Ladies and gentlemen, thank you for standing by. Welcome to the MetLife third quarter 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. With that, I would like to turn the call over to John McCallion, Head of Investor Relations.
Thank you, Greg, and good morning, everyone. Welcome to MetLife's third quarter 2011 earnings call. Before I start, let me briefly outline the logistics of today's call. We have a two-hour call today divided into two sessions. The first session will focus on our third quarter 2011 results, which will end promptly at 8:55 A.M. We will take a 10-minute break, at which time the phones will be placed on musical hold. Then at 9:05 A.M., we will host a discussion to address market concerns about a potential long-term low-interest rate environment in the U.S. Presentation materials for this interest rate discussion are currently available at metlife.com through a link on the investor relations page. Now let's get started. We will be discussing certain financial measures not based on Generally Accepted Accounting Principles, so-called non-GAAP measures.
Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures may be found on the investor relations portion of metlife.com in our earnings press release, our quarterly financial supplement, and in the other financial information section. A reconciliation of forward-looking financial information to the most directly comparable GAAP measure is not accessible because MetLife believes it is not possible to provide a reliable forecast of net investment and net derivative in 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, President and Chief Executive Officer, and Bill Wheeler, Chief Financial Officer. After their prepared remarks, we will take your questions.
Also here with us today to participate in the discussion are other members of management, including Bill Toppeta, President of International Business, Bill Mullaney, President of U.S. Business, Steve Goulart, Chief Investment Officer, and Don DeMaio, President of MetLife Bank. With that, I would like to turn the call over to Steve.
Thank you, John, and good morning, everyone. Before I discuss this quarter's results, I'd like to comment on our recent annual dividend declaration. Earlier this week, we declared an annual common stock dividend of $0.74 per share for 2011. As we announced, we recently submitted a capital distribution plan to the Federal Reserve for approval that included both an increase in MetLife's annual dividend as well as the resumption of stock repurchases. The Federal Reserve has concluded that the company's planned capital actions should be tested under a revised adverse macroeconomic scenario, which is being developed for those firms that will participate in the 2012 Comprehensive Capital Analysis and Review. As a result, the Federal Reserve did not approve the company's planned dividend increase and other proposed capital actions at this time. We are disappointed that we cannot commence increased capital actions now.
Our analysis shows that the company's current capital level and financial strength support capital action increases. Moreover, we believe increasing our capital actions in this time of high unemployment would prove beneficial to the economy as our shareholders redeploy these funds in a productive manner. We look forward to seeking and gaining the approval of our capital plan from the Federal Reserve early next year. We are firmly committed to creating shareholder value and returning capital to our shareholders. In addition, we continue to move forward on our plans to explore the sale of the depository business and the forward mortgage origination business conducted at MetLife Bank and to take the necessary steps to no longer be a bank holding company. As I have previously noted, this will ensure that MetLife is able to operate on a level regulatory playing field with other insurance companies.
Let's discuss this quarter's results. Despite some significant economic headwinds during the quarter, MetLife delivered earnings per share of $1.11, up 3% from the prior year quarter. As noted in the 8-K we filed on October 6th, MetLife recorded a number of one-time charges in the third quarter. Absent these charges and some other one-time items, MetLife's earnings would have been $1.28 per share, which we believe is closer to the company's true earnings power. In addition, our annualized operating return on equity of 10.9% for the first nine months of the year would have been 11.5% without one-time items. Let me turn to some of the broader issues facing the market. First, while Europe remains unsettled, we believe our exposure is manageable, especially given a number of actions we have taken over the past year.
Out of a general account asset pool of $493 billion, our exposure to peripheral Europe sovereign debt was $571 million on a book value basis as of September 30th, down from $1.6 billion as of December 31st, 2010. Our exposure at quarter end to European banks was $6.9 billion, down significantly from year-end. In addition, our total $42 billion of European exposure, more than 90% is investment grade. We have provided greater detail on our exposure to Europe in the appendix to the presentation deck for our call at 9:05 A.M. Second, the variable annuity market continues to experience strong growth. While the market in our sales grew substantially in the third quarter, we are taking a proactive approach to managing the growth of our variable annuity business.
As you know, we recently adjusted our GMIB Max offering to reduce risk and improve returns. We will be making further adjustments in January. While we are comfortable with the pricing and returns on our third quarter VA sales, we continue to seek opportunities to reprice and improve the risk profile of our product offerings. As of January, the roll-up rate on our GMIB Max product will be reduced from 5.5% to 5%. We are closely monitoring sales. If they rise above plan, there are steps we can take and will take to bring sales in line. You can be assured that we are reviewing all of our product features to maintain a disciplined balance between customer value, risk, and return. As a matter of sound capital management, we will only pursue growth that we believe maximizes long-term shareholder value.
