Welcome to the MetLife first quarter earnings release. (Operator Instructions) 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 would like to turn the call over to Conor Murphy, Head of Investor Relations.
Thank you and good morning, everyone. Welcome to MetLife's first quarter 2010 earnings call. We are delighted to be here this morning to talk with you about our results for the quarter. We will be discussing certain financial measures and updates on generally accepted accounting principles, 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 at Metlife.com.
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 the net investment related gains and losses which can fluctuate from period to period and may have significant impact on GAAP net income.
Joining me this morning 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. Here with us today to participate in the discussion are other members of management including Bill Mullaney, President of the U.S. business and Bill Toppeta, President of International and Bill Moore, President of Auto and Home.
With that I would like to turn the call over to Rob.
Thank you Conor and good morning everyone. We are off to an excellent start in 2010 delivering strong results across the board. During the first quarter MetLife generated $8.8 billion in premiums in fees and other revenues. That is up 12% over the prior-year period. We grew operating earnings to $834 million. That is up significantly from a year ago and it is up nearly 5% sequentially.
Book values per share improved noticeably in the quarter as well. Book value including AOCI is up 9% sequentially and book value excluding AOCI is up over 2%. The growth we are seeing on the bottom line demonstrates the discipline we have maintained in our underwriting, pricing, risk management and expense controls. We are also benefiting from the more favorable equity markets as they continue to recover. And, as you know, MetLife emerged from the economic crisis financially strong which positions us very well for the solid first quarter performance you will hear about today.
Before we do that let me take a moment to comment on our recent agreement to acquire Alico. As I have said before we expect the acquisition of this highly complementary business will be rewarding to our shareholders and will accelerate our growth strategy. While we can’t comment on Alico’s first quarter financial results, let me highlight some integration progress to date.
There are 30 regional and functional teams comprised of both MetLife and Alico associates dedicated to the integration. We have deployed a rigorous management plan to ensure a seamless transition. In the first few weeks after the announcement our team visited each of Alico’s major locations and met with many employees and approximately 200 senior leaders. We also are designing the optimal enterprise operating model which will fuel the growth of our combined businesses.
Having said that, let me be clear that although the integration is a high priority we will not be distracted from achieving our 2010 plan and we know the same is true at Alico. We will continue to focus on the fundamentals of our business in order to drive growth and shareholder value.
Now turning to some highlights from our businesses. In U.S. business premiums, fees and other revenues increased to $7.4 billion, up 11% over the prior year. This strong result reflects top line growth in corporate benefit funding which more than doubled, retirement products which also increased dramatically and insurance products. Operating earnings were strong across all of U.S. business and at $757 million it represents a substantial increase from the $178 million one year ago.
In our insurance products segment growth in premiums, fees and other revenues was driven primarily by a 6% increase in group life premiums over the first quarter of 2009. Non-medical health revenues were flat. Dental revenues increased but were partially offset by a decline in disability. Individual life premiums, fees and other revenues were also flat over the prior year. However, sales grew 15% driven by increases in whole, term and universal life products. Operating earnings nearly doubled over the prior year period with 92% growth from higher investment income, solid group life underwriting and lower expenses.
In retirement products, better equity market performance and thus higher fee income contributed to strong top line growth of 27%. Fixed annuity sales of almost $360 million are lower than last year’s record levels due to high demand for MetLife’s fixed annuities at the onset of the financial crisis. Variable annuity sales of over $4 billion are up 9% sequentially and 8% over the prior year. Net flows remain strong. Lapse rates continue to decline and the success of our new Fidelity product is contributing to our increased market share. Operating earnings and retirement products were strong at $159 million.
In corporate benefit funding, premiums, fees and other revenues increased 112% over the first quarter of 2009 driven by higher pension closeout activity primarily in the U.K. Structured settlement premiums also continued to drive the excellent top line in corporate benefit funding. Earnings for this segment were up significantly from the prior year.
Finally, within U.S. business auto and home results were solid. Top line growth was consistent with expectations and earnings were steady at $72 million. The combined ratio excluding catastrophes was very good at 88.8. MetLife Bank delivered another good quarter. The bank generated revenues of $299 million, down from the unusually high levels in the prior period and consistent with overall market activity. Operating earnings remained healthy at $53 million.
