METLIFE INC – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Index to Management's Discussion and Analysis of Financial Condition and Results of OperationsPage Number
Forward-Looking Statements and Other Financial Information 114 Executive Summary 114 Industry Trends 117 Summary of Critical Accounting Estimates 125Economic Capital 126 Acquisitions and Disposition 126 Results of Operations 127 Investments 154 Derivatives 172 Off-Balance Sheet Arrangements 175 Policyholder Liabilities 176 Liquidity and Capital Resources 185 Adoption of New Accounting Pronouncements 197 Future Adoption of New Accounting Pronouncements 197 Non-GAAP and Other Financial Disclosures 197 113
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Forward-Looking Statements and Other Financial Information
For purposes of this discussion, "MetLife ," the "Company," "we," "our" and "us" refer toMetLife, Inc. , aDelaware corporation incorporated in 1999, its subsidiaries and affiliates. Following this summary is a discussion addressing the consolidated results of operations and financial condition of the Company for the periods indicated. This discussion should be read in conjunction withMetLife, Inc.'s Annual Report on Form 10-K for the year endedDecember 31, 2012 (the "2012 Annual Report"), the forward-looking statement information included below, the "Risk Factors" set forth in Part II, Item 1A, and the additional risk factors referred to therein, and the Company's interim condensed consolidated financial statements included elsewhere herein. This Management's Discussion and Analysis of Financial Condition and Results of Operations may contain or incorporate by reference information that includes or is based upon forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements give expectations or forecasts of future events. These statements can be identified by the fact that they do not relate strictly to historical or current facts. They use words such as "anticipate," "estimate," "expect," "project," "intend," "plan," "believe" and other words and terms of similar meaning in connection with a discussion of future operating or financial performance. In particular, these include statements relating to future actions, prospective services or products, future performance or results of current and anticipated services or products, sales efforts, expenses, the outcome of contingencies such as legal proceedings, trends in operations and financial results. Any or all forward-looking statements may turn out to be wrong. Actual results could differ materially from those expressed or implied in the forward-looking statements. See "Note Regarding Forward-Looking Statements." This Management's Discussion and Analysis of Financial Condition and Results of Operations includes references to our performance measures, operating earnings and operating earnings available to common shareholders, that are not based on accounting principles generally accepted inthe United States of America ("GAAP"). Operating earnings is the measure of segment profit or loss we use to evaluate segment performance and allocate resources. Consistent with GAAP guidance for segment reporting, operating earnings is our measure of segment performance. Operating earnings is also a measure by which senior management's and many other employees' performance is evaluated for the purposes of determining their compensation under applicable compensation plans. See "- Non-GAAP and Other Financial Disclosures" for definitions of such measures.
Executive Summary
MetLife is a leading global provider of insurance, annuities and employee benefit programs throughoutthe United States ,Japan ,Latin America ,Asia ,Europe and theMiddle East . Through its subsidiaries and affiliates,MetLife offers life insurance, annuities, property & casualty insurance, and other financial services to individuals, as well as group insurance and retirement & savings products and services to corporations and other institutions.MetLife is organized into six segments, reflecting three broad geographic regions: Retail; Group, Voluntary & Worksite Benefits; Corporate Benefit Funding; andLatin America (collectively, the "Americas");Asia ; andEurope , theMiddle East andAfrica ("EMEA"). In addition, the Company reports certain of its results of operations in Corporate & Other, which includesMetLife Bank , National Association ("MetLife Bank ") (see Note 3 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report for information regardingMetLife Bank's exit from substantially all of its businesses (the "MetLife Bank Divestiture")) and other business activities. As anticipated, in the third quarter of 2012, the Company continued to realign certain products and businesses among its existing segments to better conform to the way it manages and assesses its business. Management realigned certain individual disability income and property & casualty products, which were previously reported in the Group, Voluntary & Worksite Benefits segment and began reporting such product results in the Retail segment. In accordance with this realignment, prior period operating earnings for the Retail segment increased by 114
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$28 million , net of$6 million of income tax, and$89 million , net of$25 million of income tax, with a corresponding decrease in the Group, Voluntary & Worksite Benefits segment, for the three months and six months endedJune 30, 2012 , respectively. Management also realigned the businesses inSouth Asia andIndia , which were previously reported in the EMEA segment and began reporting such results in theAsia segment. In accordance with this realignment, prior period operating earnings for theAsia segment increased by$4 million , net of$2 million of income tax, and$8 million , net of$4 million of income tax, with a corresponding decrease in the EMEA segment, for the three months and six months endedJune 30, 2012 , respectively. Also, in the third quarter of 2012,MetLife, Inc. began reporting additionalMetLife Bank operations as Divested Businesses. Consequently, prior period results for Corporate & Other have increased by$6 million , net of$5 million of income tax, and$7 million , net of$5 million of income tax, for the three months and six months endedJune 30, 2012 , respectively.
In addition, starting in the first quarter of 2013, the
Management continues to evaluate the Company's segment performance and allocated resources and may adjust related measurements in the future to better reflect segment profitability. See Note 2 of the Notes to the Interim Condensed Consolidated Financial Statements for further information on the Company's segments and Corporate & Other. We continue to experience an increase in sales in several of our businesses; however, global economic conditions continue to negatively impact the demand for several of our products. Also, additional changes to product features resulted in a decrease in sales of variable annuities. An increase in average separate account assets produced higher asset-based fee revenue, and growth in our investment portfolio, generated higher net investment income. The sustained low interest rate environment reduced investment yields, but also reduced crediting rates. Changes in interest rates and foreign currency exchange rates, as well as the impact of a nonperformance risk adjustment, resulted in a significant unfavorable change in derivative gains and losses. Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 (In millions) Income (loss) from continuing operations, net of income tax$ 508 $ 2,300 $ 1,503 $ 2,166 Less: Net investment gains (losses) 110 (64) 424 (174) Less: Net derivative gains (losses) (1,690) 2,092 (2,320) 114 Less: Other adjustments to continuing operations (1) (106) (736) (854) (1,147) Less: Provision for income tax (expense) benefit 570 (455) 964 416 Operating earnings 1,624 1,463 3,289 2,957 Less: Preferred stock dividends 31 31 61 61 Operating earnings available to common shareholders$ 1,593 $ 1,432 $ 3,228 $ 2,896
(1) See definitions of operating revenues and operating expenses for the
components of such adjustments.
Three Months Ended
During the three months ended
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net of income tax) unfavorable change in net derivative gains (losses) primarily driven by changes in interest rates and foreign currency exchange rates, as well as the impact of a nonperformance risk adjustment on embedded derivatives, partially offset by favorable changes of$174 million ($113 million , net of income tax), in net investments gains (losses) and$161 million in operating earnings available to common shareholders. Also included in income (loss) from continuing operations, net of income tax, were the favorable results of the Divested Businesses, which increased$209 million ($134 million , net of income tax) from the prior period. The increase in operating earnings available to common shareholders was primarily driven by increases in asset-based fee revenue due to growth in our average separate account assets and net investment income due to portfolio growth, partially offset by less favorable mortality and unfavorable claims experience. The sustained low interest rate environment was the primary driver of a decline in investment yields; however, it also resulted in lower crediting rates.
Six Months Ended
During the six months endedJune 30, 2013 , income (loss) from continuing operations, net of income tax, decreased$663 million from the prior period. The change was predominantly due to a$2.4 billion ($1.6 billion , net of income tax) unfavorable change in net derivative gains (losses) primarily driven by changes in interest rates and foreign currency exchange rates, partially offset by favorable changes of$598 million ($389 million , net of income tax), in net investments gains (losses) and$332 million in operating earnings available to common shareholders. Also included in income (loss) from continuing operations, net of income tax, were the favorable results of the Divested Businesses, which increased$244 million ($158 million , net of income tax) from the prior period. The increase in operating earnings available to common shareholders was primarily driven by higher asset-based fee revenue due to growth in our average separate account assets and an increase in net investment income due to growth in our investment portfolio. The sustained low interest rate environment was the primary driver of a decline in investment yields; however, it also resulted in lower crediting rates. These favorable results were partially offset by less favorable mortality and unfavorable claims experience. In addition, the prior period included a$52 million , net of income tax, charge representing a multi-state examination payment related to unclaimed property and our use of theU.S. Social Security Administration's Death Master File to identify potential life insurance claims, as well as the expected acceleration of benefit payments to policyholders under the settlements of such claims.
Consolidated Company Outlook
In 2013, despite pressure from low interest rates, we expect a solid improvement in operating earnings over 2012, driven primarily by the following:
• Growth in premiums, fees and other revenues driven by: - Rational pricing strategy in the group insurance marketplace;
- Increases in our businesses outside of the U.S., notably accident &
health, from continuing organic growth throughout our various geographic regions and leveraging of our multichannel distribution network.
• Expanding our presence in emerging markets, including potential merger and
acquisition activity. We expect that by 2016, more than 20% of our operating earnings will come from emerging markets.
• Focus on disciplined underwriting. We see no significant changes to the
underlying trends that drive underwriting results; however, unanticipated
catastrophes could result in a high volume of claims. • Focus on expense management in the light of the low interest rate environment, and continued focus on expense control throughout the Company. 116
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• Continued disciplined approach to investing and asset/liability management
("ALM"), including significant hedging to protect against low interest
rates and the purchasing of derivatives to protect against higher interest
rates.
We expect only modest investment losses in 2013, but more difficult to predict is the impact of potential changes in fair value of freestanding and embedded derivatives as even relatively small movements in market variables, including interest rates, equity levels and volatility, can have a large impact on the fair value of derivatives and net derivative gains (losses). Additionally, changes in fair value of embedded derivatives within certain insurance liabilities may have a material impact on net derivative gains (losses) related to the inclusion of a nonperformance risk adjustment. As part of an enterprise-wide strategic initiative, by 2016, we expect to increase our operating return on common equity, excluding accumulated other comprehensive income ("AOCI"), to the low end of the 12% to 14% range, driven by higher operating earnings. If we were to assume no share buybacks through year-end 2016, our estimated operating return on equity target range for 2016 would be approximately 100 basis points lower than this previously noted range, all other assumptions held constant. We will leverage our scale to improve the value we provide to customers and shareholders in order to achieve$1 billion in efficiencies,$600 million of which is expected to be related to net pre-tax expense savings, and$400 million of which we expect to be reinvested in our technology, platforms and functionality to improve our current operations and develop new capabilities. We have also begun shifting our product mix toward protection products and away from more capital-intensive products, in order to generate more predictable operating earnings and cash flows, and improve our risk profile and free cash flow. In the second quarter of 2013,MetLife, Inc. announced its plans to merge three U.S.-based life insurance companies and an offshore reinsurance subsidiary to create one larger U.S.-based and U.S.-regulated life insurance company. The companies to be merged consist of MetLife Insurance Company ofConnecticut ("MICC"), MetLife InvestorsUSA Insurance Company ("MLI-USA ") andMetLife Investors Insurance Company ("MLIIC"), each a U.S. insurance company that issues variable annuity products in addition to other products, andExeter Reassurance Company Ltd. ("Exeter"), aCayman Islands reinsurance company that mainly reinsures guarantees associated with variable annuity products issued by our U.S. insurance companies. These mergers are expected to occur towards the end of 2014, subject to regulatory approvals. As a result of these mergers, it is anticipated that the need to use holding company cash to fund derivative collateral requirements will be alleviated and transparency will be increased relative to our capital allocation and variable annuity risk management.
Industry Trends
We continue to be impacted by the unstable global financial and economic environment that has been affecting the industry.
Financial and Economic Environment
Our business and results of operations are materially affected by conditions in the global capital markets and the economy generally. Stressed conditions, volatility and disruptions in global capital markets, particular markets, or financial asset classes can have an adverse effect on us, in part because we have a large investment portfolio and our insurance liabilities are sensitive to changing market factors. Global market factors, including interest rates, credit spreads, equity prices, real estate markets, foreign currency exchange rates, consumer spending, business investment, government spending, the volatility and strength of the capital markets, deflation and inflation, all affect the business and economic environment and, ultimately, the amount and profitability of our business. Disruptions in one market or asset class can also spread to other markets or asset classes. Upheavals in the financial markets can also affect our business through their effects on general levels of economic activity, employment and customer behavior. While our diversified business mix and geographically diverse business 117
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operations partially mitigate these risks, correlation across regions, countries and global market factors may reduce the benefits of diversification.
Financial markets have also been affected by concerns over U.S. fiscal policy. While uncertainty regarding the "fiscal cliff" (a series of tax increases and automatic government spending cuts that would have become effective at the beginning of 2013) was abated following a last minute Congressional compromise onJanuary 1 , questions over the direction of U.S. fiscal policy remain as a result of further Congressional action that will be needed to again raise the U.S. federal government's debt ceiling by some point in the fall of 2013. Unless steps are taken to raise the debt ceiling and reduce the federal deficit, rating agencies have warned of the possibility of future downgrades of U.S. Treasury securities. These issues could, on their own, or combined with the possible slowing of the global economy generally, send the U.S. into a new recession, have severe repercussions to the U.S. and global credit and financial markets, further exacerbate concerns over sovereign debt of other countries and disrupt economic activity in the U.S. and elsewhere. Concerns about the economic conditions, capital markets and the solvency of certainEuropean Union member states, includingPortugal ,Ireland ,Italy ,Greece and Spain ("Europe's perimeter region") andCyprus , and of financial institutions that have significant direct or indirect exposure to debt issued by these countries, have been a cause of elevated levels of market volatility. See "- Investments - Current Environment" for information regarding credit ratings downgrades, support programs forEurope's perimeter region andCyprus and our exposure to obligations of European governments and private obligors. The financial markets have also been affected by concerns that otherEuropean Union member states could experience similar financial troubles, that some countries could default on their obligations, have to restructure their outstanding debt, or be unable or unwilling to comply with the terms of any aid provided to them, that financial institutions with significant holdings of sovereign or private debt issued by borrowers inEurope's perimeter region could experience financial stress, or that one or more countries may exit the Euro zone, any of which could have significant adverse effects on the European and global economies and on financial markets, generally. InSeptember 2012 , theEuropean Central Bank ("ECB") announced a new bond buying program, Outright Monetary Transactions, intended to stabilize the European financial crisis and help certain countries struggling with their levels of sovereign debt. This program involves the purchase by the ECB of unlimited quantities of short-term sovereign bonds, with maturities of one to three years. These large scale purchases of short-term sovereign bonds are intended to increase the price of the bonds, and lower their interest rates, making it less expensive for certain countries to borrow money. As a condition to participating in this program, countries must agree to strict levels of economic reform and oversight. This bond buying program has not been activated to date, but the possibility of its use by the ECB has succeeded in reducing investor concerns over Euro zone break-up risk and lowering sovereign yields inEurope's perimeter region. See "Risk Factors - Economic Environment and Capital Markets-Related Risks - We Are Exposed to Significant Financial and Capital Markets Risks Which May Adversely Affect Our Results of Operations, Financial Condition and Liquidity, and May Cause Our Net Investment Income to Vary from Period to Period." See also "Risk Factors - Economic Environment and Capital Markets-Related Risks - If Difficult Conditions in the Global Capital Markets and the Economy Generally Persist, They May Materially Adversely Affect Our Business and Results of Operations" included inMetLife, Inc.'s Form 10-Q for the quarter endedMarch 31, 2013 . The Japanese economy, to which we face substantial exposure given our operations there, has experienced weak economic performance for over two decades and a long period of deflation, which have led to a deterioration in public finances. The global financial crisis andMarch 2011 earthquake further pressuredJapan's budget outcomes and public debt levels. Going forward,Japan's structural and demographic challenges may continue to limit its potential growth unless reforms that boost productivity are put into place.Japan's high public sector debt levels are mitigated by low refinancing risks and its nominal yields on government debt have remained at a lower level than that of any other advanced country. However, frequent changes in government have prevented policy makers from implementing fiscal reform measures to put public finances on a sustainable path. InJanuary 2013 , the government and the Bank of Japan pledged to strengthen policy coordination to end 118
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deflation and to achieve sustainable economic growth. This was followed by the announcement of a supplementary budget stimulus program totaling 2% of gross domestic product and the adoption of a 2% inflation target by the Bank of Japan. In earlyApril 2013 , the Bank of Japan announced a new round of monetary easing measures including increased government bond purchases at longer maturities. Although the yen has weakened, deflationary pressures have eased and the stock market has rallied on the back of these announcements, it is too soon to tell whether these actions will have a sustained impact onJapan's economy.Japan's public debt trajectory could continue to rise until a strategy to consolidate public finances and growth-enhancing reforms are implemented.
Impact of a Sustained Low Interest Rate Environment
As a global insurance company, we are affected by the monetary policy of central banks around the world. Inthe United States , theBoard of Governors of theFederal Reserve System (the "Federal Reserve Board") has taken a number of actions in recent years to spur economic activity by keeping interest rates low and may take further actions to influence interest rates in the future, which may have an impact on the pricing levels of risk-bearing investments, and may adversely impact the level of product sales. TheFederal Reserve Board's Federal Open Market Committee has been purchasing agency mortgage-backed securities at a pace of$40 billion per month and longer-term U.S. Treasury securities at a pace of$45 billion per month in quantitative easing measures intended to stimulate the economy by keeping interest rates at low levels. TheFederal Reserve Board plans to keep interest rates low until such time as certain numerical thresholds are met, including with respect to the rates of unemployment, inflation and long-term inflation. InJune 2013 , theFederal Reserve Board announced that it expects to begin reducing the pace of its bond purchases later this year dependent on subsequent economic data remaining broadly aligned with its current expectations for a strengthening in the U.S. economy. Assuming these conditions are satisfied, theFederal Reserve Board expects that it will reduce the pace of purchases gradually through the first half of next year and end its purchases around mid-2014. TheFederal Reserve Board's actions to reduce its quantitative easing program will potentially increase U.S. interest rates from recent historically low levels, with uncertain impacts on U.S. risk markets, as well as possibly affecting interest rates and risk markets in other developed and emerging economies. Central banks in other parts of the world, including the ECB, the Bank ofEngland , theBank of Australia , theCentral Bank of Brazil and theCentral Bank of China , have followed the actions of theFederal Reserve Board to lower interest rates. The collective effort globally to lower interest rates was in response to concerns aboutEurope's sovereign debt crisis and slowing global economic growth. We cannot predict with certainty the effect of these programs and policies on interest rates or the impact on the pricing levels of risk-bearing investments at this time. See "- Investments - Current Environment." In periods of declining interest rates, we may have to invest insurance cash flows and reinvest the cash flows we received as interest or return of principal on our investments in lower yielding instruments. Moreover, borrowers may prepay or redeem the fixed income securities, commercial or agricultural mortgage loans and mortgage-backed securities in our investment portfolio with greater frequency in order to borrow at lower market rates. Therefore, some of our products expose us to the risk that a reduction in interest rates will reduce the difference between the amounts that we are required to credit on contracts in our general account and the rate of return we are able to earn on investments intended to support obligations under these contracts. This difference between interest earned and interest credited, or margin, is a key metric for the management of, and reporting for, many of our businesses. Our expectations regarding future margins are an important component impacting the amortization of certain intangible assets such as deferred policy acquisition costs ("DAC") and value of business acquired ("VOBA"). Significantly lower margins may cause us to accelerate the amortization, thereby reducing net income in the affected reporting period. Additionally, lower margins may also impact the recoverability of intangible assets such as goodwill, require the establishment of additional liabilities or trigger loss recognition events on certain 119
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policyholder liabilities. We review this long-term margin assumption, along with other assumptions, as part of our annual assumption review.
The Company has performed sensitivity analyses based on our 2012 annual assumption review to estimate the potential effect on the Company of a protracted low interest rate environment. The scenarios, which are described below, are outside the realm of best estimate assumptions. However, the results are useful in understanding possible ranges of balance sheet impacts from such scenarios. Specifically, if level interest rates were substituted for our current mean reversion interest rate assumptions, loss reserves of up to$400 million in present value would be required for theAmericas , within the Corporate Benefit Funding segment, and theAsia segment would require loss reserves of up to$350 million in present value. In the event these scenarios were to occur, the loss reserves noted above in the aggregate would likely be recorded over a period of five to ten years. With respect to DAC and insurance contract related intangibles, we modeled a scenario in which our general account earned rate assumptions decreased from current rates, which vary by product from 5.25% to 6.00%, to rates varying from 3.50% to 4.00%. In addition, the scenario assumed a drop in separate account total fund performance to 6.00% from the current assumption of 7.25%. For theAmericas , excludingLatin America , this scenario resulted in pre-tax losses in the aggregate of$2.5 billion on variable annuities and$350 million on the universal life and variable universal life insurance business. These losses would likely be recorded over a period of three to five years and most of these losses would not impact operating earnings. In terms of goodwill impairment testing, our analysis indicated that no write-downs would be expected over a three to five year period if interest rates remain at 2012 levels and all other economic and business factors are unchanged. Using the same assumptions referred to above to assess the potential effect on the Company, our models predicted that our domestic statutory insurance subsidiaries would not be required to strengthen statutory reserves over the short- to medium-term if the current low interest rate environment continued. We would, however, expect to continue our historical practice of strengthening reserves by approximately$300 million per year, in line with our ALM strategies.
