Ladies and gentlemen, thank you for standing by. Welcome to the MetLife fourth quarter 2012 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. MetLife specifically disclaims any obligation to update or revise any forward-looking statement, whether as a result of new information, future developments, or otherwise. I would like to turn the call to Mr. Edward Spehar, head of Investor Relations.
Thank you, John. Good morning, everyone. Welcome to MetLife's fourth quarter 2012 earnings call. We will be discussing certain financial measures not based on generally accepted accounting principles, or 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 press 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 Steven Kandarian, Chairman, President, and Chief Executive Officer, and John Hele, Chief Financial Officer.
After their prepared remarks, we'll take your questions. Also here with us today to participate in the discussions are other members of management, including William Wheeler, President of Americas, Steven Goulart, Chief Investment Officer, Michel Khalaf, President of EMEA, and Chris Townsend, President of Asia. Before we begin, I'd like to highlight that we will be including additional disclosures in our 2012 10-K on our variable annuity business and the sensitivity of earnings to a sustained low interest rate environment. I'd like to turn the call over to Steve.
Thank you, Ed, and good morning, everyone. We are pleased to report fourth quarter 2012 operating earnings of $1.4 billion, up 10% over the fourth quarter of 2011. Operating earnings per share were $1.25, above the guidance range of $1.12-$1.22 provided on the December 2012 guidance call, and 7% over the fourth quarter of 2011. For the full year 2012, we reported operating earnings per share of $5.28, up 21% from 2011, and an operating return on equity of 11.3%. We are very pleased with these results given the challenging macroeconomic environment. John Hele will discuss our financial results in detail, but I would like to highlight a few items. First, despite growing pressure in the U.S. from low interest rates, our investment spread margins were up in three of our four U.S. business lines.
The strength of our investment spread margins reflects our prudent asset liability management and the benefits of our interest rate hedge program. We continue to manage the risks of low interest rates and take actions as appropriate. Second, we continue to execute on the strategy that we outlined at our May investor day. One of our cornerstone initiatives is to refocus the U.S. business, which includes shifting our business mix away from market sensitive, capital intensive products toward protection-oriented, lower risk products. On February 4th, we introduced a new living benefit variable annuity product, GMIB Max V, to replace GMIB Max IV, which is no longer being sold. The biggest change between the two products is a reduction in the roll-up rate from 5%-4%. We believe that the new product will improve the risk profile of our VA sales and generate a higher expected return on economic capital.
These changes are important components of our plan to reduce U.S. variable annuity sales from $17.7 billion in 2012 to $10 billion-$11 billion in 2013. Consistent with our strategy to grow emerging markets, another significant development is our agreement to acquire AFP Provida, the largest pension provider in Chile, from BBVA for $2 billion in cash. MetLife is the number one life insurer in Chile, and the Provida deal will further strengthen our market position. Employees in Chile are required to contribute a fixed percentage of their salaries to a mandatory pension system. Pension companies such as Provida charge an administrative fee on contributions, not assets under management. As a result, fee income does not fluctuate with market changes. Provida is the number one player in the market with a 29% market share.
With this acquisition, MetLife's operating earnings from emerging markets are expected to grow from 14% today to approximately 17%, which brings us closer to our 2016 target of at least 20%. Also, as a fee-based business, Provida is consistent with our strategy of increasing our earnings from low capital intensity product offerings. In addition to being an excellent strategic fit, the Provida acquisition is very attractive on a financial basis. As I've said before, we strive to strike the right balance between growth, profitability, and risk. We are acquiring Provida for approximately 10 times projected forward earnings of roughly $200 million, and anticipate that the transaction will be accretive to operating earnings by approximately $0.05 per share in 2013 and $0.15 per share in 2014. While accretion from a cash acquisition is one metric to consider, it is not necessarily determined if the transaction creates shareholder value.
We modeled the long-term EPS impact of Provida, assuming we finance the transaction using a mixture of 75% equity and 25% debt. On this basis, we forecast that the transaction will be essentially neutral for EPS during the first few years and then become accretive. This analysis gives us comfort that the return on this transaction is likely to exceed our weighted average cost of capital. In addition, I have also discussed our goal of improving the free cash flow generation of our businesses. We estimate that approximately 70% of Provida's earnings will result in free cash flow available to our holding companies. I think the merits of this transaction are clear. It's important to note that the current regulatory restriction on our ability to repurchase shares was not the motivation to acquire Provida. We are doing this deal because it makes strategic and financial sense for our shareholders.
I want to close my prepared remarks with a few comments on the regulatory environment. We are pleased that our de-banking process has progressed with the closing of the sale of MetLife Bank to GE Capital Retail Bank, and we look forward to no longer being a bank holding company. Even after the de-banking process is complete, substantial uncertainty will likely remain on the regulatory front as we face the possibility of being named a non-bank systemically important financial institution, or SIFI. As we have said in the past, we do not believe that our company poses systemic risk to the financial system, and we will continue to make that case to policymakers. If MetLife is deemed to be systemically important, it is imperative that the final prudential rules be tailored to life insurance business model, which differs dramatically from that of banks.