Turning to our international business we achieved another very strong quarter with growth across all three regions. On a reported basis, premiums, fees and other revenues grew 27% over the prior year and operating earnings grew 15%. In Latin America growth in Mexico, Chile and Brazil contributed to top line growth of 28%. The Asia Pacific region grew 24% due to higher sales primarily in Hong Kong. In our Europe, Middle East and India region the top line increased by 30% driven by continued growth in India and strong sales in Europe.
We continue to experience excellent top and bottom line growth internationally which is part of the reason why I am so excited about Alico. We can build upon this and leverage the complementary strengths of both companies to accelerate our growth even further.
Steve will talk to you about our investments in a moment. I would like to say though I am very pleased with the overall performance of the portfolio which has returned to a net unrealized gain position. We also had a small net realized gain for the quarter which included impairments of $97 million after tax. So our run rate of credit losses is significantly below our projection of $1 billion for 2010.
Finally, this month MetLife celebrated its 10th anniversary as a publicly traded company. In those 10 years we have become stronger and have significantly accelerated our growth, demonstrated by our consistent delivery of shareholder value. With all that has been accomplished and with what is on the horizon I feel very optimistic about the future. While there are undoubtedly challenges ahead, I believe we have the strategy, leadership and momentum to position MetLife as one of the leading insurance companies in the world.
With that I will turn it over to Steve Kandarian.
Thanks Rob. I would like to spend a few minutes reviewing the key components of our investment results for the quarter. Overall we continue to see improvement in the markets, rising variable income and lower losses.
First, let me start with a comment on variable investment income. Pre-tax variable investment income for the first quarter was $314 million which is $114 million above the top of the plan range that I gave at investor day. This was primarily driven by strong private equity and hedge fund returns. While we expect returns to be below this level during the remainder of the year we believe variable income should remain strong.
Now let me cover investment losses for the quarter. Gross investment losses continued to decline and were $211 million while gross realized gains were $400 million. Write downs also declined and were $149 million. Excluding derivatives we had a net realized investment gain of $40 million this quarter. Gross unrealized losses on fixed maturity and equity securities were $8.5 billion at March 31st, down from $10.8 billion at December 31 as spread declined across most sectors. Overall the portfolio was in a net unrealized gain position of $1.5 billion at quarter end.
Next I would like to briefly touch upon our commercial mortgage holdings. During the first quarter delinquent loans increased from $8 million to $162 million. This increase resulted from three loans, one of which is expected to be paid off during the second quarter with a loss of no more than $2 million. The second has been restructured and the third is a high quality property we plan to transfer to our real estate equity portfolio. As such, we expect limited losses as recoveries on these loans are projected to be significantly above the historical average of 75%.
As I noted on the last call, we anticipated the delinquencies might increase in 2010 but would be manageable particularly given our commercial mortgage valuation allowance of $624 million. We believe that commercial real estate valuations have bottomed out with an average peak-to-trough decline of about 40%. The loan-to-value ratio of our portfolio increased slightly in the first quarter to 69% based on a rolling four-quarter valuation process or we estimate to the low to mid 70% range if all properties were revalued today.
Importantly only 2% of our portfolio have a loan-to-value greater than 80% and a debt service to coverage ratio of less than one times. Furthermore, we have seen pick up in office leasing activities compared to last year and hotel occupancies are also starting to improve. In summary, we remain confident our commercial mortgage portfolio will outperform the overall market and that loss levels will likely remain low.
Finally, given the recent headlines I would like to make a brief comment on MetLife’s exposure to Europe’s perimeter regions. As I mentioned in March when we announced our pending Alico transaction, MetLife’s general account has less than $40 million of total sovereign debt exposure to Italy, Ireland, Spain and Greece combined and we have no exposure to Portugal. These are countries in which we do very little business.
Alico holds approximately $1.3 billion in Greek sovereign debt and their Greek bank holdings are diminimous. Remember, when the transaction closes these assets will transfer at market value to our GAAP financials. On a statutory basis Alico must be delivered with a 400% RBC ratio. While we are closely monitoring the impact of any country’s specific situation, we continue to believe that Alico’s portfolio is of relatively high quality with manageable loss expectations.
With that I will turn the call over to Bill Wheeler.
Thanks Steve. Good morning everyone. MetLife reported $1.01 of operating earnings per share for the first quarter. As Rob mentioned this strong bottom line result represents solid business growth, higher investment income, improved equity markets and the results of our expense management efforts. 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. Total premiums, fees and other revenues which were $8.8 billion in the first quarter are up 12% from the first quarter of last year and 10% on a constant currency basis. U.S. business premiums, fees and other revenues of $7.4 billion reflect an 11% increase over the prior year. This includes a 27% increase in retirement products revenue due to increases in fees from positive net flows and higher separate account investment returns.