Third, while interest rates have rebounded somewhat since the announcement of Operation Twist, they still remain at low levels. While long-term low interest rates have an impact on our earnings, we have taken proactive steps to mitigate this impact. We will talk much more about this topic during the special one-hour teleconference following today's earnings call. For now, I would simply note that even if the 10-year Treasury remained at 2% for the next five years, MetLife would still expect to grow earnings and generate excess capital. One reason is our focus on risk management. For example, as Steve Goulart will discuss in the second hour, we purchased $18 billion of notional interest rate floors in 2004 and 2005 to protect against a sustained low-rate environment. Finally, let me cover a few highlights from this quarter.
We are extremely pleased with the performance of our international business and believe that it will continue to drive profitable growth for the enterprise. Total international sales were up 25%, including a 28% increase in Japan sales compared with MetLife's and Alico's combined results from the third quarter of 2010. Our business in Japan continues to recover from the impact of the March earthquake and tsunami. International business' operating earnings in the quarter reached $578 million on solid performance in Latin America and Asia Pacific. In these regions, our accident health products, which have low capital requirements and attractive returns, are making a strong contribution to our bottom line. Recently, we launched a new standalone whole life product, which is the only cancer-specialized product available in Korea, offering both a whole life feature and additional protection for secondary cancer diagnosis. The integration of Alico is proceeding well.
On October 3rd, almost 17 months after changing MetLife's long-term ratings outlook to negative on news of our agreement to purchase Alico, Moody's returned our ratings outlook to stable. In upgrading MetLife's ratings outlook, Moody's pointed to, among other things, our substantial progress and success with the integration of Alico. In the U.S., premiums and fees grew 9%, primarily driven by higher pension closeouts and structured settlement sales in the corporate benefit funding segment. In addition, we continue to maintain the leading position in the group insurance market. Underwriting results improved, particularly in the dental business, as we maintained our disciplined approach to underwriting. In summary, I believe MetLife is well positioned to create long-term shareholder value. With that, I will turn the call over to Bill Wheeler to cover our third quarter results in greater detail. Bill?
Thanks, Steve, and good morning, everybody. MetLife reported net income of $3.6 billion or $3.33 per share, and operating earnings of $1.2 billion, or $1.11 per share for the third quarter. There were several unusual items in this quarter. First, we have taken an after-tax charge of $117 million or $0.11 per share, to increase reserves in connection with our use of the U.S. Social Security Administration's Death Master File, and similar databases to identify potential life insurance claims for pending and incurred, but not reported claim liabilities referred to as IBNR. Over 70% of the charge is in our group life business, nearly 25% in individual life with the balance in corporate benefit funding. Next, our auto and home business incurred catastrophe losses of $88 million after tax in the quarter, including the impact of Hurricane Irene.
This result was $50 million after tax, or $0.05 per share above our third quarter plan provision of $38 million. Partially offsetting the impact of the cats, auto and home had a favorable prior year development reserve release in its auto business of $19 million, or $0.02 per share. Also, we have recorded a $40 million after-tax charge, or $0.04 per share related to MetLife's obligations under the New York State liquidation plan for Executive Life Insurance Company of New York, which we call ELNY. This charge has been recorded in our corporate and other segment. Pre-tax variable investment income was $400 million. After taxes and the impact of Deferred Acquisition Costs, variable investment income was $37 million, or $0.03 per share above the top of our Investor Day guidance, driven by strong securities lending and private equity returns, which more than offset weakness in our hedge fund performance.
I should remind you that we report our private equities on a one quarter lag, while hedge funds are reported on a one-month lag. Therefore, we would expect that our private equity portfolio would be negatively impacted in the fourth quarter based on the market performance in the third quarter. Adjusting for the items that I just mentioned and a few other minor adjustments that also impacted this quarter, our normalized operating earnings was $1.28 per share, and our normalized ROE for the first nine months of the year was 11.5%. In addition, retirement products earnings were negatively affected by the 14% decline in the S&P 500 in the quarter. The initial market impact, as a result of the higher DAC amortization cost the segment $90 million after tax, or $0.08 per share this quarter. Clearly, there were a number of unusual items in the quarter.