While it is our strong desire to return capital to shareholders, we will need to assess the regulatory environment before finalizing any share buyback program. The assumption of no share repurchases in our 2013 guidance reflects this regulatory uncertainty. We were asked on our December guidance call about our confidence in the share buyback assumption built into our plan through 2016. As I stated on the call, I am not completely confident that we can do all of the assumed $8 billion of gross share repurchases through 2016, since it's dependent on external factors that are beyond our control. During our May 2012 Investor Day, we provided our goal of achieving an ROE of between 12% and 14% by 2016. I want to provide some guidance on the sensitivity to this range of share repurchases.
If we were to assume no share buybacks through year-end 2016, our estimated operating ROE target range for 2016 would be approximately 100 basis points lower than it is today, all other assumptions held constant. Although we cannot predict what the future holds in terms of regulation and interest rates, we will continue to execute on our strategy and strike the right balance between growth, profitability, and risk. Finally, I want to assure you that our 64,000 employees around the world are working hard to deliver on our promises to our customers and to create value for our shareholders. I am confident we will succeed. 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, everyone. Today, I'll cover our fourth quarter results, including a discussion on insurance margins, investment spreads, expenses, and business highlights. I'll give you some color on the interest rate disclosure Ed referenced, and conclude with some comments on our cash and capital. To begin, MetLife reported operating earnings of $1.4 billion, or $1.25 per share, up 10% over the fourth quarter of 2011. This quarter included a few notable items, which I highlighted during our December guidance call. These four items dampened operating earnings by a net $13 million, or $0.01 per share, better than the net $0.07 estimated in December. Let me give you some detail on the four items. The first was in our P&C business.
Higher-than-budgeted catastrophe losses of $70 million after tax, primarily due to Superstorm Sandy, were partially offset by a favorable prior year reserve development of $13 million after tax. The net impact was $0.05 per share. The gross loss due to Sandy was approximately $150 million. Adjusting for reinsurance recoveries and taxes, the impact to operating earnings was $90 million. Both the gross and net loss were within the estimated ranges provided in December. The second notable item resulted from our annual assumption review. The portion related to operating earnings was a net unfavorable $13 million after tax, or $0.01 per share. In December, we had estimated the assumption review would reduce operating earnings by $0.05 per share. We had a net positive of $37 million from DAC unlocking and reserve changes.
The favorable unlocking related to our lower lapse assumption for VA was partially offset by negative unlocking for reductions in our general account and separate account return assumptions. Also included is a one-time $50 million after-tax write-down in group voluntary and worksite benefits of an intangible asset representing the value of customer relationships acquired, otherwise known as VOCRA, related to a small acquisition of a dental business in 2008. I will provide an update of the below-the-line components of the assumption review in a few moments. The third notable item was $23 million, or $0.02 per share, of reorganization costs. Pretax variable investment income was $376 million, reflecting strong private equity returns. After taxes and the impact of DAC, variable investment income was $242 million, which is $80 million, or $0.07 per share, above the top end of our 2012 quarterly guidance range.
It is also $0.02 per share better than our estimate provided in December. Turning to our bottom line results, fourth quarter net income was $96 million, or $0.09 per share, and included net derivative losses of $855 million after tax. The net derivative loss in the quarter was primarily due to the mark-to-market impact of our VA program, including the update to our lapse assumptions of $342 million after tax. Additionally, the tightening of Met's own credit spreads during the quarter and the rise in long-term rates also contributed to the net derivative loss. The net derivative loss was higher than we had estimated in December, this is a difficult item to forecast, as it's highly sensitive to capital market movements. As a reminder, most of this impact is non-economic, as a large portion of the liabilities that are being hedged are at essentially book value.
The total impact on net income for the DAC and other assumption review was $752 million after tax, which was within the $600 million-$800 million range provided in December. Most of the charge, or $739 million, was outside of operating earnings. As noted in our December call, the charge relates primarily to changes in VA policy or the behavior lapse assumptions, as well as general and separate account return assumptions for fixed income investments. Book value per share, excluding AOCI, was $46.73 at year-end, below our December estimate, largely due to the higher derivative losses and essentially flat year-over-year. Operating ROE was 11.3% in 2012, up 120 basis points from 10.1% in 2011, and better than our 2012 plan of 10%-10.6%. Turning now to margins. Underwriting was mixed but generally unfavorable this quarter.
The mortality ratio in retail life was elevated at 99% due to unfavorable experience in both VUL and UL and traditional life. This result was higher than the target range of 85%-90% and worse than the 81.1% ratio in the fourth quarter of 2011. The mortality ratio in group life was 84.6% in the quarter, slightly favorable to the prior year quarter of 85.2%, and below the target range of 85%-90%. Excluding a positive reserve adjustment, group life mortality was in the middle of our target range. Group health morbidity experience was unfavorable in the quarter. I will provide more detail on this line shortly. As you heard from Steve, investment spreads remained strong in 2012.
