Ladies and gentlemen, thank you for standing by. Your host, John McCallion, is back on the line. Please go ahead.
Thank you, Greg. We apologize, everyone. We had some technical difficulties with AT&T. Welcome back, and we're going to get through this session of the call. For this session of the call, we'll be referring to the interest rate presentation materials that can be found on the investor relations portion of metlife.com. Before we start, let me refer you to the safe harbor statement on slide two. This governs the statements made on today's call. As the statement notes, any and all forward-looking statements may turn out to be wrong. For a discussion of the factors that could cause actual results to differ, please see the risk factors in our 10-K and 10-Q reports filed with the SEC. Starting on slide three, let me remind you that we will be using non-GAAP financial measures on today's call.
Slide three and four explain how we calculate these measures and the reasons we believe they are useful. Reconciliations to the most directly comparable GAAP measures are included in the appendix. I'd like to turn the call over to Steven Kandarian.
Thank you, John. Slide five contains our agenda for today. After some opening remarks, I will turn the call over to William Wheeler, who will go through the low interest rate scenario in detail, highlighting where we have exposure and why our earnings would still be expected to grow, but at a slower pace. Steven Goulart will then describe the proactive steps we have taken to protect our portfolio from the impact of low interest rates, including our purchase of derivatives that provide significant low rate protection that extends well into the next decade. Finally, William Mullaney will briefly cover some additional business actions that could be taken to address low interest rates should they persist. As to recent actions, we mentioned on our previous call that we're reducing the roll-up rate on our GMIB Max product to 5% in January.
My hope is that by the end of this hour, you'll have a deeper appreciation of MetLife's ability to continue to grow earnings and capital, even if interest rates remain at current levels for a number of years. Let's turn to slide six. Like most major life insurers, MetLife has been trading in tight correlation to the yield on the 10-year treasury note. However, I believe the market has overreacted to the impact low rates have on our business. I thought I would take a few moments to discuss the key reasons why MetLife can still prosper in a low rate environment. First, MetLife is well diversified across products, distribution channels, and geography. It is truly one of our real strengths. Second, risk management is fundamental to how we run the business.
It starts with prudent product design and continues through asset liability management, which is a key reason why low interest rates have a relatively modest impact on our financial performance. In addition, we continue to leverage our private asset origination capabilities and look to opportunistically deploy derivatives to protect against difficult economic environments. That's why we started purchasing interest rate floors in 2004 when the 10-year treasury traded above 4%. Through proactive portfolio management, we are well positioned to navigate through difficult economic environments, whether it's the financial crisis that started in 2008 or a period of sustained low interest rates. Slide seven is a useful reminder of how diverse our business is from an earnings perspective. Currently, nearly 40% of our earnings are generated outside the United States. Over time, we believe this number will move closer to parity.
Most of our international products are not particularly sensitive to interest rates or equity markets. They are primarily protection products where we assume insurance risk rather than market risk. In addition, many parts of our U.S. business are not materially impacted by low interest rates. While all of our products have some sensitivity to rates, significant interest rate sensitivity is concentrated in three areas. Here they are, group life, individual life, and a retirement product segment. To be clear, it is not all parts of these businesses. However, these are businesses and products in which we provide some minimum rate guarantees. As a result, in a sustained low interest rate environment, these products will experience spread compression. That doesn't mean that we don't make money in these products. It just means that our earnings growth rate will be dampened.
You may have noticed that we did not mention certain long-tail products such as long-term care and those in corporate benefit funding. While there is reinvestment risk with these products, you will see later in this presentation that because of tight asset liability management and prudent hedging, the financial impact of low rates on these products is very modest. Let's turn to slide nine. The blue line is the four-quarter moving average of a blended five-year and 10-year U.S. Treasury yield. As you can see in the chart, back in 2000 when we became a public company, the blended rate was around 6%. These rates have come down significantly over the past decade and recently have been in the 2%-3% range.
