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MetLife, Inc. (MET) Keefe, Bruyette & Woods 2019 Insurance Conference (Transcript)

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About: MetLife, Inc. (MET)
by: SA Transcripts

MetLife, Inc. (NYSE:MET) Keefe, Bruyette & Woods 2019 Insurance Conference. September 4, 2019 8:40 AM ET

Company Participants

John Hall - Head of Investor Relations

John McCallion - Chief Financial Officer

Conference Call Participants

Ryan Joel Krueger - MD of Equity Research

Operator

Ryan Joel Krueger

All right. We are going to get started. Thank you to MetLife for being with us again this year. Up on stage with me, we have John McCallion, Chief Financial Officer and I also want to recognize, John Hall, Head of Investor Relations and other members of the IR team in the front row.

So to kick it off on the second quarter call, MetLife’s new CEO, Michel Khalaf stated that the company is in the midst of conducting a strategic review of the businesses. Can you talk a little bit about and provide a little more color on some of the key aspects of the review and some of the key things you are trying to accomplish with it?

John McCallion

Yes, sure. I think probably start with and reiterate the point that Michel made on the call which was that this is probably more of an evolutionary strategic review versus a revolutionary one. Obviously we’ve done a lot over the years, under Steve’s tenure to kind of right-size the firm and I think we’ve kind of stuck to some of the key principles around just being very disciplined about capital allocation, generating strong risk adjusted returns and growing in a profitable way. And I think those, those principles will be kind of be the underlying and underpinnings of our strategic review as we move forward.

I think the other thing that the – we’ve been doing a lot of now and will become more of a muscle for us as expenses. And we think that – that can be important not just from a expense perspective but to fund growth, and we think it’s vital particularly as you move through kind of how the world is changing technology and everything around that, that and really innovation. Innovation is going to be a key component from our thought perspective there, but you need to fund innovation.

And so I think expense discipline will become a key component of that. But overall, I don’t see major changes on how we act or what we do. I think we've been optimizing the portfolio for some time and I think you referenced maintaining that disciplined around the portfolio and that will continue.

Ryan Joel Krueger

It's somewhat related, but M&A has been fairly limited over the last five or so years from MetLife. I guess, how are you evaluating M&A at this point in terms of things like key financial hurdles and business strategy, and how does this tie into the strategic review?

John McCallion

Yes, M&A has always been an important muscle of ours and what we believe. We believe it's a strategic asset of ours. But M&A requires discipline and you know there's been you know the volume of deals out there hasn't been zero, it's actually -- there's been quite a bit of activity and we see all of it generally. We may choose not to bid or exercise any type of deals in there. But you know, it's been pretty active. We haven't been that very very active on a from the buy side. You know when we think about M&A, it needs to be a good strategic fit, it's kind of the first thing we think about, and it has to have strong risk adjusted returns. Those are kind of the better off principles how we would think about doing an acquisition, and if that doesn't work, then that -- it doesn't make sense for us to do that.

And then underlying that, the key metrics that are important for us to show that this is a good acquisition to our investors, are kind of the -- I'll say the top four priorities in terms of metrics where you think earnings per share, you think, ROE book value per share and free cash flow, they can all have different tensions to each other, but you think about those and being accretive to those metrics as well.

So I think, M&A will be an important aspect for us as well. We've actually done quite a bit of divesting over the last seven years. We've divested over 20 portfolios over that time. So we've been pretty active maybe more in the divesting side, but we've been active reviewing the pipeline over those years as well. We just haven't executed necessarily, and I think that's just as sticks with our philosophy around capital allocation.

Ryan Joel Krueger

I guess, are there any particular areas that would be of more interest from a strategic standpoint when you think about M&A going forward?

John McCallion

Yes I think, you know for us it would be where we can enhance our strategic and competitive advantages that we have in certain businesses, and I think you can think in the U.S. we have a group business that's very strong. We have Mexico, we have some strong businesses in Asia, so we would need to fit around kind of areas where we think we have good growth opportunities in the firm. But I don't know if I can get any more specific on that.

