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MetLife Inc. (NYSE:MET)

Q3 2009 Earnings Call

October 30, 2009 8:00 am ET

Executives

Conor Murphy – IR

Rob Henrikson – Chairman, President and CEO

Steve Kandarian – EVP and Chief Investment Officer

Bill Wheeler – EVP and CFO

Bill Mullaney – President, Institutional Business

Stanley Talbi - EVP

Analysts

Tom Gallagher - CSFB

Eric Berg - Barclays Capital

Suneet Kamath - Sanford Bernstein

John Nadel - Sterne, Agee & Leach

Jimmy Bhullar - J.P. Morgan

Colin Devine - Citigroup

Mark Finkelstein - Fox-Pitt Kelton

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the MetLife third quarter earnings release. 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 Incorporated's filings with the U.S. Securities and Exchange Commission.

MetLife Incorporated specifically disclaims any obligation to update or revise any forward-looking statements, whether as a result of new information, future developments, or otherwise.

With that, I'd like to turn the call over to Conor Murphy, Head of Investor Relations. Please go ahead.

Conor Murphy

Thank you, Greg. Good morning, everyone. Welcome to MetLife's third quarter 2009 earnings call. We are delighted to be here this morning to talk about our results for the quarter. We will be discussing certain financial measures not based on generally accepted accounting principles, or so-called non-GAAP measures. We have reconciled these non-GAAP measures to the most directly comparable GAAP measures in our earnings press release and in our quarterly financial supplement, both of which are available on our website at MetLife.com.

Our 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 the net investment-related 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 Rob Henrikson, our Chairman and Chief Executive Officer; Steve Kandarian, our Chief Investment Officer and Bill Wheeler, our Chief Financial Officer. After our brief prepared comments, we will take your questions and here with us today to participate in the discussion are Bill Mullaney, President of our U.S. Businesses; and Bill Toppeta, President of International; as well as other members of management.

With that, I would like to turn the call over to Rob.

Rob Henrikson

Thank you, Conor and good morning, everyone. During the third quarter, MetLife continue to perform well as our diverse mix of complementary businesses and our solid fundamentals yielded a strong result. We generated premiums, fees, and other revenues of $8.5 billion, consistent with both last quarter and the prior year period. Operating earnings this quarter were $718 million, an increase of 18% over the third quarter of 2008. And book value also improved, rising 27% over the second quarter of 2009 and 10% over the third quarter of 2008.

The results we have achieved are noteworthy, especially given the challenging economic environment. They also reflect our unwavering focus on growing our business while also maintaining our pricing discipline.

Let me highlight a few examples from each of our businesses.

Institutional generated solid top line results as premiums, fees, and other revenues were $4.2 billion for the quarter. Excluding the impact of lower pension close-out sales compared to this period last year, the top line grew by 3%. Group Life grew by 2.3% versus prior year, and non-medical health was up 3.2%, due mostly to our continued organic growth in the dental market.

Disability premiums are down year over year but this reflects our continued strict pricing discipline in both new business and renewals. In addition, we continued to capture market share in structured settlements as sales increased significantly this quarter.

From an underwriting perspective, group life mortality was right in line with our expectations. Our disability morbidity ratio rose above the target range for the first time this year. While it is too early to tell whether or not this is a trend, we are watching it closely.

Dental results, which continued to be impacted by higher utilization, did improve sequentially so we may be seeing signs of a peak here.

In individual business, the top line grew 4.8% over the prior year. Much like last quarter, we increased sales of our whole and term life products. In our annuity business, total deposits remained strong at $4 billion, with variable annuities at $3.4 billion and fixed annuities at $600 million.

Annuity net flows remained positive for the sixth consecutive quarter. We are very pleased with both the amount and the quality of the annuity business we wrote in the quarter.

In international, premiums, fees, and other revenues increased 9% year over year on a constant currency basis, as we had solid growth across all three of our international regions. Latin America’s top line grew 6%, driven by increased sales in Mexico and Brazil. In Asia, our top line grew 11% due to higher sales in Korea and Hong Kong. In Japan, total annuity deposits were $1.3 billion, with fixed annuity deposits up 27% and variable annuity deposits down 39%, reflecting current conditions in this market.

Finally, our European region, which includes our business in India, had top line growth of 12%.

Our auto and home business also had another solid quarter, delivering earnings of $86 million and producing a strong combined ratio of 91.1%.

Turning to investments, Steve will provide you with a detailed update in a moment. Let me just highlight -- in addition to experiencing higher net investment income, the value of our portfolio recovered considerably this quarter as net unrealized losses dropped to $1.6 billion. This amount now represents less than half of 1% of our general account assets and is actually lower than net unrealized losses as of June 30, 2008 before the deepening of the crisis.

The results we have achieved this quarter are due to a number of attributes that define MetLife, not the least of which is our financial strength. As you know, we have maintained a very strong capital position throughout this period of uncertainty. We kept our common stock dividend at $0.74 per share in 2008 and this year our board has declared another annual dividend, again of $0.74 per share.

In addition to revenue growth and capital strength, maintaining a focus on efficiencies and expense discipline has been a priority for us. With our operational excellence initiative, we are not only improving the efficiency of our organization but we are also on pace to exceed our goal of $400 million in annualized savings. And of course, our newly formed U.S. business organization is progressing very well, as we finalize its strategic and operational plans. We will share more strategy updates with you at investor day on December the 7th.

At this time last year, I told you that we were entering a period during which MetLife would set itself apart due to its stability and strength. I believe the performance we have delivered since then has demonstrated that our focus on long-term success is what has made MetLife the kind of company that customers and shareholders want to be associated with. No doubt there are challenges that remain but looking forward, it is our discipline in growth, pricing, expenses, and allocation of capital that will allow us to remain financially strong further sets us apart in the marketplace, and grow this company profitably. I am confident that MetLife will continue to build its leading market positions as we remain focused on long-term success.

And with that, I will turn it over to Steve.