The red line in this chart represents the unweighted average of the analyzed spreads shown in our quarterly financial supplement for group life variable and universal life, nonmedical health, deferred annuities, which is part of a retirement product segment, and corporate benefit funding. While our spreads have fluctuated largely due to the performance of variable investment income, core spreads have been relatively stable over time. You can see that the average spread over the entire period shown, reflected by the gray line, is around 200 basis points. This didn't happen by accident. It is a result of our making effective use of the management tools I mentioned earlier, prudent product design, ALM, hedging, risk management, and managing the company for the long run. Turning to slide 10, let me first describe the assumptions we used to create this analysis.
We held interest rates flat for the next five years with a 10-year Treasury yield of 2%, we held the slope of the Treasury yield curve constant as well. To gauge the impact of this scenario, we compared the results to a base case, which is the June 2011 forward curve consensus. In the base case, the 10-year Treasury starts at 3% and increases to 4.5% by 2013. We also assumed an S&P 500 growth rate of 5%. In addition, GDP growth remains slow, there is no material change to the current unemployment rate, nor do we assume any extraordinary management actions to counteract this environment. The intent is to isolate the impact of low interest rates. Turning to slide 11. Here is a summary of the results of our analysis. Overall earnings for MetLife will continue to grow, but at a slower rate.
While U.S. business earnings will remain relatively flat, this will be offset by the limited impact of low rates on our international earnings. I should note, while we would not be required to strengthen statutory capital reserves, we might make modest adjustments as we have in the past. Finally, on a GAAP basis, we'd expect no loss recognition over the next five years, but some impact to DAC and goodwill. All in all, we think the impact of a sustained low-rate environment on our financial performance is quite manageable. With that, I will turn the call over to William Wheeler, who will walk you through our analysis in greater detail. Bill?
Thanks, Steve, good morning again, everybody. Steve just walked you through the assumptions for this analysis and the financial impact for us if we were to remain in a sustained flat rate interest environment. My job is now to provide you with a detailed view of that analysis. Let's turn to slide 13. To analyze the impact of this scenario, we looked at both what would happen to operating earnings as well as to certain areas of our balance sheet. First, the blue line shows the base interest case rate assumption, where the 10-year starts at roughly 3%, if you follow that blue line, increases to 4.5% by 2013. We illustrate the flat rate scenario with the yellow line, where the 10-year yield drops to 2% stays there over the time period.
The operating earnings difference in 2012 as a result of this scenario is $0.21. In 2013, the total impact will be $0.42. It's a coincidence that it happens to be an additional $0.21. Now, it's important to understand that this is the incremental impact. MetLife's earnings would be growing in the base case. Another way to show this is on the next slide. So let me explain this chart on slide 14 to you. In 2011, we assume MetLife will earn approximately $5 billion in operating earnings. That includes both the domestic and international businesses. We've assumed for purposes of this illustration that MetLife's earnings would grow at 8% per year. That's 6% growth domestically and about 10% growth in international for a blended rate of 8%. So in 2016, earnings would have grown to about $7.5 billion.
In the flat rate scenario, we project that we would have about $500 million of spread compression in our U.S. business by 2016. I'll give you more details about that in a minute. We would also have a decline in operating earnings of roughly $700 million, primarily from two other factors. We estimate our pension costs would increase another $50 million after tax, and there would also be a $600 million decline in investment income from the assets held in our surplus account, which shows up in corporate and other. The remaining $50 million is made up primarily of international U.S. related assets. The total incremental decline in operating earnings in 2016 would be approximately $1.2 billion. Remember, in the base case, we said earnings would grow to approximately $7.5 billion, so in the stress case, they would only grow to $6.3 billion.
That represents about a 4% implied annual growth rate over the five-year period. I think that's worth repeating. Our earnings will grow at about 4% annually, not decline as the market seems to expect. Now let's look at the components of spread compression for U.S. business in 2016, and that's shown on slide 15. The bars show the compression in earnings relative to the base case interest rate environment for each business segment by 2016. It is important to note that the benefit from our interest rate hedges is also in these numbers. Steven Goulart will give more detail about our interest rate hedging program in a moment. The biggest impact is in retirement products or our annuity business at $200 million in 2016. Almost all of the impact here is in our deferred annuities, where much of the in-force block has a 3% minimum guarantee.