Ryan Joel Krueger

But beyond M&A, can you give an update on how you're thinking about the capital management strategy of the company at this point moving forward?

John McCallion

Yes, I think capital management always starts with first, are that you are going to do a good job pricing your new business, right. You've got it. You have to fund your new business at appropriate risk adjusted returns, and then your excess capital above that is reviewed for M&A potentially, and then in excess as we return. We generally return that to our shareholders, and you've seen us build a track record over the last several years. I think over the last three and a half years, we've returned over $14 billion through the first six months of 2019.

So that's I think that's our philosophy and certainly you know growing our dividend at a rate commensurate with let's say growth and earnings. And then the remainder being used for things like share repurchases, that that philosophy is important for us. We think it's part of our business, the type of business we have and that's a good relationship that we've been, I think building some credibility around over the last several years.

Ryan Joel Krueger

And I think last year you talked about free cash flow being a pretty good proxy at this point for Capital Management. Is that still the case?

John McCallion

I think, it is. Yes. Now I'd take like the two year average, which we often say the two year average that it can get lumpy in any one year. When you think about dividends from the operating entities, but over the two year average, we think that 65% to 75% of free cash flow is a good proxy for capital in excess of our needs to fund new business. And that can be thought about as Capital Management to be returned to shareholders through dividends and share repurchases.

Ryan Joel Krueger

Then shifted to MetLife Holdings, you assumed responsibility for that business earlier this year. Can you talk about if you think there are potential opportunities to accelerate the runoff over time?

John McCallion

I don't think a lot has changed. And certainly as the rate environment has changed, this probably puts a little more pressure on just finding that bid as spread and whether that ever narrows. It's been a bit wide for some time. I think capital has improved, although again as rates and the environment has changed, I don't know if that's backing off enough, but there's been the supply of capital has increased to some degree. So we continue to review I think the principles remain. You know our first job is to serve our policyholders and our customers. Second is, how do we continue to build efficiencies from a risk and expense perspective in that unit. And then the third is, continuing look at ways to optimize.

And we continue to look. I think it's important that we do that. It makes us actually run the business better as we continue to analyze potential opportunities, but I don't think there's been a big change or sea shift you know with me taking over.

Ryan Joel Krueger

On the cost save program that you currently have, you are several years into it, the 2020 program. Can you give an update on how much has been achieved so far and kind of what's left? And then, also help us think about seasonality a little bit. I think you're right to have a little bit of some seasonal impact as well.

John McCallion

Sure. So we started this program and kind of the 2015 timeframe and said that we would by 2020 improve profit margins by roughly 800 million of pre-tax. Now remember also that was entered into as a part of our separation exercise, because we wanted to use another 250 above that to absorb some of the stranded overhead and we've done that.

Through end of year 2018, we're about a little over 600 million of the way there, and we show that through this direct expense ratio. So the direct expense ratio -- end of the end of year 2015 was 14.3% by the end of 2018 it was 12.9% so about 130 basis points or 140 basis points I should say. And that's generated a little over 600 million pre-tax margins.

So I think we've shown good progress for the first six months of 2019 it's actually that the ratio has looked too good, and market factors have helped that. And we've talked about on our two earnings calls that you have to normalize for some of those market factors, so we've been running the first quarter I think we posted a 12.1% ratio, it's probably 50 basis points to 70 basis points to good looking underlying that is really what the real rate was. And then in the second quarter is around 12.3% and we're about 20 basis points. You’re looking too good because of market factors and some of the impact of some of our employee benefits there.

So you have to normalize for that. But nonetheless, we're on a good path to meeting our 2020, which ultimately becomes about a 200 basis point improvement from 2015 would get you to around 800 million pre-tax margin.

The second half of 2019 in any year to be quite honest, we typically have higher expenses and without the main seasonality item being group. And that's when a lot of the enrollment activity happens, right once a year you have your group employee benefits. We spend quite a bit of time on enrollment activity, right. If you think about the sales process in group, it's a two sale process right. First is, its B2B sell to the employer, and the second is how do you get the consumer or the employee to participate in the product.