Steve Kandarian

Thanks, Rob. I would like to spend a few minutes reviewing the key components of our investment results for the quarter.

First let me start with a comment on variable investment income. Pretax variable investment income for the third quarter was $105 million, which is below plan by $45 million, primarily driven by negative real estate fund returns. Real estate fund returns were negative, given the continued decline in property values. In total, we believe the overall property values have declined 30% to date and could decline another 10%.

Income from our corporate joint ventures, hedge funds, and securities lending program outperformed plan. However, we expect that variable income will remain below plan in the fourth quarter, primarily due to continued softness in real estate funds.

Now let me cover investment losses for the quarter. Gross investment losses were $491 million, down from the previous quarter. Write-downs this quarter were $661 million, also lower than the second quarter. These write-downs were experienced across a variety of sectors, including $146 million in corporate securities, $139 million from the strengthening of the mortgage valuation allowance, $77 million in structured finance securities, and $46 million in a real estate partnership.

Write-downs also included $215 million of hybrid securities and $38 million of partnership and equity securities, which were impaired because the length of time in the extent to which the market value has been below amortized cost.

Overall net investment losses for Q3 excluding derivatives declined to $854 million from $1.1 billion for Q2. We expect this favorable trend to continue going forward.

Losses from derivatives that do not qualify for hedge accounting were $1.3 billion. This is primarily attributable to a $895 million pretax loss driven by an improvement in MetLife's own credit spread and its impact on the valuation of certain insurance liabilities.

MetLife's average credit spread decreased 315 basis points over the quarter. This reverses derivative gains in previous quarters that occurred when our credit spread widened. The remaining loss was caused by several factors that negatively impacted the valuation of our derivatives, including the weakening of the U.S. dollar against certain currencies, which reduced the value of our foreign currency swaps used to hedge foreign denominated assets, and the decline in general credit spreads which decreased the value of credit default protection we purchased for our corporate bond portfolio.

Gross unrealized losses of fixed maturities were $11.4 billion at September 30th, down substantially from $19.5 billion at June 30th, and spreads declined across all sectors. Total net unrealized losses showed an even more remarkable decline to $1.6 billion from $14.6 billion at June 30th.

Next I’d like to discuss the ratings migration within the fixed maturities portfolio. As of September 30th, below investment grade fixed maturity holdings increased $3.1 billion based upon estimated fair value, of which $1.5 billion was due to market value improvements and $1.6 billion from ratings downgrades. The downgrade’s primarily attributable to our non-agency residential mortgage backed portfolio, which we’ve discussed with you previously. However, we expect that for purposes of risk-based capital, the proposed plan endorsed by a committee of the NAIC will result in capital charges that are more aligned with the risk of loss than the current methodology.

We anticipate that our portfolio, which has a high percentage of super senior and senior tranches and fixed rate collateral, will perform better than the overall market.

I’d like to briefly touch upon our commercial mortgage holdings, where delinquencies and losses remain minimal. We had no defaults in our U.S. portfolio during the third quarter and current delinquencies are only $3 million, or 1 basis point on the overall portfolio. The current portfolio loan to value is approximately 67%, based on a rolling four quarter valuation process. In addition, our current commercial mortgage valuation allowance is $542 million.

I look forward to speaking with you at the 2009 investor day, where I will provide additional detail on our portfolio and expectations for 2010. With that, I will turn the call over to Bill Wheeler.

Bill Wheeler

Thanks, Steve and good morning, everybody. MetLife reported $0.87 of operating earnings per share for the third quarter. This morning I will walk through our financial results and point out some highlights, as well as some unusual items which occurred during the quarter. Let’s begin with premiums, fees, and other revenues.

Institutional revenues declined 7.7% as compared to the third quarter of 2008, due to lower close-out sales in the current period. As I have said many times, close-out sales can vary significantly by quarter. Sometimes we say that’s lumpy. Excluding the impact of pension closeout sales, institutional revenues were up 3% versus the prior year.

Individuals revenues were up 4.8% in the quarter, due mainly to a 15.2% increase in annuity revenues. This result was driven by increased sales of income annuities, strong variable annuity sales and net flows, as well as a 15% increase in the S&P 500.

International had reported revenues of $1.1 billion in the third quarter compared to $1.2 billion in the year-ago period. A stronger dollar relative to currencies such as the Mexican Peso and the Korean Won depressed international’s reported revenues in the quarter by $152 million when compared to the third quarter of last year. If you look at it on a constant dollar basis, revenue growth was 8.9% compared to the third quarter of 2008.

Another important contributor to our revenue growth was MetLife Bank, which is part of our corporate and other reporting segment. The bank’s revenues have increased $232 million over the year-ago period, due to the acquisitions of both the forward mortgage and reverse mortgage operation in 2008. Also, forward and reverse mortgage origination volumes have increased substantially this year.

It is our intention to break out financial data concerning the bank in the fourth quarter QFS and we will also be discussing the bank’s results at our investor day in December.

Overall we had premiums, fees, and other revenues of $8.5 billion, which is a 1.2% decline compared to $8.6 billion in the third quarter of last year. If one excludes pension close-out revenues and adjusts for the currency fluctuations, our revenue actually grew 6.6% year over year, which we think is an excellent result in this environment.

Turning to our operating margins, let’s start with our underwriting results. In institutional, group life mortality of 92.2%, which was well within our guidance range of 91 to 95. In non-medic health and other, group disabilities morbidity ratio was 96.4% for the quarter. Disability claims incidents has picked up in the third quarter after several quarters of stable experience, although there was a similar up-tick in the year-ago period.

Recoveries, which have been lower than anticipated all year, remained below expectations. Dental claim utilization remained high and our 2010 renewal pricing has been adjusted to reflect higher levels of claims activity in that product area.

Individuals’ mortality ratio was high this quarter at 91.2%, due mainly to several large base amount claims. However, re-insurance coverage offset the high direct mortality ratio and the net underwriting results were relatively normal.