We assume that customers will maintain their funds in their contracts with the 3% minimum, and we will therefore experience spread compression as we reinvest assets at lower interest rates. Partially offsetting this compression is the fact that we will lower crediting rates on that part of our block where we are not at minimum crediting rates today. We will also receive income from our hedging contracts. The story is similar in individual life. Lower reinvestment income, partially offset by dividend cuts in our traditional products and crediting rate reductions in our UL products, as well as higher hedging income. There is also a DAC true-up caused by lowering dividends here. While universal life has interest rate risk, only 35% of the block is at minimum crediting rates, and we have a very effective ALM strategy. Therefore, much of the potential impact in this scenario is muted.
In group life, while these products in general have significant repricing flexibility, the impact is in the Total Control Account or TCA. TCA balances are already at their crediting rate minimums, but we do have substantial hedging activity here to partially offset the decline in reinvestment income. In non-medical health, only a small amount of the impact comes from long-term care, which might surprise some of you. Our long-term care block, which is now closed to new business, is very well immunized against changes in interest rates. Most of the impact here comes from our disability business, where lower reinvestment income cannot be offset by reduction in liability crediting rates, although we do have some hedging income here as well. The small impact of $40 million in corporate benefit funding is probably the most surprising number on this slide.
Despite the long duration of these products, the cash flows here are very predictable, and we have very tight cash flow matching in this segment, as well as several deferred starting derivative contracts to help. Again, Steven Goulart will give you some more details about that in a minute. Finally, as you would expect, the impact on auto and home is very small. We've discussed how low interest rates can affect normal operating earnings. Now we turn to the potential impact on our balance sheet on slide 16. We conduct a number of examinations at least annually and sometimes more often to determine the adequacy of our statutory reserves, our GAAP reserves, the level of our deferred acquisition costs, and whether or not our goodwill should be impaired.
Each one of these analyses is influenced by where interest rates are at the moment and what our interest rate outlook is for the future. Starting with the statutory reserve cash flow testing, we are required by New York State to analyze every major block of business in the U.S. annually. Other states generally allow cash flow testing to be done on a more consolidated basis. We take the current policy liabilities and the specific assets backing those liabilities and project out the net cash flow for virtually the entire life of the liabilities, and that could be as long as 75 years. We do these cash flow projections under seven different interest rate scenarios, which are called the New York Seven, and we do a similar type of analysis for GAAP reserve cash flow testing as well.
With regard to DAC or deferred acquisition costs, we amortize DAC over the life of the in-force policies, generally in sync with when the profits emerge from the in-force block. We review the assumptions about the ultimate profitability of each block of business, and that would include our claims experience, our lapse rates, the expenses of servicing the block, the performance of the stock market if it's a product like a variable annuity, and of course, the impact of interest rates. We don't change these assumptions very often because the liabilities are generally very long. Even if current experience is different from our DAC assumptions, we usually assume that over the life of the product, the results will revert back to the norm. We do occasionally change these assumptions.
That's called a DAC unlocking, and it will cause us to change our DAC balance, and that might be positive or negative, by the way. I give you this background because in this low interest rate scenario, we assume that we will start lowering our interest rate assumptions in our DAC calculations beginning in 2014. I don't believe it would happen any earlier than that. If we believe that interest rates were going to improve after five years, I don't think we would change any of our long-term interest rate assumptions. In this scenario, we don't assume an improvement, and I think it's important we show how big the DAC write-off might be if we don't assume any future improvements. Finally, when we acquire a business, goodwill is usually created in the purchase accounting process and then is allocated to the appropriate business line.
In the last financial crisis, we came very close to impairing the goodwill in our retirement products business because both the stock market and the interest rates had declined materially and significantly affected the profitability of the business. Many of our peers did write off some or all of their goodwill in the annuities businesses during that period. No other business at MetLife is even close to a goodwill impairment. In this scenario, the stock market performance is better, but interest rates are even lower. There is a chance we would have some good level of goodwill impairment, likely sooner rather than later. Now let's look at slide 17, which shows the results of our balance sheet analysis. In our low interest rate scenario, what were the results?