So that tends to be a little higher in the second half of the year. So yes, you would expect a uptick and they'll say the normalized direct expense ratio.

Ryan Joel Krueger

I guess, you've been -- the company has been talking more about a continuous mindset around the expense improvement. Once you achieve the 2020 target, would you envision another cost save program or is this something that is more than an ongoing effort that would be targeted at improving the expense ratio gradually over time?

John McCallion

Yes I think, and as I said in the opening around the strategy review, I think we really want to get to a expense DNA, efficiency mindset that's built into a continuous improvement mindset throughout the firm, so that we don't have these one-offs. And my preference is really to fund the continued improvement -- we would. We're going to look not to have these one-offs and as you know we have some one-offs now that's going to get us to this and that was part of the expense initiative, and we would like that to now be just part of our run rate expenses.

So our objective is to meet our target by 2020, and call that, let's say it's roughly 200 basis points improvement from the 14.3% we talked about. And then beyond that, continue to build efficiencies. Now some of those efficiencies, I think need to be used to fund growth. And I really believe that the only way to really compete in this industry is to continue to invest. And we've seen where you know challenges emerge, where when you try to in some of our products or thin margin and you try to just compete on price.

And we believe in some of our businesses that you really have to continue invest and make that part of your run rate costs.

Ryan Joel Krueger

Everyone's favorite topic, interest rates, obviously, they're down significantly this year and continue to go down in the quarter. Can you review the sensitivities that that you've provided around interest rates and also just help us think about if there's any nuances around non-parallel shift in the curve and things like derivative impact.

John McCallion

Yes. So we gave some sensitivities as part of the outlook call and we also put it in the 10-K. And we show about a 100 basis point parallel shift in the curve when we do that sensitivity back in the beginning of the year. And it shows I think it was roughly 25 million impact to operating earnings in the -- or adjusted earnings in the first year and then it grows to about 200 million in the second year. And that was relative to where we expected rates to be at the end of this year, which was obviously much higher.

Through the second quarter actually rates declined beyond that sensitivity. But we're down a little over a 100 basis points from the spot rate at the end of the beginning of the year, and that's at the 10 year. But LIBOR did not drop this much and that's when we think of inversion, that's how we think of the inversion to us, right is that LIBOR rate is only dropped maybe 70 basis points or so.

So, and then since then it's gotten a little worse, although I think LIBOR is catching up. It would just take some time for LIBOR to get there. So LIBOR can be helpful to us, obviously rates down it has some headwinds as we show those sensitivities. But as LIBOR comes down, that provides an offset in a few ways. First, you have received fixed-pay flow derivatives that we use to extend durations in some of our longer-duration products, in ALM exercise. And so as LIBOR comes down, that gives us a benefit. And that's one of the reasons why you see a low amount in the first year, and then it accelerates in the second year.

Second, we would -- our margins on sec lending get better, so that's another. And then there are a couple other places in our portfolio where crediting rates are tied to LIBOR. So that actually can help us. So LIBOR can be an offset, it's not a complete offset to a lower for longer kind of mentality, but it certainly can give us some. So the steepness of the curve or I should say the inversion of the curve, has provided additional headwinds this year. We've been able to I think offset some of them. And so you're not seeing I think the sensitivity that we gave at the beginning of the year actually is holding fairly well. But with no management action, it's a little more of a headwind.

Ryan Joel Krueger

Got it. And then on free cash flow you've talked about a 65% to 75% conversion rate for the next two years. And I think you've said that holds for 1.5% to 4.5% tenure. Can you help us think about the sensitivity there in terms of you know one; I guess, we actually are below 1.5%. How meaningful is that? And then, if we remain in this low interest rate environment do you think that 65% to 75% still holds longer term or is there more negative impacts?

John McCallion

Yes. So we said 65% to 75% with the 10-year between 1.5% and 4.5% I would say at the 1.5% range. It's at the lower end of our free cash flow ratio. And just to put it out there it's not a cliff after one and a half. Right. So there's just a gradual pressure there. And then, there's I don't know if there's any nuances to point out, but it just – it puts a little pressure on us in the early stages. I don't know if it actually changes a percentage necessarily, because it's a percent. Yes, but we have to be careful about that. But just take -- it probably has some pressure on let's say longer term growth.

