Tuesday, July 30, 2013

The Strange Situation of Met Life

The U.S. Financial Stability Council, yet another bureaucratic creature spawned by Dodd-Frank, recently moved Met Life to the final decision stage of being named a non-bank Systemically Important Financial Institution, or "SIFI."  Part of the booby prize for achieving this designation is a requirement to introduce something fuzzy called "contingent capital" into the firm's capital structure. G.E. Capital and AIG were just designated as non-bank SIFIs.

The Stern School's V-Lab ranks Met Life just behind Goldman Sachs in terms of its contribution to systemic risk from North American financial institutions.

I can't see any fundamental reasons Met Life should be put into the SIFI category.

Going back to the financial crisis that precipitated increased global financial regulation, it's interesting to look back at how the banking and insurance industries performed during the crisis.  According to an analysis of public company annual reports by Oliver Wyman, from 2007 until February 10, 2010, the cumulative global insurance industry credit losses totaled $271 billion, compared to $1,715 billion for the global banking sector.  Banking sector credit losses were over 6x those of the global insurance sector.

AIG alone accounted for 36% of the insurance sector's credit losses.  Yet, it wasn't anything in AIG's insurance businesses that precipitated the losses, but it was AIG's prop trading business and its outsized exposure to CDS.   Most insurance companies were able to absorb their losses on their balance sheets.

As a result of the crisis, the global insurance industry had to raise $170 billion of additional capital to shore up their capital structures, whereas the global banking industry had to raise $1,468 billion over the same period as above, a factor of 9x higher.  AIG accounted for 58% of the insurance sector's new capital raised, according to Oliver Wyman.

So, nothing in the experience of the great crisis suggests that the basic insurance company model would require heightened regulation or higher capital levels beyond Solvency II or Basel II's respective arcane requirements.

Met Life is the largest U.S. life insurer by assets, so it is a force to be reckoned with.  Met Life, according to Morningstar analyst Vincent Lui, chose to forgo TARP assistance, but it did take advantage of other Federal programs to strengthen its balance sheet post-crisis.

It raised $400 million from the Federal government for general corporate purposes, and it recapitalized with $2 billion in stock and more than $1 billion in debt.  The current debt/capital ratio is about 30%.

Under CEO Steve Kandarian, who joined Met Life at its Chief Investment Officer, the company has made a number of risk-reducing and potentially value-enhancing measures.  First, it gave up its bank charter, whose purpose had been to own a small deposit gathering function through which to cross-sell insurance and benefit programs.  Having sold this in 2013, Met Life was also freed from regulation by the Federal Reserve Bank.  Earlier, it had also sold its ownership in Stuyvesant Town, which removed the company from the risky and politically sensitive business of being a major landlord in New York city.

Getting to its core insurance business, the CEO has slowed the growth of Met Life's variable annuity business underwriting, and repriced the new business. In traditional products like universal life, it has also raised prices and reduced policy rates.  The variable annuity business might have been one reason to be concerned about the stability of Met Life, but this risk has been publicly recognized, the balance sheet strengthened, and the business growth tapered.

The company has made significant ventures into overseas markets.  In 2012, Met Life generated one third of its operating earnings from outside the U.S.  After its recent acquisition of ALICO from AIG, it operates in 45 countries, including Chile, India and Japan; before the ALICO acquisition foreign markets accounted for 17% of operating earnings.  Markets like Chile, the company says, are less price sensitive and customers are stickier than in developed markets where irrational pricing during underwriting cycles destroys profitability.  This move gives the company growth opportunities, margin expansion plays, and geographical diversification.

In the U.S. the company provides life insurance and other employee benefits to about 90% of the companies in the Fortune 500, according to Morningstar.  This business is also fairly sticky and not subject to underwriting cycles, as is traditional life sold to individual customers.

Over 80% of the investment portfolio are in fixed interest securities and mortgage loans.  The company operates in a highly regulated business overseen by state commissioners of insurance. Certainly if the Federal government were to decide to add Met Life to the systemically important list, it would add to policyholder costs and possibly restrict the availability of some products in some states.  When one looks at Met Life, the question is why does this company stand out among its peers for being riskier?

Of course, it is possible that the company becomes mismanaged under the current CEO, but given his initial moves as Chief Investment Officer and then as CEO, this would seem less than likely.  There is talk about raising the dividend and of buying back shares, which doesn't seem warranted where the stock is today.  This is a 140 year old company with a reputation for prudence, hopefully it reverts to its heritage.

Looking at this company through the lens of the British "twin peaks" regulatory model, the two questions would be (1) does the company's failure pose a substantial risk to the global financial system, and (2) would policy holders be protected in the event of a failure.  The answer to the first is "No," and the answer to the second is "Yes," because a supervisor in the event of an insurer failing is given much more latitude to protect policy holders from corporate assets or by sale to another solvent insurer.

Where have we lost the plot on financial regulation?  We are overrun with lawyers, both in our legislatures, government departments, and in private practice.  The British, by contrast, are probably overpopulated by people of an economic/philosophical bent.  One thing they have recognized about regulation is the benefit to keeping it simple.  The article by Andy Haldane, "The Dog and the Frisbee" makes the points well.

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