I'm sure you'll be glad to know that we have very healthy statutory insurance reserves, and while we don't think we will be required to strengthen reserves, even at these interest rate levels, we may have some modest strengthening. Our GAAP reserves are also very strong, and we expect no GAAP loss recognition under this scenario. With regard to DAC, we have assumed we will have negative unlockings in 2014, 2015, and 2016 in our annuities and universal life product areas. The cumulative impact of these unlockings is estimated at $425 million after tax, with most of that occurring in 2016. Also, we believe that in this scenario, we would impair some or all of the $1.7 billion in our retirement product segment. If we impaired at all, that would be about $1.2 billion after tax.
To put the DAC and goodwill write-offs in context, we currently have $61 billion of GAAP stockholders equity, and these charges would represent a little more than one quarter's earnings for us. In other words, they would not materially change MetLife's financial position. I think the bottom line of this study we have undertaken is that if the current low interest rate environment lasted for the next five years, it would have an impact on our financial performance, but it definitely would not weaken the company or put us in a perilous financial position. Now I'd like to pass the presentation over to Steven Goulart to discuss how our investment actions have positioned us to help mitigate some of the financial impact of a low interest rate environment. Steve.
Thanks, Bill, and good morning, everyone. I'll start on slide 19. I'm going to talk a lot about our asset liability management in this section. It's the critical underpinning to this analysis, and most importantly, it's the asset liability management you've practiced in the past that matters most because what you can do today is not that meaningful. There really aren't any magic levers to pull at this point. If you practice sound asset liability management, you're going to be in reasonably protected shape. At Met, we've always practiced sound, consistent, and disciplined asset liability management. Our investment management structure and practices include not only investment professionals, but also associates from finance and the business lines as well. Portfolios are managed according to underlying guidelines as well as ongoing input from ALM committees and regular relative value and asset allocation reviews.
Importantly, while we pay attention to total returns, we're essentially liability driven investors. That is, we invest according to the needs our liabilities create while seeking optimal returns and liquidity. As a result, our portfolios are highly matched from a cash flow perspective, and I'll show you some examples shortly. Additionally, Steve showed you the steadiness and dependability of our net margins over the last 10 years. This is a reflection of our disciplined ALM practices. It is also what led us to add low interest rate protection starting in 2004, long before anyone started talking about it, and I'll discuss that further in a few minutes too. We've continued to expand our capabilities as we have grown. Our commercial and agriculture mortgage lending and real estate platform is the best in the industry, and we have the track record to prove it.
Over the last 10 years, we've originated over $74 billion of commercial mortgages. In that time period, our total credit losses are well less than one-half of 1%. Our ability to originate assets like these and private placements continues to be strong in this environment. They provide significant additional net investment income compared to public securities and government bonds. Given the focus on ALM on asset allocation and risk management, we actively review and manage our portfolios to ensure we will continue to meet the needs of the liabilities and our policy holders, as well as, most importantly, generate attractive returns to our shareholders. Let's take a closer look at three product investment portfolios that have traditionally been thought of as having significant reinvestment risk: corporate benefit funding, deferred annuities, and long-term care. As a result of our consistent ALM practices, we have modest reinvestment risk in all three.
First is corporate benefit funding, specifically our long-term portion, which consists of U.S. and U.K. pension closeouts, structured settlements, and other benefit funding products. It is a fairly large portfolio consisting of $45 billion in invested assets. On the right bar, you can see total expected investable cash flow for 2012 of $2.9 billion. However, as indicated in green, $2.6 billion of this represents new sales, which are priced in current markets, so there is no reinvestment risk for the bulk of the cash flows. The small red slice of $300 million represents net cash flow from the portfolio to be reinvested. This includes net investment income, roll-offs, and maturities, net of outflows to customers. This relationship continues very steadily into the future. 2013 is actually even better than this. You can see the true reinvestment risk in corporate benefit funding is minimal.
On slide 21, we look at deferred annuities, part of our retirement product segment. Assets are nearly $25 billion. On the right, you see investable cash flow totals $2.7 billion. $600 million of this total represents new sales, which again are sold at current market rates, so have minimal reinvestment risk. There are 2 other categories to show you. First, the orange slice represents our estimate of how much existing customers will deposit at their guaranteed rates, which would represent reinvestment risk to us. However, it is worth noting that we also have $10 billion of interest rate floors in this portfolio protecting us against rate guarantees. The red slice is $1 billion of net cash flows from the portfolio, again representing inflows from the portfolio net of outflows to customers.