Mitigating Actions
The Company has been and continues to be proactive in its investment strategies and interest crediting rate strategies, as well as its product design, product mix and availability to mitigate the risk of unfavorable consequences from the low interest rate environment. The Company applies disciplined ALM strategies, including the use of derivatives, primarily interest rate swaps, floors and swaptions, to mitigate the risk of sustained low interest rates in the U.S. A significant portion of these derivatives were entered into prior to the onset of the current low U.S. interest rate environment. In some cases, the Company has entered into offsetting positions as part of its overall ALM strategy and to reduce volatility in net income. Lowering interest crediting rates on some products, or adjusting the dividend scale on traditional products, can help offset decreases in investment margins on some products. Our ability to lower interest crediting rates could be limited by competition, requirements to obtain regulatory approval, or contractual guarantees of minimum rates and may not match the timing or magnitude of changes in asset yields. As a result, our margins could decrease or potentially become negative. We are able to limit or close certain products to new sales in order to manage exposures. Business actions, such as shifting the sales focus to less interest rate sensitive products, can also mitigate this risk. In addition, the Company is well diversified across product, distribution, and geography. Certain of our non-U.S. businesses, reported within ourLatin America and EMEA segments, which accounted for approximately 15% of our operating earnings in 2012, are not significantly interest rate or market sensitive, particularly to any direct sensitivity to U.S. rates. The Company's primary exposure within these segments is insurance risk. We expect our non-U.S. businesses to grow faster than our U.S. businesses and, over time, to become a larger percentage of our total business. As a result of the foregoing, the Company expects to be able to substantially mitigate the negative impact of a sustained low interest rate environment in the U.S. on the Company's profitability. Based on a near to intermediate term analysis of a sustained lower interest rate environment in the U.S., the Company anticipates operating earnings will continue to increase, although at a slower growth rate. 120
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Competitive Pressures
The life insurance industry remains highly competitive. The product development and product life-cycles have shortened in many product segments, leading to more intense competition with respect to product features. Larger companies have the ability to invest in brand equity, product development, technology and risk management, which are among the fundamentals for sustained profitable growth in the life insurance industry. In addition, several of the industry's products can be quite homogeneous and subject to intense price competition. Sufficient scale, financial strength and financial flexibility are becoming prerequisites for sustainable growth in the life insurance industry. Larger market participants tend to have the capacity to invest in additional distribution capability and the information technology needed to offer the superior customer service demanded by an increasingly sophisticated industry client base. We believe that the continued volatility of the financial markets, its impact on the capital position of many competitors, and subsequent actions by regulators and rating agencies have altered the competitive environment. In particular, we believe that these factors have highlighted financial strength as the most significant differentiator from the perspective of some customers and certain distributors. We believe the Company is well positioned to compete in this environment.
Regulatory Developments
The U.S. life insurance industry is regulated primarily at the state level, with some products and services also subject to Federal regulation. As life insurers introduce new and often more complex products, regulators refine capital requirements and introduce new reserving standards for the life insurance industry. Regulations recently adopted or currently under review can potentially impact the statutory reserve and capital requirements of the industry. In addition, regulators have undertaken market and sales practices reviews of several markets or products, including equity-indexed annuities, variable annuities and group products. State insurance regulators and theNational Association of Insurance Commissioners ("NAIC") are also investigating the use of affiliated captive reinsurers or off-shore entities to hedge and reinsure insurance risks. OnJune 11, 2013 , theNew York State Department of Financial Services (the "Department of Financial Services ") issued a highly critical report setting forth its findings to date relating to its inquiry into the life insurance industry's use of captive insurance companies. In its report, theDepartment of Financial Services recommended that (i) the NAIC develop enhanced disclosure requirements for reserve financing transactions involving captive insurers, (ii) the Federal Insurance Office,Office of Financial Research , the NAIC and state insurance commissioners conduct inquiries similar to theDepartment of Financial Services inquiry and (iii) state insurance commissioners consider an immediate national moratorium on new reserve financing transactions involving captive insurers until these inquiries are complete. The NAIC and certain state insurance regulators have stated that they are opposed to an immediate moratorium on new reserve financing transactions. Like many life insurance companies, we utilize captive reinsurers to satisfy statutory reserve requirements related to universal life and term life insurance policies. We also use captive reinsurers to aggregate variable annuity risks under a single legal entity, which allows us to consolidate hedging and other risk management programs. If theDepartment of Financial Services or other state insurance regulators restrict the use of such captive reinsurers or if we otherwise are unable to continue to use such captive reinsurers in the future, our ability to write certain products or to hedge the associated risks efficiently, and/or our risk based capital ratios and ability to deploy excess capital, could be adversely affected or we may need to increase prices on those products, which could adversely impact our competitive position and our results of operations. In the second quarter of 2013,MetLife, Inc. announced its plans to merge three U.S.-based life insurance companies and an offshore reinsurance subsidiary to create one larger U.S.-based and U.S.-regulated life insurance company. The companies to be merged consist of MICC,MLI-USA and MLIIC, each a U.S. insurance company that issues variable annuity products in addition to other products, and Exeter, aCayman Islands reinsurance company that mainly reinsures guarantees associated with variable annuity products issued by our U.S. insurance companies. These anticipated mergers may mitigate to some degree the impact of any restrictions on the use of captive reinsurers that could be adopted by theDepartment of Financial Services or other state insurance regulators. For more information on our use of captive reinsurers see Note 11 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report. The regulation of the global financial services industry has received renewed scrutiny as a result of the disruptions in the financial markets. 121
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Significant regulatory reforms have been recently adopted and additional reforms proposed, and these or other reforms could be implemented. See "Risk Factors - Regulatory and Legal Risks - Our Insurance and Brokerage Businesses Are Highly Regulated, and Changes in Regulation and in Supervisory and Enforcement Policies May Reduce Our Profitability and Limit Our Growth." See also "Business - U.S. Regulation," "Business - International Regulation," "Risk Factors - Risks Related to Our Business - Our Statutory Life Insurance Reserve Financings May Be Subject to Cost Increases and New Financings May Be Subject to Limited Market Capacity," and "Risk Factors - Regulatory and Legal Risks - Changes in U.S. Federal and State Securities Laws and Regulations, andState Insurance Regulations Regarding Suitability of Annuity Product Sales, May Affect Our Operations and Our Profitability" included in the 2012 Annual Report. The Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), which was signed byPresident Obama inJuly 2010 , effected the most far-reaching overhaul of financial regulation in the U.S. in decades. The full impact of Dodd-Frank on us will depend on the numerous rulemaking initiatives required or permitted by Dodd-Frank which are in various stages of implementation, many of which are not likely to be completed for some time. See "Business - U.S. Regulation" included in the 2012 Annual Report.
Potential Regulation as a Non-Bank SIFI
OnJanuary 11, 2013 ,MetLife Bank , a subsidiary ofMetLife , andMetLife completed the sale of the depository business ofMetLife Bank toGE Capital Retail Bank . Subsequently,MetLife Bank terminated its deposit insurance andMetLife, Inc. deregistered as a bank holding company. As a result,MetLife is no longer regulated as a bank holding company or subject to enhanced supervision and prudential standards as a bank holding company with assets of$50 billion or more. However, if, in the future,MetLife, Inc. is designated by theFinancial Stability Oversight Council ("FSOC") as a non-bank systemically important financial institution ("non-bank SIFI"), it could once again be subject to regulation by theFederal Reserve Board and to enhanced supervision and prudential standards. See "Business - U.S. Regulation - Potential Regulation as a Non-Bank SIFI - Enhanced Prudential Standards" included in the 2012 Annual Report. Regulation ofMetLife as a non-bank SIFI could affect our business. For example, enhanced capital requirements that would be applicable toMetLife , ifMetLife were designated as a non-bank SIFI, may adversely affect our ability to compete with other insurers that are not subject to those requirements, and counterparty exposure limits may affect our ability to engage in hedging activities. In addition, it could give theFederal Reserve Board the right to require that any of our insurance companies, or insurance company affiliates, take prompt action to correct any financial weaknesses. The FSOC issued final rules inApril 2012 , outlining a three-stage process it will follow and the criteria it will use to assess whether a non-bank financial company should be subject to enhanced supervision by theFederal Reserve Board as a non-bank SIFI. OnJuly 16, 2013 ,MetLife was notified by the FSOC that it had reached Stage 3 in the process to determine whetherMetLife would be named a non-bank SIFI. IfMetLife is designated as a non-bank SIFI, it will be subject to a number of Dodd-Frank requirements that are also applicable to bank holding companies with assets of$50 billion or more. See "Business - U.S. Regulation" included in the 2012 Annual Report. InApril 2013 , theFederal Reserve Board proposed a rule to implement Section 318 of Dodd-Frank, which directs theFederal Reserve Board to collect assessments and other charges equal to the total expenses theFederal Reserve Board thinks is necessary for its supervision of bank holding companies and savings and loan holding companies with assets of$50 billion or more and non-bank SIFIs. As proposed, this rule would apply toMetLife for the 2012 assessment period and will apply in the future ifMetLife is designated as a non-bank SIFI. 122
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Regulatory Developments Relating to Solvency II
Our insurance business throughout the European Economic Area is also subject to the evolving Solvency II insurance regulatory directive established by the European Parliament in 2009 ("Solvency II") to codify and harmonizeEuropean Union insurance regulation. While this directive provides for new risk management practices, solvency capital standards and disclosure requirements, disagreement surrounding legislation proposed to amend certain provisions of Solvency II, including the implementation date ("Omnibus II") has created uncertainty regarding the ultimate content and effective date of Solvency II, which is currentlyJanuary 1, 2014 and could be delayed until at least 2016. In the context of the delay to Solvency II's implementation date and to help regulators prepare for the new system, theEuropean Insurance andOccupational Pensions Authority ("EIOPA") has published its Consultation on Guidelines on preparing for Solvency II (the "Interim Guidelines"). These Interim Guidelines set out EIOPA's expectations that regulators put in place important aspects of the prospective and risk-based supervisory approach that will be introduced by Solvency II byJanuary 1, 2014 despite theEuropean Union's on-going legislative process on Omnibus II. SinceEIOPA and European Union member states continue to consider what aspects could be adopted during the next three years to continue the development of a more risk-based prudential framework, we may need to accelerate or adjust our implementation accordingly. Our Solvency II program is governed by a steering committee comprised of senior management. Solvency II encompasses solvency capital requirements, allows for both standard model and internal model calculations, requires a robust governance and risk management framework fully embedded in day-to-day decision making and greater quarterly and annual reporting disclosures. As requirements are finalized by the regulators, capital requirements might be impacted in a number of jurisdictions. Compliance with these new capital standards may impact the level of capital required to be held at individual legal entities. In addition, our legal entity structure throughoutEurope may impact our capital requirements, risk management infrastructure and reporting by country. The efforts required to comply with these regulations may increase operating costs at these entities.
Regulatory Developments Relating to G-SIIs
The International Association of Insurance Supervisors ("IAIS"), an association of insurance supervisors and regulators and a member of the Financial Stability Board ("FSB"), an international entity established to coordinate, develop and promote regulatory, supervisory and other financial sector policies in the interest of financial stability, is participating in the FSB's initiative to identify global systemically important financial institutions by devising a process for designating global systemically important insurers ("G-SIIs"). OnJuly 18, 2013 , the IAIS published a revised assessment methodology for identifying G-SIIs and a framework of policy measures to be applied to G-SIIs, and the FSB published its initial list of nine G-SIIs, which includesMetLife, Inc. The FSB will update the list annually beginning in 2014. The framework of policy measures includes tiered global capital requirements for internationally active insurance groups, including G-SIIs, and G-SIIs may be subject to additional capital requirements reflecting activities deemed to be systemically risky. G-SII backstop capital requirements are to be developed by the end of 2014, for application beginning in 2019. More information on timing of development of a quantitative capital standard for large internationally active insurance groups is expected to be published by the end of 2013. The FSB and IAIS propose that national authorities ensure that any insurers identified as G-SIIs be subject to additional requirements consistent with the framework of policy measures, which include preparation of a systemic risk management plan, preparation of a recovery and resolution plan, enhanced liquidity planning and management, more intensive supervision, closer coordination among regulators led by a regulator with group-wide supervisory authority and a policy bias in favor of separation of non-traditional insurance and non-insurance activities from traditional insurance activities. The IAIS policy measures would need to be implemented by legislation or regulation in each applicable jurisdiction, and the impact onMetLife, Inc. and other designated G- SIIs in the U.S. is uncertain. 123
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We expect the scope and extent of regulation outside of the U.S., as well as general regulatory oversight, to continue to increase. The authority of our international operations to conduct business is subject to licensing requirements, permits and approvals, and these authorizations are subject to modification and revocation. The regulatory environment in the countries in which we operate and changes in laws could have a material adverse effect on our results of operations. See "Risk Factors - Risks Related to Our Business - Our International Operations Face Political, Legal, Operational and Other Risks, Including Exposure to Local and Regional Economic Conditions, That Could Negatively Affect Those Operations or Our Profitability" included in the 2012 Annual Report.
Mortgage and Foreclosure-Related Exposures
Since 2008,MetLife , through its affiliate,MetLife Bank , has been engaged in the origination, sale and servicing of forward and reverse residential mortgage loans. In 2012,MetLife Bank exited the business of originating residential mortgage loans and sold its residential mortgage servicing portfolios. It is in the process of winding down its mortgage servicing business. See Note 3 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report for information regarding the MetLife Bank Divestiture. In conjunction with the sales of residential mortgage loans and servicing portfolios,MetLife Bank has made representations and warranties that the loans sold met certain requirements (relating, for example, to the underwriting and origination of the loans), and that the loans were serviced in accordance with investor guidelines. Notwithstanding its exit from the origination and servicing businesses,MetLife Bank remains obligated to repurchase loans or compensate for losses upon demand due to alleged defects byMetLife Bank or its predecessor servicers in past servicing of the loans and material representations made in connection withMetLife Bank's sale of the loans. Estimation of repurchase liability arising from breaches of origination representations and warranties requires considerable management judgment.MetLife Bank considers the level of outstanding unresolved repurchase demands and challenges to mortgage insurance, probable future demands in light of historical experience and changes in general economic conditions such as unemployment and the housing market, and the likelihood of recovery from indemnifications made toMetLife Bank relating to loans thatMetLife Bank acquired rather than originated. Reserves for representation and warranty repurchases and indemnifications were$102 million and$95 million atJune 30, 2013 andDecember 31, 2012 , respectively. Reserves for estimated future losses due to alleged deficiencies on loans originated and sold, as well as servicing of the loans including servicing acquired, are estimated based on unresolved claims as well as projected losses under investor servicing contracts whereMetLife Bank's past actions or inactions are likely to result in missing certain stipulated investor timelines. Reserves for servicing defects were$40 million and$54 million atJune 30, 2013 andDecember 31, 2012 , respectively. Management is satisfied that adequate provision has been made in the Company's interim condensed consolidated financial statements for those representation and warranty obligations that are currently probable and reasonably estimable. State and federal regulatory and law enforcement authorities have initiated various inquiries, investigations or examinations of alleged irregularities in the foreclosure practices of the residential mortgage servicing industry. Mortgage servicing practices have also been the subject of Congressional attention. Authorities have publicly stated that the scope of the investigations extends beyond foreclosure documentation practices to include mortgage loan modification and loss mitigation practices. OnApril 13, 2011 , theOffice of the Comptroller of the Currency (the "OCC") entered into a consent order withMetLife Bank (the "OCC consent order"). The OCC consent order required an independent review of foreclosure practices and set forth new residential mortgage servicing standards. InFebruary 2013 ,MetLife Bank entered into an agreement with the OCC to amend the OCC consent order, and paid approximately$46 million to settle its obligations and end the foreclosure review. In addition, theFederal Reserve Board entered into a consent order withMetLife, Inc. in 2011 (the "Federal Reserve Board consent order"), to enhance its supervision of the mortgage servicing activities ofMetLife Bank . OnAugust 6, 2012 , theFederal Reserve Board issued an Order of Assessment of a Civil Monetary Penalty Issued Upon Consent againstMetLife, Inc. that imposes a 124
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penalty of up to
InMay 2013 ,MetLife Bank received a subpoena from theU.S. Department of Justice requiring production of documents relating toMetLife Bank's payment of certain foreclosure-related expenses to law firms and business entities affiliated with law firms and relating toMetLife Bank's supervision of such payments, including expenses submitted to the Federal National Mortgage Association, the Federal Home Loan Mortgage Corp. and theU.S. Department of Housing and Urban Development ("HUD") for reimbursement. It is possible that various state or federal regulatory and law enforcement authorities may seek monetary penalties fromMetLife Bank relating to foreclosure practices.MetLife Bank has also responded to a subpoena issued by theDepartment of Financial Services regarding hazard insurance and flood insurance thatMetLife Bank obtained to protect the lienholder's interest when the borrower's insurance has lapsed. In April andMay 2012 ,received two subpoenas issued by the Office of Inspector General for HUD regardingFederal Housing Administration ("FHA") insured loans. In June andSeptember 2012 ,MetLife Bank received two Civil Investigative Demands that theU.S. Department of Justice issued as part of a False Claims Act investigation of allegations thatMetLife Bank had improperly originated and/or underwritten loans insured by the FHA.MetLife Bank has met with theU.S. Department of Justice to discuss the allegations and possible resolution of the FHA False Claims Act investigation. The Company has included what it currently believes to be the probable and estimable amount of such loss in the Company's consolidated financial statements and is continuing to investigate matters raised during that meeting. The consent decrees, as well as the inquiries or investigations referred to above, could adversely affectMetLife's reputation or result in significant fines, penalties, equitable remedies or other enforcement actions, and result in significant legal costs in responding to governmental investigations or other litigation. The MetLife Bank Divestiture may not relieveMetLife from complying with the consent decrees, or protect it from inquiries and investigations relating to residential mortgage servicing and foreclosure activities, or any fines, penalties, equitable remedies or enforcement actions that may result, the costs of responding to any such governmental investigations, or other litigation. Management believes that the Company's consolidated financial statements as a whole will not be materially affected by theMetLife Bank regulatory matters.
Summary of Critical Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the Interim Condensed Consolidated Financial Statements. The most critical estimates include those used in determining:
(i) liabilities for future policyholder benefits and the accounting for reinsurance; (ii) capitalization and amortization of DAC and the establishment and amortization of VOBA;
(iii) estimated fair values of investments in the absence of quoted market
values; (iv) investment impairments;
(v) estimated fair values of freestanding derivatives and the recognition and
estimated fair value of embedded derivatives requiring bifurcation; (vi) measurement of goodwill and related impairment; (vii) measurement of employee benefit plan liabilities;
(viii) measurement of income taxes and the valuation of deferred tax assets;
and (ix) liabilities for litigation and regulatory matters. 125
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In addition, the application of acquisition accounting requires the use of estimation techniques in determining the estimated fair values of assets acquired and liabilities assumed - the most significant of which relate to aforementioned critical accounting estimates. In applying our accounting policies, we make subjective and complex judgments that frequently require estimates about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to our business and operations. Actual results could differ from these estimates.
The above critical accounting estimates are described in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Summary of Critical Accounting Estimates" and Note 1 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report.
Goodwill
Goodwill is tested for impairment at least annually or more frequently if events or circumstances, such as adverse changes in the business climate, indicate that there may be justification for conducting an interim test. On an ongoing basis, we evaluate potential triggering events that may affect the estimated fair value of our reporting units to assess whether any goodwill impairment exists. InJune 2013 , the government ofPoland announced proposals to the country's pension system that, if adopted, would negatively impact future operating earnings related to our pension business inPoland . We determined that this announcement was an event requiring an interim test of goodwill impairment for the EMEA reporting unit during the second quarter ofJune 30, 2013 . We performed this interim test principally using a market multiple valuation approach. Results indicated that the fair value of the EMEA reporting unit exceeded its carrying value and, therefore, such goodwill was not impaired.
The Company's annual goodwill impairment test will be performed for all reporting units, in the third quarter of 2013 as of
We apply significant judgment when determining the estimated fair value of our reporting units. The valuation methodology utilized is subject to key judgments and assumptions that are sensitive to change. Estimates of fair value represent management's reasonable expectation regarding future developments and are inherently uncertain. Declines in the estimated fair value of our reporting units could result in goodwill impairments in future periods which could materially adversely affect our results of operations or financial position.
Economic capital is an internally developed risk capital model, the purpose of which is to measure the risk in the business and to provide a basis upon which capital is deployed. The economic capital model accounts for the unique and specific nature of the risks inherent in our business. Our economic capital model aligns segment allocated equity with emerging standards and consistent risk principles. Segment net investment income is credited or charged based on the level of allocated equity; however, changes in allocated equity do not impact our consolidated net investment income, operating earnings or income (loss) from continuing operations, net of income tax.
Acquisitions and Disposition
See Note 3 of the Notes to the Interim Condensed Consolidated Financial Statements.