Also revenue growth in corporate benefit funding is up over 100% from the prior-year quarter driven by strong structured settlements and U.K. closeout sales. As we have noted before, closeout sales do fluctuate and cannot be expected to occur at the same level each quarter. Internationally revenues are up 27% on a reported basis and 10% on a constant currency basis over the prior-year quarter driven by growth in all three regions.
Turning to our operating margin let’s start with our underwriting results. In U.S. business our mortality results were mixed this quarter. The group life mortality ratio for the quarter was 89.5% versus our estimated range of 90-95% which is an excellent result. Our individual life mortality ratio for the quarter was 87.6% which is slightly below our plan. At 91.2% for the quarter the non-medical health total benefits ratio is up from 87.4% in the prior-year quarter. While we continue to see signs of stabilization in dental utilization we did experience higher claims activity. Disability margins are also weaker due to higher incidents and lower claim recoveries.
Turning to our auto and home business the combined ratio including catastrophes was 94.1% for the first quarter which is up over the prior year’s quarter results of 92.4% due to higher catastrophes and less prior year reserve releases. The combined ratio excluding catastrophes was 88.8% in the first quarter versus 88.1% in the prior year period. A non-catastrophe prior-accident year reserve release of $5 million after tax was taken in this quarter compared to a $17 million after-tax release in the prior-year period.
Moving to investment spreads. We saw an improvement in investment spreads this quarter with the improvement in the market and variable investment income results. For the quarter, variable investment income after tax and the impact of deferred acquisition costs was $71 million or $0.09 per share above the top of the 2010 quarterly guidance range given at investor day. As Steve explained this was primarily driven by strong private equity and hedge fund returns.
Moving to expenses our operational excellence initiative continues to prove successful. Additionally, pension costs have stabilized and are no longer causing a significant impact year-over-year. Our expense ratio for the quarter was 21.7%, a solid result and below the 2010 guidance of 21.8-22.5% given at investor day. This quarter we did incur a $20 million after-tax or $0.02 per share in operational excellence charges and certain other one-time items.
Turning to our bottom line results we earned $834 million in operating earnings or $1.01 per share. Included in our first quarter results is a one-time tax charge of $75 million or $0.09 per share related to the tax law change for Medicare Part D subsidy embedded in the recently enacted Healthcare reform legislation as well as a $13 million or $0.02 impact due to the expiration of certain business tax incentives for controlled foreign corporations.
With regard to investment gains and losses, in the first quarter we had after-tax net realized investment gains of $2 million which includes derivative losses of $19 million after-tax. MetLife uses derivatives to hedge a number of risks. Changes in the value of these derivatives are in general offset on an economic basis across various assets and liabilities. Impairments were $97 million after-tax in the first quarter which is a 50% decline from the fourth quarter of 2009.
Our preliminary statutory operating earnings for the first quarter of 2010 are approximately $580 million and our preliminary statutory net income is $660 million. Finally, cash and liquid assets at the holding company at quarter end were $3.8 billion.
In summary, MetLife had a very good first quarter. Our revenue growth is strong. Our investment performance has improved and our earnings continue to grow.
With that I will turn it back to the operator for your questions.
Question and Answer Session
(Operator Instructions) The first question comes from the line of Suneet Kamath - Sanford Bernstein.
Suneet Kamath - Sanford Bernstein
On the Alico deal, with respect to the 400% minimum RBC at close guarantee, are there any stipulations in the contract in terms of how Alico gets to 400%? In other words if something happened that forces them below does that [take] a capital infusion by AIG or can they do something else such as slow growth or take offsetting realized gains? Any color on that would be helpful.
There isn’t a stipulation about how they solve the 400. If you know how RBC is calculated and how complex a calculation it is it is not the thing you can kind of manage two quarters ahead of time by slowing growth. My expectation is that if…by the way and I think I have said this in a number of forums, absent investment losses this year my expectation is that Alico’s RBC will be well above 400. So they are going to have some cushion. If there are investment losses between now and when we close, by the way our expectation is we are six months away from closing. If they have investment losses they have some cushion to probably solve that problem. My guess is capital infusion will not be necessary.