These two slices account for nearly all of the $200 million in spread compression over five years that William Wheeler showed you in retirement products earlier. The final portfolio that I want to show you is long-term care on slide 22. Long-term care is a fairly small portfolio at $6.8 billion. As you know, we stopped selling long-term care, so there are no new sales. However, we still receive renewal premiums on the block. You can see here we expect investable cash flows of $900 million in 2012, representing those renewal premiums and portfolio cash flows. Nearly half of the $900 million, or about $400 million, is already hedged on a longer-term basis to provide us with interest rate protection. Again, this relationship continues into the future. I hope this has helped further impress upon you the importance of ALM at MetLife.
We're very disciplined and consistent, it has served us well. Now let's turn to slide 23. I mentioned earlier one of the previous outgrowths of our diversified ALM, existing low rate protection. In 2004, we started adding interest rate floors. They were very cheap at the time, we thought they added prudent protection against a low interest rate environment. I don't think many people were concerning themselves with this kind of an environment at the time, we were. We added over $47 billion notional amounts through interest rate floors, swaps, and swaptions over the ensuing years. In 2012, this protection would provide nearly $500 million in pre-tax income. Almost as important, you should note that this protection extends beyond 2020 and well into the next decade. Further, it is with a large and diversified group of counterparties.
Consistent with our practices, we continue to look at different scenarios and what they mean to us. As an example, we have been modestly adding protection against rising rate scenarios. On to slide 24. As we look forward, there's more to do. We will continue broadening the asset mix and diversity of our international portfolios, which was part of our strategy upon closing Alico. We do this regardless of interest rates, it will further bolster our net investment income. I mentioned commercial mortgages earlier. We've been able to continue expanding here, as well as in agricultural lending, real estate equity, and private placements without taking undue risk due in large part to current market conditions and opportunities and our strong franchises in these areas. Of course, we'll continue to analyze ways of protecting the portfolio through derivative and other ALM strategies.
Most of all, we will continue to adhere to the disciplined ALM and risk management practices the way we've always done. Before I turn it over to William Mullaney, I want to quickly review another topic with you, our European investment exposure. There are three slides in the appendix starting on slide 32, which summarize this. MetLife's total European exposure is approximately $42 billion in GAAP book value, which is less than 10% of our general account portfolio. It's important to note that the market value exceeds the GAAP book value by more than $1 billion. Generally speaking, our European exposure is focused on those higher-rated countries in the region. The largest holdings are our $24 billion of non-financial corporate bonds.
These holdings are in companies that are market leaders in the utility, telecom, or infrastructure sectors, or large investment-grade companies that are globally diversified, such as food and beverage, energy, or pharmaceuticals. I would highlight that over 90% of our European portfolio is investment grade, and of the 10% which is below investment grade, approximately 60% of it is in the corporate sector. Less than 2%, or about $8.8 billion of our portfolio is invested in European financials. This is an area where MetLife has been reducing exposure for nearly two years. Within financials, our European hybrid exposure is less than $1.4 billion or less than 0.35% of our total portfolio. Our hybrid positions are concentrated in financial companies in the U.K., Netherlands, and Switzerland. As you can see from the slide, we hold approximately $6.9 billion in European banks.
We've sold nearly $3.5 billion in book value since early 2010 at average prices in the mid-90s. Sales have focused on institutions with exposure to peripheral Europe, lower preference capital structure instruments, and larger absolute exposures, particularly where we had any credit concerns. Our remaining holdings are generally in the larger, better capitalized European banks. Turning to our peripheral sovereign exposure, when we purchased Alico one year ago, we initially acquired $1.8 billion of GAAP book value exposure, of which approximately $726 million, or 40%, was Greece. Since then, we've sold approximately $1.1 billion in book value of peripheral sovereigns. Our remaining book value exposure to the peripheral sovereigns is now $571 million, of which $377 million is Greece.