Ryan Joel Krueger

Okay.

John McCallion

Right. If you think about interest rates. I don't think, I think there's still growth. It just may be a little -- a little more pressure there.

Ryan Joel Krueger

Okay. Thanks. So shifting to the business units of service U.S. group benefits, MetLife has had very good underwriting results. A lot of peers in the industry have also seen pretty good underwriting results. Can you talk a little bit about what you're seeing there, and how -- how sustainable you think these types of underwriting margins are?

John McCallion

Yes we've had some very good results in group. I think it's a function of one; you know a lot of heavy, a lot of the work that we've been doing over the years to develop strong partnerships there with our -- with our brokers, the employers, the whole ecosystem that we have benefit providers administrators and that's doesn't happen overnight. So there's a big credit to obviously the economy does help, but our team has done a great job investing in this business for years to get to this position. I think, we're reaping the benefits of that in a strong economy.

I'd say Group Life is performing as expected, and we saw that last year if you think about and throughout 2018 we had a very strong mortality ratio in the early part of the year, it kind of came back but on average, we were right in the middle. We've had a strong first half. So we tend not to get too excited over there, we try to be balanced because this is a pretty -- we've had a lot of experience in this business and it tends to revert to the mean there.

But nonetheless, I'd say Group Life is performing well, and underwriting has been consistent with our expectations. Non-medical health ratio, we actually dropped that ratio last year, right. So we've kind of taken -- we've seen margin improvement over the years and we've said that, that should continue. So we reduced the ratio -- the range of ratios there for this year and then we're performing as expected. So far economy does help disability to some degree there. But a big driver of that also is some of our voluntary products. We've had some great success in voluntary through the year.

Ryan Joel Krueger

On the voluntary product, that's been a big initiative to increase the penetration of smaller businesses with voluntary products. So can you talk a little bit about how things are going with that initiative and the progress that you've had?

John McCallion

Yes, we've had double digit growth in voluntary now, for we've had it this year, we had it last year. It's performing very well and a lot of the comments I made earlier around the investments we're making is around voluntary. We knew that this was the kind of where things were headed, and it's across all of our markets, as we think of markets, we got the national accounts regional and small market. The national account is, how do we build penetration with existing customers. It's a mix in the regional. And I'd say, it's new kind of growth in the small market.

And we've seen some -- we have a great product set there. We spent, we're spending quite a bit of time with that ecosystem I'm talking about, and making sure our technology is in sync with these HR technology providers who elected to help administer some of these voluntary products, how do we seamlessly integrate with that. Also the benefit communications providers and how do we describe financial wellness and help promote the benefits of these to the employees, which again helps the employer.

So, those strong relationships and partnerships being a strategic advisor to our partners has really started to pay off, and we're seeing some great results there.

Ryan Joel Krueger

On the pension risk transfer side, you won a big base with FedEx last year. How are you thinking about the growth outlook in that business and your appetite to grow that business? And then, to what extent does the lower interest rate environment kind of impact the growth there?

John McCallion

Yes. So, we obviously I think believe this is a good business longer term. It's competitive right now though, and it has been for a few years. So you -- we have been staying disciplined, we tend to stay in the retired lives space mostly just given the duration fit there, and I haven't felt comfortable to move to the deferred lives for our business yet. The pipeline has been strong. People are continuing to talk about it, it's not all dependent on economic environment and interest rates. But that certainly is a headwind I think to the supply and the growth in that business.

I think as we talk about M&A, I think it's a large capital decision and it can be. We use a similar philosophy that we talked about in the beginning of the discussion here, and I think discipline is key for now. So it -- these are good returning business -- good returning businesses that we've taken on over the years. We like the business, but we're going to stay disciplined.

Ryan Joel Krueger

Thinking about the retirement on spread, you've talked about the lower half of 100 basis points to 125 basis points as being achievable this year. Given the drop in rates that we've seen, do you think that's still realistic?