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Table of Contents Results of Operations Consolidated Results We have experienced growth and an increase in sales in several of our businesses, both domestic and foreign. In the U.S., economic recovery, while continuing to be slow and unsteady, resulted in growth in our dental, disability and group term life businesses through improved persistency, increased covered lives, the positive impact of pricing actions on existing business and new sales. Despite the sustained low interest rate environment, we have seen modest growth in our closeout premiums in the U.S., however ourU.K. closeout premiums have declined. Structured settlement sales were lower reflecting a more competitive market. Sales of variable annuities declined in response to additional changes to guarantee features as we continue to focus on pricing discipline and risk management in this challenging economic environment. In our property & casualty businesses, we experienced higher policy sales as well as an increase in average premium for new policies. Sales in the majority of our businesses abroad have improved despite the challenging economic environment in certain European countries. However, a weaker yen and higher equity markets inJapan resulted in a decrease in fixed annuity sales. Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 (In millions) Revenues Premiums$ 9,158 $ 9,161 $ 18,309 $ 18,290 Universal life and investment-type product policy fees 2,371 2,097 4,662 4,175 Net investment income 5,282 4,719 11,359 10,919 Other revenues 490 393 970 990 Net investment gains (losses) 110 (64) 424 (174) Net derivative gains (losses) (1,690) 2,092 (2,320) 114 Total revenues 15,721 18,398 33,404 34,314 Expenses Policyholder benefits and claims and policyholder dividends 9,289 9,263 18,997 18,710 Interest credited to policyholder account balances 1,846 1,022 4,436 3,579 Capitalization of DAC (1,212) (1,315) (2,468) (2,679) Amortization of DAC and VOBA 958 1,479 1,782 2,193 Amortization of negative VOBA (138) (181) (284) (336) Interest expense on debt 321 342 642 700 Other expenses 4,096 4,450 8,491 9,218 Total expenses 15,160 15,060 31,596 31,385 Income (loss) from continuing operations before provision for income tax 561 3,338 1,808 2,929 Provision for income tax expense (benefit) 53 1,038 305 763 Income (loss) from continuing operations, net of income tax 508 2,300 1,503 2,166 Income (loss) from discontinued operations, net of income tax 2 3 (1) 17 Net income (loss) 510 2,303 1,502 2,183 Less: Net income (loss) attributable to noncontrolling interests 8 8 14 32 Net income (loss) attributable to MetLife, Inc. 502 2,295 1,488 2,151 Less: Preferred stock dividends 31 31 61 61 Net income (loss) available toMetLife, Inc.'s common shareholders$ 471 $ 2,264 $ 1,427 $ 2,090 127
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Three Months Ended
During the three months ended
We manage our investment portfolio using disciplined ALM principles, focusing on cash flow and duration to support our current and future liabilities. Our intent is to match the timing and amount of liability cash outflows with invested assets that have cash inflows of comparable timing and amount, while optimizing risk-adjusted net investment income and risk-adjusted total return. Our investment portfolio is heavily weighted toward fixed income investments, with over 80% of our portfolio invested in fixed maturity securities and mortgage loans. These securities and loans have varying maturities and other characteristics which cause them to be generally well suited for matching the cash flow and duration of insurance liabilities. Other invested asset classes including, but not limited to, equity securities, other limited partnership interests and real estate and real estate joint ventures, provide additional diversification and opportunity for long-term yield enhancement in addition to supporting the cash flow and duration objectives of our investment portfolio. We also use derivatives as an integral part of our management of the investment portfolio to hedge certain risks, including changes in interest rates, foreign currency exchange rates, credit spreads and equity market levels. Additional considerations for our investment portfolio include current and expected market conditions and expectations for changes within our specific mix of products and business segments. In addition, the general account investment portfolio includes, within fair value option ("FVO") and trading securities, contractholder-directed unit-linked investments supporting unit-linked variable annuity type liabilities, which do not qualify as separate account assets. The returns on these contractholder-directed unit-linked investments, which can vary significantly from period to period, include changes in estimated fair value subsequent to purchase, inure to contractholders and are offset in earnings by a corresponding change in policyholder account balances ("PABs") through interest credited to policyholder account balances. The composition of the investment portfolio of each business segment is tailored to the specific characteristics of its insurance liabilities, causing certain portfolios to be shorter in duration and others to be longer in duration. Accordingly, certain portfolios are more heavily weighted in longer duration, higher yielding fixed maturity securities, or certain sub-sectors of fixed maturity securities, than other portfolios. Investments are purchased to support our insurance liabilities and not to generate net investment gains and losses. However, net investment gains and losses are incurred and can change significantly from period to period due to changes in external influences, including changes in market factors such as interest rates, foreign currency exchange rates, credit spreads and equity markets; counterparty specific factors such as financial performance, credit rating and collateral valuation; and internal factors such as portfolio rebalancing. Changes in these factors from period to period can significantly impact the levels of both impairments and realized gains and losses on investments sold. We use freestanding interest rate, equity, credit and currency derivatives to hedge certain invested assets and insurance liabilities. Certain of these hedges are designated and qualify as accounting hedges, which reduce volatility in earnings. For those hedges not designated as accounting hedges, changes in market factors lead to the recognition of fair value changes in net derivative gains (losses) generally without an offsetting gain or loss recognized in earnings for the item being hedged. Certain variable annuity products with guaranteed minimum benefits contain embedded derivatives that are measured at estimated fair value separately from the host variable annuity contract, with changes in estimated fair value recorded in net derivative gains (losses). The Company uses freestanding derivatives to hedge the market risks inherent in these variable annuity guarantees. The valuation of these embedded derivatives includes a nonperformance risk adjustment, which is unhedged and can be a significant driver of net derivative gains (losses) but does not have an economic impact on the Company. 128
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The variable annuity embedded derivatives and associated freestanding derivative hedges are collectively referred to as "VA program derivatives" in the following table. All other derivatives that are economic hedges of certain invested assets and insurance liabilities are referred to as "non-VA program derivatives" in the following table. The table below presents the impact on net derivative gains (losses) from non-VA program derivatives and VA program derivatives: Three Months Ended June 30, 2013 2012 (In millions) Non-VA program derivatives Interest rate$ (951) $ 1,376 Foreign currency exchange rate (408) 164 Credit 15 (25) Equity 17 (1) Non-VA embedded derivatives 92 (24) Total non-VA program derivatives (1,235)
1,490
VA program derivatives
Market risks in embedded derivatives 1,312
(1,538)
Nonperformance risk on embedded derivatives (236)
608
Other risks in embedded derivatives (89)
(424)
Total embedded derivatives 987
(1,354)
Freestanding derivatives hedging embedded derivatives (1,442)
1,956
Total VA program derivatives (455)
602
Net derivative gains (losses)$ (1,690) $
2,092
The unfavorable change in net derivative gains (losses) on non-VA program derivatives was$2.7 billion ($1.8 billion , net of income tax). This was primarily due to long-term interest rates increasing in the current period and decreasing in the prior period, unfavorably impacting receive-fixed interest rate swaps, long interest rate floors, receiver swaptions and long interest rate futures. These freestanding derivatives were primarily hedging long duration liability portfolios. Additionally, the weakening of the Japanese yen relative to other key currencies unfavorably impacted foreign currency forwards and futures that primarily hedge certain bonds. Because certain of these hedging strategies are not designated or do not qualify as accounting hedges, the changes in the estimated fair value of these freestanding derivatives are recognized in net derivative gains (losses) without an offsetting gain or loss recognized in earnings for the item being hedged. The unfavorable change in net derivative gains (losses) on VA program derivatives was$1.1 billion ($687 million , net of income tax). This was due to an unfavorable change of$844 million ($549 million , net of income tax) related to the change in the nonperformance risk adjustment on embedded derivatives, an unfavorable change of$548 million ($356 million , net of income tax) on market risks in embedded derivatives, net of the impact of freestanding derivatives hedging those risks, partially offset by a favorable change of$335 million ($218 million , net of income tax) on other risks in embedded derivatives. Other risks relate primarily to the impact of policyholder behavior and other non-market risks that generally cannot be hedged. The nonperformance risk adjustment loss of$236 million ($153 million , net of income tax) in the current period was comprised of a gain of$17 million due to an increase in the Company's own credit spread, as well as a loss of$253 million due to the impact of changes in capital market inputs, such as long-term interest rates and key equity index levels, on the variable annuity guarantees. The Company calculates the nonperformance risk adjustment as the change in the embedded derivative discounted at the risk adjusted rate (which includes the Company's own credit spread to the extent that the embedded derivative is in-the-money) less the change in the embedded derivative discounted at the risk free rate. 129
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When equity index levels decrease in isolation, the variable annuity guarantees become more valuable to policyholders, which results in an increase in the undiscounted embedded derivative liability. Discounting this unfavorable change by the risk adjusted rate yields a smaller loss than by discounting at the risk free rate, thus, creating a gain from including an adjustment for nonperformance risk.
When the risk free interest rate decreases in isolation, discounting the embedded derivative liability produces a higher valuation of the liability than if the risk free interest rate had remained constant. Discounting this unfavorable change by the risk adjusted rate yields a smaller loss than by discounting at the risk free rate, thus, creating a gain from including an adjustment for nonperformance risk.
When the Company's own credit spread increases in isolation, discounting the embedded derivative liability produces a lower valuation of the liability than if the own credit spread had remained constant. As a result, a gain is created from including an adjustment for nonperformance risk. For each of these primary market drivers, the opposite effect occurs when they move in the opposite direction.
The foregoing
• Refinement in the attribution and valuation model to better reflect
product features, which resulted in favorable period over period change in
the valuation of the embedded derivatives.
• A decrease in the risk margin adjustment caused by lower policyholder
behavior risks, which resulted in a favorable period over period change in
the valuation of the embedded derivatives. • The mismatch of fund performance between actual and modeled funds and
periodic updates to the mapping of policyholder funds into groups of representative indices, which resulted in an unfavorable period over period change in the valuation of the embedded derivatives. • Periodic updates of future capital market assumptions to better reflect
the future capital markets environment, which resulted in an unfavorable
period over period change in the valuation of the embedded derivatives.
• A combination of all other factors, such as in-force changes, the cross
effect of capital markets changes, and the basis mismatch between assets and liabilities, which resulted in a favorable period over period change in the valuation of the embedded derivatives. The foregoing unfavorable change of$548 million ($356 million , net of income tax) is comprised of a$3.4 billion ($2.2 billion , net of income tax) unfavorable change in freestanding derivatives that hedge market risks in embedded derivatives, which was offset by a$2.9 billion ($1.8 billion , net of income tax) favorable change in market risks in embedded derivatives.
The primary changes in market factors are summarized as follows:
• Long-term interest rates increased in the current period and decreased in
the prior period, contributing to an unfavorable change in our freestanding derivatives and a favorable change in our embedded derivatives.
• Key equity index levels increased in the current period and decreased in
the prior period, contributing to an unfavorable change in our freestanding derivatives and a favorable change in our embedded derivatives.
• Changes in foreign currency exchange rates contributed to an unfavorable
change in our freestanding derivatives and a favorable change in our embedded derivatives. 130
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• Key equity volatility measures increased more in the current period than
in the prior period, contributing to a favorable change in our freestanding derivatives and an unfavorable change in our embedded derivatives.
The favorable change in net investment gains (losses) primarily reflects an increase in net gains on sales of fixed maturity securities in the current period coupled with a decrease in fixed maturity securities impairments.
Income (loss) from continuing operations, before provision for income tax, related to Divested Businesses, excluding net investment gains (losses) and net derivative gains (losses), increased$209 million to a loss of$26 million in the second quarter of 2013 from a loss of$235 million in the prior period. Included in this earnings improvement was a decrease in total revenues of$120 million and a decrease in total expenses of$329 million . Income tax expense for the three months endedJune 30, 2013 was$53 million , or 9% of income (loss) from continuing operations before income tax, compared with$1.0 billion , or 31%, of income (loss) from continuing operations before income tax, for the prior period. The Company's second quarter 2013 and 2012 effective tax rates differ from the U.S. statutory rate of 35% primarily due to non-taxable investment income, tax credits for investments in low income housing, and foreign earnings taxed at lower rates than the U.S. statutory rate. As more fully described in "- Non-GAAP and Other Financial Disclosures," we use operating earnings, which does not equate to income (loss) from continuing operations, net of income tax, as determined in accordance with GAAP, to analyze our performance, evaluate segment performance, and allocate resources. We believe that the presentation of operating earnings and operating earnings available to common shareholders, as we measure it for management purposes, enhances the understanding of our performance by highlighting the results of operations and the underlying profitability drivers of the business. Operating earnings and operating earnings available to common shareholders should not be viewed as substitutes for income (loss) from continuing operations, net of income tax, and net income (loss) available toMetLife, Inc.'s common shareholders, respectively. Operating earnings available to common shareholders increased$161 million , net of income tax, to$1.6 billion , net of income tax, for the three months endedJune 30, 2013 from$1.4 billion , net of income tax, in the prior period. 131
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Six Months Ended
During the six months endedJune 30, 2013 , income (loss) from continuing operations, before provision for income tax, decreased$1.1 billion ($663 million , net of income tax) from the prior period primarily driven by an unfavorable change in net derivative gains (losses), partially offset by a favorable change in investment gains (losses). Also included in income (loss) from continuing operations, before provision for income tax, are the results of the Divested Businesses. The variable annuity embedded derivatives and associated freestanding derivative hedges are collectively referred to as "VA program derivatives" in the following table. All other derivatives that are economic hedges of certain invested assets and insurance liabilities are referred to as "non-VA program derivatives" in the following table. The table below presents the impact on net derivative gains (losses) from non-VA program derivatives and VA program derivatives: Six Months Ended June 30, 2013 2012 (In millions) Non-VA program derivatives Interest rate$ (1,166) $ 588 Foreign currency exchange rate (812) 13 Credit 59 (107) Equity 17 - Non-VA embedded derivatives 102 (47) Total non-VA program derivatives (1,800)
447
VA program derivatives
Market risks in embedded derivatives 3,186
1,394
Nonperformance risk on embedded derivatives (650)
(636)
Other risks in embedded derivatives 125
(265)
Total embedded derivatives 2,661
493
Freestanding derivatives hedging embedded derivatives (3,181 )
(826 )
Total VA program derivatives (520)
(333)
Net derivative gains (losses)$ (2,320) $
114
The unfavorable change in net derivative gains (losses) on non-VA program derivatives was$2.2 billion ($1.5 billion , net of income tax). This was primarily due to long-term interest rates increasing in the current period and decreasing in the prior period, unfavorably impacting receive-fixed interest rate swaps, long interest rate floors and receiver swaptions. These freestanding derivatives were primarily hedging long duration liability portfolios. The weakening of the Japanese yen relative to other key currencies unfavorably impacted foreign currency forwards and futures that primarily hedge certain bonds. This impact was partially offset by the strengthening of the U.S. dollar relative to other key currencies, which favorably impacted foreign currency swaps hedging certain bonds. Because certain of these hedging strategies are not designated or do not qualify as accounting hedges, the changes in the estimated fair value of these freestanding derivatives are recognized in net derivative gains (losses) without an offsetting gain or loss recognized in earnings for the item being hedged.
The unfavorable change in net derivative gains (losses) on VA program derivatives was
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nonperformance risk adjustment on embedded derivatives, partially offset by a favorable change of$390 million ($253 million , net of income tax) on other risks in embedded derivatives. Other risks relate primarily to the impact of policyholder behavior and other non-market risks that generally cannot be hedged. The nonperformance risk adjustment loss of$650 million ($422 million , net of income tax) in the current period was comprised of a loss of$152 million due to a decrease in the Company's own credit spread, as well as a loss of$498 million due to the impact of changes in capital market inputs, such as long-term interest rates and key equity index levels, on the variable annuity guarantees. The Company calculates the nonperformance risk adjustment as the change in the embedded derivative discounted at the risk adjusted rate (which includes the Company's own credit spread to the extent that the embedded derivative is in-the-money) less the change in the embedded derivative discounted at the risk free rate.
The foregoing
• Refinement in the attribution analysis and valuation model to better reflect product features, which resulted in favorable period over period change in the valuation of the embedded derivatives.
• A decrease in the risk margin adjustment caused by lower policyholder
behavior risks, which resulted in a favorable period over period change in
the valuation of the embedded derivatives. • The mismatch of fund performance between actual and modeled funds and
periodic updates to the mapping of policyholder funds into groups of
representative indices, which resulted in an unfavorable period over
period change in the valuation of the embedded derivatives. • Modeling refinement in the economic scenario generator and periodic
updates of future capital market assumptions to better reflect the future
capital markets environment, which resulted in an unfavorable period over
period change in the valuation of the embedded derivatives. • A combination of all other factors, such as in-force changes, the cross
effect of capital markets changes, and the basis mismatch between assets and liabilities, which resulted in a favorable period over period change in the valuation of the embedded derivatives. The foregoing unfavorable change of$563 million ($366 million , net of income tax) is comprised of a$2.4 billion ($1.5 billion , net of income tax) unfavorable change in freestanding derivatives that hedge market risks in embedded derivatives, which was offset by a$1.8 billion ($1.2 billion , net of income tax) favorable change in market risks in embedded derivatives.
The primary changes in market factors are summarized as follows:
• Long-term interest rates increased in the current period and decreased in
the prior period, contributing to an unfavorable change in our freestanding derivatives and a favorable change in our embedded derivatives.
• Key equity index levels increased more in the current period than in the
prior period, contributing to an unfavorable change in our freestanding
derivatives and a favorable change in our embedded derivatives.
• Key equity volatility measures decreased less in the current period than
in the prior period, contributing to a favorable change in our freestanding derivatives and an unfavorable change in our embedded derivatives.
• Changes in foreign currency exchange rates contributed to an unfavorable
change in our freestanding derivatives and a favorable change in our embedded derivatives. 133
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The favorable change in net investment gains (losses) primarily reflects an increase in net gains on sales of fixed maturity securities in the current period coupled with a decrease in fixed maturity securities impairments.
Income (loss) from continuing operations, before provision for income tax, related to Divested Businesses, excluding net investment gains (losses) and net derivative gains (losses), increased$244 million to a loss of$152 million in the first half of 2013 from a loss of$396 million in the prior period. Included in this earnings improvement was a decrease in total revenues of$434 million and a decrease in total expenses of$678 million . Income tax expense for the six months endedJune 30, 2013 was$305 million , or 17% of income (loss) from continuing operations before income tax, compared with$763 million , or 26%, of income (loss) from continuing operations before income tax, for the prior period. The Company's effective tax rates for the six months endedJune 30, 2013 and 2012 differ from the U.S. statutory rate of 35% primarily due to non-taxable investment income, tax credits for investments in low income housing, and foreign earnings taxed at lower rates than the U.S. statutory rate. In addition, for the six months endedJune 30, 2013 , the Company received an income tax refund from the Japanese tax authority and recorded a$119 million reduction to income tax expense.
Operating earnings available to common shareholders increased
Reconciliation of income (loss) from continuing operations, net of income tax, to operating earnings available to common shareholders
Three Months Ended
Group, Voluntary Corporate & Worksite Benefit Latin Corporate Retail Benefits Funding America Asia EMEA & Other Total (In millions) Income (loss) from continuing operations, net of income tax$ 301 $ 26 $ 230 $ 228 $ (34) $ 69 $ (312) $ 508 Less: Net investment gains (losses) 23 (28) (3) 9 85 23 1 110 Less: Net derivative gains (losses) (421) (310) (209) (28) (486) (4) (232) (1,690) Less: Other adjustments to continuing operations (1) (32) (45) 27 171 (117) (21) (89) (106) Less: Provision for income tax (expense) benefit 150 134 65 (49) 154 3 113 570 Operating earnings$ 581 $ 275 $ 350 $ 125 $ 330 $ 68 (105) 1,624 Less: Preferred stock dividends 31 31 Operating earnings available to common shareholders$ (136 ) $ 1,593 134
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Three Months Ended
Group, Voluntary Corporate & Worksite Benefit Latin Corporate Retail Benefits Funding America Asia EMEA & Other Total (In millions) Income (loss) from continuing operations, net of income tax$ 907 $ 611 $ 595 $ 18 $ 271 $ 86 $ (188) $ 2,300 Less: Net investment gains (losses) 58 13 144 (13) (43) (18) (205) (64) Less: Net derivative gains (losses) 972 555 288 (14) 50 14 227 2,092 Less: Other adjustments to continuing operations (1) (262) (38) (7) (128) 6 (24) (283) (736) Less: Provision for income tax (expense) benefit (269) (186) (148) 38 (21) 36 95 (455) Operating earnings$ 408 $ 267 $ 318 $ 135 $ 279 $ 78 (22) 1,463 Less: Preferred stock dividends 31 31 Operating earnings available to common shareholders$ (53) $ 1,432
(1) See definitions of operating revenues and operating expenses for the
components of such adjustments.