Slide 34 provides the key takeaways relating to our European exposure, let me just say in summary, we've managed our exposures to the most sensitive credits very well and according to plan. We knew Alico had exposures that we would need to proactively manage. We've managed them down materially, and we will continue to do so. Given the size and diversification of our total portfolio, we do not feel that our remaining European exposures pose a material risk, and we deem our level exposure to be very manageable going forward. With that, let me now introduce William Mullaney.
Thanks, Steve, and good morning, everybody. In addition to the actions that we're taking on the investment portfolio, there are also actions being taken in the business to address the interest rate risk environment. As you would expect, the most impactful action we can take is to increase prices where we can on existing business. The most common way this is done is for products with shorter liabilities that renew periodically. An example of this is our group insurance businesses. This business renews annually, subject to rate guarantees. We have the opportunity to adjust prices to reflect the current environment. Auto and home is another business that renews annually where we have the ability to change prices. As you saw in the earlier slide, these businesses are not particularly interest rate sensitive. We also have some longer liability businesses in which the contract permits us to increase prices.
As we have discussed in the past, we've been raising prices on our in-force long-term care business to improve returns. On slide 26, here are some additional actions that we're taking and some of the actions that we can take in the future in dealing with low interest rates. For longer liability businesses where we can change prices, here are some actions we can take. In our variable annuity business, for example, one of the actions we are pursuing is adding some of the new funds that we have in our new VA product to our in-force business. These funds are managed to reduce volatility, but also reduce interest rate exposure by virtue of the interest rate swaps that are in the Protected Growth Strategies funds. As a result, these products require less capital.
Getting these funds adopted in existing business in a meaningful way could increase returns by reducing our capital requirements. It will also decrease the amount of hedging that we need to do, since some of the hedges are embedded in the funds. If low interest rates persist, we're also looking at implementing an increase in fees when a VA policyholder elects to step up the contract to the higher income base. We have more flexibility on business we write going forward, as we can adjust prices to reflect the current environment. In the past, we've talked about how we measure returns on new business. As interest rates have come down over the last couple of years, we've continued to adjust prices to reflect the low interest rate environment.
More interest rate sensitive products such as universal life, structured settlements, pension closeouts, and group disability have all seen increases in prices, in some cases, multiple price increases, to reflect our expected returns on the assets invested, and we will continue to do this. Another action we've taken is to reduce the minimum interest rate guarantees we have embedded in our products. Before the year 2000, it was not uncommon for many products to have minimum interest rate guarantees of 3%. Over the last decade, we've been reducing these minimum guarantees. The total control account is a great example of this. The 3% minimum guaranteed rate was reduced to 1.5% in April 2003, and reduced again to 0.5% in April 2009. We're also considering whether to reduce the minimum further to reflect the current environment, and we are taking similar steps with our other products.
Finally, we can put greater emphasis on selling less interest rate sensitive products, either through pricing actions, adjusting compensation to agents, or placing some limits on more interest rate sensitive offerings. Not on the slide here, but obviously, we also have the option to reduce expenses in our businesses as we look to maintain returns in a low interest rate environment. With that, let me turn it back over to Steven Kandarian.
Thank you, Bill. Let me wrap up by summarizing the key takeaways from today's call, starting on slide 28. Overall, even if interest rates remain at historically low levels for another five years, MetLife's earnings will continue to grow, the impact on our balance sheet would be modest, no stat reserve strengthening would be required, and most importantly, we would continue to generate excess capital. We also possess a number of tools that management can and would use to respond to protracted low rates. To conclude on slide 29, I believe MetLife is less of a play on the 10-year treasury and more of a play on the growing middle class around the world, which is eagerly seeking financial protection and retirement security. It is our diversification that will provide us with strong and growing earnings, even under a scenario of prolonged low interest rates.
The U.S. business would hold steady, while the international business would provide continued earnings growth. This is yet another testament to our commitment to managing MetLife for the long term. We saw the financial downturn coming long before others and took a number of steps that might have seemed overly cautious at the time. Now, with our recent acquisition of Alico and the actions we have taken in our U.S. business, we are well positioned to weather a prolonged period of low interest rates. If rates return to more normal levels, the amount of value we create for our shareholders will only accelerate. With that, I will turn the call back to John McCallion.