However, when you strip those out, I believe our results are quite strong, reflecting good underlying fundamentals in a challenging environment. Let's take a look at the results in the quarter by line of business. U.S. business reported operating earnings of $655 million for the third quarter. Excluding the impact of unusual items in this quarter, normalized earnings for U.S. business was $768 million. If you exclude the initial market impact of $90 million after tax in the quarter, U.S. business operating earnings were up 7% versus normalized operating earnings in the prior year period.
U.S. business had strong top-line growth in the quarter as premiums, fees, and other revenue were $7.7 billion, up 9% from the prior year quarter, driven by solid closeout and structured settlement sales and corporate benefit funding, and strong net flows in our retirement products business due to variable annuity sales and continued low lapse rates. While the insurance products top line was essentially flat this quarter, we are having a good 2012 sales and renewal season as favorable pricing trends are slowly returning to the group insurance market. Insurance products normalized earnings of $362 million is up 9% over the prior year quarter. This strong performance reflects improved non-medical health underwriting margins, a better individual expense margin, and continued solid interest margins. The group life mortality ratio for the quarter was 98.5%.
It's elevated due to the reserve strengthening related to the life insurance claims adjustment that I mentioned previously. Adjusting for this item, the loss ratio was 88.9%, near the low end of the 2011 guidance range of 88%-93%, and in line versus the prior year quarter of 89%. Overall, we are pleased with group life's steady underwriting results reflecting our ongoing pricing discipline. The non-medical health total benefits ratio for the quarter was 86.6%, which was down from the prior year quarter of 88% and well within our 2011 guidance of 86%-90%. Results in dental continue to improve as we execute the second year of our re-margining strategy. We are seeing more stable utilization and favorable price trends. Disability results improved significantly versus a very poor quarter last year. Incidents, recoveries, and offsets on open claims were all better versus the third quarter of 2010.
Our individual life mortality ratio for the quarter was 98.5%, elevated due to the reserve strengthening related to the life insurance claims adjustment that I mentioned previously. On a normalized basis, the mortality loss ratio was 89%, up from the prior year quarter of 86.7% and above plan due to higher large face claims in the quarter. I should point out that we introduced a new higher priced ULSG product in the third quarter. However, as the old product was still available in the quarter, we saw UL sales somewhat elevated. We would expect to see lower UL sales going forward. Turning to our auto and home business, the combined ratio, including catastrophes, was 105.7% for the third quarter, which was up over the prior year quarter's results of 93.6% due to unusually heavy storm activity, including the impact from Hurricane Irene.
The combined ratio excluding catastrophes was 88% in the third quarter versus 88.2% in the prior. Auto and home operating earnings were significantly impacted by the cat impact this quarter, as well as other related non-catastrophe losses. I should note that this has already been the worst catastrophe year in the history of the company, and despite that fact, our auto and home business is expected to pay a dividend up to the holding company before the end of the year. Auto and home premiums, fees, and other revenues were up 3% on solid growth fundamentals and favorable pricing trends in the market. We will look to take further pricing actions consistent with the market. Retirement products operating earnings were down significantly due to the 14% drop in the S&P 500 this quarter. This negatively impacted the segment by $90 million after tax due to higher DAC amortization.
Premiums, fees, and other revenue were up 39% from the prior year quarter, driven by strong net flows due to variable annuity sales of $8.6 billion and continued low lapse rates. Our hedging program continues to perform well despite the very volatile markets. Corporate benefit funding operating earnings were up 45% over the prior period quarter, driven by higher net investment income coming from both variable and recurring income. Premiums, fees, and other revenues were up 65% due to higher closeouts both in the U.S. and the U.K., and structured settlement sales. Let's move to international business. International reported operating earnings in the third quarter of $578 million, up from $189 million in the prior year quarter, largely due to the acquisition of Alico and strong growth in the business, particularly in the Latin American and Asia Pacific regions.
To give you a better sense of international's overall growth for the quarter, our international revenues were $4 billion. This is approximately 11% higher than the third quarter of 2010 on a combined basis, as if we had owned Alico in both periods, and it's 3% higher on a constant currency basis. We continue to see strong sales growth for the business. The sales of $1.5 billion in the quarter represent year-over-year and sequential growth of 25% and 9% respectively on a constant rate basis. In Japan, operating earnings were $315 million, up 29% over the second quarter of 2011 due to higher net investment income, reduced claims from the March earthquake, lower operating expenses, and improved persistency.