Six Months Ended
Group, Voluntary Corporate & Worksite Benefit Latin Corporate Retail Benefits Funding America Asia EMEA & Other Total (In millions) Income (loss) from continuing operations, net of income tax$ 702 $ 157 $ 632 $ 334 $ (111) $ 152 $ (363) $ 1,503 Less: Net investment gains (losses) 96 (11) 19 9 213 39 59 424 Less: Net derivative gains (losses) (577) (439) (104) (19) (1,038) (10) (133) (2,320) Less: Other adjustments to continuing operations (1) (296) (85) 59 106 (386) (13) (239) (854) Less: Provision for income tax (expense) benefit 272 187 9 (30) 437 (19) 108 964 Operating earnings$ 1,207 $ 505 $ 649 $ 268 $ 663 $ 155 (158) 3,289 Less: Preferred stock dividends 61 61 Operating earnings available to common shareholders$ (219) $ 3,228
Six Months Ended
Group, Voluntary Corporate & Worksite Benefit Latin Corporate Retail Benefits Funding America Asia EMEA & Other Total (In millions) Income (loss) from continuing operations, net of income tax$ 1,009 $ 583 $ 684 $ 147 $ 515 $ 161 $ (933) $ 2,166 Less: Net investment gains (losses) 125 6 46 (10) (121) (36) (184) (174) Less: Net derivative gains (losses) 446 180 45 23 20 43 (643) 114 Less: Other adjustments to continuing operations (1) (368) (74) 14 (197) 4 (10) (516) (1,147) Less: Provision for income tax (expense) benefit (71) (39) (37) 48 32 14 469 416 Operating earnings$ 877 $ 510 $ 616 $ 283 $ 580 $ 150 (59) 2,957 Less: Preferred stock dividends 61 61 Operating earnings available to common shareholders$ (120) $ 2,896
(1) See definitions of operating revenues and operating expenses for the
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Reconciliation of GAAP revenues to operating revenues and GAAP expenses to operating expenses
Three Months Ended
Group, Voluntary Corporate & Worksite Benefit Latin Corporate Retail Benefits Funding America Asia EMEA & Other Total (In millions) Total revenues$ 4,627 $ 4,161 $ 1,865 $ 1,216 $ 3,210 $ 702 $ (60) $ 15,721 Less: Net investment gains (losses) 23 (28) (3) 9 85 23 1 110 Less: Net derivative gains (losses) (421) (310) (209) (28) (486) (4) (232) (1,690) Less: Adjustments related to net investment gains (losses) and net derivative gains (losses) (4) - - - 2 7 - 5 Less: Other adjustments to revenues (1) (34) (45) (1) 4 436 (132) 26 254 Total operating revenues$ 5,063 $ 4,544 $
2,078
Total expenses$ 4,173 $ 4,130 $ 1,510 $ 903 $ 3,236 $ 640 $ 568 $ 15,160 Less: Adjustments related to net investment gains (losses) and net derivative gains (losses) (112) - - - (1) 9 - (104) Less: Other adjustments to expenses (1) 106 - (28) (167) 556 (113) 115 469 Total operating expenses$ 4,179 $ 4,130 $
1,538
Three Months Ended
Group, Voluntary Corporate & Worksite Benefit Latin Corporate Retail Benefits Funding America Asia EMEA & Other Total (In millions) Total revenues$ 5,824 $ 4,929 $ 2,518 $ 1,160 $ 2,828 $ 683 $ 456 $ 18,398 Less: Net investment gains (losses) 58 13 144 (13) (43) (18) (205) (64) Less: Net derivative gains (losses) 972 555 288 (14) 50 14 227 2,092 Less: Adjustments related to net investment gains (losses) and net derivative gains (losses) 8 - - - (1) 13 - 20 Less: Other adjustments to revenues (1) (20) (38) 10 53 (351) (178) 138 (386) Total operating revenues$ 4,806 $ 4,399 $ 2,076 $ 1,134 $ 3,173 $ 852 $ 296 $ 16,736 Total expenses$ 4,438 $ 3,999 $ 1,604 $ 1,144 $ 2,396 $ 596 $ 883</money> $ 15,060 Less: Adjustments related to net investment gains (losses) and net derivative gains (losses) 242 - - - (1) 16 - 257 Less: Other adjustments to expenses (1) 8 - 17 181 (357) (157) 421 113 Total operating expenses$ 4,188 $ 3,999 $ 1,587 $ 963 $ 2,754 $ 737 $ 462 $ 14,690
(1) See definitions of operating revenues and operating expenses for the
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Six Months Ended
Group, Voluntary Corporate & Worksite Benefit Latin Corporate Retail Benefits Funding America Asia EMEA & Other Total (In millions) Total revenues$ 9,423 $ 8,624 $ 4,057 $ 2,415 $ 6,612 $ 1,916 $ 357 $ 33,404 Less: Net investment gains (losses) 96 (11) 19 9 213 39 59 424 Less: Net derivative gains (losses) (577) (439) (104) (19) (1,038) (10) (133) (2,320) Less: Adjustments related to net investment gains (losses) and net derivative gains (losses) (6) - - - 3 5 - 2 Less: Other adjustments to revenues (1) (71) (85) 24 13 1,074 261 65 1,281 Total operating revenues$ 9,981 $ 9,159 $ 4,118 $ 2,412 $ 6,360 $ 1,621 $ 366 $ 34,017 Total expenses$ 8,365 $ 8,398 $ 3,083 $ 1,974 $ 6,837 $ 1,715 $ 1,224 $ 31,596 Less: Adjustments related to net investment gains (losses) and net derivative gains (losses) (176) - - - (11) 5 - (182) Less: Other adjustments to expenses (1) 395 - (35) (93) 1,474 274 304 2,319 Total operating expenses$ 8,146 $ 8,398 $ 3,118 $ 2,067 $ 5,374 $ 1,436 $ 920 $ 29,459
Six Months Ended
Group, Voluntary Corporate & Worksite Benefit Latin Corporate Retail Benefits Funding America Asia EMEA & Other Total (In millions) Total revenues$ 10,206 $ 8,806 $ 4,229
125 6 46
(10) (121) (36) (184) (174) Less: Net derivative gains (losses)
446 180 45 23 20 43 (643) 114 Less: Adjustments related to net investment gains (losses) and net derivative gains (losses) 3 - - - (2) 13 - 14 Less: Other adjustments to revenues (1) (32) (74) 39 129 162 280 475 979
Total operating revenues
Total expenses$ 8,676 $ 7,928 $ 3,176 $ 2,277 $ 5,546 $ 1,852 $ 1,930 $ 31,385 Less: Adjustments related to net investment gains (losses) and net derivative gains (losses) 51 - - - (2) 16 - 65 Less: Other adjustments to expenses (1) 288 - 25 326 158 287 991 2,075
Total operating expenses
$ 1,951 $ 5,390 $ 1,549 $ 939 $ 29,245
(1) See definitions of operating revenues and operating expenses for the
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Consolidated Results - Operating
Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 (In millions) OPERATING REVENUES Premiums$ 9,157 $ 9,139 $ 18,308 $ 18,246 Universal life and investment-type product policy fees 2,281 1,999 4,492 4,008 Net investment income 5,104 5,172 10,236 10,249 Other revenues 500 426 981 878 Total operating revenues 17,042 16,736 34,017 33,381 OPERATING EXPENSES Policyholder benefits and claims and policyholder dividends 9,204 9,132 18,310 18,071 Interest credited to policyholder account balances 1,521 1,525 3,075 3,064 Capitalization of DAC (1,212) (1,313) (2,468) (2,675) Amortization of DAC and VOBA 1,105 1,162 2,121 2,180 Amortization of negative VOBA (124) (164) (255) (301) Interest expense on debt 287 297 575 612 Other expenses 4,014 4,051 8,101 8,294 Total operating expenses 14,795 14,690 29,459 29,245 Provision for income tax expense (benefit) 623 583
1,269 1,179
Operating earnings 1,624 1,463 3,289 2,957 Less: Preferred stock dividends 31 31 61 61 Operating earnings available to common shareholders$ 1,593 $ 1,432 $ 3,228 $ 2,896
Three Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
The primary drivers of the increase in operating earnings were higher asset-based fee revenues, higher net investment income from portfolio growth and lower interest credited expenses, partially offset by lower yields and unfavorable mortality and claims experience. Changes in foreign currency exchange rates had a
We benefited from strong sales, as well as growth and higher persistency, in our business across many of our products. In 2013, we made additional changes to variable annuity guarantee features which, in combination with product changes made in 2012, resulted in a significant decrease in variable annuity sales in our Retail segment. The demand for fixed annuity products inJapan also declined as a result of a weakening yen and a sharp increase in equity markets, which decreased sales. However, as a result of significant positive net flows since the prior period, we experienced growth in our average separate account assets. Current period deposits and funding agreement issuances in our Corporate Benefit Funding segment resulted in growth in our investment portfolio. Positive net flows in our universal life business also contributed to portfolio growth. The increase in our investment portfolio generated higher net investment income of$82 million . Since many of our products are interest spread-based, the increase in net investment income was partially offset by a$72 million increase in interest credited expense, most notably in the Corporate Benefit Funding segment. The growth in our average separate account assets generated higher policy fee income of$126 million . A decrease in commissions, which was primarily driven by the decline in annuity sales, was partially offset by a decrease in 138
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related DAC capitalization and resulted in an$11 million increase in operating earnings. Overall business growth was the primary driver of higher DAC amortization of$68 million in the current period. Higher premiums partially offset by higher policyholder benefits in our international segments improved operating earnings by$49 million . Market factors, including the sustained low interest rate environment, continued to impact our investment yields as well as our crediting rates. Excluding the Divested Businesses, yields decreased as a result of the low interest rate environment, lower returns on real estate joint venture and alternative investments and lower inflation in theLatin America segment. These declines were partially offset by higher income on interest rate derivatives and the favorable impact of the continued repositioning of theJapan portfolio to higher yielding investments. A significant portion of these derivatives were entered into prior to the onset of the current low interest rate environment to mitigate the risk of low interest rates in the U.S. The low interest rate environment also resulted in lower interest credited expense as we set interest credited rates lower on both new business and certain in-force business with rate resets that are contractually tied to external indices or contain discretionary rate reset provisions. Our average separate account balance grew with the equity markets driving higher fee income in our annuity business. This continued positive equity market performance combined with the prior period having negative market performance also generated favorable DAC amortization. The changes in market factors discussed above resulted in an$89 million increase in operating earnings. Unfavorable claims experience was driven by higher claim frequencies and severities in our property & casualty businesses as well as higher claims incidence in our long-term care ("LTC"), accidental death and dismemberment ("AD&D") and dental businesses. This was partially offset by a decrease in catastrophe-related losses. In addition, favorable mortality in ourCorporate Benefit Funding and Group , Voluntary & Worksite Benefits segments was partially offset by less favorable mortality in our Retail segment. The combined impact of mortality and claims experience decreased operating earnings by$40 million . Certain insurance-related liability and DAC refinements in both the current and prior periods resulted in a net unfavorable impact of$25 million to operating earnings. Operating earnings increased by$52 million as a result of a tax benefit recorded in the current period to reflect the Company's decision to permanently reinvest certain foreign earnings. This was partially offset by a tax charge of$30 million , also in the current period, related to the write-off of a foreign tax loss carryforward. In addition, the Company benefited from the impact of certain other permanent tax differences, including non-taxable investment income and tax credits for low income housing. As a result, our effective tax rates differ from the U.S. statutory rate of 35%. In the second quarter of 2013, we benefited primarily from higher utilization of tax preferenced investments, which improved operating earnings by$8 million over the prior period.
Six Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
The primary drivers of the increase in operating earnings were higher asset-based fee revenues, higher net investment income from portfolio growth and lower interest credited expenses, partially offset by lower yields and unfavorable mortality and claims experience. In addition, the prior period included a$52 million charge representing a multi-state examination payment related to unclaimed property and our use of theU.S. Social Security Administration's Death Master File to identify potential life insurance claims, as well as the expected acceleration of benefit payments to policyholders under the settlements of such claims. Changes in foreign currency exchange rates had a$17 million negative impact on results compared to the prior period. We benefited from strong sales, as well as growth and higher persistency, in our business across many of our products. In 2013, we made additional changes to variable annuity guarantee features which, in 139
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combination with product changes made in 2012, resulted in a significant decrease in variable annuity sales in our Retail segment. The demand for fixed annuity products inJapan also declined as a result of a weakening yen and a sharp increase in equity markets, which decreased sales. However, as a result of significant positive net flows since the prior period, we experienced growth in our average separate account assets. Current period deposits and funding agreement issuances in our Corporate Benefit Funding segment resulted in growth in our investment portfolio. Positive net flows in our universal life business also contributed to portfolio growth. The increase in our investment portfolio generated higher net investment income of$170 million . Since many of our products are interest spread-based, the increase in net investment income was partially offset by a$142 million increase in interest credited expense, most notably in the Corporate Benefit Funding segment. The growth in our average separate account assets generated higher policy fee income of$246 million . A decrease in commissions, which was primarily driven by the decline in annuity sales, was partially offset by a decrease in related DAC capitalization, which combined, resulted in a$36 million increase to operating earnings. Overall business growth was the primary driver of higher DAC amortization of$138 million in the current period. Higher premiums partially offset by higher policyholder benefits in our international segments improved operating earnings by$81 million . Market factors, including the sustained low interest rate environment, continued to impact our investment yields as well as our crediting rates. Excluding the Divested Businesses, yields decreased as a result of the low interest rate environment, lower returns on real estate joint venture and alternative investments and lower inflation in theLatin America segment. These declines were partially offset by higher income on interest rate derivatives, improved private equity returns and the favorable impact of the continued repositioning of theJapan portfolio to higher yielding investments. A significant portion of these derivatives were entered into prior to the onset of the current low interest rate environment to mitigate the risk of low interest rates in the U.S. The low interest rate environment also resulted in lower interest credited expense as we set interest credited rates lower on both new business and certain in-force business with rate resets that are contractually tied to external indices or contain discretionary rate reset provisions. Our average separate account balance grew with the equity markets driving higher fee income in our annuity business. This continued positive equity market performance also generated favorable DAC amortization. The changes in market factors discussed above resulted in a$140 million increase in operating earnings. We experienced less favorable mortality in ourRetail and Group , Voluntary & Worksite Benefits segments. In our Group, Voluntary & Worksite Benefits segment, mixed claims experience, with a net unfavorable result was driven by an increase in claims incidence. In addition, higher claim frequencies in our property & casualty businesses were partially offset by a decrease in catastrophe-related losses. The combined impact of mortality and claims experience decreased operating earnings by$138 million . Certain insurance-related liability and DAC refinements in both the current and prior periods resulted in a net unfavorable impact of$20 million to operating earnings. Operating earnings increased by$52 million as a result of a tax benefit recorded in the second quarter of 2013 to reflect the Company's decision to permanently reinvest certain foreign earnings. This was partially offset by a tax charge of$30 million , also in the second quarter of 2013, related to the write-off of a foreign tax loss carryforward. In addition, the Company benefited from the impact of certain other permanent tax differences, including non-taxable investment income and tax credits for low income housing. As a result, our effective tax rates differ from the U.S. statutory rate of 35%. In the first half of 2013, we benefited primarily from higher utilization of tax preferenced investments, which improved operating earnings by$35 million over the prior period. 140
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Segment Results and Corporate & Other
Retail Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 (In millions) OPERATING REVENUES Premiums$ 1,581 $ 1,576 $ 3,128 $ 3,200 Universal life and investment-type product policy fees 1,238 1,119 2,405 2,233 Net investment income 1,987 1,894 3,948 3,805 Other revenues 257 217 500 426 Total operating revenues 5,063 4,806 9,981 9,664 OPERATING EXPENSES Policyholder benefits and claims and policyholder dividends 2,272 2,212 4,425 4,440 Interest credited to policyholder account balances 589 590 1,168 1,186 Capitalization of DAC (344) (446) (718) (922) Amortization of DAC and VOBA 396 477 727 881 Interest expense on debt 1 - 1 - Other expenses 1,265 1,355 2,543 2,752 Total operating expenses 4,179 4,188 8,146 8,337 Provision for income tax expense (benefit) 303 210 628 450 Operating earnings$ 581 $ 408 $ 1,207 $ 877
Three Months Ended
Unless otherwise stated, all amounts, with the exception of sales data, discussed below are net of income tax.
In 2013, the Company made additional changes to variable annuity guarantee features as we continue to manage sales volume, focusing on pricing discipline and risk management. These actions, in combination with product changes in 2012, resulted in a$1.9 billion , or 39% decrease in annuity sales. Variable and universal life sales were higher partially driven by accelerated sales subsequent to the announcement earlier this year that we will discontinue the sale of universal life policies with secondary guarantees; however, this was offset by lower traditional life sales. In our property & casualty business, policy sales increased 5% in the current period with premiums from the sales of new policies increasing 15% for both our auto and homeowners businesses as compared to the prior period. Positive net flows in our universal life business resulted in higher net investment income; however, this increase was partially offset by higher interest credited and an increase in DAC amortization. Despite the decline in annuity sales, we earned higher asset based fees as we had significant positive net flows since the prior period. Higher allocated equity also bolstered net investment income. Premium growth in our property & casualty business, coupled with an increase in average premium per policy in both our auto and homeowners businesses, improved operating earnings. The net impact of the above items resulted in a$62 million increase in operating earnings. Our average separate account balance also grew with the equity markets driving an increase in asset based fee income. This continued positive equity market performance combined with the prior period having negative market performance also generated favorable DAC amortization and drove higher income from other limited partnership interests. The impact of the low interest rate environment resulted in a decline in net investment income on our fixed maturity securities and mortgage loans as proceeds from maturing 141
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investments are reinvested at lower yields. Additionally, we had a lower crediting rate on allocated equity in the current period, which resulted in lower net investment income. These negative interest rate impacts were partially offset by higher income on interest rate derivatives. Lower returns on real estate joint ventures also decreased operating earnings. The net impact of these items resulted in a$115 million increase in operating earnings. With respect to our closed block, the impact of the low interest rate environment contributed to less favorable closed block experience resulting in a reduction to our dividend scale, which was announced in the fourth quarter of 2012. This dividend action favorably impacted operating earnings by$16 million , but was partially offset by the other earnings drivers of the closed block that were unfavorable. Less favorable mortality experience in the variable and universal life and traditional life businesses resulted in a$13 million decrease in operating earnings. In our property & casualty business, current period non-catastrophe claim costs increased$15 million , the result of higher frequencies and severities in both our auto and homeowners businesses. Catastrophe-related losses decreased$6 million as compared to the prior period. The impact of the items discussed above can be seen in the unfavorable change in the combined ratio, excluding catastrophes, to 86.1% in the current period, compared to 80.8% in the prior period, as well as the unfavorable change in the combined ratio including catastrophes to 107.5% in the current period compared to 105.4% in the prior period.
Refinements to DAC and certain insurance-related liabilities in both the current and prior periods resulted in an
Also contributing to the increase in operating earnings was a decline in expenses of
Six Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
Positive net flows, mainly in our universal life business, resulted in higher net investment income; however, this increase was partially offset by higher interest credited and an increase in DAC amortization. Despite a decline in annuity sales, we earned higher asset based fees as our average separate account assets grew due to significant positive net flows since the prior period. Higher allocated equity also bolstered net investment income. Premium growth in our property & casualty business, coupled with an increase in average premium per policy in both our auto and homeowners businesses, improved operating earnings. The net impact of the above items resulted in a$145 million increase in operating earnings. Our average separate account balance also grew with the equity markets driving an increase in asset based fee income. This continued equity market growth also drove higher income from other limited partnership interests and generated favorable DAC amortization. However, this growth in the equity markets resulted in a less favorable impact on our variable annuity guaranteed minimum death benefit costs as reinsurance recoverables were lower. The impact of the low interest rate environment resulted in a decline in net investment income on our fixed maturity securities and mortgage loans as proceeds from maturing investments are reinvested at lower yields. Additionally, we had a lower crediting rate on allocated equity in the current period, which resulted in lower net investment income. These negative interest rate impacts were partially offset by higher income on interest rate derivatives and lower interest credited expense as we reduced interest credited rates on contracts with discretionary rate reset provisions. Lower returns on real estate joint ventures also decreased operating earnings. The net impact of these items resulted in a$130 million increase in operating earnings. With respect to our closed block, the impact of the low interest rate environment contributed to less favorable closed block experience resulting in a reduction to our dividend scale, which was announced in the fourth quarter of 2012. This dividend action favorably impacted operating earnings by$34 million , but was mostly offset by the other earnings drivers of the closed block that were unfavorable. 142
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Less favorable mortality experience in the variable and universal life, traditional life, and income annuities businesses resulted in a$37 million decrease in operating earnings; however, this was partially offset by the$26 million favorable impact of a prior period charge for the expected acceleration of benefit payments to policyholders under a multi-state examination related to unclaimed property. In our property & casualty business, current period non-catastrophe claim costs increased$28 million , the result of higher frequencies and severities in both our auto and homeowners businesses. Catastrophe-related losses were essentially flat as compared to the prior period. The impact of the items discussed above can be seen in the unfavorable change in the combined ratio, excluding catastrophes, to 87.4% in the current period, compared to 83.9% in the prior period, as well as an unfavorable change in the combined ratio including catastrophes to 101.0% in the current period compared to 98.3% in the prior period.
Refinements to DAC and certain insurance-related liabilities in both the current and prior periods resulted in a
Also contributing to the increase in operating earnings was a decline in expenses of
Group, Voluntary & Worksite Benefits
Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 (In millions) OPERATING REVENUES Premiums$ 3,797 $ 3,683 $ 7,671 $ 7,268 Universal life and investment-type product policy fees 170 165 350 331 Net investment income 472 439 925 875 Other revenues 105 112 213 220 Total operating revenues 4,544 4,399 9,159 8,694 OPERATING EXPENSES Policyholder benefits and claims and policyholder dividends 3,514 3,391 7,154 6,704 Interest credited to policyholder account balances 39 43 78 85 Capitalization of DAC (35 ) (33 ) (68 ) (64 ) Amortization of DAC and VOBA 33 28 67 58 Interest expense on debt 1 - 1 - Other expenses 578 570 1,166 1,145 Total operating expenses 4,130 3,999 8,398 7,928 Provision for income tax expense (benefit) 139 133 256 256 Operating earnings$ 275 $ 267 $ 505 $ 510
June 30, 2013 Compared with the Three Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
Economic recovery has remained slow and unsteady, although we continue to see signs of improvement to the macro-economic environment that should continue to instill confidence in the economy and spur stronger growth. We have seen growth in premiums from our dental, disability and group term life businesses generated through improved persistency, increased covered lives, the positive impact of pricing actions on existing business, and new sales. Our dental business also continues to benefit from the implementation of a large contract that began in the second quarter of 2012. Although we have discontinued 143
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selling our LTC product, we continue to collect premiums and administer the existing block of business, contributing to asset growth in the segment. Property & casualty policy sales increased 45% in the second quarter of 2013 as compared to the same period in 2012. Premium related to the sales of new policies increased 34% for both our auto and homeowners businesses in the second quarter of 2013 compared to the same period in 2012.
The impact of market factors, including higher returns on other limited partnership interests and real estate joint ventures, in combination with increased derivative income on interest rate floors and increased prepayment fee income resulted in improved investment yields. Unlike in the Retail and Corporate Benefit Funding segments, a change in investment yield does not necessarily drive a corresponding change in the rates credited on certain insurance liabilities. The increase in investment yield, as well as lower crediting rates in the current period, contributed
An increase in allocated equity and growth in current period premiums and deposits, partially offset by a reduction in other liabilities, resulted in an increase in our average invested assets, increasing operating earnings by$3 million . Consistent with the growth in average invested assets from current period premiums and deposits, primarily in our LTC business, interest credited on long-duration contracts and policyholder account balances increased by$5 million . The increase in average premium per policy in both auto and homeowners businesses improved operating earnings by$8 million and an increase in exposures resulted in a$3 million increase in operating earnings as the positive impact from higher premiums exceeded the negative impact from higher claims. Exposures are primarily each automobile for the auto line of business and each residence for the property line of business. An increase in claims incidence in our LTC, AD&D and dental businesses resulted in a$22 million decrease in operating earnings. Driving this decrease in operating earnings were higher paid claims in both our LTC and AD&D businesses, coupled with an increase in utilization in our dental business. Current period property & casualty non-catastrophe claim costs increased$9 million as a result of higher frequencies and severities in both our auto and homeowners businesses. In addition, favorable development of prior year non-catastrophe losses was lower, which reduced operating earnings by$7 million . The negative impact of these items was partially offset by a decrease in catastrophe-related losses of$14 million as compared to the prior period. Also, our life businesses experienced favorable mortality in the current period, mainly due to lower severity in the group universal life business, which was partially offset by less favorable claims experience in the group term life business, resulting in an increase in operating earnings of$6 million . The impact of the items discussed above related to the property & casualty business can be seen in the unfavorable change in the combined ratio, excluding catastrophes, to 92.1% in the current period from 86.6% in the prior period. The combined ratio, including catastrophes, however, yielded a favorable change to 97.7% in the current period from 98.7% in the prior period.