Thanks, Steve. Again, we'd like to apologize for the technical difficulties we had. This will be available for replay. Again, the dial-in number is the same as was in the press release at 320-365-3844. Obviously, we in investor relations will be available for your questions as well. We're going to extend the call for 10 minutes for Q&A. I understand we're backing up against some other calls here, but for those that can stay on, we'll make ourselves available for another 10 minutes. Let me turn it back over to Greg for questions.
Thank you. Ladies and gentlemen, as a reminder, if you'd like to ask a question, please press star then one. Once again, for questions, please press star then one. Your first question comes from the line of John Nadel from Sterne Agee. Please go ahead.
Hey, good morning. I have one going back to the third quarter and then one for this one, if I could. When you guys characterize excess capital, in the prior call you mentioned $3 billion to the holding company at year-end after you paid the common dividend and the $750 million debt maturity, and I believe that was above your $1 billion consistent cushion. My question for you is this, hypothetically speaking, if you weren't a bank holding company and subject to the stress testing, is it your view that the entire $3 billion is fully deployable?
Yes.
The last question I have for you is just, is there a certain type of insurance business that if you were looking at it, let's say from an M&A perspective
In this type of five-year, 2%, 10-year treasury yield type of environment, that you would be extremely concerned about its ability to pass the statutory cash flow testing or New York Seven tests? If so, which types of business would sort of be on the top of your list of concerns?
No, I'm not going to go there. No, you got your job, John. You're the one who's supposed to.
All right, if I could just follow up then with a different one. The pension cost, the incremental $50 million over the next several years, that surprised me as low. I guess the question for you is why?
You're right, it is low. Remember, that's the 2016 number. It's interesting. The impact is later in the 2016 timeframe, as assumptions get modified and smoothed. It's a bigger impact in the early years, and that's factored into that $0.21.
Okay. Understood. That's just the incremental $50 from 2015 to 2016.
No, actually it's from now till then. It starts out, if it's a $50 million impact then, it's a bigger number now, and then as the impact gets smoothed over time.
Okay.
In the $0.21 number for 2012, we include the full 2012 impact of the pension.
Okay. Appreciate it. Thank you.
Your next question comes from the line of Thomas Gallagher from Credit Suisse. Please go ahead.
Thanks. Yeah, I just had a quick one from the earlier call as well, then an interest rate one. I just want to confirm, I know for 2012 you're going to need Fed approval for your capital management. Assuming the bank sale goes through, I just want to confirm that your understanding is you will no longer need Fed approval post the sale of that bank, in terms of capital management.
Tom, that's correct. If a bank is sold, and we're no longer a bank holding company, the Fed would not be approving our capital management. Obviously, it's a little time before we get that bank sold. We're doing everything we can to move that along as fast as possible. There are a number of regulatory approvals that are necessary to go through. I can't tell you exactly what the timing's going to be. We're hoping by the end of the second quarter of 2012 that we'd no longer be a bank holding company.
Okay.
Tom, I should probably add that we're going to resubmit here in January, and are looking forward to hearing back from the Fed sometime before the end of March. You can figure out that timing in terms of the bank holding company.
Got it. Your timing back from the SCAP would be potentially March. The potential close of the sale of the bank, end of 2Q. For the 2012 plan, it sounds like it would be Fed approval, beyond that, the hope would be no longer assuming the sale of the bank goes through. Is that the right way to think about it?
Yes. Most likely we'll be receiving a response from the Fed before we're no longer a bank holding company.
Got it. That's what I thought. On the interest rate side, on slide 15, when you get into the $540 million of spread compression by product, are you allocating any hedge offsets? Can you just give us an idea of how you're allocating the hedge gains as a partial offset? Is it done pro rata, or That's my first question on interest rates.
Yes. The hedging offsets, and that was in my remarks, are in these numbers. It's not pro rata or anything like that. The specific derivatives contracts, which are both swaps and floors as well as now swaptions, are allocated to different portfolios. Of course, it's to match the risk and the liability shape and things like that. That's how it's allocated.
Bill, what's the aggregate hedge gain in 2016 again? These are net numbers, obviously, but what is the absolute hedge gain that's being assumed here for 2016?