In the fourth quarter, our investment spreads increased year-over-year and sequentially in corporate benefit funding, annuities, and retail life. Were down only modestly from the sequential quarter in group, voluntary, and worksite benefits. You can see in our QFS that the spreads in the U.S. business increased in 2012. While variable investment income was strong last year, our spreads excluding VII were mostly higher as well. Spreads excluding variable investment income are not evident from our QFS. Let me provide some detail. Deferred annuities was 284 basis points for the full year of 2012 versus 258 basis points in 2011. Variable Universal Life was 167 versus 105. Group, voluntary, and worksite benefits was 237 versus 250. Finally, corporate benefit funding was 112 versus 105.
While we expect investment spreads will decline in 2013, the resilience of our investment margins in 2012 illustrates that this is a manageable risk factor. As Ed referenced earlier, there will be a new disclosure in our 10-K on the anticipated impact of sustained low interest rates on our financial results. The low rate scenario in the 10-K is based on 1.69% 10-year treasury yield for 2013 and 2014. This scenario contrasts with our plan, which assumes the 10-year treasury gradually rises to 2.38% by the end of 2013. Then remains flat through the end of 2014. The difference between the 10-K scenario and our plan translates to an estimated negative impact on operating earnings of approximately $45 million in 2013 and approximately $150 million in 2014.
The results for the 2013 low rate scenario are consistent with the guidance we provided on our December call. The new disclosure on 2014 highlights the relatively small incremental impact on earnings next year if rates remain low. Turning to expenses, the operating expense ratio was 22.4% for the fourth quarter and 23.8% for the full year of 2012. This was better than our plan of 23.9%-24.5% and our estimate in December. Excluding the impact of pension and post-retirement benefits and closeouts, the operating expense ratio was 24.5% for the fourth quarter and 24.1% for the full year of 2012. This compares to the fourth quarter and full year of 2011 of 24.6% and 24.1% respectively. I will now discuss some of the business highlights in the quarter.
Rather than go through every segment, I want to focus on areas where our results may differ from your expectations. Therefore, my comments will be on, number 1, retail annuities, 2, group voluntary and worksite benefits, and number 3, Asia. Retail annuities had operating earnings of $462 million, an increase of $253 million from the prior year quarter. Normalized earnings were $320 million in the fourth quarter after adjusting for a positive DAC unlocking of $133 million from our annual assumption review and variable investment income that was $9 million above plan. On a normalized basis, retail annuity earnings were up 30% versus the fourth quarter of 2011 due to growth in the business, interest on economic capital, lower DAC amortization, and lower operating expenses. Higher interest on economic capital reflects the increased amount of capital we are allocating to this business line.
Group voluntary and worksite benefits reported operating earnings of $167 million, down 30% year-over-year. After adjusting for above plan catastrophe experience of $33 million, the VOCRA write down of $50 million and $36 million of other favorable items, normalized operating earnings were $214 million, down 11% versus the prior year. The decline on a normalized basis was primarily due to an elevated group health benefit ratio of 91.6%, which was 89.7% in the prior year quarter, and the targeted range of 86%-90%. The primary drivers of the higher ratio were long-term disability and long-term care. In disability, we saw higher average reserves on new claims and lower net closures, partially offset by lower claim incidents. In long-term care, the benefit ratio was above plan due to higher average reserves on new claims, lower net closures, and reserve adjustments.
Although long-term care earnings are under pressure, we believe this suggests only a couple of pennies risk to our 2013 EPS guidance. While the group health benefit ratio was elevated for the quarter, the full year 2012 ratio was 88.6% and within our plan range. With regard to statutory results, we completed our asset adequacy testing for 2012, and we will have no reserve strengthening in long-term care. New York requires us to have a segregated account for long-term care with standalone cash flow testing. This is a more stringent approach relative to other states and should provide comfort to our investors regarding the balance sheet for this business. Turning to Asia, operating earnings of $198 million in the quarter were down 24% year-over-year.
Asia had negative DAC unlockings of $62 million, higher than we had estimated in December, primarily due to changes in long-term lapse assumptions in Japan. Adjusting for this, normalized operating earnings were $260 million, down 1% year-over-year. I know analysts and investors have concerns regarding the recent earnings for Asia. The current environment for the region, most notably in Japan, has some challenges. Since we developed our 2013 plan, the yen has weakened materially, and interest rates are lower than we had anticipated. Based on those two factors, our current operating earnings expectation for Asia will be close to the low end of our 2013 guidance range. Specifically, with regard to currency, we have hedges on our 2013 projected yen exposed operating earnings at strike prices above JPY 90 to the US dollar.
These hedges are currency options, which provide protection against the yen weakening above JPY 90 but allow us to participate in the upside should the yen strengthen. However, we are unhedged for the yen between JPY 90 and our average plan rate of approximately JPY 82. It is worth noting that we remain disciplined in Japan. There are more questions today on the profitability of various products and distribution channels in Japan, with concerns relating to savings products and the bank channel. In the fourth quarter, our total Japan sales were down 1%, and this was driven by a 34% decline in our bank channel sales. Our decline in the bank channel resulted from a conscious effort to maintain margins. Finally, let me discuss our cash and capital position.