Suneet Kamath - Sanford Bernstein
I guess their ownership stake in Met is a pretty good incentive not to do anything too tricky there. The second question is on derivatives legislation. I know it is early days here but I am assuming you are in touch with the folks in Washington about what might happen there. Can you at a high level give us some thoughts in terms of what we should be looking for and what we might expect the impact on Met to be?
In terms of being in touch let me start out there. We both as a company and as an industry leader we are very in touch continuously with people on the hill and people in the agencies and so forth. I will be a little more philosophical about this than you might want but it would be hard to be more specific. Everybody recognizes, and I mean everyone, that closing regulatory gaps to avoid future crisis is an objective.
If we had all started out with a blank sheet of paper and said let’s identify the challenges and the objectives and from that we will glean language and that language will be efficient, elegant and clear relative to reform one would have envisioned a race horse; something very elegant. In fact, we knew that was not possible a long time ago. So you have realistically given the charged political climate and so forth people have been working on constructing a camel now for some time. If you know anything about camels you can construct one and it may look a little funny and it may not look particularly elegant but it gets you there.
So we in the industry are working to make sure the Camel gets us where we want to go and it doesn’t spit, bite and kick. So that is sort of the philosophical answer and it is a good one relative to where discussions are. Quite frankly, most everyone in the debate recognizes the business of insurance needs to be protected from unintended consequences on bank regulations and we are pretty optimistic the debate is proceeding pretty nicely actually despite the turmoil we see in the press. We don’t think it is going to have too much adverse effect on the insurance industry. So that is a prognostication. Tune in.
Suneet Kamath - Sanford Bernstein
While the racehorse/camel analogy will probably live on for awhile, Warren Buffet I guess is trying to get some rules changed or some sort of exception around how much capital or collateral you would have to post. Is that something that will impact you in terms of how you manage the business? Any thoughts there would be helpful.
I think it may impact others much more than it would us. Remember in terms of derivative use and what not being regulated we have a derivatives use plan that has to be approved by the regulator. We are collateralized in that activity. So the idea of a carve out for the insurance companies is probably not going to happen but to carve out around specific insurance activities and how you measure that both on the liability and the asset side most likely will be the result.
Rather than start out totally clean with some exceptions we will start out with the other end of the spectrum and then back out the business of insurance that needs to be protected. So that is kind of the flavor of what is going on at present.
The next question comes from the line of Jimmy Bhullar – JP Morgan.
Jimmy Bhullar – JP Morgan
On your spreads, obviously very strong across the board this quarter. I think part of the reason is [inaudible] income but you have been deploying excess liquidity as well. Maybe you can give us numbers on where your liquidity position stood at the end of the quarter and whether you intended to reduce that this quarter as well. Secondly, on disability losses or non-medical loss ratio, your disability losses seem like they are picking up, not a lot, but they are picking up as the economy has gotten worse. That is a little different than what the results have been for some of the other disability companies which have shown relatively stable margins. If you could give some detail on whether it is incident rates picking up or the recoveries not being that great? Finally, a numbers question since there were questions on Alico before, what was the RBC of Alico when the deal was announced so we can get an idea of how much they can absorb in terms of losses before having to put in more capital?
I will take the one on us reinvesting some cash which we have done over the last couple of quarters. Our cash is down over $5 billion since the third quarter. Those funds have been invested in a broad array of normal assets and asset sectors we typically invest in. It has been kind of across the board in various different sectors. We have seen spreads tighten in a little bit more recently. We have taken advantage earlier on in terms of some higher spread assets we thought had very good risk/reward tradeoffs. That obviously that has helped our yields here and our spreads.
On disability I think what is happening in disability is really a result of macroeconomic trends. We have been seeing the disability loss ratio pick up really for a good part of 2009. It is actually down a little bit over where it was in the fourth quarter. It is driven by a few things. The primary thing that is driving the loss ratio is recoveries and getting people back to work. Our level of recoveries is significantly below where we would expect it to be and that is having a big impact on the loss ratio.
Incidents is up a little bit but it is not a lot. We had anticipated we were going to see this as the economy started to soften. We have been raising prices on the disability business. That is one of the reasons why non-medical health revenue was a little bit depressed because disability sales have been below what we would have expected if we hadn’t been taking the price increases. It is something we have been watching for awhile. We continue to manage it aggressively and we think the numbers will start to improve as the unemployment rate begins to come down.