Turning to auto and home, the combined ratio, including catastrophes, remains strong at 91.1% versus last year’s combined ratio of 89%. Catastrophe experience was much lower this year due to the absence of significant hurricane activity. Also, included in this combined ratio result is a non-cap prior accident year reserve release of $7 million after tax, compared to a $27 million after-tax release in the same period of 2008.

Moving to investment spreads, investment spreads generally improved this quarter as some funds were shifted from cash and government securities to higher yielding investments. In addition, variable investment income increased sequentially, although it was still down versus the year-ago period.

With regard to variable investment income, as Steve has explained, we again saw mixed performance of certain variable alternative asset classes this quarter, negative returns on real estate were offset by strong results in securities lending, hedge funds, and corporate joint ventures.

For the quarter, variable investment income after tax and the impact of deferred acquisition costs was $32 million, or $0.04 per share lower than the 2009 quarterly plan.

Our earnings in the annuity portion of individual business were negatively impacted by a significant drop in interest rates this quarter and I want to take a minute to explain why. The accounting pronouncement, SOP03-1, requires us to reserve for expected future GMIB claims by estimating the future annuitization rate on account balances and the comparing it to our guaranteed annuitization rate on the customer benefit base for all contracts.

In general, when interest rates fall as they did in the third quarter, the reserve model calculates higher expected GMIB claims in the future, which increases our GMIB reserves. This phenomenon mainly impacts our older GMI block and we have re-insurance on this business which partially offset the interest rate movements. However, the reserve impact this quarter more than offset the positive impacts from equity market increases. The net result was a decrease of $46 million after tax, or $0.06 per share.

Moving to expenses, our overall reported expenses were higher this quarter versus the year-ago period but that was driven by much higher expenses at MetLife Bank and higher pension and post retirement benefit costs, partially offset by continued progress in our operational excellence initiative. As Rob mentioned, we are confident we will exceed our $400 million goal and intend to announce a new target at the December investor day.

Also, we incurred $47 million pretax in operational excellence charges this quarter, which consisted mainly of severance payments and real estate related expenses.

Turning to our bottom line results, we earned $718 million in operating income, or $0.87 per share. With regard to net investment gains and losses in the third quarter, we had net realized investment losses of $1.4 billion after tax, which of course seems like a big number but you have to keep in mind our derivative losses were $857 million after taxes and as Steve mentioned, the largest portion of that result was a $582 million after-tax loss caused by the tightening of MetLife's own credit spreads.

Most of the remaining derivative losses were due to changes in currency rates and a decline in CVS spreads generally, which were substantially offset in our strong AOCI improvement this quarter.

Now I’d like to take a moment to talk about cash and capital. Let me start by telling you that our cash and liquid assets at the holding company stood at $5 billion as of September 30. As you know, MetLife's board of directors has declared an annual common stock dividend of $0.74 per share, which amounts to a little over $600 million. We will pay that dividend from the holding company in the fourth quarter. Turning to capital, our preliminary statutory operating earnings for the third quarter of 2009 are approximately $1.3 billion after tax and our preliminary statutory net income is approximately $900 million after tax. That’s positive net income. You will note that these figures are significantly higher than our GAAP results. Many of the statutory reserve adjustments which we made six or nine months ago in a more difficult environment are now being reversed. So statutory earnings strength and its effect on capital is quite good.

Steve spoke a bit about ratings migrations in our investment portfolio and the potential impact that a change in methodology being proposed at the NAIC may have. While we are optimistic that there will be an adjustment on the risk-based capital charges, it is too soon to say how much that will be. Therefore, we may need to move some capital down to MLIC, our main life insurance company, to cover increased capital requirements. Because of all the moving pieces here, I’d hesitate to give you a dollar figure but I am confident that it is an amount the holding company will be able to comfortably afford.

In summary, the fundamentals of our business continue to be strong and we are continuing to succeed in this challenging market environment. And with that, let me turn it over to the operator so that we might take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Tom Gallagher with CSFB.

Tom Gallagher - CSFB

First, just Bill, a follow-up on the interest rate related charge in the annuities. Would you describe this as something that is more accounting noise related to specifically the way the GMIB is accounted for? Or is this something that you think suggests you need to alter something on the hedge back in that product? That’s my first question.

Bill Wheeler

I think I got that -- you’re breaking up a little bit. Hopefully we can fix that with the -- I think that’s a problem on our end. Is it accounting noise? It’s a little bit of both. I mean, think what happened this quarter -- we have pretty low interest rates in general to begin with and then we had a 50 basis point decline in what we would call new money [SPIA] rates, which are sort of an income annuitization rates, and the -- in the quarter, so you start from a low base and then you have a big move downward, which is pretty unusual. But there’s been a lot of unusual events over the last year. So that’s really what triggered it but I think what it highlighted was that sort of some of the assumptions we are using regarding annuitization rates may need to be adjusted in the future. Because these income annuities or these GMIBs, the first ones don’t even become available for an annuitization for a number of years yet and so we are a long ways away from having this -- having what I would say a real impact on our business. So probably some sort of smoothing makes sense here. And we will obviously be examining that over the coming weeks.

In terms of hedging now, this is really an issue more for the old GMIB block as opposed to sort of the new product, and so -- the old GMIB block, you know, we use sort of a combination of delta hedging of the equity exposure and then some re-insurance cover to handle things like GMBB and other issues. So there is some interest rate protection here. I don’t think we feel the fix here is to change our hedging strategy on this whole block. This has not been historically a very material -- had a very material effect on our financial statements. You know, we’ve had this hedging strategy in place, we’ve had this accounting in place, and it’s not triggered a very material move historically. So we’ve had some weird, fairly extreme interest rate move from a low base combined with -- you know, which sort of highlights maybe a change we might need to make for some of the assumptions.

Tom Gallagher - CSFB

Got it, okay, that’s helpful. And the other question I had is just since we’ve had a pretty extreme tightening in the credit markets, I guess you’ve got two issues going on there -- one is I guess it becomes more difficult to put out new money but that is sort of the negative but the positive is I assume the potential financing markets for any possible transactions in terms of M&A suddenly looks more attractive. Can you address both of those issues in particular? Do you think this environment makes things more likely or interesting from an M&A standpoint?

