Thursday, March 13, 2014

Is Met Life a SIFI? Still Undecided.

Since the middle of 2013, a decision about Met Life being a "Systemically Important Financial Institution" was imminent.  Now with the publication of their 2013 10-K, the company is still waiting.

In all our of American regulatory fog about SIFIs, it is funny to note that most documents and studies acknowledge that key concepts like "systemically important" or "contingent capital" do not have widely accepted definitions.

Recent research from the New York Fed, found in its Liberty Street Blog, has assiduously tried to show that the effects of the current "unconventional" monetary policy has been equivalent to conventional policies relating to monetary aggregates and Fed funds.  Their conclusion, not surprisingly, is that rates are not in a very different position than they would have been under a conventional policy.  Forget about the conceptual difficulties of this exercise, but the critical effects of a persistent, artificial low rate environment are on the behavior of market participants, which fall outside of any of these studies.

Insurance companies fall under the SIFI umbrella because it has been suggested that the pressures put on their net interest margins would inevitably force them to take inordinate risks so as to maintain their earnings.
In the case of Met Life specifically, this seems to be incomprehensibly far off the mark.

Researchers from the Society of Actuaries--not exactly cowboy risk takers--have long written about the risks of a low rate environment for insurers.  Their advice, beyond the creation of deeper risk management processes within companies, really talked about product redesign, changes to the nature of policy guarantees and crediting rates, and hedging or re-insuring older products. These are the kinds of things that are evident in Met Life's financial disclosures.

MET reported fourth quarter 2013 operating earnings of $1.6 billion, up 14% yr/yr, and full year operating earnings of $6.3 billion, up 12%.  Diluted EPS on an operating basis was $1.37 in the fourth quarter (+10%) and $5.63 for 2013.  All of these were better than expected by the Street.

Adjusted return on equity for the fourth quarter was 11.5%, and 12% for the full year 2013.  Equity market performance in the fourth quarter and the steepening of the yield curve at the front end helped the return on equity and variable investment income by 50 bp and by 40 bp respectively in the fourth quarter.

Equity/Assets ratio was 8.1% in 2010 and rose to 8.9% in 2012 and finished 2013 at 9.9%, so the company has deleveraged through the risky period of low rates.

Sales of variable annuity products, per management guidance, have been reduced to $10-$11 billion, with the kind of product changes suggested by the SoA implemented in new product sold.

Although the absolute size is still small, international revenue, which is more oriented towards protection products, has been a strong point in Europe, Japan, and in Latin America, where the company acquired a profitable Chilean operation.  A shift in mix towards international should, all things equal, be better for the corporate risk profile.

The argument made by Met Life management is that imposing a bank-centric set of capital rules on an insurance operation with a fundamentally different business model will generate unintended consequences like raising the cost of guarantees and policy pricing for health and life products.

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