Jimmy Bhullar – JP Morgan
Have dental claims been picking up as well or have they stabilized?
We saw a pretty big spike in dental claims starting in the first quarter of 2009 which went through pretty much the rest of 2009. 2010 is better than the increase we saw in 2009 but it is still a little bit elevated over where we would have expected it to be. Again we were pretty aggressive on pricing actions in dental. We re-price most of those contracts either every year or every other year. So we took some pricing actions in 2010. That is bringing the dental loss ratio down. The way I would characterize dental is I would say the claim activity there is stabilizing and we expect over time it is going to improve.
Finally on Alico’s RBC ratio. You know Alico doesn’t actually, you probably know this, but Alico doesn’t actually publish an RBC ratio. That is kind of a unique statutory filing. So it is not a number in the public domain.
Jimmy Bhullar – JP Morgan
That’s why I was asking.
Think a number of approximately 400 RBC ratio.
Jimmy Bhullar – JP Morgan
So the pluses and minuses obviously the earnings accrue to that and that goes up and then you have investment losses and whatever other changes right?
The next question comes from the line of Nigel Dally – Morgan Stanley.
Nigel Dally – Morgan Stanley
A question on the expense ratio this quarter. It came in very robust near the low end of your guidance range provided at investor day. How sustainable is that likely to be and what level of incremental expense save do you still have from the operational excellence initiatives yet to come?
The 21.7 is slightly below the target range in our plan. I think our target range was 21.8-22.3% and so we are trending a little bit better than plan. I will also tell you the 21.7 if anything, what drove the number. Revenues were better than forecast so that obviously helps the number look better but we also had some one-time negative expenses which were obviously not planned for. I don’t know if those quite cancel each other out but they are probably close. I actually think it is quite sustainable though it is a little bit below plan but it is certainly within the reasonable range.
How much more room do we have? As you know we put out an original operational expense reduction target of $400 million. We upped it to $600 million last December and we said we would be sort of at a $600 million run rate by the end of this year. We are clearly on track to do that. We feel very comfortable about that number. So that is probably all I can say today.
Nigel Dally – Morgan Stanley
There has been various [inaudible] out there by the regulators with regards to required capital gains commission mortgage [lends]. Have you done any calculations as to how that has impacted you with [respect to capital]?
That jumbled a little bit. Were you talking about the proposed increases to the capital for commercial mortgages? Is that right?
Nigel Dally – Morgan Stanley
That’s right and what impact that would have on your RBC ratio.
There has been some speculation the NAIC, well certainly there are some discussions among NAIC members…by the way that is different than being an initiative of the NAIC. Everybody needs to appreciate that. They may raise the capital requirements for commercial mortgages. I think the current number is 2.6% and the idea was it would go to 4% but depending on how your portfolio was performing it could be anywhere from 3-5%.
Interestingly, since I think our performance of the commercial mortgage portfolio will be at the positive end, it is possible depending on how wide that band ultimately is between 3-5% and how low it dips, the honest truth is even if this passed it might have a very, very modest effect on our RBC ratio. I think if you took the midpoint of the range and said 4% it is I think Moody’s put out a piece which estimated the impact on us would be like 25 RBC points. I actually think we are obviously very close to what goes on in the NAIC and I think we have to wait and see how that initiative lands but I think we feel pretty good that is probably not going to be the final result of the capital requirements for commercial mortgages.
The next question comes from the line of Tom Gallagher – Credit Suisse.
Tom Gallagher – Credit Suisse
I know one of the rating agencies has been talking about, and I think has you on negative watch, and is suggesting they would like to see more capital pro forma the Alico deal. Can you give us an update on where you stand in terms of overall capital adequacy relative to balancing out the rating situation? Second, I notice you had a $160 million increase in net investment income for fixed maturity securities and the actual annualized yield went up by 14 basis points. That compares to 4Q into 1Q. Just curious what is driving that? What kind of new money yields you are seeing for bonds? Is it possible that you can keep that steady or are you investing for where you are and might we see a drag there?
With regard to the capital situation as opposed to sort of aiming this at a rating agency let me just sort of give you a synopsis of where we are. We ended up 2009 with a 432% consolidated RBC ratio. That is the highest RBC ratio this company has ever had frankly by quite a ways. On top of that we had $3.8 billion of cash. So fast forward a quarter and while we had very good statutory earnings on a stat basis a realized investment gain and the cash position at the holding company hasn’t changed.