Steve Kandarian

I think you were talking about putting money out, and spreads are in dramatically from where they were in the fourth quarter of last year and the first quarter of this year but still above sort of normal spread levels in a growth economy. The issue in terms of yields is really interest rates are so low, so that’s what is really driving of course this unrealized loss number down dramatically, is tightening spreads and very low interest rates. So that does make it challenging in terms of getting yield but on the other hand, the spreads coming in show you that the markets are far less dislocated than they were a couple of quarters ago, so that’s obviously good news.

Bill Wheeler

And with regard to is it a great time to do financing for deals, you know, unfortunately even -- our spreads have come in a lot, so it’s better than it was certainly but I wouldn’t call it -- I’m not sure I would call it ideal yet. I still think we -- I think still if you look at some of the spreads on our fixed income securities, I still think they are inappropriately wide but what do I know.

I think the equity -- the thing you have to keep in mind here, of course, is if this is a transaction of any size, it’s not only going to have a debt component, it will have a fixed income component or a hybrid component; it will have an equity component and valuations are not really stellar here. So in terms of -- so it all kind of depends on prices of potential targets and what sellers realistic expectations are, because we are still in a relatively low valuation marketplace for insurance stocks, or financial services generally.

So yeah, it’s a little better than it was, that’s for sure, but I wouldn’t call it ideal.

Tom Gallagher - CSFB

Thanks.

Operator

Next we will go to the line of Eric Berg with Barclays Capital.

Eric Berg - Barclays Capital

Two questions -- first in the variable annuity business, I’d love to get, Bill, your perspective to build on that of the IR team’s -- with companies pretty much everywhere raising prices and reducing the strength of guarantees and my sense is that has happened not only in the withdrawal market but also in the income market, in short with the deal seemingly -- well, not seemingly just in fact not nearly as good as it had been for the [inaudible], what is happening with demand for variable annuities and where do you think demand is headed? And then I have one follow-up question.

Bill Mullaney

I’ll respond to your question on variable annuities. You know, if we look at the market quarter over quarter, it appears that even though it is early, sales will probably be flat industry wide. They might be down a little bit quarter over quarter and so -- and we think it’s probably a good level of demand to think about from a marketplace perspective going forward. So we had a good quarter in terms of our level of sales. They came down a little bit over where we were in the year-ago period but we are writing business at good margins and I think the marketplace is coming back to the kind of products that I think not only provide good returns for the insurance companies but also provide good guarantees for consumers. So we think the marketplace is settling out in the right spot.

Eric Berg - Barclays Capital

Okay, then my question is along the same lines in the life insurance area, I noticed that you had a big pick-up in sales of which you caption as traditional, which includes not only of course whole life but also term. As others, your universal life sales were down. It feels like for many, many months now the American public has been buying fewer policies, more term policies, smaller base amount policies -- that’s how it seems to me, that’s how it feels to me. What’s your sense and more importantly, where are we headed in terms of the future of sales in this industry over the next two years? What will be the complexion of the sales? Thank you.

Bill Mullaney

I think on life insurance, your assessment on what is happening in the market is right. There has been more of a shift away from universal life and variable life into more traditional products like whole life and term and face amounts have been down.

You know, it will be interesting to see what happens going forward as the economy begins to pick back up. We may see a pick-up in life insurance sales. I am not sure you will see the same level of growth in the universal life markets as you have seen in the past, the number of companies, including us, have made changes to that product and I think that for the people who are buying life insurance today, they are looking for protection at a lower price and I think term insurance provides that. And I think in addition to that, we are starting to see a greater level of interest in whole life insurance, which I think is just a way from -- a move away from equity based products and I think that you are going to see that continue to be the mix for the foreseeable future.

Eric Berg - Barclays Capital

Thank you.

Operator

Next we will go to the line of Suneet Kamath with Sanford Bernstein.

Suneet Kamath - Sanford Bernstein

Again, on the variable annuity business, I think Rob, in your opening remarks, you said that you were happy with the quality of the business that you are writing. Can you perhaps dimension how you are pricing this product from a return perspective and what sort of market environment you are assuming? Is that sort of our standard 2% equity market depreciation for the quarter or what would happen on the returns of this business if we kind of went through something similar to what we went through over the past 12 months, and then I’ll have another question.

Bill Mullaney

In terms of the pricing on the current VAs, we have got the changes that we made in our product that we -- we made a couple of changes earlier this year in February and in May and so for our GMIB product, which comprised the vast majority of our sales in the third quarter at the 5% rollup rate, the returns are good. You know, the returns are in excess of our hurdle rate of 15% ROI, so we feel pretty good about the level of business that we are writing. The assumptions that we have used in this product are very similar to the assumptions that we have used in the past as it relates to equity market growth and so we were pleased with the level of sales that we had in the third quarter in our VA business, given the fact that we are using the product with the 5% roll-up rate and the fact that a couple of the companies that we compete against were out there with pretty hot products in the third quarter. Now, some of them are making some changes to their products to reduce some of the levels of their guarantees but we felt that we got a very good market share -- our market share, we don’t have the exact numbers but it will probably come in north of 10, probably in the 11% to 12% range and we think that that’s a pretty good market share, given the level of returns we were getting on the product and the market environment.

Suneet Kamath - Sanford Bernstein

That’s helpful -- I guess I want to come back, if I could, to that 15% hurdle rate that you talked about because clearly if we assume 2% market appreciation, that would -- I think most people would feel that that’s a pretty good environment versus what we have seen, so if you -- I am assuming when you price the product and re-price it, you stress tested it for a down market, kind of what we have been through or something like that. I’m just wondering if you are doing 15% plus in a kind of decent market, what’s the downside risk to that return based on the new product? Thanks.