The year-over-year increase in revenues on a combined basis was approximately 13%, driven largely by the favorable exchange rate of the JPY versus the U.S. dollar and higher persistency. On a constant rate basis, revenues were up 2%. Japan sales recovered strongly in the quarter at $534 million, up 28% year-over-year on a constant rate basis, and 22% over the sequential quarter. Sales increased in all product and distribution channels, with the strongest gains coming from the bank channel and in whole life and fixed annuities. In the other international regions, operating earnings were $263 million, up 39%, driven by the Alico acquisition and growth in the Latin America and Asia Pacific regions. Overall, the key business drivers included solid underwriting, improved persistency, lower operating expenses, and a focus on high ROI products.
The year-over-year increase in revenues on a combined basis was approximately 10% for the region, with strong revenue growth in both Latin America and Asia Pacific driving these results. In Latin America, premiums, fees, and other revenue were up 10% year-over-year, highlighted by strong sales in accident and health in Argentina and Chile, and the pension business in Mexico. Overall, persistency remains strong for the region. Asia Pacific revenue is up 11% year-over-year, driven by group sales in Australia and persistency improvements in Korea. On a constant rate basis, revenues were up 4% year-over-year, while sales were up 23% on a constant rate basis, a very strong result. Overall, our international business had a very good quarter and continues to perform well in spite of the challenging global environment.
We are realizing the value and growth expected from the Alico acquisition. We are delivering on our commitments. Diversification of geography, products, and distribution has positioned international to withstand recessionary pressures. Moving to expenses. Our operating expense ratio for the quarter was 23.2% and 20.3% when excluding the impact of MetLife Bank and pension and post-retirement benefits. Both ratios are below our 2011 guidance of 23.5%-24.1% and 21.2%-21.7% respectively. Overall, a very good result. Turning to our investment portfolio. Net unrealized gains in fixed maturity and equity securities were $19.8 billion, up from $11 billion last quarter. Please keep in mind that interest rate-driven unrealized gains and losses in our investment portfolio are generally offset by changes in the economic value of our liabilities.
With regard to realized investment gains and losses, in the third quarter, we had after-tax investment portfolio net gains of $14 million. Included in this net gain are impairments of $167 million after tax, of which $134 million after tax relate to our Greek sovereign debt holdings. With respect to our derivatives portfolio, we had net after-tax gains of $2.7 billion. The impact of MetLife's own credit spreads contributed $1.3 billion after tax, while lower interest rates was the other key driver. As a reminder, derivative gains or losses related to MetLife's credit spreads do not have an economic impact on the company. These large derivative gains had a significant and somewhat unintended impact on our overall portfolio yield for the quarter as a result of the mechanics of the yield calculation. The overall portfolio yield fell by 20 basis points from 4.83% in Q2 to 4.63% this period.
Approximately one half of this yield decline relates to the substantial increase in derivative asset values, coupled with the related increase in cash collateral that we receive from our derivative counterparties. Overall, we are very pleased with the performance of our investment portfolio and feel it is well-positioned to deal with the challenging macro environment, including a potential sustained flat rate environment. Steve Goulart will provide you with more details on our investment portfolio shortly. I would like to provide you with an update on our capital position. Our preliminary statutory operating earnings and statutory net income for our domestic insurance companies for the third quarter of 2011 was approximately a $5 million loss and $117 million gain, respectively. The results in the quarter were impacted by higher reserves related to the market performance in the quarter and other non-recurring items, which we mentioned earlier.
While reserve adjustments go through the income statement, the hedges in our derivatives portfolio do not go through the income statement, but are rather reflected in unrealized gains. Therefore, our total adjusted capital, or TAC, increased by $2.3 billion in the quarter, primarily due to unrealized gains on derivatives and other invested assets, and now stands at $28.7 billion as of September 30. For the first nine months of 2011, statutory operating earnings and statutory net income was approximately $1.4 billion and $1.5 billion respectively. On a year-to-date basis, this is about in line with our expectations. In addition, our international capital position is strong with Alico Japan's reported second quarter solvency margin ratio on the 2012 basis is 896%, while the third quarter has not been reported, we do expect to see similar levels. Cash and liquid assets at the holding company at September 30 were approximately $3.3 billion.
Last quarter, we provided an estimate of year-end 2011 holding company excess capital of about $5 billion, which continues to be in line. This excess was before capital management actions and assumed a $1 billion liquidity buffer. Of this total, we plan to use $750 million to repay maturing debt and about $780 million for common dividend payments in December of this year, which leaves a little bit over $3 billion of additional holding company excess capital at year-end. In summary, MetLife had a very good third quarter in spite of the ongoing challenging environment. Now, before I turn it over to the operator for questions, John McCallion has asked me due to time constraints, that you limit yourself to one question and only one follow-up, which relates to your initial question. Make sure they relate. Now, I'd like to turn it back to the operator. Thanks.
Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star then one on your touchtone phone. You will hear a tone indicating you have been placed in queue. You may remove yourself from queue at any time by pressing the pound key. If you are using a speakerphone, please pick up the handset before pressing the numbers. Once again, if you have a question, please press star one at this time. Your first question comes from the line of Jay Gelb from Barclays Capital. Please go ahead.
Thank you and good morning. The variable annuities clearly benefited from trying to get the current roll-up rate. What do you think that contributed in the quarter?
Hi, Jay, it's Bill Mullaney. Is your question about specifically do I think the higher roll-up rate contributed to higher sales? Is that your question?
Well, yeah, I'm pretty sure that's the case, but I'm just, with $9 billion of sales in the quarter, what do you think is a reasonable run rate going forward?
Well, as you know, we're taking some steps to bring the roll-up rate down. We set the roll-up rate on MAX, it was very early in the year when interest rates were higher, and there were some competitor products out there at 6%. We wanted MAX to get good traction in the market, and so we set a 6% roll-up rate, and then obviously the macroeconomic environment changed by the time that product got in the market, which obviously made it quite attractive, and that was a big contributor to the overall sales level in the third quarter. In addition, we did announce that we were bringing the roll-up rate down to 5.5%, so there is some fire sale impact in the third quarter as a result of that.
I think for the fourth quarter, you can expect to see sales be lower than they were in the third quarter, probably in the $7 billion-$7.5 billion range. Again, you're going to see some fire sale impact because the changes didn't take place until the second week in October, and so we saw pretty heavy volume on the 6% product in the first couple of weeks of October. The run rate will obviously come down as a result of being at 5.5%.
Right. Would you think maybe a $5 billion run rate going into early 2012 on a quarterly basis is good for a placeholder?
Yeah, I would say it's probably in that range. That's a good way to look at it.
Thanks very much.
Your next question comes from the line of Jimmy Bhullar from JPMorgan. Please go ahead.
Hi. Thank you. Good morning. I had a question also on variable annuities. Bill, maybe if you could talk about, given where equity market volatility is and cost of options, just the price that you're charging for guarantees, is that enough to cover the cost of hedging? It doesn't seem like it would be. If it isn't, are you planning on taking any actions at some point? How are you looking at that?
Yeah, Jimmy, we're looking very closely at that. For the third quarter, because of the volatility in the markets, the cost to hedge for the overall book was slightly above the fees that we were charging for the hedges. We are monitoring that pretty closely, and over time, if hedging costs don't come back in line, we would take some steps to adjust our fees.
Just cheating a little bit, I guess, on variable annuities also, Bill Wheeler mentioned that there was about a $0.08 hit because of a higher DAC. I think Steve's comments mentioned 128 as a normal run rate. In the past, you've added any market-related items to your estimate of run rate, because that shouldn't repeat going forward. Just was wondering why you view 128 as a run rate as opposed to 136. That's all I have.
Yeah. Jimmy, I think that the answer to that is pretty simple. We actually generally don't add back market impact, one way or another. I think the only time I can remember that we did adjust for it is when we had a huge change in the performance of the stock market. I guess my feeling is that markets move up and down. That's part of the business we're in, and unless it truly distorted the number, it shouldn't be adjusted.
I'm looking at the list of numbers you gave us in the third quarter of last year, this was one of the items that you'd mentioned.
Well, I can't remember the third quarter of last year right off the top of my head, there isn't some special message there.
It was like $0.05 that quarter, $43 million.
Okay. What we'll do is, we thought we'll give people the information. Obviously, we'll quantify the market impact and let them decide what they should normalize.
As you think about that business, that $0.08 is specifically related to DAC and not lower fees or something else that might be ongoing, right?
I'm sorry, can you just say it one more time?
The $0.08 in the annuity business was specifically related to DAC, and it's not lower fees or anything else that might be ongoing.
That's correct.
Okay
DAC related.
Thank you.
Your next question comes from the line of Chris Giovanni from Goldman Sachs. Please go ahead.
Thanks so much. Just one question regarding sort of the decision by the Fed. Any way you can provide any insight into terms of kind of what you went to the Fed with? Around that same tone, any reason not to go to the board and get the approval from the board for what internally you guys are comfortable deploying and sharing that with investors?
