Brighthouse Financial, Inc. quarterly report, Q2 FY2018

Brighthouse Financial, Inc. — Q2 2018 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2018. Financial amounts are in millions of dollars unless stated otherwise. Brighthouse sells individual annuities and life insurance and reports Annuities, Life, Run-off, and Corporate & Other segments. MetLife sold its remaining Brighthouse shares on June 14, 2018, ending its related-party status.

Financial performance

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Total revenue	$1,702	$2,025	$3,517	$2,990
Net income (loss) available to common shareholders	$(239)	$246	$(306)	$(103)
Adjusted earnings, non-GAAP	$153	$324	$436	$604
Net cash from operating activities	Not presented quarterly	$1,017	$1,325

Q2 revenue fell about 16% year over year, while first-half revenue rose about 18%. These totals were materially affected by investment and derivative fair-value movements; they should not be read as a simple measure of underlying operating growth. Q2 net derivative losses were $312 million versus $78 million a year earlier. First-half derivative losses were $646 million versus $1.043 billion in 2017.

• Q2 adjusted earnings declined $171 million; first-half adjusted earnings declined $168 million. Management cited higher expenses and insurance-related costs, with lower fee income affecting Q2. Lower income taxes partly offset the declines.
• Q2 net investment income was $806 million, up from $766 million. First-half net investment income was $1.623 billion, up from $1.548 billion. Adjusted net investment income yield was 4.37% for Q2 and 4.44% for the first half, versus 4.40% and 4.57%, respectively, in 2017.
• Q2 total expenses were $2.019 billion versus $1.704 billion; first-half expenses were $3.947 billion versus $3.259 billion. DAC/VOBA amortization was $246 million in Q2 and $551 million in the first half, compared with $21 million and a $127 million credit in the comparable 2017 periods.
• Q2 adjusted earnings by segment: Annuities $221 million, Life $37 million, Run-off loss of $6 million, and Corporate & Other loss of $99 million. First-half adjusted earnings were $447 million, $103 million, $44 million, and a $158 million loss, respectively.
• Basic and diluted EPS were both $(2.01) for Q2 and $(2.56) for the first half, compared with $2.05 and $(0.86), respectively, in 2017.

Balance sheet, debt, and liquidity

• At June 30, total assets were $216.2 billion, down from $224.2 billion at year-end 2017; total liabilities were $202.7 billion and total equity was $13.5 billion, down from $14.6 billion.
• Investments totaled $80.9 billion, including $62.3 billion of available-for-sale fixed maturities and $12.3 billion of mortgage loans. Cash and cash equivalents were $2.1 billion. Separate-account assets and liabilities were each $111.6 billion.
• Long-term debt was $3.607 billion on the balance sheet. The debt schedule identifies $1.490 billion of 3.700% senior notes due 2027, $1.477 billion of 4.700% senior notes due 2047, a $600 million term loan due 2019, and other debt. No Revolving Credit Facility borrowings were outstanding; $2.0 billion of commitments remained available under the credit facilities.
• Consolidated liquid assets were $35.0 billion and short-term liquidity was $1.5 billion. At the parent and certain non-insurance subsidiaries, liquid assets were $569 million and short-term liquidity was $336 million.
• Operating cash flow was $1.017 billion, down from $1.325 billion. Investing activities used $2.023 billion and financing activities provided $1.284 billion; cash increased $278 million to $2.135 billion.

Material changes and unusual items

• Management attributed the Q2 GAAP loss primarily to variable-annuity hedge results amid strong equity markets. First-half results also reflected the effect of rising interest rates on freestanding interest-rate derivatives. These market-sensitive items contributed to substantial GAAP volatility.
• Gross unrealized losses on fixed-maturity securities increased $778 million during the first half to $1.1 billion, primarily due to higher longer-term interest rates and wider credit spreads. The company concluded the securities were not other-than-temporarily impaired at June 30.
• A 2018 Portfolio Realignment changed how capital and invested assets are allocated among segments. It did not change consolidated net income or adjusted earnings, but management estimated it increased first-half pre-tax adjusted earnings in Life by $60–$70 million, with most of the offset in Run-off; prior-period segment results were not recast.
• Shield Annuity sales increased 41% in the first half versus the first half of 2017. Variable-annuity separate-account balances fell to $104.6 billion from $109.9 billion at year-end, reflecting negative net flows partly offset by market performance.
• The Board authorized up to $200 million of common-stock repurchases on August 5, 2018; none had been made as of August 7. The company did not pay regular common-stock dividends.

Outlook, risks, and contingencies

• The filing provides no specific earnings or revenue guidance. Management expects to maintain $2–$3 billion of assets above CTE95 to support variable-annuity contracts; at June 30, the excess was $2.7 billion and more than $500 million above CTE98. The company planned to incorporate the new variable-annuity capital framework in its 2018 actuarial review.
• The NAIC approved a variable-annuity capital-reform framework on August 7, 2018, with an expected effective date of January 1, 2020. Implementation details and effects on reserves, capital, and hedging were not yet clear. Changes to RBC calculations were also expected to reduce insurance-subsidiary RBC ratios.
• Other material risks include equity and interest-rate volatility, effectiveness and cost of hedging, policyholder withdrawals, credit and liquidity conditions, insurer capital requirements, reinsurance counterparty performance, regulatory changes, and costs of operating as a standalone company. New York Regulation 187, adopting a best-interest standard for sales, was scheduled to take effect for annuities in August 2019 and life insurance in February 2020; the company was assessing its impact.
• For litigation losses considered reasonably possible but not probable, the estimated aggregate range in excess of accruals was $0–$10 million. The company noted that some matters could not be estimated and that adverse outcomes could affect results or cash flows in particular periods. A new group-annuity class action was filed in June 2018; the company said it intended to defend the action.
• Disclosure controls were assessed as effective at June 30. MetLife continued to provide transitional services while Brighthouse changed processes and stood up standalone systems; the filing identified these changes as a material change in internal control over financial reporting.

Important facts for investors to verify

• Reconcile GAAP losses with adjusted earnings and examine the assumptions and hedge offsets driving variable-annuity and derivative results.
• Review capital adequacy, CTE95/CTE98 excess assets, RBC changes, and the eventual implementation of NAIC variable-annuity reform.
• Track liquidity at the parent and insurance subsidiaries, available borrowing and reinsurance facilities, collateral demands, and policyholder withdrawals.
• Assess the persistence of higher expenses, mortality costs in Run-off, DAC/VOBA amortization, and results under the new segment-capital allocation method.
• Monitor unrealized investment losses, credit quality, and the exposure to rising rates and wider credit spreads, as well as litigation developments and the proposed share repurchases.