METLIFE INC quarterly report, Q2 FY2014

Business context and reporting period

MetLife, Inc. is a global provider of life insurance, annuities, employee benefits and asset management. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods unless noted. Amounts are in U.S. dollars.

MetLife reports Americas segments (Retail, Group, Voluntary & Worksite Benefits, Corporate Benefit Funding and Latin America), Asia, EMEA, and Corporate & Other. Management uses operating earnings, a non-GAAP measure that excludes net investment and derivative gains and losses and makes other adjustments; it is not a substitute for GAAP earnings.

Financial performance and position

• Revenue growth and the sharp increase in GAAP earnings principally reflect derivative results: net derivative gains were $311 million in Q2 2014 versus losses of $1.690 billion in Q2 2013; for the first half they were gains of $654 million versus losses of $2.320 billion.
• Net investment gains (losses) were losses of $125 million in Q2 and $536 million in the first half, compared with gains of $110 million and $424 million, respectively, in 2013. Net investment income was $5.259 billion for Q2 and $10.294 billion for the first half, down from $5.282 billion and $11.359 billion.
• Operating earnings were nearly flat in Q2 and decreased $60 million for the first half. Management cited adverse mortality and morbidity and lower investment yields, partly offset by higher asset-based fees, portfolio growth and lower interest credited expense. The filing does not provide a standard consolidated operating profit-margin figure.
• Investment-yield disclosure shows net portfolio yield, on management’s stated basis, of 4.88% in Q2 2014 versus 4.87% in Q2 2013, and 4.89% for the first half versus 4.84%. Fixed maturity yields improved, while mortgage loan yields declined.
• Operating cash flow was $6.921 billion for the first half, compared with $7.314 billion. Investing cash used was $6.700 billion and financing cash used was $434 million; cash and cash equivalents ended the period at $7.393 billion.
• At June 30, total assets were $911.120 billion, total liabilities $840.838 billion, and total equity $70.174 billion; MetLife, Inc. stockholders’ equity was $69.591 billion. Stockholders’ equity increased from $61.553 billion at year-end, with accumulated other comprehensive income rising to $11.058 billion from $5.104 billion.
• Balance-sheet debt included $100 million short-term debt, $16.783 billion long-term debt, $4.196 billion collateral financing arrangements and $3.193 billion junior subordinated debt. The company’s $4.0 billion unsecured credit facility had $3.7 billion of remaining availability and no borrowings at June 30.
• Management reported short-term liquidity of $15.0 billion and liquid assets of $238.3 billion at June 30. These are defined measures and should not be equated with cash alone. Common dividends declared were $0.35 per share in Q2; a further $0.35-per-share third-quarter dividend was declared in July.

Material changes and unusual items

• MetLife completed the sale of MetLife Assurance Limited in May for $702 million net cash consideration. It recorded a $633 million pretax loss ($442 million after tax) for the first half; the Q2 loss was $138 million pretax ($99 million after tax). MAL’s results remain in continuing operations under newly adopted discontinued-operations guidance.
• First-half other-than-temporary impairment losses on fixed maturity and equity securities were $59 million, down from $121 million in 2013. Gross unrealized losses on fixed maturity securities fell to $1.6 billion from $4.6 billion at year-end, mainly as interest rates declined and credit spreads narrowed. Management said the securities in an unrealized loss position were not other-than-temporarily impaired at June 30.
• MetLife paid $50 million to New York’s Department of Financial Services and $10 million to the New York County District Attorney in Q1 to resolve licensing matters involving American Life and Delaware American Life. The first-half operating results include $57 million of related charges.
• The Affordable Care Act health insurer fee reduced operating earnings by $15 million in Q2 and $29 million for the first half. A $56 million after-tax favorable reserve adjustment related to disability premium waivers benefited current-period results.
• In April, MetLife issued $1.0 billion of senior notes due 2024 at a 3.60% fixed rate; it also redeemed $200 million of 5.875% notes and repaid notes at maturity. In May, it replaced two unsecured credit agreements with a single $4.0 billion five-year facility.
• Mortgage loans totaled $57.223 billion; the company reported 99% of its mortgage loan portfolio as performing. Commercial mortgage loans averaged a 54% loan-to-value ratio and 2.5x debt-service coverage at June 30.

Outlook, commentary and risks

• Management targets 2016 operating return on common equity, excluding AOCI, of 12%–14%, assuming sufficient share repurchases; if repurchases are insufficient, the target is 11%–13%. It also targets $1 billion in efficiencies, including $600 million of pretax expense savings and $400 million primarily reinvested in technology and capabilities.
• Management aims to shift toward protection products, grow international and emerging-market businesses, and have 20% or more of operating earnings from emerging markets by 2016. These are targets, not guarantees. Management noted mixed sales, with lower variable annuity and Japan life sales amid pricing discipline and risk-management actions.
• Key operating pressures include sustained low interest rates and reinvestment at lower yields, unfavorable mortality and morbidity, and severe-weather claims. Market movements and policyholder behavior can materially affect variable-annuity guarantees and derivative results; non-qualifying hedges can create earnings volatility without an offsetting GAAP gain or loss on the hedged item.
• Regulatory uncertainty includes possible enhanced requirements if MetLife is designated a U.S. non-bank SIFI and additional capital standards as a global systemically important insurer. Restrictions on captive reinsurance could affect product economics, hedging, statutory capital and the ability to deploy capital. The planned merger of four insurance entities was expected in Q4 2014, subject to approvals.
• Litigation and regulatory matters include asbestos claims, mortgage-related investigations, unclaimed-property disputes, sales-practice claims and other proceedings. The estimated aggregate reasonably possible loss in excess of accrued amounts was $0–$390 million for matters where a range could be estimated; losses in other matters could not be estimated clearly. Management stated outcomes were not expected to materially affect financial position, while acknowledging possible material effects on particular periods’ earnings or cash flows.
• Other commitments included $3.6 billion of mortgage loan commitments and $4.9 billion of commitments to fund partnerships and other investments. The company’s written credit default swaps had $10.0 billion notional exposure assuming referenced obligations became worthless. Securities lending and derivative collateral demands, ratings downgrades, foreign currency movements and limits on subsidiary dividends are additional liquidity and capital risks.

Most important facts for investors to verify

• Separate recurring operating performance from GAAP earnings: review the large derivative swings, investment losses and MAL disposal loss, and the company’s reconciliation of operating earnings to GAAP.
• Track whether mortality, morbidity, catastrophe claims and investment yields improve, and whether operating earnings stabilize after the first-half decline.
• Assess the quality and sensitivity of investment assets, including structured securities, Level 3 valuations, commercial real estate exposure and variable-annuity guarantees.
• Monitor progress and approvals for the insurance-company mergers, captive-reinsurance regulation, SIFI/G-SII requirements and the related implications for capital, dividends and buybacks.
• Follow developments in asbestos and other litigation, mortgage investigations, unclaimed-property claims and the New York licensing commitments; compare any new accruals with disclosed possible losses.
• Confirm execution of the 2016 return and efficiency targets, intended share repurchases, and the sustainability of dividends given regulatory constraints and reliance on subsidiary distributions.