Cash and liquid assets at the holding companies were approximately $5.7 billion at year-end, slightly above our guidance call estimate due to the timing of certain cash flows. We plan to use $2 billion from our existing cash and liquid assets at the holding companies to fund the Provida acquisition, which is not contemplated in our guidance call outlook for 2013. Moving to our capital position, while we have not completed our risk-based capital calculations for 2012, we estimate our RBC ratio will be in the 450%-475% range, which is above the 425%-450% range we provided on our December guidance call. We estimate that our Japan solvency margin ratio will be at the high end of our guidance range of 800%-900%.
Our preliminary statutory operating earnings and statutory net income for our domestic insurance companies for the fourth quarter of 2012 were approximately $1.5 billion and a loss of approximately $200 million respectively. Fourth quarter operating earnings benefited from a favorable market, while the net loss resulted from a new statutory accounting treatment for certain partnerships and joint ventures. This accounting change caused a shift from an unrealized loss to a realized loss and was neutral for capital and surplus. For the full year 2012, statutory operating earnings were approximately $4.4 billion, and statutory net income was approximately $2.8 billion. Our total adjusted capital is expected to be approximately $29 billion as of December 12, up 5% compared to the prior year. With that, I will turn it back to the operator for your questions.
Ladies and gentlemen, if you would like to ask a question today, please press the star then one. You'll hear a tone indicating you've been placed in the queue. If your question gets answered, you wish to remove yourself from the queue, please press the pound key. Once again, star one if you have a question. First in the line of Jeff Schuman with KBW. Please go ahead.
Thanks. Good morning, everyone. I was wondering if we could get a little bit more color about the international growth outlook. If we look at the fourth quarter or 2012 as a whole, I think Latin America premium growth was pretty modest relative to your normalized expectations, yet I think you forecast a pretty big acceleration in 2013. I wonder if you can remind us why that is. I guess you did touch on Asia a little bit, but even before the recent devaluation, your outlook there was, I think, for premium growth to decelerate quite significantly relative to what we've seen recently. Maybe you can remind us what the factors are there, please.
Hi, Jeff. It's William Wheeler. I'll talk about Latin America. Revenue growth on a constant currency basis was about 4%. We are forecasting, I guess, on a constant currency basis too, 10% for next year. We had very good sales volumes. Our sales volumes in Latin America were up to 26% year-over-year. What held back the overall PFO growth rate was there's a couple of group cases that we have lost, one in Mexico, one in Chile, that are large. They weren't terribly profitable, so that's affected our top-line growth. I think we've said this before on other calls, especially in the third quarter, the comparison, especially the one in Mexico, we lost at the beginning of this year, so that comparison will go away next year. Latin America, except for noise like these group cases is, I think, more like a 10% grower.
With regard to Asia, this is John. Our bank channel was down, which is a large premium. These are generally single premium products, so it's quite an impact when you look at the premiums, but we're seeing growth in the independent agency channels and other areas across Asia. We're pleased that we're remaining disciplined as we grow all of our channels.
That's helpful. Thank you.
Our next question is from Mark Finkelstein with Evercore Partners. Please go ahead.
Hi. Good morning. Just a couple questions on Provida. Should we assume that the 70% of GAAP earnings, which I think you characterized as $200 million, would you expect that to be fully dividended to the holding company?
We expect that to be a good distribution. It may go to the international holding companies because it's in the international operations, but we expect that to be available.
Okay. Just a few quick questions. I think you characterized the returns on this as at least equal to your weighted average cost of capital. How should we think about the IRRs on this trade? I would assume it would be above your weighted average cost of capital. Should we look at this given growth, et cetera, as low teens, mid-teens, high teens? What's the IRR that you're projecting on this?
We're looking at this at a mid-teen return. We think that's a good return given the Chilean economy and environment. It's one of the best places to be investing in, if you call it an emerging market, it's a very stable government and economy. We're very pleased with that type of return.
Okay. Maybe just going back to the comment that Steve made on buybacks and an impact going out to 2016 if there were zero buybacks. Obviously, the difference between zero and $8 billion is a very wide range. I think it's helpful to frame out kind of what I would hope to be kind of a downside scenario. Is there any feel for how we should be thinking about or moderating capital deployment expectations out to 2016? I assume the answer isn't zero, is there any feeling for maybe what management is kind of thinking about as a reasonable range?
Yeah. I can't give you a lot of guidance at this very moment. As things unfold here in the coming months, I think we'll be able to provide more clarity, but we are still doing our analysis. We're still trying to understand the regulatory environment and what the capital rules may be going forward for us. Unfortunately, I can't give you more than that.
Okay. Just one final question, if I may. With the Provida acquisition and the free cash flow generated from that, is there any change in your view on the de-leveraging that you're expecting as part of your capital model looking out to 2013?
