dramatically in that 2008, 2009 period. Things snapped back in 2010 when people felt like the crisis is now over. Recovery hasn't occurred, but the crisis piece is over.
We're stable, at least in that sense. The 10-year Treasury went back up over 3% at one point. Rates have come down since, you can see the cost of equity capital for us, I would say also for the industry in general, has gone up somewhat as people get worried about the risk associated with low rates for a long period of time for our industry. In our case, probably in the case of a two other large insurers, the regulatory issues. How will very large life insurers be regulated going forward under Dodd-Frank? What will FSOC do? If MetLife or others are declared a non-bank SIFI, what will the rules look like from the Federal Reserve, which as of this time have not been written, therefore we don't know.
A combination of all those factors, I'd add one more, which is that some of the products that we were selling in this industry back in this pre-crisis era, including variable annuities with very high roll-up rates and lifetime guarantees, induce risk in a low-rate environment. All those things affect this chart. Obviously, our valuation's impacted by two things. How much do we earn, what's our cost of capital? We're working on both of those two parts of the equation. We're working hard to get our ROEs up. Deals like Provida speak to that. We're working hard to get the cost of equity capital down in terms of parts we can control, which is a risk piece. We can't control the 10-year Treasury, but we can control things that we produce, we manufacture. We can control things that we hedge in terms of risks.
We certainly can control things like our expenses and what markets we're going to play in. Okay. Key takeaways. We feel like it was a good year, 2012. You've seen our projections for 2013. Obviously, we think it's going to be a tough year, pretty much a sideways year for us. Not where we want to be, but still strong earnings. We're going to continue to execute on the strategy initiatives that I've just gone over with you. We can't control the regulatory environment, but we certainly are speaking. We're at the table. We're having conversations with regulators. We're trying to explain the potential impact of rules that could be coming out of Washington that could affect us.
We're working hard on driving up our return on equity and trying to do everything we can to drive down our cost of equity capital to create shareholder value over time. With that, let me open up to questions.
Maybe just to kick it off here and staying with the low rate environment, the forward curve is starting to price in a little bit of improvement, and expectation level is starting to get a little bit better that maybe we're starting to come out of this very low rate environment. Is there a level of rates where there's an inflection point for you that would really start to have an impact?
A negative impact?
A positive impact.
A positive. Okay. Positive. I'd say if you get up to around the 3% level, we're quite happy. 3%-5% is kind of a sweet spot for us. A very quick spike up to excessive interest rates in a kind of a panic scenario in terms of inflation would not be good for us any more than very low rates would be good for us. The sweet spot's kind of 3%-5%, even a little higher if it's gradual. That's how the industry basically was built over the years. Having said that, we're not necessarily expecting or running our business assuming rates go back up to those 4% or 5% levels in the near or even intermediate term. If they do, that's great. That's upside potential. We're assuming low rates for a long period of time. We're building our company around that scenario.
It's really a downside protection scenario.
On the earnings call this morning, you gave some sensitivity if you didn't do any buybacks versus the $8 billion, assuming the original analysis. What assumptions did you have for Provida in that 11%-13% ROE number with no buybacks?
I'm not sure I understood. Our 2016 projection of 12%-14% assume $8 billion buybacks over that whole period of time. What I said just now was if we did 0 buybacks, we did 11%-13%.
Right.
$8 billion equals 1%.
Right. What about when you originally did that, your projections? I don't think you had Provida, right?
No. It was not there. Provida wasn't in there, although, and I don't remember the exact number, we did assume some small acquisitions just because we always do a handful of small acquisitions over time. That was built in. The 2016 model. It may have been a couple billion dollars in total. I don't remember the exact number. Provida was bigger than anything we assumed in that modeling. We took cash, which was making almost nothing for us, and turned it into earnings, which will throw off $0.15 a share, we think in 2014, unlevered. That should add to the ROE. Yes.
All else equal, the ROE would be higher because you did the Provida transaction.
Yes.
In 2016 on that forecast.
That should help. It definitely should help in terms of getting up to that 12%-14% range. I think one could view the Provida $2 billion deal as being comparable to a buyback, like three years or so out in terms of the accretiveness and therefore its impact on ROE. Yes. We could do it by buybacks or acquisitions, but let me just go on for a little bit about acquisitions. I hope people who followed us over the years understand how disciplined we are about acquisitions. We've bid on a lot of things, and we win very few things, very few deals, and that's a good thing. We're very disciplined, and we bought Provida at 10 times projected earnings. For an asset management business, that's a pretty good price.
That wasn't the first asset management deal we bid on, but we were outbid by a lot in some other cases. We really look at, does this clear the hurdles that we'd have for a share buyback? Does it clear a hurdle in terms of our overall ROE based upon our view of riskiness? When it does, then we'll move forward. We're not shy about doing that. If it doesn't, we're not going to chase a deal just to say we did a deal, even with cash on our balance sheet. Sounds like someone wants to come in.
A few months ago, you spoke about buying protection against rates going up potentially as you guys were very prescient in doing so when rates were much higher, quite a few bought protection for rates to go down.
Right.
Can you give us an update as to what you're doing and where you hope to be and what the timeframe is and what type of instruments you're talking about?