Six Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
An increase in claims incidence in our LTC, disability, and AD&D businesses, partially offset by favorable claims experience in our dental business, resulted in a$36 million decrease in operating earnings. Driving the decrease in operating earnings were higher paid claims in our LTC, disability and AD&D businesses, partially offset by lower utilization in our dental business. Our life businesses experienced unfavorable mortality in the current period, mainly due to less favorable claims experience in the group term life business, partially offset by lower severity in the group universal life business, resulting in a decrease in operating earnings of$16 million . Current period property & casualty non-catastrophe claim costs increased$17 million as a result of higher frequencies in both our auto and homeowners businesses. In addition, favorable development of prior year non-catastrophe losses was lower, which reduced operating results by$12 million . The negative impact of these items was partially offset by a decrease in catastrophe-related 144
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losses of$14 million as compared to the prior period, as well as a decrease in severities in both our auto and homeowners businesses of$8 million . The impact of the items discussed above related to the property & casualty business can be seen in the unfavorable change in the combined ratio, excluding catastrophes, to 91.3% in the current period from 88.2% in the prior period. The combined ratio, including catastrophes, however, yielded a favorable change to 95.3% in the current period from 95.5% in the prior period.
The impact of market factors, including higher returns on other limited partnership interests and real estate joint ventures, in combination with increased derivative income on interest rate floors and increased prepayment fee income resulted in improved investment yields. Unlike in the Retail and Corporate Benefit Funding segments, a change in investment yield does not necessarily drive a corresponding change in the rates credited on certain insurance liabilities. The increase in investment yield, as well as lower crediting rates in the current period, contributed
An increase in allocated equity and growth in current period premiums and deposits, partially offset by a reduction in other liabilities, resulted in an increase in our average invested assets, increasing operating earnings by$7 million . Consistent with the growth in average invested assets from current period premiums and deposits, primarily in our LTC business, interest credited on long-duration contracts and policyholder account balances increased by$9 million . The increase in average premium per policy in both auto and homeowners businesses improved operating earnings by$18 million and an increase in exposures resulted in a$3 million increase in operating earnings as the positive impact from higher premiums exceeded the negative impact from higher claims. Corporate Benefit Funding Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 (In millions) OPERATING REVENUES Premiums$ 503 $ 523 $ 967 $ 1,030 Universal life and investment-type product policy fees 65 57 133 108 Net investment income 1,443 1,431 2,878 2,832 Other revenues 67 65 140 129 Total operating revenues 2,078 2,076 4,118 4,099 OPERATING EXPENSES Policyholder benefits and claims and policyholder dividends 1,110 1,131 2,208 2,223 Interest credited to policyholder account balances 305 338 648 677 Capitalization of DAC (6 ) (8 ) (23 ) (15 ) Amortization of DAC and VOBA 6 4 17 14 Interest expense on debt 2 2 4 4 Other expenses 121 120 264 248 Total operating expenses 1,538 1,587 3,118 3,151 Provision for income tax expense (benefit) 190 171 351 332 Operating earnings$ 350 $ 318 $ 649 $ 616
Three Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
The sustained low interest rate environment has contributed to pension plans being underfunded, which limits our customers' ability to engage in full pension plan closeout terminations, and is reflected by a 145
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decrease in premiums of$45 million , before income tax. While we have experienced a decline inU.K. closeout premiums, we have seen modest growth in our closeout premiums in the U.S. However, we expect that customers may choose to close out portions of pension plans over time, at costs reflecting current interest rates and availability of capital. In addition, structured settlement sales were lower reflecting a more competitive market. These premium decreases were partially offset by a 62% increase in income annuity sales driven by employee actions on two contracts. Changes in premiums for these businesses were almost entirely offset by the related changes in policyholder benefits. The impact of current period deposits and funding agreement issuances contributed to an increase in invested assets, resulting in an increase of$66 million in operating earnings. Growth in deposits and funding agreement issuances generally results in a corresponding increase in interest credited on certain insurance liabilities; this decreased operating earnings by$46 million compared to the prior period. The low interest rate environment continued to impact our investment returns, as well as interest credited on certain insurance liabilities. Lower investment returns on our fixed maturity securities and mortgage loans were partially offset by increased earnings on other limited partnership interests and interest rate derivatives. Many of our funding agreement and guaranteed interest contract liabilities have interest credited rates that are contractually tied to external indices and, as a result, we set lower interest credited rates on new business, as well as on existing business with terms that can fluctuate. The net impact of lower investment returns and lower interest credited expense resulted in an increase in operating earnings of$6 million . More favorable mortality, primarily in the domestic closeout business, resulted in a$17 million increase in operating earnings. The net impact of insurance liability refinements in the current and prior periods decreased operating earnings by$6 million . Operating earnings also decreased$3 million primarily driven by higher information technology costs in the current period.
Six Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
The impact of current period deposits and funding agreement issuances contributed to an increase in invested assets, resulting in an increase of$156 million in operating earnings. Growth in deposits and funding agreement issuances generally results in a corresponding increase in interest credited on certain insurance liabilities; this decreased operating earnings by$96 million compared to the prior period.
Operating earnings increased
The low interest rate environment continued to impact our investment returns, as well as interest credited on certain insurance liabilities. Lower investment returns on our fixed maturity securities and mortgage loans were partially offset by increased earnings on other limited partnership interests and interest rate derivatives. Many of our funding agreement and guaranteed interest contract liabilities have interest credited rates that are contractually tied to external indices and, as a result, we set lower interest credited rates on new business, as well as on existing business with terms that can fluctuate. The positive impact of lower interest credited rates was partially offset by an increase in interest credited expense resulting from the impact of derivatives that are used to hedge certain insurance liabilities. The net impact of lower investment returns and lower interest credited expense resulted in a decrease in operating earnings of$17 million .
Mortality results were mixed across products and resulted in a
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Table of ContentsLatin America Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 (In millions) OPERATING REVENUES Premiums$ 710 $ 652 $ 1,385 $ 1,338 Universal life and investment-type product policy fees 235 196 460 392 Net investment income 281 283 558 582 Other revenues 5 3 9 8 Total operating revenues 1,231 1,134 2,412 2,320 OPERATING EXPENSES Policyholder benefits and claims and policyholder dividends 601 568 1,155 1,160 Interest credited to policyholder account balances 103 90 207 190 Capitalization of DAC (108) (71) (213) (155) Amortization of DAC and VOBA 83 54 157 109 Amortization of negative VOBA - (1 ) (1 ) (3) Interest expense on debt 1 - - 1 Other expenses 390 323 762 649 Total operating expenses 1,070 963 2,067 1,951 Provision for income tax expense (benefit) 36 36 77 86 Operating earnings$ 125 $ 135 $ 268 $ 283
Three Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
Operating earnings decreased by$10 million from the prior period. The impact of changes in foreign currency exchange rates increased operating earnings by$6 million for the second quarter of 2013 compared to the prior period.Latin America experienced strong sales growth primarily driven by accident and health products inMexico ,Argentina andBrazil . Changes in premiums for these products were almost entirely offset by the related changes in policyholder benefits. The growth in our businesses drove an increase in average invested assets, which generated higher net investment income and higher policy fee income, partially offset by a corresponding increase in interest credited on certain insurance liabilities. However, the increase in sales also generated a more significant increase in operating expenses and commissions, which were partially offset by a corresponding increase in DAC capitalization. The items discussed above were the primary drivers of an$8 million decrease in operating earnings. Market factors contributed to a$4 million increase in operating earnings, primarily due to improved yields on fixed maturity securities inArgentina and a decrease in interest credited expense inMexico . In addition, lower inflation in the current period resulted in a decrease in policyholder benefits, which was partially offset by a corresponding decrease in net investment income. These increases in operating earnings were partially offset by lower returns on fixed maturity securities inBrazil and lower income on currency related derivatives inChile .
Higher expenses, primarily generated by employee-related costs, decreased earnings by
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unfavorable claims experience of$4 million . The net impact of refinements to DAC and certain insurance-related liabilities in both periods resulted in an$11 million increase in operating earnings.
Six Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
Operating earnings decreased by$15 million from the prior period. The impact of changes in foreign currency exchange rates increased operating earnings by$4 million for the first half of 2013 compared to the prior period.Latin America experienced strong sales growth primarily driven by retirement products inMexico and by accident and health products inMexico ,Argentina andBrazil . Changes in premiums for these products were almost entirely offset by the related changes in policyholder benefits. The growth in our businesses drove an increase in average invested assets, which generated higher net investment income and higher policy fee income, partially offset by a corresponding increase in interest credited on certain insurance liabilities. However, the increase in sales also generated a more significant increase in operating expenses and commissions, which were partially offset by a corresponding increase in DAC capitalization. The items discussed above were the primary drivers of a$3 million decrease in operating earnings. Market factors contributed to an$8 million decrease in operating earnings. A decrease in investment yields was primarily attributable to lower returns on fixed maturity securities, primarily inBrazil , and lower income on currency related derivatives inChile . In addition, a decrease in net investment income from lower inflation in the current year was partially offset by a corresponding decrease in policyholder benefits. These decreases were partially offset by improved yields on fixed maturity securities, primarily inArgentina , and a decrease in interest credited expense inMexico .
Higher expenses, primarily generated by employee-related costs, decreased earnings by
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Table of ContentsAsia Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 (In millions) OPERATING REVENUES Premiums$ 1,980 $ 2,064 $ 3,978 $ 4,103 Universal life and investment-type product policy fees 442 352 886 714 Net investment income 723 760 1,455 1,441 Other revenues 28 (3) 41 13 Total operating revenues 3,173 3,173 6,360 6,271 OPERATING EXPENSES Policyholder benefits and claims and policyholder dividends 1,433 1,435 2,848 2,795 Interest credited to policyholder account balances 437 426 879 855 Capitalization of DAC (522) (555) (1,068) (1,142) Amortization of DAC and VOBA 392 419 793 792 Amortization of negative VOBA (113) (128) (226) (259) Interest expense on debt - 4 - 5 Other expenses 1,054 1,153 2,148 2,344 Total operating expenses 2,681 2,754 5,374 5,390 Provision for income tax expense (benefit) 162 140 323 301 Operating earnings$ 330 $ 279 $ 663 $ 580
Three Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
Operating earnings increased by$51 million over the prior period. The impact of changes in foreign currency exchange rates reduced operating earnings by$19 million for the second quarter of 2013 compared to the prior period.Asia experienced sales growth over the prior period driven by strong life and accident and health sales inJapan . Growth inJapan was dampened by the impact of a consumer shift away from foreign currency denominated retirement products in light of a weaker yen and higher equity markets, which resulted in a decline in fixed annuity sales and an increase in surrender activity. InAustralia , sales increased 82% over the prior period as the business benefitted from a number of successful group sales. InIndia , sales increased 36% over the prior period as our new relationship with Punjab National Bank continued to drive results.Asia's premiums and fee income increased over the prior period primarily driven by growth of ordinary life and accident & health products inJapan and group insurance inAustralia . Higher surrenders of fixed annuity products inJapan also contributed to higher fee income and higher DAC amortization. Changes in premiums for these businesses were partially offset by related changes in policyholder benefits. Average invested assets increased over the prior period, reflecting positive cash flows from our life business inJapan , which generated an increase in net investment income. However, this was more than offset by an increase in interest credited to policyholders. The combined impact of the items discussed above improved operating earnings by$65 million . Investment yields were negatively impacted by lower returns on private equity investments and the adverse impact of the low interest rate environment on our mortgage loans, partially offset by increased 149
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yields from the continued repositioning of the
Prior period results include the unfavorable impact of changes in actuarial assumptions of
Six Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
Operating earnings increased by$83 million over the prior period. The impact of changes in foreign currency exchange rates reduced operating earnings by$23 million for the first half of 2013 compared to the prior period. A sharp weakening in the Japanese yen combined with equity market increases drove a shift in consumer preferences away from foreign currency denominated retirement products, which resulted in lower fixed annuity sales and higher surrenders inJapan . The sales decline in retirement products was partially offset by strong life and accident and health sales across the region, particularly inJapan , during the second quarter of 2013. Sales inIndia increased 39% compared to the prior period as the business benefited from our new relationship with Punjab National Bank.Asia's premiums and fee income increased over the prior period primarily driven by growth in ordinary life, variable life and accident & health products inJapan andKorea and group insurance inAustralia . Higher surrenders of fixed annuity products inJapan also contributed to higher fee income and higher DAC amortization. Changes in premiums for these businesses were partially offset by related changes in policyholder benefits. Positive net flows resulted in an increase in average invested assets over the prior period, generating an increase in net investment income inJapan , however, this was offset by an increase in interest credited to policyholders. The combined impact of the items discussed above improved operating earnings by$90 million . Investment yields increased from the continued repositioning of theJapan investment portfolio to higher yielding investments and higher prepayment fees, partially offset by lower returns on other limited partnership interests. These improvements in investment yields combined with the positive impact of foreign currency hedges increased operating earnings by$38 million .
Current period results include an unfavorable liability refinement of
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Table of Contents EMEA Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 (In millions) OPERATING REVENUES Premiums$ 558 $ 627 $ 1,125 $ 1,279 Universal life and investment-type product policy fees 96 71 187 151 Net investment income 120 127 248 284 Other revenues 34 27 61 63 Total operating revenues 808
852 1,621 1,777
OPERATING EXPENSES Policyholder benefits and claims and policyholder dividends 256 343 493 686 Interest credited to policyholder account balances 37 26 72 59 Capitalization of DAC (192) (200) (369) (377) Amortization of DAC and VOBA 195 180 360 326 Amortization of negative VOBA (11) (35) (28) (39) Interest expense on debt (1) 1 - 1 Other expenses 460 422 908 893 Total operating expenses 744
737 1,436 1,549
Provision for income tax expense (benefit) (4) 37 30 78 Operating earnings$ 68 $ 78 $ 155 $ 150
Three Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
Operating earnings decreased by$10 million from the prior period. There was essentially no impact to operating earnings due to changes in foreign currency exchange rates for the second quarter 2013 compared to the prior period. The third quarter 2012 acquisition of life insurance businesses in theCzech Republic ,Hungary andRomania from the members of the Aviva Plc. group increased operating earnings by$6 million . This was offset by the disposal of certain blocks of business in theU.K. in the first quarter of 2013, which decreased operating earnings by$7 million . Operating earnings decreased as a result of a$30 million tax charge in the current period related to the write-off of aU.K. tax loss carryforward. Operating earnings were negatively impacted by a$26 million write-down of DAC and insurance intangible assets related to proposed pension reforms inPoland . In addition, prior period results benefited by$12 million primarily due to a release of negative VOBA associated with the conversion of certain policies. These items were partially offset by a$52 million tax benefit recorded in the current period to reflect the Company's decision to permanently reinvest certain foreign earnings. While sales increased compared to the prior period, this business growth was somewhat dampened by challenging economic environments in some European countries. This business growth was driven primarily byTurkey ,Russia and the Persian Gulf, partially offset by management's decision to cease fixed annuity sales in theU.K. Operating expenses decreased primarily inFrance ,Poland andGreece as a result of expense reduction initiatives; however, this was more than offset by higher corporate allocations. The combined impact of the items discussed above increased operating earnings by$5 million . 151
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An increase in average invested assets inIreland ,Poland andRussia in the second quarter of 2013 contributed to an increase in operating earnings of$6 million . Operating earnings decreased$4 million reflecting lower investment yields on certain alternative asset classes including mutual fund investments, primarily inGreece , and floating-rate securities, primarily inIreland andPoland .
Six Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
Operating earnings increased by$5 million over the prior period. The impact of changes in foreign currency exchange rates increased operating earnings by$2 million for the first half 2013 compared to the prior period. The third quarter 2012 acquisition of life insurance businesses in theCzech Republic ,Hungary andRomania from the members of the Aviva Plc. group increased operating earnings by$10 million . This was partially offset by the disposal of certain blocks of business in theU.K. in the first quarter of 2013, which decreased operating earnings by$22 million . Operating earnings decreased as a result of a$30 million tax charge in the second quarter of 2013 related to the write-off of aU.K. tax loss carryforward. Operating earnings were negatively impacted by a$26 million write-down of DAC and insurance intangible assets related to proposed pension reforms inPoland . In addition, prior period results benefited by$12 million primarily due to a release of negative VOBA associated with the conversion of certain policies. These items were partially offset by a$52 million tax benefit recorded in the second quarter of 2013 to reflect the Company's decision to permanently reinvest certain foreign earnings. In addition, operating earnings benefited from adjustments totaling$8 million inGreece for liability refinements in our ordinary and deferred annuity businesses, as well as the impact of a change in the local corporate tax rate, both in the first quarter of 2013. While sales increased compared to the prior period, this business growth was somewhat dampened by challenging economic environments in some European countries. This business growth was driven primarily byTurkey ,Russia and the Persian Gulf, partially offset by management's decision to cease fixed annuity sales in theU.K. Operating expenses decreased primarily inFrance ,Poland andGreece as a result of expense reduction initiatives; however, this was more than offset by higher corporate allocations. The combined impact of the items discussed above increased operating earnings by$36 million .
An increase in average invested assets due to growth in
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Table of Contents Corporate & Other Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 (In millions) OPERATING REVENUES Premiums$ 28 $ 14 $ 54 $ 28 Universal life and investment-type product policy fees 35 39 71 79 Net investment income 78 238 224 430 Other revenues 4 5 17 19 Total operating revenues 145 296 366 556 OPERATING EXPENSES Policyholder benefits and claims and policyholder dividends 18 52 27 63 Interest credited to policyholder account balances 11 12 23 12 Capitalization of DAC (5) - (9) - Interest expense on debt 283 290 569 601 Other expenses 146 108 310 263 Total operating expenses 453 462 920 939 Provision for income tax expense (benefit) (203)
(144) (396) (324)
Operating earnings (105) (22) (158) (59) Less: Preferred stock dividends 31 31 61 61
Operating earnings available to common shareholders
Three Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
Operating earnings available to common shareholders and operating earnings each decreased$83 million , primarily due to lower net investment income and higher other expenses. These decreases were partially offset by an increase in the earnings of our assumed reinsurance of a variable annuity business and a higher tax benefit in the second quarter of 2013. Net investment income decreased$104 million , excluding the divestedMetLife Bank operations, driven by an increase in the amount credited to the segments due to growth in the economic capital managed by Corporate & Other on their behalf and lower returns from our real estate joint venture and alternative investments and fixed maturity securities. Other expenses increased by$12 million , primarily due to increases in interest on uncertain tax positions, other employee-related costs, costs associated with a change in the dividend structure from annually to quarterly and higher advertising costs, partially offset by lower internal resource costs for associates committed to the American Life Insurance Company andDelaware American Life Insurance Company (collectively, "ALICO") acquisition. Costs associated with the Company's enterprise-wide strategic initiative were essentially flat as compared to the prior period, however, the portion that represents employee-related restructuring charges decreased by$3 million . Operating earnings associated with the assumed reinsurance of certain variable annuity products from our former operating joint venture inJapan increased$26 million . This was primarily due to a decrease in benefit liabilities resulting from higher returns in the underlying funds. 153
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Corporate & Other benefits from the impact of certain permanent tax differences, including non-taxable investment income and tax credits for investments in low income housing. As a result, our effective tax rates differ from the U.S. statutory rate of 35%. In 2013, we benefited primarily from higher utilization of tax preferenced investments which improved operating earnings by$9 million from the prior period.
Six Months Ended
Unless otherwise stated, all amounts discussed below are net of income tax.
Operating earnings available to common shareholders and operating earnings each decreased$99 million , primarily due to lower net investment income, higher other expenses and lower earnings on invested assets that were funded usingFederal Home Loan Bank ("FHLB") advances. These decreases were partially offset by higher operating earnings from the assumed reinsurance of a variable annuity business and a higher tax benefit over the prior period. Net investment income decreased$107 million , excluding theFHLB which is discussed below and the divestedMetLife Bank operations, driven by an increase in the amount credited to the segments due to growth in the economic capital managed by Corporate & Other on their behalf and lower returns from our real estate joint venture and alternative investments and fixed maturity securities. In the first quarter of 2012, the Company benefited from the positive resolution of certain legal matters totaling$16 million . In the current period, the Company incurred$8 million of higher costs associated with its enterprise-wide strategic initiative, of which$1 million represents employee-related restructuring charges. In addition, the current period included higher costs associated with interest on uncertain tax positions, higher employee-related costs, and costs associated with a change in the dividend structure from annually to quarterly and higher advertising costs, which combined totaled$28 million . Partially offsetting these costs was a prior period charge of$26 million , representing a multi-state examination payment related to unclaimed property andMetLife's use of theU.S. Social Security Administration's Death Master File. In addition, the current period included$12 million of lower internal resource costs for associates committed to the ALICO acquisition. Operating earnings on invested assets that were funded usingFHLB advances decreased$10 million , reflected by decreases in net investment income and interest expense on debt, due to the transfer of$3.8 billion ofFHLB advances and underlying assets fromMetLife Bank to Corporate Benefit Funding inApril 2012 . Operating earnings associated with the assumed reinsurance of certain variable annuity products from our former operating joint venture inJapan increased$34 million . This was primarily due to a decrease in benefit liabilities resulting from higher returns in the underlying funds. Corporate & Other benefits from the impact of certain permanent tax differences, including non-taxable investment income and tax credits for investments in low income housing. As a result, our effective tax rates differ from the U.S. statutory rate of 35%. In 2013, we benefited primarily from higher utilization of tax preferenced investments which improved operating earnings by$12 million from the prior year. Investments Investment Risks Our primary investment objective is to optimize, net of income tax, risk-adjusted investment income and risk-adjusted total return while ensuring that assets and liabilities are managed on a cash flow and duration basis. We are exposed to the following primary sources of investment risk:
• credit risk, relating to the uncertainty associated with the continued
ability of a given obligor to make timely payments of principal and interest;
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• interest rate risk, relating to the market price and cash flow variability
associated with changes in market interest rates. Changes in market interest
rates can result from governmental monetary policies, domestic and
international economic and political conditions, and other factors beyond our
control, and will impact the net unrealized gain or loss position of our
fixed income investment portfolio and the rates of return we receive on both
new funds invested and reinvestment of existing funds. • liquidity risk, relating to the diminished ability to sell certain investments, in times of strained market conditions;
• market valuation risk, relating to the variability in the estimated fair
value of investments associated with changes in market factors such as credit
spreads. A widening of credit spreads will adversely impact the net
unrealized gain (loss) position of the fixed income investment portfolio,
will increase losses associated with credit-based non-qualifying derivatives
where we assume credit exposure, and, if credit spreads widen significantly
or for an extended period of time, will likely result in higher
other-than-temporary impairments ("OTTI"). Credit spread tightening will
reduce net investment income associated with purchases of fixed maturity
securities and will favorably impact the net unrealized gain (loss) position
of the fixed income investment portfolio.