No, not really. Provida will close sometime later on this year, it's uncertain when that might close, it's hard to predict exactly the cash and earnings impact that we would have in 2013.
Okay. All right. Thank you.
Our next question's from Ryan Krueger with Dowling & Partners. Please go ahead.
Good morning. First question was, could you just remind us of your operating EPS sensitivity to the equity market? I think that the market's probably running at 4% or 5% better than your original assumption at this point.
For about 1% change in the S&P 500, it's about $0.01.
$0.01 annually?
In our EPS?
Yep.
Operating EPS, yeah.
Okay. Back to the group non-medical health business. When you gave the 2013 outlook, did you kind of have all the information on the fourth quarter and some of the weakness that occurred, and was that factored into the outlook for 2013?
Well, in terms of the group, the full year was within our targeted range, so we still believe our targeted range is appropriate for 2013.
Okay. Thank you.
Our next question's from Suneet Kamath with UBS. Please go ahead.
Thanks. Good morning. First question just on the long-term ROE target without buyback, the 11%-13%. I guess I'm pleasantly surprised that that's up from what you did in 2012 at the midpoint. Two questions on that. First, what is the interest rate environment that's predicated in that 11%-13%? Second, in terms of the $8 billion of capital that you would not be buying back in this scenario, what is the return that you're getting or the assumption for the return that you're getting on that capital? Thanks.
With regard to the first question, I think that we've said that should rates remain generally flat, we expect to be the lower end of that 12%-14% with the buybacks. Now without the buybacks, your 11%-13% range will be at the low end of that range. Could you say the second question again? I didn't get that.
Just on the $8 billion of capital that you would not be using for share buybacks, what's the return assumption in this scenario? How is that capital being used?
That's in a series of investments. Would be high-quality liquid investments.
It's like a bond return as opposed to like a-
Yeah.
Okay.
Shorter-term bond returns.
Okay. I guess the other question on the VA DAC. I think on the guidance conference call, you characterized half of the roughly $700 million impact being related to a change in your fixed income return assumption in your separate account growth model from, I think it was like 7.5 to 7.25. I guess first, is that accurate? Then second, how does that return compare to your assumption for equities? I guess related to that, if that 7.25 maybe has to come down again because interest rates are rising and bond returns are falling, could we be looking at another sizable DAC hit at some point down the road? Thanks.
Of the total charge, about half was lapsed, a quarter returns, and a quarter for other.
Okay.
With regard to this, that's a separate account assumption, which is a blended assumption, which is an equity bond assumption weighting. People also have the opportunity to switch to a general account if bonds rise. If interest rates rise, then bond funds go down. We're comfortable with this return.
Okay. Then just lastly on the comments that you made, John, about the year-end stat net income versus operating income. Does any of that change the cash flow roll forward that you guys provided to us in terms of your outlook, the $3 billion-$3.5 billion of subsidiary dividends? Is that still in place, or is this affected somehow by that net income loss?
No, this is within our range that we had expected.
Okay, thanks.
Our next question is from Jimmy Bhullar with J.P. Morgan. Please go ahead.
Thank you. Good morning. I had a few questions. First, on the Latin American business, the reported earnings seem close to the level that they've been in recent quarters. You didn't call anything out, but it seems like there's a tax benefit, because on a pre-tax basis, the earnings are a lot weaker than they've been in recent quarters. For Steve, could you just discuss how Alico is tracking versus your initial assumptions? Because if we look at Asia earnings, they've been weaker than expected the last few quarters. You ended up taking a reserve charge this quarter as well. Finally, on just your capital deployment philosophy, assuming that you're able to de-register as a bank holding company, would you want to wait for SIFI guidance before you do something with the dividend or buybacks?
Could you raise the dividend even before the SIFI guidance comes out? How would you view that, assuming that you are able to de-register as a bank holding company over the next few months? Thanks.
Yeah, I hope I get all these questions, Jimmy. On the Latin American business, there was an $18 million tax benefit. It's in Latin America, but it is offset in corporate, it's not a total change to our normalized earnings. If you could repeat the second question.
The second just views on how the Alico business is tracking versus initial assumptions, given the weakness in Asia earnings recently.
Overall, Alico is tracking well. There's ups and downs, and there's some of the markets that we're in Alico that are tracking a little bit below our expectations. Some other markets were above. Overall, the Alico transaction is still very much on target for what we assumed going into the transaction. We're very happy that we did the deal and think it's a very attractive transaction on many bases, strategic as well as financial. In terms of our dividend, Jimmy, it's the same issue that we have around share buybacks. We're going to assess all these factors, regulatory factors. We're going to talk to our board, obviously, and get board approval before we make any changes in our dividend. That still is to come.
Okay, then just following up on Latin America. On a pre-tax basis, what drove the weakness there in earnings?
Well, we've been growing direct marketing and a lot of new business channels, moving to our multiple distribution channels throughout Latin America, that's had some higher costs associated with that. Direct marketing doesn't get DAC as much, you have just higher fixed costs in the year.