John McCallion

I think so. Yes, we think so. We think the lower half is still achievable for this year. As LIBOR and again it goes back to -- as we see even with these lower rates. What we expect the curve to look like in the outer part of this year, LIBOR will be a friend to us eventually. Where it has been hurting us, as it's coming down and where we had some caps. We actually have some flaws that would kick in, and help kind of offset and mitigate some of the lower rate pressure there.

So we think as I said, and I’ll reiterate what I said -- we've kind of started to hit the bottom of that spread compression for at least in the near term as LIBOR continues to come down, and I think some of the management actions that the team has taken. But yes, we'll still be at the lower half of that range.

Ryan Joel Krueger

Did the derivatives -- did the duration, I guess how short term of those derivatives can still have a positive impact as we move further?

John McCallion

Yes. That's why I said near -- when I say near term, it's a few years, right. I'm not saying like three months, I’m saying 19, 20 we probably had to look beyond that for how things look after that.

Ryan Joel Krueger

In Asia, you've had a good pickup in growth over the last couple of years. On the call though, you referenced some headwinds around things like FX, annuity sales in Japan, I think, been under some pressure. So I was hoping you could review the growth dynamics in Asia and Japan and kind of what you're seeing.

John McCallion

Yes. I think the first thing to point out is we had outsized growth between 17 and 18, right. And so we're starting against a very difficult comparison 19 to 18. So that was one; two, just with the drop in U.S. rates since these are U.S. denominated products, there's been the market has come down. I think it came down maybe 9% in the quarter. And then the third thing where we found is, we had a first mover advantage. We've talked about that, and that showed up I think in 18 and as a result of some of the positive results that we've had, we've had newcomers come in and so competition has increased even from the domestic players who are getting into U.S. dollar denominated products. So we still think we have a competitive advantage given some of our private origination capabilities in the U.S. but you know we have to remain disciplined.

Ryan Joel Krueger

Then a lot focus is on Japan, but outside of Japan, you can just remind us how big the other Asian businesses have kind of gotten in and the dynamic there?

John McCallion

Yes Japan's 65% in total probably. So it's still a major contributor. But as we've talked about and we -- in like in our Asia Investor Day, we think there's a a very positive outlook in China and I know there's some pressures with China. And so certainly with the trade war and stuff, but we still believe there's a good growth strong growth trajectory there for us and we're pretty bullish about that.

Ryan Joel Krueger

On the investment portfolio, can you talk about any changes you've made to prepare for later cycle risk on -- and anything you're doing to the portfolio?

John McCallion

Yes. So we back in 18 started to make some adjustments to the portfolio, particularly in areas of syndicated bank loans and some of the BBB and high yield assets. And we took, I'd say 18 months to kind of transition some of those assets out and move into different ones primarily in the private space. Some of the private places since we believe we have better covenants and protections there. So that was quite a 18-month journey, but we still are I think firm view is that the U.S. economy is still strong, although as we've seen trade friction can put some pressure there and it has. So we're mindful of that. And I think the efforts that we've gone through between 18 and first half of 19 have really just been precautionary and being thoughtful about some of that, the leverage that's built up in some of the BBB space over the years. But it's really individual underwriting of each security, and taking into account what we believe the outlook could be, but also what's the fundamentals of the individual security that we hold.

So I think we've a great team out there. They've proven that for years. We underwrite all around securities. We don't rely on any one rating per say. And there's really a security buy security type of underwriting.

Ryan Joel Krueger

Give us any sense of the new money rates that you've been achieving, I guess in the investment portfolio relative to the portfolio.

John McCallion

Yes. I don't know if we've updated that number since the second quarter. If we give it on the second quarter, but -- and it depends to rate and just what your -- what flows come in and what type of asset you're buying. But I think we gave it a number that wasn't too far off from the first quarter. If you remember, so even though rates went down, it was in the 4% range.

Ryan Joel Krueger

All right. I think we're going to wrap it up. Thank you very much John for being here.

John McCallion

Great. Thanks Ryan.

Question-and-Answer Session

End of Q&A