• currency risk, relating to the variability in currency exchange rates for
foreign denominated investments. This risk relates to potential decreases in
estimated fair value and income resulting from a strengthening or weakening
in currency exchange rates versus the U.S. dollar. In general, the weakening
of foreign currencies versus the U.S. dollar will adversely affect the estimated fair value of our foreign denominated investments; and
• real estate risk, relating to commercial, agricultural and residential real
estate, and stemming from factors, which include, but are not limited to,
market conditions including the demand and supply of leasable commercial
space, creditworthiness of tenants and partners, capital markets volatility
and the inherent interest rate movement.
We manage investment risk through in-house fundamental credit analysis of the underlying obligors, issuers, transaction structures and real estate properties. We also manage credit risk, market valuation risk and liquidity risk through industry and issuer diversification and asset allocation. For commercial, agricultural and residential assets, we manage credit risk and market valuation risk through geographic, property type and product type diversification and asset allocation. We manage interest rate risk as part of our asset and liability management strategies. These strategies include maintaining an investment portfolio with diversified maturities that has a weighted average duration that is approximately equal to the duration of our estimated liability cash flow profile through product design, such as the use of market value adjustment features and surrender charges. We also manage interest rate risk through proactive monitoring and management of certain non-guaranteed elements of our products, such as the resetting of credited interest and dividend rates for policies that permit such adjustments. In addition to hedging with foreign currency derivatives, we manage currency risk by matching much of our foreign currency liabilities in our foreign subsidiaries with their respective foreign currency assets, thereby reducing our risk to foreign currency exchange rate fluctuation. We also use certain derivatives in the management of credit, interest rate, and equity market risks. We use purchased credit default swaps to mitigate credit risk in our investment portfolio. Generally, we purchase credit protection by entering into credit default swaps referencing the issuers of specific assets we own. In certain cases, basis risk exists between these credit default swaps and the specific assets we own. For example, we may purchase credit protection on a macro basis to reduce exposure to specific industries or other portfolio concentrations. In such instances, the referenced entities and obligations under the credit default swaps may not be identical to the individual obligors or securities in our investment portfolio. In addition, our purchased credit default swaps may have shorter tenors than the underlying investments they are hedging. However, we dynamically hedge this risk through the rebalancing and rollover of its credit default swaps at their most liquid tenors. We believe that our purchased credit default swaps serve as effective legal and economic hedges of our credit exposure. 155
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We generally enter into market standard purchased and written credit default swap contracts. Payout under such contracts is triggered by certain credit events experienced by the referenced entities. For credit default swaps covering North American corporate issuers, credit events typically include bankruptcy and failure to pay on borrowed money. For European corporate issuers, credit events typically also include involuntary restructuring. With respect to credit default contracts on Western European sovereign debt, credit events typically include failure to pay debt obligations, repudiation, moratorium, or involuntary restructuring. In each case, payout on a credit default swap is triggered only after theCredit Derivatives Determinations Committee of the International Swaps andDerivatives Association deems that a credit event has occurred.
Current Environment
The global economy and markets continue to be affected by stress and volatility, which has adversely affected the financial services sector in particular and global capital markets. As a global insurance company, we are affected by the monetary policy of central banks around the world. Inthe United States , theFederal Reserve Board has taken a number of policy actions in recent years to spur economic activity, by keeping interest rates low and, more recently, through its asset purchase programs. See "- Industry Trends - Impact of a Sustained Low Interest Rate Environment" for information on actions taken by theFederal Reserve Board and central banks around the world to support the economic recovery. See "- Industry Trends - Financial and Economic Environment" for information on actions taken byJapan's central government and the Bank of Japan to end deflation and achieve sustainable economic growth inJapan . TheFederal Reserve Board and other central banks may take further actions to influence interest rates in the future, which may have an impact on the pricing levels of risk-bearing investments and may adversely impact the level of product sales. European Region Investments. ExcludingEurope's perimeter region andCyprus which is discussed below, our holdings of sovereign debt, corporate debt and perpetual hybrid securities in certainEuropean Union member states and other countries in the region that are not members of theEuropean Union (collectively, the "European Region ") were concentrated in theUnited Kingdom ,Germany ,France ,the Netherlands ,Poland ,Norway andSweden . The sovereign debt of these countries continues to maintain the highest credit ratings from all major rating agencies. In theEuropean Region , we have proactively mitigated risk in both direct and indirect exposures by investing in a diversified portfolio of high quality investments with a focus on the higher-rated countries. Sovereign debt issued by countries outside ofEurope's perimeter region andCyprus comprised$8.6 billion , or over 99% of ourEuropean Region sovereign fixed maturity securities, at estimated fair value atJune 30, 2013 .The European Region corporate securities (fixed maturity and perpetual hybrid securities classified as non-redeemable preferred stock) are invested in a diversified portfolio of primarily non-financial services securities, which comprised$25.1 billion , or 75% ofEuropean Region total corporate securities, at estimated fair value atJune 30, 2013 . Of theseEuropean Region sovereign fixed maturity and corporate securities, 91% were investment grade and, for the 9% that were below investment grade, the majority were non-financial services corporate securities atJune 30, 2013 .European Region financial services corporate securities at estimated fair value were$8.6 billion , including$6.6 billion within the banking sector, with 94% invested in investment grade rated corporate securities, atJune 30, 2013 .Europe's Perimeter Region andCyprus . Concerns about the economic conditions, capital markets and the solvency of certainEuropean Union member states, includingEurope's perimeter region andCyprus and of financial institutions that have significant direct or indirect exposure to their sovereign debt continue to create market volatility. This market volatility will likely continue to affect the performance of various asset classes in 2013, and perhaps longer, until there is an ultimate resolution of theseEuropean Union sovereign debt-related concerns. TheMarch 2012 restructuring ofGreece domestic law sovereign debt had an adverse impact on the capital level ofCyprus' largest financial institutions, which triggered downgrades ofCyprus sovereign debt. InApril 2013 , theEuropean Union approved a €10 billion financial support program forCyprus , the first tranche of which was released inMay 2013 . This official support program includes financing to coverCyprus government's needs over a three year period. It also includes a restructuring ofCyprus banking, tax and financial systems. 156
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These restructurings, which adversely impact private investors, private creditors and uninsured depositors of the two largest banks, are intended to avoid a default of
As a result of concerns about the ability ofEurope's perimeter region andCyprus to service its sovereign debt, certain of these countries have experienced credit rating downgrades. Despite official financial support programs for the most stressed governments inEurope's perimeter region andCyprus , concerns about sovereign debt sustainability have expanded to otherEuropean Union member states. As a result, several otherEuropean Union member states experienced credit rating downgrades or had their credit rating outlook changed to negative.
As presented in the table below, we have an insignificant exposure to the sovereign debt of
Due to the current level of economic, fiscal and political strain inEurope's perimeter region andCyprus , we continually monitor and adjust our level of investment exposure in these countries. We manage direct and indirect investment exposure in these countries through fundamental credit analysis. The following table presents a summary of investments by invested asset class and related purchased credit default protection acrossEurope's perimeter region, by country, andCyprus . The Company has written credit default swaps where the underlying is an index comprised of companies across various sectors in the European region. AtJune 30, 2013 , the written credit default swaps exposure toEurope's perimeter region andCyprus amounted to$18 million in notional and less than$1 million in estimated fair value. The information below is presented on a country of risk basis (e.g. the country where the issuer primarily conducts business). Summary of Select European Country Investment Exposure at June 30, 2013 (1) (2) Fixed Maturity Securities (1) All Other General Non- Account Total Purchased Financial Financial Investment Exposure Credit Default Net Sovereign Services Services Total Exposure (2) (3) %
Protection (4) Exposure %
(In millions) (In millions)Europe's perimeter region: Portugal $ - $ -$ 55 $ 55 $ 10$ 65 2% $ -$ 65 2% Italy 3 88 675 766 91 857 30 (3) 854 30 Ireland - - 155 155 951 1,106 39 - 1,106 39 Greece 3 - - 3 117 120 4 - 120 4 Spain - 96 498 594 46 640 22 - 640 22 Total Europe's perimeter region 6 184 1,383 1,573 1,215 2,788 97 (3) 2,785 97 Cyprus 72 - - 72 4 76 3 - 76 3 Total$ 78 $ 184 $ 1,383 $ 1,645 $ 1,219 $ 2,864 100% $ (3)$ 2,861 100% As percent of total cash and invested assets 0.0% 0.0% 0.3% 0.3% 0.3% 0.6% 0.0% 0.6% Investment grade percent 5% 94% 94% Non-investment grade percent 95% 6% 6%
(1) Presented at estimated fair value. Both the par value and amortized cost of
the fixed maturity securities were$1.6 billion atJune 30, 2013 .
(2) Comprised of equity securities, fair value option ("FVO") general account
securities, real estate and real estate joint ventures, other limited
partnership interests, cash, cash equivalents and short-term investments, and
other invested assets at carrying value. See Note 1 of the Notes to the
Consolidated Financial Statements included in the 2012 Annual Report for an
explanation of the carrying value for these invested asset classes. Excludes
FVO contractholder-directed unit-linked investments of
support unit-linked variable annuity type liabilities and do not qualify for
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Company, directs the investment of these funds. The related variable annuity
type liability is satisfied from the contractholder's account balance and not
from our general account investments.
(3) For
investments atJune 30, 2013 .
(4) Purchased credit default protection is stated at the estimated fair value of
the swap. For
financial services corporate securities and these swaps had a notional amount
of
The counterparties to these swaps are financial institutions with Standard &
Poor's Ratings Services ("S&P") credit ratings ranging from A+ to A as ofJune 30, 2013 . Current Environment - Summary. All of these factors have had and could continue to have an adverse effect on the financial results of companies in the financial services industry, includingMetLife . Such global economic conditions, as well as the global financial markets, continue to impact our net investment income, net investment gains (losses) and net derivative gains (losses), level of unrealized gains and (losses) within the various asset classes within our investment portfolio and our allocation to lower yielding cash equivalents and short-term investments. See "- Industry Trends" and "Risk Factors - Economic Environment and Capital Markets-Related Risks - We Are Exposed to Significant Financial and Capital Markets Risk Which May Adversely Affect Our Results of Operations, Financial Condition and Liquidity, and May Cause Our Net Investment Income to Vary from Period to Period."
Investment Portfolio Results
The following yield table presents the yield and investment income (loss) for our investment portfolio for the periods indicated. As described in the footnotes below, this table reflects certain differences from the presentation of net investment income presented in the GAAP consolidated statements of operations. This yield table presentation is consistent with how we measure our investment performance for management purposes, and we believe it enhances understanding of our investment portfolio results. At or For the Three Months EndedJune 30 , At or For the Six Months EndedJune 30, 2013 2012 2013 2012 Yield %(1) Amount Yield %(1) Amount Yield %(1) Amount Yield %(1) Amount (In millions) (In millions) (In millions) (In millions) Fixed maturity securities (2)(3) 4.71 %$ 3,687 4.76 %$ 3,720 4.77 %$ 7,520 4.86 % $
7,560
Mortgage loans (3) 5.40 % 716 5.44 % 764 5.46 % 1,454 5.53 %
1,594
Real estate and real estate joint ventures 4.26 % 106 8.75 % 185 3.33 % 166 6.25 % 265 Policy loans 5.18 % 152 5.27 % 156 5.20 % 307 5.28 % 314 Equity securities 5.13 % 36 5.24 % 38 4.28 % 60 4.69 % 70 Other limited partnerships 15.43 % 275 16.07 % 266 14.85 % 521 13.74 % 448 Cash and short-term investments 1.10 % 42 0.65 % 34 0.98 % 87 0.67 % 66 Other invested assets 222 197 401 329 Total before investment fees and expenses 5.00 % 5,236 5.05 % 5,360 4.97 % 10,516 5.03 % 10,646 Investment fees and expenses (0.13) (131) (0.13) (139) (0.13) (274) (0.13) (279) Net investment income including Divested Businesses 4.87 % 5,105 4.92 % 5,221 4.84 % 10,242 4.90 %
10,367
Less: net investment income from Divested Businesses (4) 1 49 6 118 Net investment income (5)$ 5,104 $ 5,172 $ 10,236 $ 10,249 158
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(1) Yields are calculated as investment income as a percent of average quarterly
asset carrying values. Investment income excludes recognized gains and losses
and reflects GAAP adjustments presented in footnote (5) below. Asset carrying
values exclude unrealized gains (losses), collateral received in connection
with our securities lending program, freestanding derivative assets,
collateral received from derivative counterparties, the effects of
consolidating under GAAP certain variable interest entities ("VIEs") that are
treated as consolidated securitization entities ("CSEs"),
contractholder-directed unit-linked investments and securitized reverse
residential mortgage loans. A yield is not presented for other invested
assets, as it is not considered a meaningful measure of performance for this
asset class.
(2) Investment income includes amounts for FVO and trading securities of (
million and
2013, respectively, and
six months endedJune 30, 2012 , respectively.
(3) Investment income from fixed maturity securities and mortgage loans includes
prepayment fees.
(4) Yield calculations include the net investment income and ending carrying
values of the Divested Businesses. The net investment income adjustment for
the Divested Businesses for the three months and six months ended
2012 of
securitized reverse residential mortgage loans that were included in the
Divested Businesses adjustment of
below, respectively. For further information on Divested Businesses and the
related sale of the securitized reverse residential mortgage loans in 2012,
see Note 3 of the Notes to the Consolidated Financial Statements included in
the 2012 Annual Report.
(5) Net investment income presented in the yield table varies from the most
directly comparable measure presented in the GAAP consolidated statements of
operations due to certain reclassifications and excludes the effects of
consolidating under GAAP certain VIEs that are treated as CSEs and
contractholder-directed unit-linked investments. Such reclassifications are
presented in the table below. Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 (In millions) Net investment income - in the above yield table$ 5,104 $ 5,172 $ 10,236 $ 10,249 Real estate discontinued operations (3) (2) (4) (2) Scheduled periodic settlement payments on derivatives not qualifying for hedge accounting (167) (113) (298) (202) Equity method operating joint ventures (1) - (1) - Contractholder-directed unit-linked investments 314 (517) 1,353 498 Divested Businesses 1 137 6 291 Incremental net investment income from CSEs 34 42 67 85 Net investment income - GAAP consolidated statements of operations$ 5,282 $ 4,719 $ 11,359 $ 10,919 See "- Results of Operations - Consolidated Results - Three Months EndedJune 30, 2013 Compared with the Three Months EndedJune 30, 2012 " and "- Results of Operations - Consolidated Results - Six Months EndedJune 30, 2013 Compared with the Six Months EndedJune 30, 2012 " for analyses of the period over period changes in net investment income.
Fixed Maturity and Equity Securities Available-for-Sale
Fixed maturity securities available-for-sale ("AFS"), which consisted principally of publicly-traded and privately-placed fixed maturity securities and redeemable preferred stock, were$356.5 billion and$374.3 billion , at estimated fair value, atJune 30, 2013 andDecember 31, 2012 , respectively, or 71% and 70% of total cash and invested assets, atJune 30, 2013 andDecember 31, 2012 , respectively. Publicly-traded fixed maturity securities represented$309.0 billion and$323.8 billion of total fixed maturity securities, at estimated fair value, atJune 30, 2013 andDecember 31, 2012 , respectively, or 87% of total fixed maturity securities, at bothJune 30, 2013 andDecember 31, 2012 . Privately-placed fixed maturity securities represented$47.5 billion and$50.5 billion , at 159
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estimated fair value, atJune 30, 2013 andDecember 31, 2012 , respectively, or 13% of total fixed maturity securities, at bothJune 30, 2013 andDecember 31, 2012 . Equity securities AFS, which consisted principally of publicly-traded and privately-held common and non-redeemable preferred stock, including certain perpetual hybrid securities and mutual fund interests, were$3.2 billion and$2.9 billion , at estimated fair value, atJune 30, 2013 andDecember 31, 2012 , respectively, or 0.6% and 0.5%, of total cash and invested assets, atJune 30, 2013 andDecember 31, 2012 , respectively. Publicly-traded equity securities represented$2.2 billion and$1.8 billion , at estimated fair value, or 69% and 62% of total equity securities, atJune 30, 2013 andDecember 31, 2012 , respectively. Privately-held equity securities represented$1.0 billion and$1.1 billion , at estimated fair value, atJune 30, 2013 andDecember 31, 2012 , respectively, or 31% and 38%, of total equity securities, atJune 30, 2013 andDecember 31, 2012 , respectively. Included within fixed maturity and equity securities were$1.3 billion of perpetual securities, at estimated fair value, at bothJune 30, 2013 andDecember 31, 2012 . Upon acquisition, we classify perpetual securities that have attributes of both debt and equity as fixed maturity securities if the securities have an interest rate step-up feature which, when combined with other qualitative factors, indicates that the securities have more debt-like characteristics; while those with more equity-like characteristics are classified as equity securities. Many of such securities, commonly referred to as "perpetual hybrid securities" have been issued by non-U.S. financial institutions that are accorded the highest two capital treatment categories by their respective regulatory bodies (i.e. core capital, or "Tier 1 capital" and perpetual deferrable securities, or "Upper Tier 2 capital"). Included within fixed maturity securities were$1.3 billion and$1.6 billion of redeemable preferred stock, at estimated fair value, atJune 30, 2013 andDecember 31, 2012 , respectively. These securities, which have stated maturity dates and cumulative interest deferral features, are commonly referred to as "capital securities," and are primarily issued by U.S. financial institutions.
See also "Management's Discussion and Analysis of Financial Condition and Results of Operations - Investments - Fixed Maturity and Equity Securities AFS - Valuation of Securities" included in the 2012 Annual Report for further information on the processes used to value securities and the related controls.
Fair Value ofFixed Maturity and Equity Securities - AFS. Fixed maturity and equity securities AFS measured at estimated fair value on a recurring basis and their corresponding fair value pricing sources are as follows: June 30, 2013 Fixed Maturity Equity Securities Securities (In millions) (In millions) Level 1: Quoted prices in active markets for identical assets$ 26,519 7.4 % $ 1,017 31.5 % Level 2: Independent pricing source 271,113 76.1 708 21.9 Internal matrix pricing or discounted cash flow techniques 37,319 10.5 915 28.3 Significant other observable inputs 308,432 86.6 1,623 50.2 Level 3: Independent pricing source 9,069 2.5 456 14.1 Internal matrix pricing or discounted cash flow techniques 10,692 3.0 117 3.6 Independent broker quotations 1,802 0.5 18 0.6 Significant unobservable inputs 21,563 6.0 591 18.3 Total estimated fair value$ 356,514 100.0 % $ 3,231 100.0 %
See Note 8 of the Notes to the Interim Condensed Consolidated Financial Statements for the fixed maturity securities and equity securities AFS fair value hierarchy.
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The composition of fair value pricing sources for and significant changes in Level 3 securities at
• The majority of the Level 3 fixed maturity and equity securities AFS, or 83%,
were concentrated in four sectors: U.S. and foreign corporate securities,
asset-backed securities ("ABS"), and residential mortgage-backed securities
("RMBS"). • Level 3 fixed maturity securities are priced principally through market
standard valuation methodologies, independent pricing services and, to a much
lesser extent, independent non-binding broker quotations using inputs that
are not market observable or cannot be derived principally from or
corroborated by observable market data. Level 3 fixed maturity securities
consist of less liquid securities with very limited trading activity or where
less price transparency exists around the inputs to the valuation
methodologies. Level 3 fixed maturity securities include: sub-prime RMBS;
certain below investment grade private securities and less liquid investment
grade corporate securities (included in U.S. and foreign corporate securities); and less liquid ABS and foreign government securities. • During the three months endedJune 30, 2013 , Level 3 fixed maturity
securities decreased by
transfers out of Level 3 and a decrease in estimated fair value recognized in
other comprehensive income (loss) ("OCI"), partially offset by purchases in
excess of sales. The net transfers out of fixed maturity securities were
concentrated in U.S. and foreign corporate securities and foreign government
securities. The purchases in excess of sales for fixed maturity securities
was concentrated in U.S. and foreign corporate, RMBS and foreign government
securities, and the decrease in estimated fair value recognized in OCI was
concentrated in U.S. and foreign corporate securities.
• During the six months ended
decreased by
out of Level 3 and a decrease in estimated fair value recognized in OCI,
partially offset by purchases in excess of sales. The net transfers out of
fixed maturity securities were concentrated in U.S. and foreign corporate
securities and ABS. The purchases in excess of sales for fixed maturity
securities was concentrated in RMBS, ABS, foreign corporate securities and
foreign government securities, and the decrease in estimated fair value
recognized in OCI was concentrated in foreign corporate securities and
foreign government securities.