Stanley Talbi

The 15% [inaudible] return. We are still talking about [inaudible] a return on capital. The equity market returns assumed is kind of like a more normalized level and that is what he was saying was kind of consistent with last year. You know, it’s above 5 but it’s under 8.

Suneet Kamath - Sanford Bernstein

I got that, Stan. I guess -- I understood that he was talking about the return on capital. I guess my follow-up question was how bad could that return on capital get if we go through this market environment that we just saw.

Stanley Talbi

Obviously [it would go lower]. You know, it could go into the high-single-digits. I would say that the market turning down and then back up again doesn’t mean that we’ve locked in a lower return. It really depends on the longer term rates. So for example, the business that was sold in 2006, 2007 where the market ran up and then came back down again, it’s back up again. So the returns are looking much better on that business today.

Suneet Kamath - Sanford Bernstein

Okay, and then my second question I guess is on the comments about the RBC and the potential change to the residential mortgage backed security calculation of capital. I guess my question is how much -- how material of an event is this? I know you are not going to quantify it but just based on what I have been reading from the rating agencies, it seems like a lot of them are going to sort of look through this anyway and so from their perspective or from a capital redeployment perspective, if they are not going to give you credit for it, I’m not so sure that it changes things. I’m just wondering if that is the correct interpretation or am I missing something? Thanks.

Bill Mullaney

I think if you look -- Moody’s put out a release on this and what they said was this doesn’t change our view about the economic fundamentals of those securities. And I would sort of -- which I would totally agree with. I mean, it’s not -- you know, the question really is is are those good securities, are they going to be money good or are we going to see defaults or impairments, and that is of course the real fundamental question and I think that was what they first wanted to get their point across.

If you read the Moody’s release down further, it did also say that we view this is going to provide capital flexibility to certain companies because they are not going to have this RBC charge, so if you had, for instance, any kind of test related to RBC, it’s going to be -- you know, it will be a good thing for you. So I found that to be a fairly benign public statement by Moody’s.

You know, to just take a step back from this a minute, the rating agencies have -- they have taken a bunch of securities which were rate triple A and they have now kind of in a blanket sort of way, kind of a back-up-the-truck kind of way rate them single B, okay? Now that’s not very impressive and I think -- and I think frankly, I would suspect if you asked the people who cover the insurance industry in the rating agencies as opposed to the structured credit people, they weren’t probably terribly impressed by that either. So that’s I don’t think an indication of economic reality about the basis of those securities and I think that was Steve Kandarian’s point. So this triggers effectively this phenomenon of going from triple A to single B, which triggers a capital tax, okay? And the regulators have recognized, jumped on this immediately with I don’t think a lot of prodding, even before they got any kind of commentary from the industry and said this just doesn’t make sense. And you know what, we should maybe do something which reflects reality a little better.

So I think the rating agencies are going to understand this and I don’t really -- the idea is not whether they get credit or not because I totally agree with the idea that look, the economic risk of these securities has not changed, no matter what somebody says they are rated, but it is causing kind of an arbitrary, somewhat false capital issue and that’s really the issue and I think they kind of get that. So I’m actually kind of hopeful that they will treat this the way it should be done.

Suneet Kamath - Sanford Bernstein

Thank you.

Operator

Next we will go to the line of John Nadel from Sterne, Agee & Leach.

John Nadel - Sterne, Agee & Leach

Good morning, everybody. I have a couple of real quick ones -- first, just to clarify, the impairments and credit losses this quarter, even those that you took on the hybrid side, both are running through statutory and GAAP similarly?

Steve Kandarian

Yes.

John Nadel - Sterne, Agee & Leach

Second one, Rob, I was interested -- you sort of -- I think you sort of changed your inflection when you talked about the quality of the variable annuity sales during the quarter and I wanted to come back to that. Obviously a lot of competition in the variable annuity space especially has come in and out and in and out of the market here over the past couple of quarters. You guys have been obviously stable players. Can you maybe expound on your comment there? I mean, I know you are not going to necessarily take shots at a particular company but can you give us a sense at what is going on in the marketplace and why you sort of -- why you highlighted the quality of the sales that you are making?

Rob Henrikson

Well, sure, John and yes, you are right -- I don’t like to take shots at people and I really don’t need to, other than focus on what the fundamental business is all about. You know, you probably -- lord knows I’ve been public enough about my feelings about business in general, even the market share horse race measured by sales and who’s hot this quarter and so forth and so on. You know, the sales at one end of the spectrum but you know, we’ve had a flight to quality, quite frankly. That has helped us with market share. That connected with disciplined underwriting with our very strong retention track record and our positive net cash flows tells me that on top of a strong financial base, and I might say all this business being written on a platform that has much better operating leverage because of what we are doing on the expense side, tells me that I feel very, very good about the health of our business. I have said over and over again, I love the variable annuity business. I am not in love with it, and I think people that come in and out, you know, they are in love and they are out of love and they got other things they have to worry about. We see it sometimes on aggressiveness in other product lines when somebody has a little bit of an adjustment on their variable annuity business, all of a sudden we see them popping up in institutional, writing literally unsustained business -- unsustainable business.

So we are here for the long run. We are looking at the health of our business. We are focused on our customers and we are focusing on our policy, on our shareholders and I feel good about that.

So quality, you know, quality is a word that sometimes gets discounted as kind of like oh, that’s mom and apple pie but if you peel back the onion and look at the quality, you have to look at all of these issues -- the growth in the assets, the positive flows, the retention possibilities, how you are pricing for it, what your reserving is, and so forth. And with all of that, I feel great. So other than that -- and the Yankees won last night.

John Nadel - Sterne, Agee & Leach

I feel great about that too. One last quick one, if I could, Bill, the tax rate appeared to be unsustainably low this quarter. I’m not sure if I’m reading that right. It’s a little bit more difficult when you are looking at it on a segment by segment basis but maybe you could go through that?

