MetLife May Increase Investments

Dec. 7.10 | About: MetLife, Inc. (MET)

MetLife (NYSE:MET) is one of the largest provider of life insurance in the US with about 6% market share of the US life and health insurance industry. MetLife competes with other established insurance providers like AIG (NYSE:AIG), The Hartford (NYSE:HIG) and New York Life. We have a price estimate of $47.67 on MetLife, which is around 17% ahead of the current market price.

Life and health insurance is MetLife’s primary business division which accounted for about 50% of its total revenues in 2009. MetLife also provides retirement annuities and property & casualty insurance such as auto insurance and home insurance. Apart from insurance policies, MetLife also earns revenues from investments of insurance policy premiums. So we ask our readers …

Investment of Insurance Premiums

Insurance companies receive premiums from the policy owners up front and then hold onto them until claims arise that they need to pay. This is often referred to as “float” and is why Warren Buffett loves owning well run insurance companies. While insurance companies hold this money, they often invest it and assuming they are earning an underwriting profit, they are essentially holding this money for free or being paid to hold this money. The difference between what insurance companies earn from underwriting and what the policies cost (how much they have to pay) is the underwriting gain or loss.

Given how competitive insurance rates are, insurance companies depend heavily on these investment returns and many find it difficult to meet its liabilities and remain profitable otherwise. In other words, insurance companies earn very little – and some operate at underwriting losses – in the hopes of earning more on the investments to cover these losses. The majority of these investments are in fixed income securities like government and corporate bonds and the remainder in equity securities, mortgage loans, policy loans and other investment securities.

MetLife has about $230 billion invested in fixed maturity securities as of year-end 2009.

The chart below examines the impact of changes in total fixed maturity investments on MetLife’s stock value. Growth in its investments depend on growth in insurance policies and premiums, and higher returns on invested portfolios. An aging US population and the economic recovery will boost sales of insurance policies and could push premiums higher. Thus, we forecast an increase in investments.

Sensitivity to Yields

In addition to a growing asset base, MetLife’s return on fixed income investments is a crucial driver of its value. Interest rate on fixed maturity securities is the most important factor driving the return on fixed income investments. High interest rate leads to high returns and vice-versa. But a long period of high interest rate can adversely affect the company. The policyholders may surrender their contracts in a rising interest rate environment, requiring the company to liquidate fixed income investments in a loss position. Thus, we forecast a modest increase in MetLife’s return on fixed income investments.

Downside Scenario

If MetLife’s yield on fixed maturity securities were to stabilize at 2009 levels of about 4% beyond 2011 while its fixed investment assets remained flat, the Trefis price estimate would decline roughly 5% from its current value of $47.67. Also, the contribution of income from investment of insurance premium to MetLife’s stock value would become roughly 20% from its current value of 24%. A corresponding decline in operating margins to 7% beyond 2011 (from an estimated 8% in 2011) would create an additional 5% downside, dropping the contribution from investment of insurance premiums to only 16% of the company’s stock value.

Disclosure: No position