See Note 8 of the Notes to the Interim Condensed Consolidated Financial Statements for a rollforward of the fair value measurements for fixed maturity securities and equity securities AFS measured at estimated fair value on a recurring basis using significant unobservable (Level 3) inputs. Total gains and losses in earnings and OCI are calculated assuming transfers into or out of Level 3 occurred at the beginning of the period. Items transferred into and out of Level 3 during the same period are excluded from the rollforward. Total gains (losses) for fixed maturity securities included in OCI subsequent to their transfer into Level 3 was($12) million and($18) million for the three months and six months endedJune 30, 2013 , respectively. Total gains (losses) included in earnings for fixed maturity securities subsequent to their transfer into Level 3 was($1) million for the three months endedJune 30, 2013 , and there were no gains (losses) included in earnings for the six months endedJune 30, 2013 .
An analysis of transfers into and/or out of Level 3 for the three months and six months ended
See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Summary of Critical Accounting Estimates - Estimated Fair Value of Investments" included in the 2012 Annual Report for further information on the estimates and assumptions that affect the amounts reported above. See Note 8 of the Notes to the Interim Condensed Consolidated Financial Statements for further information about the valuation techniques and inputs by level by major classes of invested assets that affect the amounts reported above. Fixed Maturity Securities AFS. See Note 6 of the Notes to the Interim Condensed Consolidated Financial Statements for further information about fixed maturity securities AFS. 161
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Fixed Maturity Securities Credit Quality - Ratings. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Investments - Fixed Maturity and Equity Securities AFS - Fixed Maturity Securities Credit Quality - Ratings" included in the 2012 Annual Report for a discussion of the credit quality designations assigned by rating agencies and ratings methodologies used by theSecurities Valuation Office of the NAIC for fixed maturity securities. The NAIC has adopted revised rating methodologies for certain structured securities comprised of non-agency RMBS, commercial mortgage-backed securities ("CMBS") and ABS. The NAIC's objective with the revised rating methodologies for these structured securities was to increase the accuracy in assessing expected losses, and to use the improved assessment to determine a more appropriate capital requirement for such structured securities. The revised methodologies reduce regulatory reliance on rating agencies and allow for great regulatory input into the assumption used to estimate expected losses from structured securities. We apply the revised NAIC rating methodologies to structured securities held byMetLife, Inc.'s insurance subsidiaries that maintain the NAIC statutory basis of accounting. The NAIC's present methodology is to evaluate structured securities held by insurers using the revised NAIC rating methodologies on an annual basis. If our insurance subsidiaries acquire structured securities that have not been previously evaluated by the NAIC, but are expected to be evaluated by the NAIC in the upcoming annual review, an internally developed rating is used until a final rating becomes available.
The following table presents total fixed maturity securities by Nationally Recognized Statistical Rating Organizations ("NRSRO") designation and the equivalent designations of the NAIC, except for certain structured securities, which are presented as described above, as well as the percentage, based on estimated fair value that each designation is comprised of at:
June 30, 2013 December 31, 2012 Estimated Estimated NAIC Amortized Unrealized Fair % of Amortized Unrealized Fair % of Rating Rating Agency Designation Cost Gain (Loss) Value Total Cost Gain (Loss) Value Total (In millions) (In millions) 1 Aaa/Aa/A$ 232,246 $ 15,869 $ 248,115 69.6 %$ 234,371 $ 24,197 $ 258,568 69.1 % 2 Baa 78,671 4,835 83,506 23.4 81,530 8,663 90,193 24.1
Subtotalinvestment grade 310,917 20,704 331,621 93.0 315,901 32,860 348,761 93.2 3 Ba 13,690 218 13,908 3.9 13,882 552 14,434 3.8 4 B 9,248 54 9,302 2.6 9,470 137 9,607 2.6 5 Caa and lower 1,724 (110 ) 1,614 0.5 1,543 (164 ) 1,379 0.4 6 In or near default 47 22 69 - 74 11 85 - Subtotal below investment grade 24,709 184 24,893 7.0 24,969 536 25,505 6.8 Total fixed maturity securities$ 335,626 $
20,888$ 356,514 100.0 %$ 340,870 $ 33,396 $ 374,266 100.0 % 162
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The following tables present total fixed maturity securities, based on estimated fair value, by sector classification and by NRSRO designation and the equivalent designations of the NAIC, except for certain structured securities, which are presented as described above: Fixed
NAIC Rating: 1 2 3 4 5 6 Total Caa and In or Near Estimated Rating Agency Designation: Aaa/Aa/A Baa Ba B Lower Default Fair Value (In millions)June 30, 2013 : U.S. corporate$ 49,211 $ 45,786 $ 8,625 $ 4,838 $ 508 $ 40 $ 109,008 Foreign corporate 29,244 30,182 3,054 1,640 63 3 64,186 Foreign government 45,492 4,687 610 1,356 152 - 52,297 U.S. Treasury and agency 47,426 - - - - - 47,426 RMBS 31,484 1,222 1,545 1,328 841 21 36,441 CMBS 17,081 104 32 16 30 - 17,263 ABS 14,594 880 32 124 20 5 15,655 State and political subdivision 13,583 645 10 - - -
14,238
Total fixed maturity securities
13,908$ 9,302 $ 1,614 $ 69 $ 356,514 Percentage of total 69.6 % 23.4 % 3.9 % 2.6 % 0.5 % - % 100.0 % December 31, 2012: U.S. corporate$ 51,648 $ 48,622 $ 8,597 $ 4,831 $ 380 $ 48 $ 114,126 Foreign corporate 31,937 30,509 3,249 1,418 66 5 67,184 Foreign government 46,314 8,501 933 1,504 84 - 57,336 U.S. Treasury and agency 47,967 - - - - - 47,967 RMBS 32,377 894 1,582 1,809 790 27 37,479 CMBS 18,843 193 43 11 39 - 19,129 ABS 15,247 673 18 34 20 5 15,997 State and political subdivision 14,235 801 12 - - -
15,048
Total fixed maturity securities
14,434$ 9,607 $ 1,379 $ 85 $ 374,266 Percentage of total 69.1 % 24.1 % 3.8 % 2.6 % 0.4 % - % 100.0 %U.S. and Foreign Corporate Fixed Maturity Securities . We maintain a diversified portfolio of corporate fixed maturity securities across industries and issuers. This portfolio does not have an exposure to any single issuer in excess of 1% of total investments and the top ten holdings comprise 2% of total investments at bothJune 30, 2013 andDecember 31, 2012 . The tables below present information for U.S. and foreign corporate securities at: June 30, 2013 December 31, 2012 Estimated Estimated Fair % of Fair % of Value Total Value Total (In millions) (In millions) Corporate fixed maturity securities - by sector: Foreign corporate (1)$ 64,186 37.1 %$ 67,184 37.1 % U.S. corporate fixed maturity securities - by industry: Industrial 28,060 16.2 29,324 16.2 Consumer 28,019 16.2 29,852 16.4 Finance 21,047 12.1 21,857 12.1 Utility 19,531 11.3 20,216 11.1 Communications 8,697 5.0 9,084 5.0 Other 3,654 2.1 3,793 2.1 Total$ 173,194 100.0 %$ 181,310 100.0 %
(1) Includes both U.S. dollar and foreign denominated securities.
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Structured Securities . We held$69.4 billion and$72.6 billion of structured securities, at estimated fair value, atJune 30, 2013 andDecember 31, 2012 , respectively, as presented in the RMBS, CMBS and ABS sections below.
RMBS. The table below presents information about RMBS at:
June 30, 2013 December 31, 2012 Estimated Net Estimated Net Fair % of Unrealized Fair % of Unrealized Value Total Gains (Losses) Value Total Gains (Losses) (In millions) (In millions) (In millions) (In millions) By security type: Collateralized mortgage obligations$ 19,950 54.7% $ 811$ 20,567 54.9% $ 889 Pass-through securities 16,491 45.3 335 16,912 45.1 924 Total RMBS$ 36,441 100.0% $ 1,146$ 37,479 100.0% $ 1,813 By risk profile: Agency$ 25,065 68.8% $ 1,108$ 26,369 70.4% $ 1,944 Prime 3,408 9.4 66 4,206 11.2 101 Alt-A 5,117 14.0 (71) 4,950 13.2 (154) Sub-prime 2,851 7.8 43 1,954 5.2 (78) Total RMBS$ 36,441 100.0% $ 1,146$ 37,479 100.0% $ 1,813 Ratings profile: Rated Aaa/AAA$ 25,874 71.0%$ 26,555 70.9% Rated NAIC 1$ 31,484 86.4%$ 32,377 86.4% See also "Management's Discussion and Analysis of Financial Condition and Results of Operations - Investments - Fixed Maturity and Equity Securities AFS -Structured Securities " included in the 2012 Annual Report for further information about collateralized mortgage obligations and pass-through mortgage-backed securities; and agency, prime, alternative residential mortgage loans ("Alt-A") and sub-prime RMBS. AtJune 30, 2013 andDecember 31, 2012 , our Alt-A securities portfolio had no exposure to option adjustable rate mortgages ("ARMs"). AtJune 30, 2013 andDecember 31, 2012 , our Alt-A securities portfolio was comprised primarily of fixed rate mortgages (94% at bothJune 30, 2013 andDecember 31, 2012 ). Historically, we have managed our exposure to sub-prime RMBS holdings by acquiring older vintage year securities that benefit from better underwriting, improved credit enhancement and higher levels of residential property price appreciation; reducing our overall exposure; stress testing the portfolio with severe loss assumptions and closely monitoring the performance of the portfolio. In 2012 and 2013, we increased our exposure by purchasing sub-prime RMBS at significant discounts to the expected principal recovery value of these securities. The 2012 and 2013 sub-prime RMBS purchases are performing within our expectations and were in an unrealized gain position of$82 million and$59 million atJune 30, 2013 andDecember 31, 2012 , respectively. 164
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CMBS. The following tables present our CMBS holdings by rating agency designation and by vintage year at:
June 30, 2013 Below Investment Aaa Aa A Baa Grade Total Estimated Estimated Estimated Estimated Estimated Estimated Amortized Fair Amortized Fair Amortized Fair Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value Cost Value Cost Value Cost Value (In millions) 2003$ 961 $ 970 $ 46 $ 49 $ 61 $ 62 $ 25 $ 25 $ 29 $ 29 $ 1,122 $ 1,135 2004 3,207 3,276 385 405 90 95 77 80 14 12 3,773 3,868 2005 3,242 3,439 339 367 318 345 104 113 29 37 4,032 4,301 2006 2,390 2,537 216 229 98 106 16 21 37 36 2,757 2,929 2007 936 984 110 113 150 154 184 186 75 65 1,455 1,502 2008 - 2010 - - - - 55 52 1 1 7 5 63 58 2011 588 618 25 24 91 91 - - 6 5 710 738 2012 629 680 262 253 922 870 - - 29 31 1,842 1,834 2013 315 312 121 113 490 473 - - - - 926 898 Total$ 12,268 $ 12,816 $ 1,504 $ 1,553 $ 2,275 $ 2,248 $ 407 $ 426 $ 226 $ 220 $ 16,680 $ 17,263 Ratings Distribution 74.2 % 9.0 % 13.0 % 2.5 % 1.3 % 100.0 % December 31, 2012 Below Investment Aaa Aa A Baa Grade Total Estimated Estimated Estimated Estimated Estimated Estimated Amortized Fair Amortized Fair Amortized Fair Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value Cost Value Cost Value Cost Value (In millions) 2003$ 2,957 $ 2,997 $ 113 $ 114 $ 82 $ 82 $ 37 $ 36 $ 33 $ 33 $ 3,222 $ 3,262 2004 3,466 3,606 380 401 97 99 52 51 21 9 4,016 4,166 2005 3,348 3,636 303 329 275 296 144 142 - - 4,070 4,403 2006 2,283 2,484 263 284 44 44 47 50 38 36 2,675 2,898 2007 1,070 1,143 112 117 87 95 194 187 20 21 1,483 1,563 2008 - 2010 2 3 - - - - 56 60 26 24 84 87 2011 598 650 12 11 108 112 - - 7 6 725 779 2012 524 559 403 417 939 956 - - 36 39 1,902 1,971 Total$ 14,248 $ 15,078 $ 1,586 $ 1,673 $ 1,632 $ 1,684 $ 530 $ 526 $ 181 $ 168 $ 18,177 $ 19,129 Ratings Distribution 78.8 % 8.7 % 8.8 % 2.8 % 0.9 % 100.0 %
The tables above reflect rating agency designations assigned by nationally recognized rating agencies including
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ABS. Our ABS are diversified both by collateral type and by issuer. The following table presents information about our ABS holdings at:
June 30, 2013 December 31, 2012 Estimated Net Estimated Net Fair % of Unrealized Fair % of Unrealized Value Total Gains (Losses) Value Total Gains (Losses) (In millions) (In millions) (In millions) (In millions) By collateral type: Foreign residential loans$ 3,616 23.1% $ 66$ 3,811 23.8% $ 88 Student loans 2,667 17.0 15 2,480 15.5 14 Collateralized debt obligations 2,585 16.5 (7) 2,453 15.3 (68) Automobile loans 2,472 15.8 10 2,454 15.4 28 Credit card loans 2,246 14.4 56 2,640 16.5 106 Equipment loans 489 3.1 8 597 3.7 22 Other loans 1,580 10.1 5 1,562 9.8 45 Total$ 15,655 100.0% $ 153$ 15,997 100.0% $ 235 Ratings profile: Rated Aaa/AAA$ 9,969 63.7%$ 10,405 65.0% Rated NAIC 1$ 14,594 93.2%$ 15,247 95.3%
OTTI Losses on Fixed Maturity and Equity Securities AFS Recognized in Earnings
See Note 6 of the Notes to the Interim Condensed Consolidated Financial Statements for information about OTTI losses and gross gains and gross losses on AFS securities sold.
Overview of Fixed Maturity and Equity Security OTTI Losses Recognized in Earnings. Impairments of fixed maturity and equity securities were$40 million and$121 million for the three months and six months endedJune 30, 2013 , respectively, and$93 million and$241 million for the three months and six months endedJune 30, 2012 , respectively. Impairments of fixed maturity securities were$39 million and$99 million for the three months and six months endedJune 30, 2013 , respectively, and$91 million and$224 million for the three months and six months endedJune 30, 2012 , respectively. Impairments of equity securities were$1 million and$22 million for the three months and six months endedJune 30, 2013 , respectively, and$2 million and$17 million for the three months and six months endedJune 30, 2012 , respectively. Credit-related impairments of fixed maturity securities were$39 million and$81 million for the three months and six months endedJune 30, 2013 , respectively, and$68 million and$141 million for the three months and six months endedJune 30, 2012 , respectively.
Explanations of changes in fixed maturity and equity securities impairments are as follows:
Three months endedJune 30, 2013 compared to the three months endedJune 30, 2012 - Overall OTTI losses recognized in earnings on fixed maturity and equity securities were$40 million for the three months endedJune 30, 2013 as compared to$93 million in the prior period. The decreases in the current period, as compared to the prior period, were concentrated in RMBS, CMBS, and ABS, which comprised$10 million in fixed maturity impairments for the three months endedJune 30, 2013 , as compared to$62 million for the three months endedJune 30, 2012 , reflecting improved economic fundamentals. Six months endedJune 30, 2013 compared to the six months endedJune 30, 2012 - Overall OTTI losses recognized in earnings on fixed maturity and equity securities were$121 million for the six months endedJune 30, 2013 as compared to$241 million in the prior period. The most significant decreases were in U.S. and foreign corporate securities and CMBS, which comprised$52 million for the six months endedJune 30, 2013 , as 166
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compared to$170 million for the six months endedJune 30, 2012 . The decrease of$68 million in OTTI losses on U.S. and foreign corporate securities were concentrated in financial services and utility industries and were primarily attributable to prior period intent-to-sell impairments, while the$50 million decrease on CMBS reflects improving economic fundamentals. Future Impairments. Future OTTI will depend primarily on economic fundamentals, issuer performance (including changes in the present value of future cash flows expected to be collected), changes in credit ratings, changes in collateral valuation, changes in interest rates and changes in credit spreads. If economic fundamentals deteriorate or if there are adverse changes in the above factors, OTTI may be incurred in upcoming periods.
FVO and trading securities are primarily comprised of securities for which the FVO has been elected ("FVO Securities ").FVO Securities include certain fixed maturity and equity securities held for investment by the general account to support asset and liability matching strategies for certain insurance products.FVO Securities are primarily comprised of contractholder-directed investments supporting unit-linked variable annuity type liabilities which do not qualify for presentation as separate account summary total assets and liabilities. These investments are primarily mutual funds and, to a lesser extent, fixed maturity and equity securities, short-term investments and cash and cash equivalents. The investment returns on these investments inure to contractholders and are offset by a corresponding change in policyholder account balances ("PABs") through interest credited to policyholder account balances.FVO Securities also include securities held by CSEs (former qualifying special purpose entities). We have a trading securities portfolio, principally invested in fixed maturity securities, to support investment strategies that involve the active and frequent purchase and sale of actively traded securities and the execution of short sale agreements. FVO and trading securities were$16.1 billion and$16.3 billion at estimated fair value, or 3.2% and 3.1% of total cash and invested assets, atJune 30, 2013 andDecember 31, 2012 , respectively. See Note 8 of the Notes to the Interim Condensed Consolidated Financial Statements for the FVO and trading securities fair value hierarchy and a rollforward of the fair value measurements for FVO and trading securities measured at estimated fair value on a recurring basis using significant unobservable (Level 3) inputs.
Securities Lending
We participate in a securities lending program whereby blocks of securities, which are included in fixed maturity securities, equity securities and short-term investments, are loaned to third parties, primarily brokerage firms and commercial banks. We obtain collateral, usually cash, in an amount generally equal to 102% of the estimated fair value of the securities loaned, which is obtained at the inception of a loan and maintained at a level greater than or equal to 100% for the duration of the loan. Securities loaned under such transactions may be sold or repledged by the transferee. We are liable to return to our counterparties the cash collateral under our control. These transactions are treated as financing arrangements and the associated cash collateral liability is recorded at the amount of the cash received.
See "- Liquidity and Capital Resources - The Company - Liquidity and Capital Uses - Securities Lending" and Note 6 of the Notes to the Interim Condensed Consolidated Financial Statements for financial information regarding our securities lending program.
Mortgage Loans
Our mortgage loans are principally collateralized by commercial real estate, agricultural real estate and residential properties. The carrying value of mortgage loans was$55.6 billion and$57.0 billion , or 11.1% and 10.7% of total cash and invested assets, atJune 30, 2013 andDecember 31, 2012 , respectively. See Note 6 of the Notes to the Interim Condensed Consolidated Financial Statements for a table that presents our mortgage loans by portfolio segment. The information presented herein excludes the mortgage loans held-for-investment where we elected the FVO and the effects of consolidating certain VIEs that are treated as CSEs. Such amounts are presented in the aforementioned table. 167
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We diversify our mortgage loan portfolio by both geographic region and property type to reduce the risk of concentration. Of our commercial and agricultural mortgage loans, 89% are collateralized by properties located inthe United States , with the remaining 11% collateralized by properties located outsidethe United States , calculated as a percent of the total mortgage loans held-for-investment (excluding mortgage loans held-for-investment where we elected the FVO and commercial mortgage loans held by CSEs) atJune 30, 2013 . The three states with the largest commercial and agricultural mortgage loan investments wereCalifornia ,New York andTexas at 19%, 11% and 7%, atJune 30, 2013 , respectively. Additionally, we manage risk when originating commercial and agricultural mortgage loans by generally lending only up to 75% of the estimated fair value of the underlying real estate collateral. Commercial Mortgage Loans byGeographic Region and Property Type. Commercial mortgage loans are the largest component of the mortgage loan invested asset class. The tables below present the diversification across geographic regions and property types of commercial mortgage loans held-for-investment at: June 30, 2013 December 31, 2012 % of % of Amount Total Amount Total (In millions) (In millions) Region: Pacific$ 7,879 20.2 %$ 7,932 19.6 % South Atlantic 7,276 18.6 7,969 19.7 Middle Atlantic 6,987 17.9 6,780 16.7 International 5,364 13.7 5,567 13.8 West South Central 3,444 8.8 3,436 8.5 East North Central 2,714 6.9 3,026 7.5 New England 1,476 3.8 1,489 3.7 Mountain 874 2.2 906 2.2 East South Central 454 1.2 457 1.1 West North Central 283 0.7 288 0.7 Multi-Region and Other 2,359 6.0 2,622 6.5 Total recorded investment 39,110 100.0 % 40,472 100.0 % Less: valuation allowances 242 293 Carrying value, net of valuation allowances$ 38,868 $ 40,179 Property Type: Office$ 18,096 46.3 %$ 18,012 44.5 % Retail 8,746 22.4 9,445 23.3 Apartment 3,811 9.7 3,944 9.8 Hotel 3,426 8.7 3,355 8.3 Industrial 3,045 7.8 3,159 7.8 Other 1,986 5.1 2,557 6.3 Total recorded investment 39,110 100.0 % 40,472 100.0 % Less: valuation allowances 242 293 Carrying value, net of valuation allowances$ 38,868
Mortgage Loan Credit Quality - Restructured, Potentially Delinquent, Delinquent or Under Foreclosure. We monitor our mortgage loan investments on an ongoing basis, including reviewing loans that are restructured, potentially delinquent, and delinquent or under foreclosure. These loan classifications are consistent with those used in industry practice. 168
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We define restructured mortgage loans as loans in which we, for economic or legal reasons related to the debtor's financial difficulties, grant a concession to the debtor that we would not otherwise consider. We define potentially delinquent loans as loans that, in management's opinion, have a high probability of becoming delinquent in the near term. We define delinquent mortgage loans consistent with industry practice, when the mortgage loan is past due as follows: commercial and residential - 60 days or more and agricultural - 90 days or more. We define mortgage loans under foreclosure as loans in which foreclosure proceedings have formally commenced.