So in many ways I think our capital position is frankly as strong as it has ever been. I don’t think the risk profile of the company has changed on whit frankly. Certainly we feel like we are properly capitalized and we have a very nice capital cushion currently. Now, the rating agencies obviously are concerned about the industry and about asset problems and certain categories especially the real estate business and commercial mortgages. I think we have spent a lot of air time discussing the high quality of our commercial mortgage portfolio, about how differentiated it really is. That is not just us talking. Remember the federal government stress test a year ago right about this time. The 19 large financial institutions of this country we were the only insurance company in that group. Our results of their stress test in our commercial mortgage portfolio is we had the highest performing portfolio. It wasn’t really close.
We feel we are in very good shape. But I think we are at a point in time I think in the economic cycle where we have gone through a crisis. We have gone through the fire. A lot of people are very nervous. I think as the months tick by and our results are good and the market environment is getting better I think people will feel better. I don’t know the answer is we should be stockpiling more capital but we will continue to monitor it and we will obviously continue to have discussions with the rating agencies to make sure we would like to persuade them of our position.
So that is my general feeling on capital. With regard to financing for Alico, I think we have said this before. We do need to raise some external capital. We said when we announced this transaction we expected to raise $2 billion of common and that we expected to do that publicly or privately and if we did it publicly we would be in a position to do it sometime this summer. None of that has changed. The only thing that has changed is I think when we made that announcement the stock was at $38 and I think it closed yesterday at $45 and change.
So obviously we don’t have to sell quite as many shares. We probably wouldn’t have to sell quite as many shares as we originally had modeled. So that is sort of where we stand.
I would say two factors are driving the increase. One is the reinvestment of about $1.3 billion of cash in the quarter. The second thing is we have some inflation linked assets in Latin America and due to some accounting quirks, if you will, that resulted in some more positive net investment income that shows up in that line item. There is an offset though on the liability side so you might see that elsewhere in the financial statements. So bottom line is you wouldn’t necessarily expect that number to trend up given current yields and spreads in the marketplace.
Tom Gallagher – Credit Suisse
What kind of yields are you seeing in terms of new money as it relates to just fixed income portfolio?
It is around 5% right now for fixed income. Obviously that varies based upon whether you are buying floating rate assets and matching up against floating rate liabilities or buying longer assets and matching up against our longer liabilities.
The next question comes from the line of Colin Devine – Citigroup.
Colin Devine - Citigroup
On pension quotas obviously some [chunk] sales this quarter but as you noted they were coming out of the U.K. I am starting to hear there is maybe a couple of large deals being worked on in the U.S. and I’m not sure if Rob you want to comment on that but maybe we will get something out of you on it. Even as Bill mentioned with your own pension its funding situation is stabilized. Are we starting to see the domestic pension closeout market warm up? Secondly, with respect to the legislative development I guess there is also some chatter out of Washington that we may see some favorable tax treatment change on annuities specifically encouraging people to annuitize. If you could perhaps comment on that? Then with respect to the comments you made earlier with the NAIC change to the commercial mortgage charge is that really all that important? I would assume it is really the rating agencies the charge on commercial mortgages that is ruling the day here. Perhaps you could compare the figures you put up for where the NAIC charge or capital charge may go on mortgages for what you are holding now under the various rating agency models?
Let me start by talking about closeouts. We did have a very strong quarter in pension closeouts particularly in the U.K. The U.K. market has changed quite a bit over the last couple of years. A number of the competitors that were very aggressive in terms of pricing closeouts back in 2007 and 2008 have pulled back out of the market. There is still quite a bit of closeout activity and as a result we are writing a fair amount of business and we are writing it at good returns.
In terms of what is happening in the U.S. I think your observations are right. The market is starting to open up a little bit. I think as the equity markets have recovered and funding status of the pension plans has improved there are more deals to be done. I would say some of the deals that are currently close to being resolved are on the smaller end in terms of size. Having said that there are some bigger deals and there are conversations that have been taking place over a number of months with some larger plan sponsors about potential closeout activity there. So we will see how that ultimately develops.
Relative to tax changes a broad answer is obviously there is a thirst for revenue from the federal government. Everyone is working very hard relative to making sure that tax increases at least are consistent with what the overall focus is. For example, driven by both the Department of Labor and the Treasury Department at the moment there is quite a bit of focus on the need for securing more retirement income. That is work being done by DOL and the Treasury, not driven by the life industry. So one might presume it would be counter to exactly what the focus is to turn around and focus on taxes out of annuities.