Okay. I did notice that you added the P&C income statement, I guess we could thank Ed for that.
You can definitely thank Ed for that. Yeah.
Thank you.
Next we go to Tom Gallagher with Credit Suisse. Please go ahead.
Hi, a few questions for John. Can you just explain again what was the driver of the statutory loss for the quarter, and why would the loss RBC came in higher than expected? Was there something going on, some moving parts there?
Sure. This was for an investment that we had that had unrealized losses, and that was deducted from capital. There's a change in statutory accounting or an interpretation of statutory accounting. We're now reflecting more of this through net income. We moved from an unrealized loss to a realized loss through net income. It was just a geography change through the income statement and had no impact on capital.
Did you say that was limited partnership investments, or what type of investments were those?
It was a joint venture and limited partnership type investment.
Got it. Was that $1 billion, or how big was that?
It's a series of them, and it was about that amount.
Okay, thank you. Why did the RBC go up?
Just from core favorable markets and good operating earnings.
Got it. The impact of the loss was, I guess, was that already being factored in when it was an unrealized loss, and so it wasn't much of a change on the RBC? I'm just a little confused as to why that wouldn't have-
Yeah, why? It's not in your capital. It's not counted as part of your capital. It's an unrealized loss.
Understood. Thanks. The other question I had for you was on the variable annuity policyholder behavior charge, $342 million. I guess just a general question on it. How do we get confidence that you've taken enough on this? We don't have any parameters to really measure this around, just that, I guess you got more conservative, you lowered the lapse rate. We've seen other competitors of yours with similar product structure take multiple charges. Is there any way you can give us confidence that this isn't the first of the series of charges?
Okay. Well, this was done after several years of study as customers who are in or close to the money get off of this surrender charge period. We've had a few years of experience now. We also participated in an industry study of almost many of the major players, and our experience is tracking very well or almost exactly to that industry study. I think we're pretty comfortable with where we are now, both we've had a few years of experience of this and how people behave as they get close to the money. When we looked at this, our assumptions were pretty good when people are well out of the money and well in the money. The curve for this dynamic lapse function, where we had to adjust it was how people react when they get close to being in the money.
People are a little more sensitive than we had all initially assumed. We had benchmarked our original assumptions somewhat 10 years ago against people, and we were pretty close to what others had done. We've now adjusted, I think, to be what the experience is truly coming out. We had to wait till people get off their surrender charge period and also see people who might be closer in the money, so you could really see the experience of how to calibrate this lapse function. We've had not only our experience of a few years, but also industry experience.
John, hasn't the progression been worse, meaning lapses have continued to decline on sort of a consistent basis? If that, are you assuming continued shrinkage of the lapse rate, or how should I think about that?
Well, it depends how people move in and out of the money and what happens to the equity markets and interest rates. It's quite dynamic in how we price this and reserve for it. It's not a simple answer that I can give you, but we have reflected our experience, and I think we're comfortable right now with where we stand on this function.
Okay, thanks.
Our next question's from John Nadel with Sterne Agee. Please go ahead.
Hi, good morning. I have a question for Steve. I'm just curious if you could give us any color around what the process was like gaining approvals from, in particular from the Federal Reserve for the Provida deal.
John, we weren't required to actually get an approval from any federal regulator on this, but we certainly talk to our regulators when there's any significant transaction we're engaged in. There was communication, but there was not an approval process.
Yeah, I understand that. I guess I'm just wondering if there was any real back and forth, real questions about, or any indication maybe as part of that dialogue as to what specific capital levels or specific ratios or items were of most concern to the Federal Reserve around this deal or around your capital levels.
Yeah, I don't wish to speak about confidential conversations with federal regulators.
Oh,
Probably not a good thing to do.
Figured I had to give it a shot. The incremental disclosure around rate sensitivity, in particular, I guess, around the annuities business, I understand, so the impact on an operating earnings basis when we look out the next couple of years is relatively modest. You didn't really speak to anything below the line as it relates to DAC charges or reserve adjustments or any such thing. I was wondering, is there any help you can provide there? I assume we'd see some impacts as well there.
Well, below the line, if rates stay lower, derivatives are going to be higher, so we'd have gains from where we are now. It's hard to predict what, because a lot of this is non-economic when you get to the net income side.
I guess we should just assume that below the line impacts at a 169 tenure for the next couple of years would be essentially immaterial relative to your base plan?
No, the net income is quite sensitive to how markets move, and the vast majority of this movement is non-economic in nature. The dynamic lapse function change we did to VAs, that was an economic change, but the rest of it is really non-economic in nature, and I can't predict how that's going to move quarter to quarter.
Okay, last question is just thinking about the annuity segment and the core earnings. If I look back at the last several quarters and then look at fourth quarter, you're suggesting to us that the core earnings level for this segment has increased from the first three quarters of the year, somewhere around $240 million average rates, average quarterly earnings level, to now $320 million in the fourth quarter. If we were to run rate off of a $320 million, that puts your guidance for the annuity segment for 2013 at, I think it clearly indicates that guidance would be very conservative. Is there something still inside the fourth quarter core number that we should be thinking about as not something that's going to recur as we move forward?