Well, this is Steve. The Fed process is one in which disclosure around their supervisory information is not permitted. Some of the language you heard from us actually was approved specifically by the Fed for us to give to you because we felt that given their action, we really needed to say more than simply we can't raise our dividend. The language we gave you is pretty much all we can tell you about the inner workings of this process. We're simply not allowed to give you more than what we've given so far. I'm sorry to limit it, but it's not our decision in terms of what can be disclosed.
Can you just talk some about the conversations you and the board are having in terms of internally, what you guys might be thinking is comfortable in terms of deployment?
Yeah, I think it's not a wise thing for us in the middle of this process with the Fed to start putting out those numbers. We're working with the Fed closely. You can be assured our board and we management are in sync on this issue. We want to return capital to our shareholders as soon as possible. We're working hard with the Fed to enable that to happen.
Okay. Thank you very much.
Your next question comes from the line of Colin Devine from Citigroup. Please go ahead.
Good morning. I have sort of three small ones. Bill, first you mentioned stat earnings. Can you just, I guess, quantify what the strain was from the very large VA sales? It would seem to me that was the bigger driver of why you actually reported a stat loss. Second, can you confirm that the I didn't catch it in the opening remarks, that the guarantee step up on the VA has now since been lowered to 5%? I would assume maybe for Bill Mullaney, we're going to continue to have a fire sale at least through this quarter until you get that product off. Lastly, Bill, what if you can't sell the bank? What are you going to do?
Okay. You asked three questions.
Yeah. Two of them are small ones. Two of them are small. Come on.
Okay. You're right, they were small. Just a couple layups there. I'll answer one and three, and then I'll let Mr. Mullaney answer two. With regard to stat earnings, yes. We did report basically a break-even stat operating earnings quarter, and you're right, the break-even number was driven by the fact that we did have to increase some of our stat reserves because of the VA. Not just the sales necessarily, the strain from the sales, but because of the market performance in the third quarter. That order of magnitude after tax was $400 or $500 million. Now, keep in mind that the hedging offset to that, and that's what I tried to say in my prepared remarks, is it doesn't actually flow through the income statement. It shows up later in our statutory financials. Stat is strange.
If you take all of our hedging, including the hedging related to the VAs, obviously we had a very big stat gain with regard to total adjusted capital. Yes, we did have some strain caused by market performance in the variable annuity block, but it was
Obviously substantially offset by hedging activity.
Yeah. We're getting at the commissions, Bill. If I'm thinking 6% on almost $9 billion of sales, t hat's the biggest swing factor.
Well, yeah. Look, you do have ongoing strain, remember, just keep in mind that we have a very large annuity block at which we have ongoing fees.
Okay.
Yeah. We have decent stat strain from commissions every quarter. Obviously our M4 sort of overwhelms that number in terms of the profits we get.
Okay.
With regard to the bank, look, I would just say, we talked about a sale process. That sale process is on track. We're confident we will be able to sell the bank. If for some reason that doesn't happen or we would probably plan B, though I think this would be an extreme scenario, which we would wind it down.
Okay.
I think a sale is much more likely.
Colin, it's Bill Mullaney. Let me just add a little color to what Steven Kandarian said in his opening remarks about VAs. We made a decision to drop the roll-up rate to 5.5%. That was effective in the middle of October. We've since filed to bring our roll-up rate down to 5%, and that change will take place in the first quarter, or actually the first week of January of 2012. Yeah, I think the fourth quarter will be somewhat noisy. The run rate of VA sales just on the 5.5% product, a fire sale impact from going from 6% to 5.5%. There will be some, though I think less of a fire sale impact going from 5.5% to 5%. A couple of points I'd make. The sales at 5.5%, the return on those sales are good. The ROIs are around 15%.
Even in the fourth quarter or in the third quarter, at the 9/30 capital markets, the returns on the products were about 14% on the Max product, and Max was over two-thirds of our VA sales in the third quarter. By moving down to 5%, it also reduces our hedging costs, and hedging costs are already reduced in the Max product because some of the hedging is being done inside the fund. We think that the steps we're taking to bring the roll-up rate down will get us to an appropriate level of sales going into 2012.
Okay. I hope you're right on the returns, Bill.
Your next question comes from the line of Joanne Smith from Scotia Capital. Please go ahead.