Who knows. That is across almost any kind of business activity in the United States. Everybody is hunkering down and making sure there are not unintended consequences about revenue gathering. I wish I could be more specific but obviously again both we are a company and we as a leader in the industry are very involved in these dialogues.
With regard to your question about commercial mortgages and the capital we hold I guess your point was it is really not so much about what the RBC impact is. It is really about what the rating agencies think we should be holding for capital against those asset classes and how that may or may not change. Is that kind of the gist of it?
Colin Devine - Citigroup
I think that is fair.
Moody’s just put out a piece recently and they were pretty explicit. They said the proposed NAIC change is probably consistent with our base case in terms of losses we expect over the next three years for the industry. But they said the fact that this doesn’t really change our view because obviously we already had a view about investment losses. They did say that in a stress scenario the losses could be significantly larger. I think that is kind of the point. S&P I don’t think they have put out the same sort of piece. I think it is messaging the same thing. They feel in a stress scenario the losses in the commercial sector could be significantly larger and therefore people need to hold even more capital to be able to stress scenario.
This is sort of about an economic capital, third sigma event or fourth sigma event or whatever you want to call it. A tail event. It is interesting. We obviously build our own economic capital models and I think have done a lot of really good work. One thing we have sort of learned is tail events are very, very hard and the world has also learned over the last few years that tail events are very hard to predict. How much capital or what the losses are likely to be in a tail event are difficult. It is really more art than science. This is maybe if you want to think about it is sort of the dispute we are sort of having with the rating agencies right now.
It is sort of what capital is really appropriate for a tail event. I don’t know if there is any obvious answer to that. I guess I sort of think a couple of things. One, I don’t think there is any doubt the quality of our commercial portfolio is at one end of the spectrum both in this industry and just in general to that asset class. It is high quality. The way that portfolio was built over many years was not an effort to chase yield. It was an effort to diversify against corporate credit risk. I think anybody who has looked at those properties or understands the mortgage portfolio would readily agree with us it is very high quality and the statistics we get kind of back that up.
So what may happen to the industry I don’t think is necessarily indicative of what may happen to us. Then I think it becomes a kind of a theoretical debate about what capital levels should be to deal with a stress test environment. That is sort of an interesting risk policy kind of decision. I think we are in a very good spot in terms of how we look at it. That is sort of why we are holding the capital we are today. I know I am giving kind of a long winded rant here but you are right it isn’t just necessarily about what is the immediate RBC impact. It really has more to do with what theoretically should be the ultimate level of capital held against that asset class.
Colin Devine - Citigroup
On the pension closeouts in the U.S. there may be some big ones. You have always talked about that as being analogous potentially to an M&A deal. Do you have enough capital available right now post Alico that you can really be a player if we start to see closeouts in the U.S.?
Certainly. Just think about it, first of all it depends on the size. How big are we really talking here?
Colin Devine - Citigroup
I am hearing big.
I think there are certainly pension plans that are out there that are big enough that probably it might require additional capital. So I couldn’t say in all cases we would have enough but certainly we have enough for any reasonable level of activity. Remember this becomes a capital allocation decision. Even though we are not back to full earnings power we are going to generate good earnings this year and we are going to generate excess capital this year. Then the question becomes where does that get redeployed. If business is good enough and we are seeing a lot of well priced pension closeout business that is where it is going to get redeployed to because that is a great growth initiative. Just like any growth initiative. If there is no big growth initiative it will get redeployed in another manner. That is the kind of decision we make every day.
I would make the observation that our discussion over the last few minutes in the absolute jumbo market clearly that both the buyer and the seller understand the dynamics of everything we have just discussed. That is just a comment I would make and there again I would make the analogy to the M&A business.
The next question comes from the line of John Hall – Wells Fargo.
John Hall – Wells Fargo
When you mentioned the exposure to Greece you didn’t really mention any of the other perimeter countries. I was wondering if you could give us an idea of where we stand there. Then secondly, you talked about the 400% RBC floor. Does Alico really need a 400% RBC really to operate? I guess the question is if you get it at 400 RBC are you going to be getting a company that is effectively over-capitalized given the mix of business it has?
I will start. We have to be a little careful in terms of what we put out because these are Alico numbers and I will simply point you to the stat filing Schedule D for them. If you look at the other perimeter countries in total if you look at the schedule D you will see that their sovereign exposure to Ireland, Italy, Portugal and Spain equal in aggregate about what they have to Greece in rough numbers. That will give you some direction in terms of their holdings.