I'll go back a little bit. Back in 2000, I think it was 2004, we first started buying protection for potentially lower rates. Frankly, it wasn't a call back in 2004. Think about, we're just coming out of a recession, the dotcom recession. We finally got some wind to our back. It was simply a realization by MetLife that's very focused always on risk in the long term to say, "Let's just buy some out of money protection." Yes, it'll take down our earnings a little bit, but it's just insurance. It's insurance in our portfolio. We got a big portfolio. We increased that position over time as rates drifted higher and higher as the economy heated up over time. When things fell off the cliff, we stopped doing that because the price got too high for protection.
That rates are extremely low, we've taken the opposite tact, and we're buying out of the money hedges to protect against significantly higher interest rates. If interest rates drift up to 3%, it's not a big deal to us, but if they spike quickly to a much higher number, it could be a problem. That is the kind of protection we're buying now. We'll continue accumulating a position based upon the markets. We look at the markets and say, "This is a good time to buy." Rates just went down for a period of time. We can buy some out of the money protection very inexpensively, longer dated, just like we did on the low rates, which go up, in some cases, past 10 years.
We're building the same kind of protection for a higher rate scenario that we did back in '04 for the low rate scenario. Over here.
Steven, could you just describe your commercial real estate exposure within your investments, and then maybe just characterize what sort of in-place yields you have on the commercial real estate and what sort of realizations you're getting as well?
Are you talking about the mortgages, the real estate equity?
Equity.
Equity. Okay. All right. I used to be the investment guy. I had these numbers on the top of my head. I no longer do. We have a real estate equity portfolio. We did sell a lot of it pre-crisis. You may remember Peter Cooper Stuyvesant Town sale, other sales of 200 Park Avenue, 1 Madison Avenue, our original corporate headquarters, and so on. We shrunk that portfolio. We really didn't buy much in terms of real estate equity for a number of years. It was for the following reason. As prices got kind of frothy in that market, the bet was rents can go up dramatically, and we'll chase the future in terms of a capital gain down the road. The yields on those buildings, if you bought them, were exceedingly low because with depreciation, they got you down to a couple % current return.
Given how we're graded, if you will, in the marketplace on income and EPS and quarterly earnings, having a 2% yield when you could buy bonds with yields in the mid fives and high-quality instruments just put a drag, if you will, on our earnings, our crediting rates in terms of selling insurance and so on. We backed away from that market. In addition, we were worried about were we in a bubble, we didn't think it was a great play for capital gains anyway. Occasionally, we'd sell a big building with a big capital gain. We get a one-time pop based upon book value, no multiplier on earnings. The assumption was it's not repeatable. We're not going to give you a multiple on your ability to do trades in the real estate business. We pulled back from that market for several years.
We are now back in the acquisition of real estate equity market in a very selective basis. The same kinds of things we always talk about in terms of our mortgages. The top tier markets, A quality properties, strong rent rolls, diversified, all those kinds of factors we take into account. Now there are some properties we can get a reasonable yield even after depreciation, and you're able to have the potential of a capital gain down the road, which will be accretive in a meaningful way over time to book value. We look at earnings per share, we also look at book value. Back pre-crisis, mid part of last decade, the EPS piece was just too dilutive for us to do much. Now that's no longer a drag, we are back in that market looking for real estate equity opportunities. We're pursuing some right now.
Hi. Now that you have fully debanked, can you give your updated thoughts on the possible buyback and increase in dividends? Keeping in mind that you obviously are being reviewed for SIFI, but also the fact that other companies in a similar position are taking the steps. Thank you.
The obvious question is, as of today, we're no longer a bank holding company. We're no longer regulated by the Federal Reserve. What's your plan? This is not an easy analysis because the simple thing to say is, "I'm free. We'll increase our dividend. We'll do a bunch of stock buybacks, make a big announcement, big splash. Isn't that wonderful?" The problem is we don't know whether we'll be declared a non-bank SIFI. I don't think we are systemic, MetLife. I don't think the industry, the regulated insurance industry, is systemic. The problems at AIG were not insurance regulated entities. However, it doesn't mean that our point of view is going to prevail when FSOC makes its determination about the largest insurers in the United States.
Prudential and AIG have been under review by Federal Reserve since, I think it's probably September of last year, in the final phase 3, where there's interaction back and forth. To date, there have not been any pronouncements by Federal Reserve. Some think that as time goes on here, we'll probably be hearing something fairly soon. The betting line would be, if you're in Las Vegas, that if AIG and Prudential were to be, I'm not saying they will, but were to be declared non-bank SIFIs, then it'd be logical to assume MetLife would be one, too. At which point the Federal Reserve would be charged with writing the rules under which all of us will then live. First of all, we're not declared one yet. Second of all, those rules are not written.
It's very difficult to lay out a capital plan not knowing what the rules of the road are. Now we can take our chances and do something. If the rules are very harsh from our perspective, that something might have to be reversed. As much of upbeat feeling there might be for the first part of that equation, I'm sure there'd be some really negative reaction to the second part of that equation. Those are the things that we're thinking about. We just learned today that we're no longer a bank holding company. We've had conversations not only internally within management but with our board, and we will continue having those conversations, and we'll continue assessing the landscape. We'll continue to watch and see what's happened in other arenas, meaning with AIG and Prudential, and we'll make an assessment and we'll go from there.
I don't have anything to tell you today specifically on that. I know that's not probably the comment you wanted to hear, but that is our thinking and that's where we stand today.
Okay. I think that's time. Thanks very much.
Appreciate it. Thank you.