Yeah. Hi, good morning. I had so many things I want to talk about, I know I'm only allowed one question, I'm going to talk about non-bank SIFI. Let's say that you get the bank sold and you're designated a non-bank SIFI. It seems to me that the regulatory trends in this country are getting more and more tight, to say the least. What do you think the implications are for any insurance company that's designated a non-bank SIFI? If you're having so much trouble as a bank holding company getting your capital plan approved, does that imply that there might be some constraints under the non-bank SIFI categorization?
Obviously, at this point, no one knows exactly who will be designated non-bank SIFI or if you are designated, what the rules will be. I suspect we won't know who's designated until sometime in 2012. As to what it means, might even be 2013. That's just a guess on my part, but that seems to be the direction things are going in. The hope is that over time people in Washington will understand the difference between the banking business model and the insurance industry business model, and they are quite different. Very different liquidity factors in terms of what kinds of liabilities they have. It's just a very different business model. One of the challenges is Washington has not regulated insurance. The states have, and the level of understanding of our industry is relatively limited. It's growing, but it's relatively limited at this point in time.
We and others in the industry are working hard to help those in Washington making these policies better understand the differences in these models, and if we are designated non-bank SIFI, what might be the appropriate way to regulate that group of companies. At the end of the day, we are discussing this issue at length with people in Washington, and we're trying to make sure they understand the importance of a level regulatory feel for our industry so that they don't simply pluck out a few companies and say, "You're a non-bank SIFI and everyone else is not." That's also very important to us. The story's unfolding over really years here, and our hope is we get to the right answer at the end of the day. No one knows at this point how this will sort out.
What worries me, Steve, is that the federal government seems to think that they know the banking system very well, they've really kind of messed that up. I certainly hope that there's a good education process that happens over the next year or so for the insurance industry because that could just be a mess. Thank you very much.
Your next question comes from the line of Mark Finkelstein from Evercore Partners. Please go ahead.
Good morning. I'm actually going to use my follow-up to follow up on Colin's question and then a real question. Can you just explain one thing, which is if the hedging costs exceed the rider fee, it's a little counterintuitive that the projected margins on Q3 sales and I assume into Q4, that the returns would be in the mid-teens. I guess, one, can you just explain that? Two, are you fully hedging the product, and is that incorporated in that mid-teen projected return on Q3 sales on VAs?
Yeah, Mark, it's Bill Mullaney. The base contract is performing well in the annuity business, even though the rider fees are slightly below the cost of hedging, we're still able to generate the returns that I talked about earlier.
Okay. Bill Wheeler, you gave a comment on private equity into the fourth quarter. I don't think that's a huge surprise, but you also mentioned that Securities lending was fairly strong. Can you just talk a little bit about Securities lending, and what is the outlook on that revenue stream, and how sustainable is it?
Maybe I'll pass that over to Steven Goulart.
Thanks, Bill. Let me comment on private equity and Securities lending. For private equity, as Bill said, we had very good returns this quarter, but given the lag in that and given what happened in the third quarter equity markets, we do expect that to fall off in the fourth quarter. I think we wanted everyone to realize that. Again, just reminding you that there's a lag in our performance, and so we'll probably see that in the fourth quarter. Securities lending continues to be very stable and very strong for us, and over the near term, we don't see that really changing. Our balances remain pretty flat, and margins still remain very positive. The curve has seen some compression, but given our investment strategies and the low cost of funds, we're able to maintain the spreads that we have in that business.
Like I said, we foresee that continuing in the near future.
Okay. All right. Thank you.
Your next question comes from the line of Andrew Kligerman from UBS. Please go ahead.
Great. I'm going to go with the Colin Devine three, including two easy ones. One, the tax rate. It was 26.4%. I think at the beginning of the year, you guided for 32. Should I consider the difference an unusual? Second, on the SIFI item, the regulator. Let's say you're designated a SIFI, would your regulator be the Fed, or would it still be your insurance regulator? More extensive. On international, your PFO you mentioned was 3%. I think with some of the asset dispositions, that would've been closer to say, 6%, 7%, 8% if you kind of normalized it. Is that right? What kind of revenue outlook are you expecting?
Okay. This is Bill Wheeler. I'll do the tax thing quickly. I think our projected tax rate that we said at the beginning of the year would be about effective tax rate would be about 30%. Because earnings are coming in just a little bit lower, mainly because of a lot of the one-timers we've talked about on this call, we've moved the effective tax rate down to 29% for the year, and the catch-up occurred this quarter, so that's why you see the dip to 26. It's a true-up, basically, based on what's happened in the last two quarters, but still just getting the overall tax rate down to 29.