Bill Wheeler

No, we don’t think that effective tax rate is normal. It requires a little bit of explanation. You know, we just filed -- I forget, which tax return was it? I think -- we just filed -- yeah, it was last year’s tax return and when we did that, we had a true-up of our DRD credit, and you know, DRD is something we take every quarter and adjust for in our tax provision every quarter. But sometimes we have to true it up occasionally. So it’s -- I would say real earnings obviously that we would take credit for but it’s a little lumpy this quarter and so when you think about sort of the effective tax rate going forward, yeah, I don’t think 18.5% is the right number. But that’s because of the lumpy DRD credit we took.

John Nadel - Sterne, Agee & Leach

Yeah, and understanding that a lot of things move around on a quarterly basis, what’s a better -- is the long-term, longer term rate better look at the last couple of years to get a sense for that? I mean, the business mix hasn’t really shifted that meaningfully and maybe international is a little bit bigger now.

Bill Wheeler

Yeah, I wouldn’t say -- the problem with -- of course, if you go back to 2007, we earned a lot of money in 2007 and so on every incremental dollar of profits, the tax rate is higher, it’s 35%. So as your earnings -- as our earnings levels get restored here, we will unfortunately enjoy a higher effective tax rate but I don’t know if it will go quite all the way back to where it was in 2007 until we get to that level of earnings again.

John Nadel - Sterne, Agee & Leach

Thank you very much.

Operator

Next we will go to the line of Jimmy Bhullar from J.P. Morgan.

Jimmy Bhullar - J.P. Morgan

I had a question first on ratings migration and capital -- as we look at your below investment grade bonds, those have actually obviously gone up a lot and specifically within that, your triple Cs are up about $2 billion, or triple Cs up about $4.5 billion actually, single B is up about $2 billion. And on that basis alone, if you are using a 350% RBC as sort of a target, the capital charge would be significantly over $5 billion, so obviously there are other offsetting factors, either it’s stat income or something else. But I was wondering if you could address -- you mentioned you can't precisely give us the amount but if you could address the amount of capital that you need to put into the subs with or without NAIC relief, and if you can't quantify it, just give us the range -- is it $1 billion to $2 billion, is it $3 billion or $4 billion? Is it higher than that? Just so people have an idea on how you will go about using the money that is sitting at the holding company. And then I have a follow-up after this.

Rob Henrikson

I’m not sure I quite agree with your 5 bill, but I don’t want to downplay it. It’s material. Ratings migration is a material issue for us.

Jimmy Bhullar - J.P. Morgan

That I’m basing just on the B and triple Cs going up by about $6.5 billion, if you apply the charge and assume a 350% RBC, if you sort of separate that out, it does give you a decent sized amount.

Rob Henrikson

Fair enough, but it’s a big issue. My number is -- our numbers are south of that but they are not that much south in terms of the overall impact.

Obviously we start with a -- you know, remember, Jimmy, last year we had total RBC balance of 391 in sort of our consolidated RBC ratio across all of our insurance companies, so we started the year at a pretty substantial cushion relative to 350 and you know, even though we’ve had some realized losses this year, we have also had obviously pretty good stat earnings and certainly the second and third quarters were quite good. So I think there are other factors going on in terms of the RBC balances.

So to go back to your more specific question about well, come on, tell me how much it is that you might have to put down in cash, so let’s just go through the math. We talked about $5 billion of cash at the holding company. Now we are going to pay a $600 million common stock dividend, so the -- so certainly the RBC -- or certainly the cash at the holding company now is 4.4, call it. There’s some other ins and outs in the fourth quarter. They are not all that material. The holding company cash -- you know, I said this a month ago publicly and I wouldn’t mind saying it again. I don’t see how we are going to -- I don’t think we would put up half the cash even in kind of what I would say a fairly worst case scenario going down in the insurance subs, half the cash at the holding company. So you could say okay, half -- now that’s 2.2, okay? I actually -- my expected number is it’s going to be quite a bit less than that. But I hate to get more precise than that because we don’t know how effective this relief will be and -- or how extensive it will be and so we will have to -- so we will see it from there.

So when I go back to my statement I made in my prepared remarks, which is we think that our -- we are comfortable with the holding company is going to be able to deal with this issue and make sure that the insurance subs keep their RBC ratios above 350.

Jimmy Bhullar - J.P. Morgan

Okay, and then secondly I just had a question on your ROE -- obviously the returns are very high, even variable investment income was peaking. But if you could talk about what you believe your long-term ROE is based on your business mix and also what type of capital do you hold longer term versus what you held in the past? And then secondly, what do you believe it will be, or the range it will be in over the next couple of years? Because it would seem like 2011, the return might be depressed even worse as your lower long-term potential.

Rob Henrikson

Let me start with the short-term and then we will think about the long-term. I think we’ve said previously that when we look out at 2010, even though we haven’t -- we are just now finishing our 2010 plan, financial plan, we have sort of -- my estimate is that we will end up at something like a -- you know, I said in shouting distance of 10% and I think that still sounds right.

But partially the reason it’s that number is we don’t think we are going to have any spring back recovery in things like variable investment income. You know, we are not assuming that’s going to bail us out next year. First, it’s hard to predict and second is that’s not -- we don’t really see those alternatives recovering that quickly.

Our current earnings plan or the 2009 earnings plan of 600 variable investment income included $600 million of variable investment income. Implied in that $600 million number is basically a 1% return on all our alternative asset classes. So that’s pretty weak, okay? You know, we did try to call the bottom here. We just didn’t quite get right about how severe it was. We’re not assuming I think that that’s going to recover very much in 2010, really if at all, and versus that assumption. And I think -- so that’s probably going to continue to hold down the ROE.

The other thing of course is, and we’ve talked about this a lot, is we are -- you know, we’ve been holding lots of liquidity in terms of cash and if you look at our treasury and agency holdings, they are also very healthy. And we have gradually been moving back into a fully invested state but I think that’s gradual and I don’t think that is going to necessarily reverse itself for a while yet until we really get what I would call fully invested. So that’s going to take a while but more to do.