Well, the retail annuity business has a lot of ups and downs. It's sensitive to the marketplace, and what goes on in that business. We're not updating our guidance on that at this time.
Well, sorry. I mean, the first three quarters of the year, though, on a core basis, the volatility in those earnings was not nearly as severe. I guess to the extent that there's any help you can provide, it would be appreciated.
We're not going to update our guidance at this time.
Thank you.
Our next question is from Chris Giovanni with Goldman Sachs. Please go ahead.
Thanks so much. Good morning. I guess you guys are doing a good job slowing down sort of the run-on of VA sales, but curious if you're considering any strategies to accelerate the run-off of VAs, either through buyout programs or if there are any structures or vehicles out there that you would explore.
Hi, Chris. It's William Wheeler. I think our strategies about VAs, obviously, we're driving down GMIB sales, we're making product changes to do that. I think you'll see us make some announcements about new product introductions later this year, as we sort of change the character of that business. In terms of buying out inforce, we've examined that. We've looked at what others have done. I don't think that's an option we're considering at this time.
Okay. Are you still committed to the GMIB product, or would you consider other lifetime withdrawal benefit features?
Well, I'm not sure this is well appreciated. We sell more than a GMIB today. We sell a healthy amount of lifetime withdrawal benefit. I think what you're going to see going forward is a much more diverse annuity, new business model in terms of what we're going to sell.
Okay, just one quick follow-up just on the returns of the new 4% roll-up rate versus what you were selling before. How much different are your expected returns?
Well, GMIB 4 with the 5% roll-up rate, but the lower dollar for dollar, had an ROI in the fourth quarter of about 15.8%. GMIB 5 with the 4% roll-up rate, our ROI model is over 18%. It's a meaningful jump.
Okay, thanks. One just quick question for John. I guess book value ex-AOCI is up just $0.04 year-over-year, and it's grown, I guess just 3% since 2008. What can be done to accelerate the growth in book? Is your hedging strategy to protect economic capital versus maybe smoothing GAAP results really just put you at the mercy of below the line charges that are kind of out of your control?
Well, clearly, it moves around a lot. We just have to continue to focus on it. It's one of those metrics, I think, that it's even hard year-over-year to look at. You have to look at it over a long-term time horizon. We want to make sure that you know that we have it in our sight, and slowly over time, we believe that this can improve.
Okay, thanks so much.
Our next question is from Sean Dargan with Macquarie. Please go ahead.
Thanks. Following up on the notion that book value ex-AOCI is not growing much. Your long-term ROE target, is that impacted at all by book value perhaps being lower than where people were thinking about at the time of your investor day?
No, other than for the adjustments we've already announced in terms of the goodwill.
Okay. Just thinking about long-term care, are we correct to think that if interest rates stay where they are and mortality and utilization is consistent with what you saw in the fourth quarter, in that scenario, there would only be a couple of penny impact to 2013 EPS?
Yes.
Okay, thank you.
Next, go to John Hall with Wells Fargo Securities. Please go ahead.
Great. Thanks very much. This question's for Steve. As I think about the debanking process, I guess the way we think about it is ultimately going to occur, then you must also be planning in some fashion for it to occur. I guess the question has to do with, do you have sort of a series of contingency plans about the debanking process that when you get actual word of it, you can move quickly, depending upon when that word comes, whether it's perhaps two weeks from now or six months from now?
Hi, John. We are obviously planning for it. There's still some work being done on our side in terms of assessing the regulatory landscape. We do get insights on an ongoing basis. That's why I'm reluctant at this point in time to make any pronouncements around share repurchases, dividend changes, and the like, because the landscape does evolve. Until we get to that point when we're able to take capital actions, we don't think it's prudent for us to make pronouncements that may end up changing over time.
Understood. Say you got word in two weeks. Do you have a contingency plan to roll forward to the board on whatever your decision would be?
We have ongoing conversations and have for many quarters with our board on these issues. It's not as if we're going to start with them in a few weeks to have this discussion. We're doing a lot of analysis internally around all kinds of measures that can impact us from a capital perspective, and that has to be taken into account as we decide how we address the issue of capital.
Okay, great. Thank you very much.
Next, we'll go to Eric Berg with RBC Capital Markets. Please go ahead.
Thanks very much. Two questions. First, admittedly, the Eastern Europe or Europe, Middle East, and Africa business is the smallest of your three international units. There too, there seems to be a revenue issue in the quarter on a constant currency basis. I think the revenues were flat or down very, essentially flat. What's happening there? My second question relates to Japan. I'm just hoping you can provide additional detail on the nature of the products that are subject of this intense competition that you referenced. The nature of the competition, is it pricing? Is it terms?
Who is proving to be the troublemaker here? Is it indigenous companies? Is it foreign competitors? Thank you.