Andrew, it's Steve. On a SIFI question, we'd be regulated both by the Fed, and we continue to be regulated by the state regulators. It'd be both.
Okay.
Your next question comes from the line of-
Sorry, I think we got one more answer before we get to the next question, right? It's Bill Toppeta, Andrew. Let me start for context and go back to last year's Investor Day on the question of premiums and fees. If you recall, what we said at that point was overall for the international segment, we called out that sales growth would be 22%, premium and fee growth would be 8%, and the combination of those two would lead to earnings growth of 16% for this year. Where do we stand now? I would say, simply put, we're right on track for the earnings growth, which I think is the most important. We're also on track for the sales growth. The premium and fee growth, as you said, correct, is on a constant rate basis, 3%, we're short. Here's why.
In the legacy MetLife business, we have intentionally not renewed some large group cases. I can think of a few in particular, one in Mexico, a large one in Australia, on the basis that they did not meet our profitability targets. Those cases, I would say, would account for about 3%. Also, as you pointed out, we've been making dispositions during the course of the year, and I think it's important for me to tell you what is our planning process with respect to acquisitions and dispositions. That is simply that we don't include anything in the plan unless it's actually done. Okay? Even though we're very certain that we're going to dispose of something, as long as we still own it at the time of the plan, we put it in the plan, and we put it in for the full year.
Same thing is true for acquisitions. We have been making dispositions during the course of this year, things like Taiwan, things like the closed block in the U.K., things like Venezuela and those dispositions, and I would say one other thing, softness in the credit life business in Europe, all those things account for almost the remaining 2%. I think that gets you from the three to the eight that we talked about on Investor Day. The only other item that I would mention here is that one more thing. In some countries, we are seeing a change in product mix from FAS 60 products to FAS 97 products, which tends to dampen premium and fee growth. Generally, I would say our experience tells us that that kind of thing is usually cyclical and not permanent. That's one piece to remember.
The second thing I would say is on the margins and the ROEs on our FAS 97 products, they're just as good or better than on our FAS 60 products. The product mix shift does not affect profitability. I would say this is also, and I spoke about this on the last quarter conference call a little bit, this is also why I think to get a fuller picture of our business, of really what's going on in the business, it's important not just to look at premiums and fees, but it's also important to look at sales, to look at persistency, and to look at other metrics. That gives you a fuller picture. I hope I'm being responsive to your question.
That was perfect.
Great. Thanks.
Your next question comes from the line of Randy Binner from FBR Capital Markets. Please go ahead.
Great. Thank you. Just hoping to get an update on the DAC 09-G changes, if you have any estimates or color you can provide on the book value or earnings impact.
We are going to give those estimates on Investor Day in early December. We're not quite ready to give people, I think, a refined estimate. Just a little color, of course, is what the thing that will impact us more than others is maybe the fact that we have a substantial amount of VOBA, which has been created through our acquisitions over the past number of years. We do expect an earnings drag, though we'll be able to quantify that more clearly in early December.
Is the VOBA issue more related to the recent Alico acquisition, or is it kind of balanced across all the acquisitions over the years?
It's more about Alico, but that's only because Alico is the biggest and the most recent. Obviously, VOBA has been created in other acquisitions like Travelers and such.
That VOBA was kind of branch distribution heavy. Or I'm sorry, like a control distribution heavy. Is that a fair way to describe the Alico business?
No, VOBA, remember, DAC gets wiped out in purchase accounting, and then it's replaced by VOBA. VOBA is value of business acquired. It's really sort of determining the value of the in-force block based on various discount rates and hurdle returns. That's how VOBA gets built.
That's fair. Thank you.
Your final question comes from the line of Jeffrey Schuman from KBW. Please go ahead.
Thanks. Good morning. I just wanted to come back for clarification on the non-bank SIFIs. I think Steve said that non-bank SIFIs would answer to the Fed. I was wondering about the role of the FSOC. The FSOC clearly determines who is a non-bank SIFI. Do they have any role in determining how they're regulated by the Fed or what the capital standards are or anything like that?
FSOC's going to be involved in determining whether you're a non-bank SIFI. The regulation will be by the Fed going forward if you're designated as such.
Okay. I was wondering because obviously you have insurance representation on the FSOC. I guess if they were to hand you over to the Fed, I guess that influence doesn't continue. Okay. Thank you.
Okay. Thank you. Greg, we will, and everyone on the phone, we'll take a 10-minute break, and we will come back to you at 9:05. Thanks.
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