So that’s probably going to hold down ROE in the near-term. I don’t think there is any -- but if you think about what sort of -- what has really changed fundamentally about our business, I would say not much. We are still --

Jimmy Bhullar - J.P. Morgan

Although the capital you will hold going forward will probably be significantly higher than what you have held.

Rob Henrikson

Well, you know, you say that -- I’m not sure why you think it. And I -- I’ll start practicing my speech with you guys. I think that if you look at the capital levels in the life insurance industry, never mind us, but the capital levels in the life insurance industry through what is the biggest financial crisis anybody can remember in living memory here that we have gone over the last 12 months, I think the insurance industry has held up incredibly well in terms of solvency ratios and tests and then certainly we have. And I think I would say that in general, I don’t necessarily think -- by the way, I don’t know if I would say that about the banking industry. I think banking capital levels may change a lot. I’m not so sure I would go look at what the experience of the last year and say oh well, obviously the insurance industry needs more capital.

I think there will be a healthy discussion about this between regulators, rating agencies, and the industry. But I personally think when you kind of parse through it and you look at underlying capital levels and performance, I think we hold the right amount of capital given the risks we take and that is sort of what our economic capital and value of risk models tell us.

So will we have to hold a lot more capital going forward? That’s not my expectation, but we will see. But certainly -- so I’m not going to try to predict that in terms of how the effect that might have on ROE because I think it’s a very uncertain thing.

In terms of long-term ROE goals, I don’t think they have really changed for us. We hit a 15% ROE in 2007. Obviously that was a very strong variable investment income performance. We’ve been I think more aggressively managing expenses. That’s obviously going to also help margins and help returns a little bit over the coming years.

Will the industry buy back stock like it used to? Probably not. But will they maybe increase dividends more in the next three or four years? Maybe they will. So I think there are other ways to kind of think about how you manage capital levels going forward.

So I guess that’s kind of a long-winded rant way of saying I’m not sure much has really changed in terms of what we will have to hold for capital, what our -- you know, the amount of profitability we can enjoy going forward. It’s going to take us a while to get back to what I would say full speed ahead operating at 70 miles an hour again in terms of earnings power. You know, we are a good 12 months away from that, I think but --

Jimmy Bhullar - J.P. Morgan

The one thing I would add to that is obviously I think companies would want to have a little bit more of a cushion so that the industry went through this okay but a bunch of companies ended up raising equity on a significantly dilutive basis. A couple of them needed government help, so it might -- don’t you think management teams would hold a little bit more capital so that in a bad scenario, that they don’t have to go out to the market again? Or at least pull back on buying back stock as aggressively, as you saw in ’06, ’07?

Rob Henrikson

Certainly I think on the margin, those things are going to be true. Will those -- will that really fundamentally alter ROE expectations in the industry a lot -- you know, really move it? I’m not sure. It might on the margin affect it a little bit but I don’t -- and how long will those sort of sentiments last about how much capital cushion people should hold over and above what they would normally think is appropriate, I -- you know, that’s hard to say.

Jimmy Bhullar - J.P. Morgan

Okay, thank you.

Operator

Next we will go to the line of Colin Devine from Citigroup.

Colin Devine - Citigroup

Just a couple of quick questions -- Bill, you touched on the cash and I certainly was surprised to see the cash balance rise this quarter when I thought you had been saying you were going to be spending it down and have you just changed where you are going to keep that?

Secondly, on some of these possible NAIC RBC charges, it certainly strikes me that your bond department is pretty sharp and I think you knew the risk of what you were buying so I would be surprised if you need that to help favorably boost your RBC, certainly model those things as well as anybody. But there is something else that I think they are looking at as well and that’s a possible bright line for impairments on structure credit products. I was wondering if you could comment on that and what possible impact that may have on you because it would seem to me that could also go the other way.

And then lastly, Rob, you made the comment on the somewhat irrational variable annuity competitors but it is certainly our view that Met probably offers one of the most aggressive products in the market today with the dollar for dollar withdrawal feature on the GMIB, so -- and that’s really what’s been a key part of driving your strong sales. So how much have you really de-risked the products? I know they are down from 12 months ago, taking a 6% step-up down to 5% but aren’t they still considerably riskier than they were two or three years ago?

Bill Wheeler

I’ll start with cash levels. We are -- you know, for everybody’s benefit to level set here, we had $22 billion of cash and short-term. That was actually up $1 billion in the quarter versus the June 30 number. That’s a little deceiving. It just so happened right around year-end there was some sort of cash coming in the door that hadn’t quite -- or quarter end, I mean, that had been coming in the door that hadn’t got quite reinvested. It got reinvested within a week or so of the -- in what I think are pretty good spread assets. And that was roughly worth about $2 billion, so instead of cash being up a bill, it really when you kind of take into effect the sort of quarter end move, it was really down a bill.

Now, we hold about -- so call it sort of adjusted $20 billion cash and short-term balance, we have $3 billion that are backing -- that are collateral that are backing derivative positions, so that is obviously not what I would call true cash, so sort of real cash balance is more like $17 billion.

You know, we think normalized cash levels really here are really probably closer to 13 bill, so something like that. So we still have quite a bit of excess cash cushion and our expectation is we will get that reinvested. Now I don’t think it is going to happen necessarily in the fourth quarter. There’s some reasons why where some of the cash is tied up right now in certain portfolios and it’s not worth getting into why, but our expectation is that will get reinvested and we are not going to stay at sort of a net 17 cash billion forever.

Colin Devine - Citigroup

Where do you think it will bottom out?

Bill Wheeler

Well, again I think -- I’m not talking about next quarter now but if you kind of look at history and maybe how the business has evolved a little bit over the past year or two, I think 13 bill is a good -- is a decent kind of bottom out target.

Colin Devine - Citigroup

Okay.