I think the way to look at that is look at the chart. Let's just go to that page quickly. Wherever it is. I always have to dig down here. I think it's on page 23. You can kind of see that. If you assume the orange line, which is the middle in 2016, you can see that the number's crudely $600 million pre-tax-
Okay
of derivative income from all these contracts.
That's pre-tax, and these are after-tax numbers, that $540 million?
That's right.
The last question I had is, when you do this interest rate assumption, are you assuming any level of sort of stressed prepayment activity from your portfolio, meaning some convexity prepays on mortgage backs or bond calls, or are you not making much of an assumption there?
It's Steven Goulart. Yes, we are. I mean, again, we're reflecting how we think the investment portfolio would perform given this interest rate environment.
Steve, just broadly speaking, how should we think about that? Is 20% of your portfolio really at convexity risk? Or maybe just a little bit of explanation as to under normal markets, not low interest rates And how that roll off of your portfolio would change under the low rate stress scenario due to early bond calls and/or mortgage-backed prepays?
Tom, it's John. We'll address that offline. We're going to just keep moving here.
Got it.
Why don't we take the next question, Greg?
Your next question comes from the line of Suneet Kamath from Sanford Bernstein. Please go ahead.
Thanks. I'm going to stick with the pattern of one earnings call and then one interest rate question. On the capital issue, I hear what you're saying about applying for approval and all that. Let's just assume that for whatever reason, regulatory-wise or political-wise, you don't get to redeploy the capital that you'd like to. My question is, what is plan B? You're going to be building a ton of capital. You mentioned the dividends coming out of the international subs in January. You're going to be sitting on a lot of this capital. What is plan B? What are the alternatives in terms of what you can do with that? I'll have an interest rate question.
Well, let me start by saying our expectation is that our plan will be approved next year. That's our starting point. You're saying, what if it's not approved? We will continue generating excess capital. We will look for ways to deploy it. We hope to no longer be a bank holding company by mid-year. Things will unfold on that basis.
Just as a follow-up, if you wanted to do something with that capital in terms of M&A or what have you, would you need approval for that as well, or is it just the capital return to shareholders?
Yeah. We'll look at M&A in the normal course. Obviously, we look at it in the context of how accretive is it compared to a share buyback. Right now, as you know, we can't do the share buyback, but our assumption is we will be able to do share buybacks in the first part of next year. We'll continue looking at M&A opportunities. We inform the Fed about our activities, but we don't seek approval from them.
Okay, terrific. Then just on the interest rate presentation. Thanks, by the way, that was very helpful. You mentioned no stat reserve impact or the GAAP impact is pretty small in terms of reserves five years out. Not that this is likely, but what happens if we extend the timeframe beyond 2016? I guess, at what point does it become a bigger problem in terms of stat reserves or GAAP reserves? Is there a cliff sometime beyond 2016, or how should we think about that?
No, there's no cliff. Remember, the way stat works, we're actually projecting the cash flows for the life of the liability and then present valuing it back. We're not thinking that somehow magically in 2017, that answer will change. The GAAP analysis works the same way. There wouldn't be a cliff kind of impact there.
Okay. A quick question for Steven Goulart. In your plan, what is the new money rate assumption that you're using in this five-year outlook?
Based on essentially what we're seeing currently, which is just under 4%.
Okay, thanks.
Your final question today comes from the line of Nigel Daly from Morgan Stanley. Please go ahead.
Great, thanks. Good morning. On the investment portfolio, can you provide some details as to how you're changing your asset mix given the current environment? I'm guessing traditional corporates look somewhat less attractive there. What are the key areas that you're looking at increasing your allocation of new investments in? Perhaps you can also provide some details internationally as how you're broadening your asset mix there as well.
Nigel, it's Steve. Some of this is also what I commented on in the low rate scenario, too. What we're seeing today is really still great opportunities in private asset originations, in commercial mortgages, and agricultural mortgages. We have been, over the course of the year, increasing our allocation to those sectors. As we look forward to next year, we're likely to see that relationship continue. At the same time, we continue to check from a relative value basis how it compares versus other opportunities in traditional corporate bonds and the like. We really like what we see in private assets.
Very good. Thanks.
Great. Well, thank you everyone. Again, we will post the replay information on our investor relations portion of the website, and that's going to end the call. Thanks for joining.
Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.