Let me answer the question on Europe. We stopped selling in the U.K. annuities, we're down $57 million year-on-year in PFOs in that and sales. That makes a difference. We also have weakness in Western Europe, but that's been offset by strong growth in Russia, Turkey, and also the Aviva acquisition. It's kind of balanced out some negatives with some positives, and that's why you're seeing it sort of flattish.
Actually, before we go onto this, I appreciate that. Just one quick question about these premium fees and other that you referenced. I'm just wondering, given the transition that Met is affecting away from high capital intensive products, or let's just say, given the transition that you contemplated that you're beginning here towards more, say, insurance products, you continue to publish this statistic and highlight it, which suggests to me that you think it's important. I'm just wondering whether you're giving thought to, and whether you might go in the direction of looking at total operating revenues if investment income figures, if in fact it will be the case, that investment income will figure increasingly prominently in your revenue mix. I just don't know, and I'd like to know how you're thinking about that.
We'll take that under consideration, but I think we're comfortable now with how we record our revenues.
Okay. If you could just talk about Japan a little bit, I would be grateful. Thank you.
Actually, I missed your question. Could you repeat Japan?
Sure. Earlier in the conversation, there was discussion about, I think there was reference to certain competition in the bank channel. I was just looking for a little bit more detail about the specific products that are the subject to competition. Is it explicit pricing? Is it other terms on the contracts that are the subject of the competition? Who are proving to be the troublesome competitors? Is it indigenous companies or is it your foreign competitors?
Okay. What's sold in the bank channel are mainly single premium style products, both in yen, US dollar and Australian dollar, and some other currencies. Of course, as interest rates move throughout 2012, these products can become more or less attractive. You have to be very careful with these product lines. You have to adjust your crediting rates quickly, and if you don't, you can get a large volume of lower ROE business. We have been diligent in ensuring that the business that we do sell to the bank channel meets our profitability hurdles.
Let me just add to that, if I can. It's Chris Townsend here. John referenced the minus 34% in the bank channel earlier. I think the way for you to look at Japan would be look at the breadth of distribution and product that we have. While the bank channel is down, I assure you that we're growing very fast in terms of the A&H product through the bank channel. We grew that at 76% for the quarter, and we're selling A&H through 40 different banks at the moment in Japan. Also our independent agency grew at about 26% for the quarter. We've got different levers to pull to make sure we're adhering to the discipline that both Steve and John referenced earlier.
Thank you.
Eric, let me just make one other comment. This is Steve. When we did our investor day in May of last year, we did not give guidance on the top line, and that was very intentional. That was a signal of a shift in thinking at our company about what we should be focusing on in the near term as we look at our strategic initiatives, as we try to refocus our business on markets that we think will create shareholder value for us. It's not that we don't have internal targets on top line, but we're trying to signal, we're not going to run this company based upon the top line, drive sales that may end up being sales that come back later and with low ROEs for us. That is, I think, a cultural shift here.
Again, we are looking to grow our business, but we are looking to grow it profitably. We're looking to get business on the books that is in excess of our cost of equity capital, that really is the driving force here for us.
That's a helpful addition. Thank you, Steven.
Our final question will come from the line of Steven Schwartz with Raymond James. Please go ahead.
Hey, good morning, everybody. If I could just quickly and then go into some other things. Chris, maybe you could touch on the A&H business in Japan. I think Aflac came out and said April 1 they're going to hold their rates steady. I think Sumitomo said that they were going to lower rates 3%. What's Met doing come April 1?
We priced a 15% ECR ROI. That's consistent across all of our product range, including A&H.
Okay, no change there. Steven, a little bit of a conflict I have here in my thinking. Most companies would say, I've got $8 billion to deploy. I'm going to deploy that through either acquisitions or through share repurchase. Is it fair to say you don't see it like that? That you don't think that $2 billion for Provida comes out of that $8 billion?
I think it does. I mean, we have X amount of capital available to either make acquisitions with or to do share buybacks or to raise our dividend, yes.
Okay. I guess I don't get the downside guidance of if we don't do this $8 billion, shouldn't it be if we don't do this $6 billion?
Well, we did have baked into our guidance through 2016 the plan, some acquisition activity.
Okay.
Some was in there. It wasn't any super large deals, but there was some ongoing acquisitions that we assumed in that plan.
Okay. John, if you could, I don't know, you guys haven't done this before, I don't think, but it might be worthwhile in this case if you're willing. A point on the actual to expected in individual life, what does that equal to in earnings?
I think one point's about $2 million.
One point's about $2 million. Okay. Finally, the guidance that you gave, it was a little unclear, the guidance that you gave on the interest rate assumption, that was cumulative? It was 45 in the first year, going up another 95. That was a cumulative thing. That wasn't another 150.
150 is the combined number.
Okay, great. That's what I wanted to know. Thank you very much.
Okay. Thank you very much for joining us. Have a good day.
Ladies and gentlemen, that does conclude your conference. Thank you for your participation. You may now disconnect.