Rob Henrikson

Let me just start off by saying in terms of the irrational, I was trying to remember what I said in terms of irrational pricing. I said I thought I thought some people were doing things on an unsustainable basis. That comment was directly related to what we were seeing in the institutional side of the business, as you may recall when I said you know, we are seeing people that are in both lines of business that are being somewhat conservative and put all of a sudden on the other side, grasping for market share via sales. And in terms of the variable annuity business, my point there is that people fall in and out of love with a product. We’ve been here, we are going to be here tomorrow and the book of business is quite sustainable and also quite healthy. You know, as I look at everything other than just market share horse race from quarter to quarter, measured by sales only. In terms of the more specific question, I’ll pass it to Bill Mullaney.

Bill Mullaney

Just to follow-up on the point you made about the product changes, yeah we did change the roll-up rate from 6 to 5 but we’ve done some other things around asset allocation and making the investments more restrictive, so that we keep -- people have to keep a fairly high percentage of their money in fixed. We’ve also increased pricing on some of the riders.

You know, we understand the dollar for dollar issue. We’ve looked at that very closely. We modeled that out in -- and I’m make a couple of points. You know, first of all, we’ve got a pretty large stable block of GMIB business and what really influences dollar for dollar, as you know, is policy holder behavior and we have watched policy holder behavior very closely over the last several years and even during the economic crisis, policy holder behavior really hasn’t changed and it would have to change fairly dramatically in terms of people opting in for the dollar for dollar feature for it to have any real material impact. And when we do hedge this product and when we do charge the fees for the riders, you know, we model policy holder behavior to a certain extent into our strategy, so we feel as though we understand that risk fairly well and the structure of our product will give us the right level of protection.

Colin Devine - Citigroup

Okay, and then there are questions for Steve Kandarian or Bill on the NAIC proposal for impairing structured credits.

Steve Kandarian

I am not quite sure what you are referring to. I know obviously --

Colin Devine - Citigroup

They are looking at a bright line impairment once the structure breaks that you’ve got to write it down to market value.

Steve Kandarian

I have not seen that so I really --

Colin Devine - Citigroup

Okay.

Bill Wheeler

You know, just to follow-up on that, under GAAP obviously the rules regarding GAAP impairments of structure products have really been refined to kind of deal with this issue, that if you break the buck, if you will, even on a structured product, you don’t necessarily have to write it down to what people think the market is. You have to write it down to where you think the loss is, or and obviously adjustments for interest rate losses versus real capital losses, so there is a lot of -- so our attitude is, of course, is that the -- you know, GAAP has really led the way here and of course in our minds, GAAP when we take an impairment for GAAP, we take it for stat as well, so the GAAP guidance has really been refined and I think reflects kind of good common sense now. So it -- my expectation is that will -- stat will stay consistent with that.

Colin Devine - Citigroup

There’s no plan to sort of run at a two-tier impairment methodology, one for stat, one for GAAP? It’s all the same [inaudible]?

Bill Wheeler

That’s correct.

Colin Devine - Citigroup

Thank you.

Operator

Your final question today comes from the line of Mark Finkelstein from Fox-Pitt Kelton.

Mark Finkelstein - Fox-Pitt Kelton

I guess just one clarification -- Bill, I know you didn’t want to go too far down this route but the way I interpreted your comment was if the NAIC relief did happen, that you might not need to put capital from the holding company down? Did I characterize that correctly?

Bill Wheeler

I mean, that’s possible. It depends on the extent of the relief, obviously so -- and it may not be a very material amount. I mean, it’s -- certainly at year-end, there’s always some moving pieces and we obviously have to do our -- you know, a lot of these RBC calculations are pretty complicated [inaudible] modeling and we have to do cash flow testing in our reserves and so there’s a lot involved. It’s just sort of right we don’t publish in RBC every quarter is because it’s really it’s quite an involved calculation. But -- and so there are a lot of moving pieces but I -- we’ve tried to estimate what the relief might be and there’s a range and if you are at the top of the range, I think you can squint your eyes and say we may not need to put anything down. But I don’t think that’s my middle-of-the-road expectation.

Mark Finkelstein - Fox-Pitt Kelton

Okay, fair enough. I guess the question I would ask is -- I mean, I think that there’s a fair assumption that something does get passed but if it doesn’t, would you go down the [re-remic] route, and if not, why not?

Bill Wheeler

I’m looking at [Ken Baron], see if he will answer that question. I guess it’s on me. We certainly get pitched on a lot of people who would like to help us [re-remic] a bunch of stuff. There’s problems with it. One, it’s too expensive to do. Two, it’s -- we’re not sure that the accounting really hangs, okay, in terms of [re-remicing] certain securities. I mean, investment bankers love to tell you no, no, don’t worry about that. Of course, that’s the whole point is we do have to worry about it so there -- so I think we are not sure re-remicing is really a solution which works for us, though people do disagree about this, about the accounting impact. So I am not sure the re-remicing is the answer.

Mark Finkelstein - Fox-Pitt Kelton

Okay, and then just a final question -- oh, was there another comment?

Steve Kandarian

Also remember in these [re-remics], there is a loss oftentimes taken up front, so there is some offset there in terms of the benefit.

Mark Finkelstein - Fox-Pitt Kelton

Right. Final question, just the reserve adjustments that you mentioned, Bill, were those purely equity market related or were there other adjustments that were made that are kind of more permanent in nature and maybe not specific to equity markets, or even interest rates? And I guess what I’m getting at is if we have kind of another turn down, do we give back what we gained in stat income this quarter?

Bill Wheeler

Yes, if we have another 40% decline in the stock market, we’ll have to set up those reserves again, so they -- I mean, you know, a small downturn has no material impact. We are talking about -- remember what was going on with the S&P in December and at March, where it dropped as low as what, 660, so yeah, I mean, -- yes, the answer is when you have that kind of extreme move, the stat reserve adjustments will have to be adjusted again.

Mark Finkelstein - Fox-Pitt Kelton

Okay, so no revisions to kind of underlying assumptions that are above and beyond macro assumptions?

Bill Wheeler

No.

Mark Finkelstein - Fox-Pitt Kelton

Okay, that’s all I have. Thanks.

Conor Murphy

Okay, everyone. Thank you.

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Source: MetLife Q3 2009 Earnings Call Transcript
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