With regard to Alico’s 400% RBC, here is a good way to answer that. For MetLife overall we have said we have a bright line we need to be above 350. I think that means 350 plus a cushion and I think the debate is therefore about the size of the cushion. By the way Moody’s I think still says 350 is what is necessary to be a AA company in normal times at least. I wouldn’t think there is anything about Alico which would make me change that policy.
I start with the idea of what is good for MetLife is certainly good for Alico and so 350 plus is going to make sense. 400 I would not expect we would need to actually manage Alico to an RBC of 400 but it is 350 plus a cushion which might get you close to 400. Clearly the capital requirements in most of these foreign operations are not as tough as they are in the U.S. or what would really be required in the U.S. So if anything the bias is the other direction.
The next question comes from the line of John Nadel - Sterne, Agee & Leach.
John Nadel - Sterne, Agee & Leach
With respect to Alico I think when you announced the deal one of the things you highlighted was the improved perception I guess of Alico with met behind it especially within the bank distribution channel in Japan. I know it has been a relatively short period of time but I was hoping you could give us an update on whether you are seeing any real evidence of that in the sales or surrender activity in the bank channel in Japan from Alico?
I really don’t want to front-run any announcements that AIG is going to make including Alico performance. I think I would prefer to defer on that question until after they have made their announcement.
John Nadel - Sterne, Agee & Leach
Can you answer yes or no?
What I am saying is I think it is most appropriate that we defer.
John Nadel - Sterne, Agee & Leach
That’s fair I guess. On the group insurance side, your results this quarter I think stand in stark contrast to a couple of your larger competitors in terms of loss ratios. I know you have talked about over the past couple of years some increased competition and maybe not just on price but on terms as well. So I am wondering with some of the elevated loss activity we are seeing at some of the guys who maybe were taking market share over the past couple of years whether you are seeing that come back to you in terms of new sales opportunities? If you could comment on what January 1 sales activity looked like in the group business?
I can give you some perspective on first quarter sales. First quarter sales were relatively strong compared to our expectation. As I mentioned in response to an earlier question we took some pretty aggressive pricing actions in both disability and dental. As a result of that we expected sales to be down in the first quarter of 2010 relative to 2009. That actually occurred. You see that I think reflected in the top line of the non-medical health segment but pretty much in line with what we expected.
From a life insurance perspective pricing has continued to be very aggressive in group life segment particularly at the upper end of the market. We saw that very evidently in the first quarter of this year. We have, as we have talked about all along, been very disciplined about our pricing. Really over the last couple of years. That has had some impact on our sales results so our sales results in group life although in line with our expectations for 01/01 we are down relative to 2009. I think the real testament to the way we run our business is in the mortality ratio. We had one of the strongest mortality ratios we have had in group life in the first quarter which is typically not a great quarter for us.
We really feel like the strategy we have deployed over the last few years in terms of running that business is the right one and we think that is showing up in our results for this quarter particularly as it relates to the mortality ratio.
The next question comes from the line of Eric Berg – Barclays Capital.
Eric Berg – Barclays Capital
It just seems like we are in this blissful state right now in which your yields are going up but you are somehow able to pay less to your customers in their crediting base. My question is why is that possible? One would think that an environment of improving yields that would be passed on to your customers and that yields and crediting rates would be moving in the same direction rather than an opposite direction. Maybe Steve or another member of the team could help me understand how those two numbers are moving away from each other rather than in parallel?
You are absolutely right. Given the macro environment both crediting rates and yields should be going in the same direction. Then you manage to kind of a steady spread. But of course what is happening here is the macro environment didn’t change much in the first quarter and interest rates are still very low so as liabilities get re-priced or crediting rates get adjusted slowly for the whole book because sometimes crediting rates don’t change for as much as a year, that means that in a low environment you are still going to see crediting rates tick down.
For us the reason yields have gone up isn’t really because the interest rate environment is better. It is really because we are putting money to work. Cash balance has dropped this quarter and we are just getting better investment performance out of our alternative asset classes or through variable investment income. So that is why you see the…by the way I would say in general spreads widen but they are only getting back to normal in terms of, and if you compare them to our guidance that we gave this year they are a little better than guidance in many cases but really only back to normal.
Thank you everyone.
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