The following table presents the carrying value prior to valuation allowance ("recorded investment") and valuation allowance for all mortgage loans held-for-investment distributed by the above stated loan classifications:
June 30, 2013 December 31, 2012 % of % of Recorded % of Valuation Recorded Recorded % of Valuation Recorded Investment Total Allowance Investment Investment Total Allowance Investment (In millions) (In millions) (In millions) (In millions) Commercial: Performing$ 38,713 99.0% $ 210 0.5%$ 40,064 99.0% $ 214 0.5% Restructured (1) 397 1.0 32 8.1% 406 1.0 79 19.5% Potentially delinquent - - - -% - - - -% Delinquent or under foreclosure - - - -% 2 - - -% Total$ 39,110 100.0% $ 242 0.6%$ 40,472 100.0% $ 293 0.7% Agricultural: Performing$ 12,506 98.7% $ 35 0.3%$ 12,657 98.6% $ 31 0.2% Restructured (2) 53 0.4 7 13.2% 64 0.5 8 12.5% Potentially delinquent 7 0.1 - -% 6 - - -% Delinquent or under foreclosure (2) 103 0.8 7 6.8% 116 0.9 13 11.2% Total$ 12,669 100.0% $ 49 0.4%$ 12,843 100.0% $ 52 0.4% Residential: Performing$ 1,702 97.7% $ 9 0.5% $ 929 97.0% $ - -% Restructured (3) 1 0.1 - -% - - - -% Delinquent or under foreclosure 38 2.2 2 5.3% 29 3.0 2 6.9% Total$ 1,741 100.0% $ 11 0.6% $ 958 100.0% $ 2 0.2%
(1) As of
commercial mortgage loans for both periods, all of which were performing.
(2) As of
which 11 were performing and four were delinquent. As of
there were 15 restructured loans, all of which were performing.
(3) As of
all of which were performing. There were no restructured residential mortgage
loans at
See also Note 6 of the Notes to the Interim Condensed Consolidated Financial Statements for tables that present, by portfolio segment, mortgage loans by credit quality indicator, impaired mortgage loans, past due and nonaccrual mortgage loans, as well as loans modified through troubled debt restructurings.
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Mortgage Loan Credit Quality - Monitoring Process - Commercial and Agricultural Mortgage Loans. We review all commercial mortgage loans on an ongoing basis. These reviews may include an analysis of the property financial statements and rent roll, lease rollover analysis, property inspections, market analysis, estimated valuations of the underlying collateral, loan-to-value ratios, debt service coverage ratios, and tenant creditworthiness. The monitoring process focuses on higher risk loans, which include those that are classified as restructured, potentially delinquent, delinquent or in foreclosure, as well as loans with higher loan-to-value ratios and lower debt service coverage ratios. The monitoring process for agricultural mortgage loans is generally similar, with a focus on higher risk loans, such as loans with higher loan-to-value ratios, including reviews on a geographic and property type basis. Loan-to-value ratios and debt service coverage ratios are common measures in the assessment of the quality of commercial mortgage loans. Loan-to-value ratios are a common measure in the assessment of the quality of agricultural mortgage loans. Loan-to-value ratios compare the amount of the loan to the estimated fair value of the underlying collateral. A loan-to-value ratio greater than 100% indicates that the loan amount is greater than the collateral value. A loan-to-value ratio of less than 100% indicates an excess of collateral value over the loan amount. Generally, the higher the loan-to-value ratio, the higher the risk of experiencing a credit loss. The debt service coverage ratio compares a property's net operating income to amounts needed to service the principal and interest due under the loan. Generally, the lower the debt service coverage ratio, the higher the risk of experiencing a credit loss. For our commercial mortgage loans, our average loan-to-value ratio was 56% and 57% atJune 30, 2013 andDecember 31, 2012 , respectively, and our average debt service coverage ratio was 2.2x at bothJune 30, 2013 andDecember 31, 2012 . The commercial mortgage loan debt service coverage ratio and loan-to-value ratio, as well as the values utilized in calculating these ratios, are updated annually, on a rolling basis, with a portion of the commercial mortgage loan portfolio updated each quarter. For our agricultural mortgage loans, our average loan-to-value ratio was 45% and 46% atJune 30, 2013 andDecember 31, 2012 , respectively. The values utilized in calculating the agricultural mortgage loan loan-to-value ratio are developed in connection with the ongoing review of the agricultural loan portfolio and are routinely updated. Mortgage Loan Valuation Allowances. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Investments - Mortgage Loans - Mortgage Loan Valuation Allowances" included in the 2012 Annual Report for further information on our mortgage valuation allowance policy. See Notes 6 and 8 of the Notes to the Interim Condensed Consolidated Financial Statements for information about activity in and balances of the valuation allowance and the estimated fair value of impaired mortgage loans and related impairments included within net investment gains (losses) as of and for the six months endedJune 30, 2013 and 2012.
Real Estate and
We diversify our real estate investments by both geographic region and property type to reduce risk of concentration. Of our real estate investments, 86% were located inthe United States , with the remaining 14% located outsidethe United States , atJune 30, 2013 . The three locations with the largest real estate investments wereCalifornia ,Japan andFlorida at 20%, 12% and 11% respectively, atJune 30, 2013 . 170
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Real estate investments by type consisted of the following:
June 30, 2013 December 31, 2012 Carrying % of Carrying % of Value Total Value Total (In millions) (In millions) Traditional$ 7,426 75.1%$ 8,488 85.6% Real estate joint ventures and funds 855 8.7 941 9.5 Subtotal 8,281 83.8 9,429 95.1 Foreclosed (commercial, agricultural and residential) 465 4.7 488 4.9 Real estate held-for-investment 8,746 88.5 9,917 100.0 Real estate held-for-sale 1,140 11.5 1 - Total real estate and real estate joint ventures$ 9,886 100.0%$ 9,918 100.0% See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Investments - Real Estate andReal Estate Joint Ventures " included in the 2012 Annual Report for a discussion of the types of investments reported within traditional real estate and real estate joint ventures and funds. The estimated fair value of the traditional and held-for-sale real estate investment portfolios was$11.1 billion and$10.7 billion atJune 30, 2013 andDecember 31, 2012 , respectively. In the second quarter of 2013, we committed to sell real estate investments in the next twelve months in connection with our investment management business with a carrying value of$1.1 billion . Accordingly, these properties were classified as held-for-sale atJune 30, 2013 . There were no impairments recognized on real estate and real estate joint ventures for the three months endedJune 30, 2013 . There were$9 million of impairments recognized on real estate and real estate joint ventures for the six months endedJune 30, 2013 . There were$3 million and$7 million of impairments recognized on real estate and real estate joint ventures for the three months and six months endedJune 30, 2012 , respectively.
Other Limited Partnership Interests
The carrying value of other limited partnership interests was
Other Invested Assets
The following table presents the carrying value of our other invested assets by type: June 30, 2013 December 31, 2012 Carrying % of Carrying % of Value Total Value Total (In millions) (In millions) Freestanding derivatives with positive estimated fair values$ 10,434 58.2%$ 13,777 65.2% Tax credit partnerships 2,436 13.6 2,268 10.7 Leveraged leases, net of non-recourse debt 1,988 11.1 1,998 9.4 Funds withheld 645 3.6 641 3.0 Joint venture investments 166 0.9 180 0.9 Other 2,251 12.6 2,281 10.8 Total$ 17,920 100.0%$ 21,145 100.0% 171
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Short-term Investments and Cash Equivalents
The carrying value of short-term investments, which approximates estimated fair value, was$13.0 billion and$16.9 billion , or 2.6% and 3.2% of total cash and invested assets, atJune 30, 2013 andDecember 31, 2012 , respectively. The carrying value of cash equivalents, which approximates estimated fair value, was$5.5 billion and$6.1 billion atJune 30, 2013 andDecember 31, 2012 , respectively, or 1.1% of total cash and invested assets, at bothJune 30, 2013 andDecember 31, 2012 . Derivatives Derivatives. We are exposed to various risks relating to our ongoing business operations, including interest rate, foreign currency exchange rate, credit and equity market. We use a variety of strategies to manage these risks, including the use of derivatives. See Note 7 of the Notes to the Interim Condensed Consolidated Financial Statements for:
• A comprehensive description of the nature of our derivatives, including the
strategies for which derivatives are used in managing various risks.
• Information about the notional amount, estimated fair value, and primary
underlying risk exposure of our derivatives by type of hedge designation,
excluding embedded derivatives held at
• The statement of operations effects of derivatives in cash flow, fair value,
or non-qualifying hedge relationships for the three months and six months
ended
See "Quantitative and Qualitative Disclosures About Market Risk - Management of Market Risk Exposures - Hedging Activities" for more information about our use of derivatives by major hedge program.
Fair Value Hierarchy. See Note 8 of the Notes to the Interim Condensed Consolidated Financial Statements for derivatives measured at estimated fair value on a recurring basis and their corresponding fair value hierarchy.
The valuation of Level 3 derivatives involves the use of significant unobservable inputs and generally requires a higher degree of management judgment or estimation than the valuations of Level 1 and Level 2 derivatives. Although Level 3 inputs are unobservable, management believes they are consistent with what other market participants would use when pricing such instruments and are considered appropriate given the circumstances. The use of different inputs or methodologies could have a material effect on the estimated fair value of Level 3 derivatives and could materially affect net income. Derivatives categorized as Level 3 atJune 30, 2013 include: interest rate swaps and interest rate forwards with maturities which extend beyond the observable portion of the yield curve; cancellable foreign currency swaps with unobservable currency correlation inputs; foreign currency swaps and forwards with certain unobservable inputs, including unobservable portion of the yield curve; credit default swaps priced using unobservable credit spreads, or that are priced through independent broker quotations; equity variance swaps with unobservable volatility inputs; and equity options with unobservable correlation inputs. At bothJune 30, 2013 andDecember 31, 2012 , less than 1% of the net derivative estimated fair value was priced through independent broker quotations.
See Note 8 of the Notes to the Interim Condensed Consolidated Financial Statements for a rollforward of the fair value measurements for derivatives measured at estimated fair value on a recurring basis using significant unobservable (Level 3) inputs.
Level 3 derivatives had a
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that are valued using models dependent on an unobservable market correlation input and equity variance swaps that are valued using observable equity volatility data plus an unobservable equity variance spread. The unobservable equity variance spread is calculated from a comparison between broker offered variance swap volatility and observable plain vanilla equity option volatility. Other significant inputs, which are observable, include equity index levels, equity volatility and the swap yield curve. We validate the reasonableness of these inputs by valuing the positions using internal models and comparing the results to broker quotations. The primary drivers of the loss during the three months endedJune 30, 2013 were increases in interest rates and increases in equity index levels, which in total accounted for approximately 22% of the loss. Changes in the unobservable inputs accounted for approximately 78% of the loss. The primary drivers of the loss during the six months endedJune 30, 2013 were increases in interest rates and increases in equity index levels, which in total accounted for approximately 59% of the loss. Changes in the unobservable inputs accounted for approximately 41% of the loss. See "- Summary of Critical Accounting Estimates - Derivatives" included in the 2012 Annual Report for further information on the estimates and assumptions that affect derivatives. Credit Risk. See Note 7 of the Notes to the Interim Condensed Consolidated Financial Statements for information about how we manage credit risk related to derivatives and for the estimated fair value of our net derivative assets and net derivative liabilities after the application of master netting agreements and collateral. Our policy is not to offset the fair value amounts recognized for derivatives executed with the same counterparty under the same master netting agreement. This policy applies to the recognition of derivatives in the consolidated balance sheets, and does not affect our legal right of offset.
Credit Derivatives. The following table presents the gross notional amount and estimated fair value of credit default swaps at:
June 30, 2013 December 31, 2012 Notional Estimated Notional Estimated Credit Default Swaps Amount Fair Value Amount Fair Value (In millions) Purchased (1)$ 3,299 $ (19) $ 3,674 $ (23) Written (2) 9,644 82 8,879 74 Total$ 12,943 $ 63 $ 12,553 $ 51
(1) The notional amount and estimated fair value for purchased credit default
swaps in the trading portfolio were$385 million and($4) million , respectively, atJune 30, 2013 and$380 million and($1) million , respectively, atDecember 31, 2012 .
(2) The notional amount and estimated fair value for written credit default swaps
in the trading portfolio were$10 million and$0 , respectively, at bothJune 30, 2013 andDecember 31, 2012 . 173
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The following table presents the gross gains, gross losses and net gain (losses) recognized in income for credit default swaps as follows:
Three Months Six Months Ended Ended June 30, June 30, 2013 2012 2013 2012 Net Net Net Net Gross Gross Gains Gross Gross Gains Gross Gross Gains Gross Gross Gains
Credit Default Swaps Gains (1) Losses (1) (Losses) Gains (1) Losses (1) (Losses) Gains (1) Losses (1)
(Losses) Gains (1) Losses (1) (Losses)
(In millions) (In millions) Purchased (2), (4) $ 5$ (5) $ -$ 6 $ 13 $ 19 $ 10 $ (19) $ (9) $ 7 $ (185) $ (178) Written (3), (4) 6 (11) (5) (20) (33) (53) 52 (25) 27 88 (37) 51 Total$ 11 $ (16) $ (5) $ (14) $ (20) $ (34) $ 62 $ (44) $ 18 $ 95 $ (222) $ (127)
(1) Gains (losses) are reported in net derivative gains (losses), except for
gains (losses) on the trading portfolio, which are reported in net investment
income.
(2) The gross gains and gross (losses) for purchased credit default swaps in the
trading portfolio were
three months ended
respectively, for the six months ended
gross (losses) for purchased credit default swaps in the trading portfolio
were
months endedJune 30, 2012 .
(3) The gross gains and gross (losses) for written credit default swaps in the
trading portfolio were not significant for the three months and six months
endedJune 30, 2013 and 2012.
(4) Gains (losses) do not include earned income (expense) on credit default
swaps.
For the three month period, the unfavorable change in net gains (losses) on purchased credit default swaps of$19 million was due to credit spreads being mixed in the current period compared to credit spreads widening in the prior period on credit default swaps hedging certain bonds. The favorable change in net gains (losses) on written credit default swaps of$48 million was due to credit spreads being mixed in the current period compared to credit spreads widening in the prior period on certain credit default swaps used as replications. For the six month period, the favorable change in net gains (losses) on purchased credit default swaps of$169 million was due to credit spreads being mixed in the current period compared to credit spreads narrowing in the prior period on credit default swaps hedging certain bonds. The unfavorable change in net gains (losses) on written credit default swaps of$24 million was due to credit spreads narrowing less in the current period than in the prior period on certain credit default swaps used as replications. The maximum amount at risk related to our written credit default swaps is equal to the corresponding notional amount. The increase in the notional amount of written credit default swaps is primarily a result of our decision to add to our credit replication holdings within the Company. In a replication transaction, we pair an asset on our balance sheet with a written credit default swap to synthetically replicate a corporate bond, a core asset holding of life insurance companies. Replications are entered into in accordance with the guidelines approved by insurance regulators and are an important tool in managing the overall corporate credit risk within the Company. In order to match our long-dated insurance liabilities, we will seek to buy long-dated corporate bonds. In some instances, these may not be readily available in the market, or they may be issued by corporations to which we already have significant corporate credit exposure. For example, by purchasing Treasury bonds (or other high-quality assets) and associating them with written credit default swaps on the desired corporate credit name, we, at times, can replicate the desired bond exposures and meet our asset-liability management needs. In addition, given 174
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the shorter tenor of the credit default swaps (generally 5-year tenors) versus a long-dated corporate bond, we have more flexibility in managing our credit exposures.
Embedded Derivatives. See Note 8 of the Notes to the Interim Condensed Consolidated Financial Statements for information about embedded derivatives measured at estimated fair value on a recurring basis and their corresponding fair value hierarchy.
See Note 8 of the Notes to the Interim Condensed Consolidated Financial Statements for a rollforward of the fair value measurements for net embedded derivatives measured at estimated fair value on a recurring basis using significant unobservable (Level 3) inputs.
See Note 7 of the Notes to the Interim Condensed Consolidated Financial Statements for information about the nonperformance risk adjustment included in the valuation of guaranteed minimum benefits accounted for as embedded derivatives.
See "- Summary of Critical Accounting Estimates - Derivatives" included in the 2012 Annual Report for further information on the estimates and assumptions that affect embedded derivatives.
Off-Balance Sheet Arrangements
Credit and Committed Facilities
We maintain unsecured credit facilities and committed facilities with various financial institutions. See "- Liquidity and Capital Resources - The Company - Liquidity and Capital Sources - Credit and Committed Facilities" for further descriptions of such arrangements.
Collateral for Securities Lending, Repurchase Program and Derivatives
We participate in a securities lending program in the normal course of business for the purpose of enhancing the total return on our investment portfolio. Periodically, we receive non-cash collateral for securities lending from counterparties on deposit from customers, which cannot be sold or repledged, and which has not been recorded on our consolidated balance sheets. We had no such collateral as ofJune 30, 2013 . The amount of this collateral was$104 million at estimated fair value atDecember 31, 2012 . See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Investments - Securities Lending" and "Summary of Significant Accounting Policies - Investments - Securities Lending Program" in Note 1 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report for further information on discussion of our securities lending program and the classification of revenues and expenses and the nature of the secured financing arrangement and associated liability. We also participate in a third-party custodian administered repurchase program for the purpose of enhancing the total return on our investment portfolio. We loan certain of our fixed maturity securities to financial institutions and, in exchange, non-cash collateral is put on deposit by the financial institutions on our behalf with the third-party custodian. The estimated fair value of securities loaned in connection with these transactions was$934 million and$729 million atJune 30, 2013 andDecember 31, 2012 , respectively. Non-cash collateral on deposit with the third-party custodian on our behalf was$1.0 billion and$785 million atJune 30, 2013 andDecember 31, 2012 , respectively, which cannot be sold or repledged, and which has not been recorded on our consolidated balance sheets. We enter into derivatives to manage various risks relating to our ongoing business operations. We have non-cash collateral from counterparties for derivatives, which can be sold or repledged subject to certain constraints, and which has not been recorded on our consolidated balance sheets. The amount of this collateral was$3.2 billion and$3.7 billion atJune 30, 2013 andDecember 31, 2012 , respectively. See "- Liquidity and Capital 175
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Resources - The Company - Liquidity and Capital Uses - Pledged Collateral" and "Derivatives" in Note 7 of the Notes to the Interim Condensed Consolidated Financial Statements for information on the earned income on and the gross notional amount, estimated fair value of assets and liabilities and primary underlying risk exposure of our derivatives.
Guarantees
See "Guarantees" in Note 14 of the Notes to the Interim Condensed Consolidated Financial Statements.
Other Additionally, we have the following commitments in the normal course of business for the purpose of enhancing the total return on our investment portfolio: commitments to fund partnership investments; mortgage loan commitments; and commitments to fund bank credit facilities, bridge loans and private corporate bond investments. See "Net Investment Income" and "Net Investment Gains (Losses)" in Note 6 of the Notes to the Interim Condensed Consolidated Financial Statements for information on the investment income, investment expense, gains and losses from such investments. See also "Fixed Maturity and Equity Securities Available-for-Sale," and "Mortgage Loans" in Note 6 of the Notes to the Interim Condensed Consolidated Financial Statements and " - Investments - Real Estate andReal Estate Joint Ventures " and " - Investments - Other Limited Partnership Interests" for information on our investments in fixed maturity securities, mortgage loans and partnership investments. Other than the commitments disclosed in Note 14 of the Notes to the Interim Condensed Consolidated Financial Statements, there are no other material obligations or liabilities arising from the commitments to fund partnership investments, mortgage loans, bank credit facilities, bridge loans, and private corporate bond investments. For further information on commitments to fund partnership investments, mortgage loans, bank credit facilities, bridge loans and private corporate bond investments.
Policyholder Liabilities
We establish, and carry as liabilities, actuarially determined amounts that are calculated to meet policy obligations or to provide for future annuity payments. Amounts for actuarial liabilities are computed and reported in the interim condensed consolidated financial statements in conformity with GAAP. For more details on Policyholder Liabilities, see "- Summary of Critical Accounting Estimates" included in the 2012 Annual Report. Due to the nature of the underlying risks and the high degree of uncertainty associated with the determination of actuarial liabilities, we cannot precisely determine the amounts that will ultimately be paid with respect to these actuarial liabilities, and the ultimate amounts may vary from the estimated amounts, particularly when payments may not occur until well into the future. Our actuarial liabilities for future benefits are adequate to cover the ultimate benefits required to be paid to policyholders. We periodically review our estimates of actuarial liabilities for future benefits and compare them with our actual experience. We revise estimates, to the extent permitted or required under GAAP, if we determine that future expected experience differs from assumptions used in the development of actuarial liabilities. We charge or credit changes in our liabilities to expenses in the period the liabilities are established or re-estimated. If the liabilities originally established for future benefit payments prove inadequate, we must increase them. Such an increase could adversely affect our earnings and have a material adverse effect on our business, results of operations and financial condition. 176
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Insurance regulators in many of the non-U.S. countries in which we operate require certain
We have experienced, and will likely in the future experience, catastrophe losses and possibly acts of terrorism, as well as turbulent financial markets that may have an adverse impact on our business, results of operations, and financial condition. Due to their nature, we cannot predict the incidence, timing, severity or amount of losses from catastrophes and acts of terrorism, but we make broad use of catastrophic and non-catastrophic reinsurance to manage risk from these perils. Future Policy Benefits We establish liabilities for amounts payable under insurance policies. See Notes 1 and 4 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report for additional information. See also "- Industry Trends - Interest Rate Stress Scenario" included in the 2012 Annual Report and "- Variable Annuity Guarantees." A discussion of future policy benefits by segment follows. Retail For the Retail Life & Other business, future policy benefits are comprised mainly of liabilities for traditional life and for universal and variable life insurance contracts. In order to manage risk, we have often reinsured a portion of the mortality risk on new individual life insurance policies. The reinsurance programs are routinely evaluated and this may result in increases or decreases to existing coverage. We have entered into various derivative positions, primarily interest rate swaps and swaptions, to mitigate the risk that investment of premiums received and reinvestment of maturing assets over the life of the policy will be at rates below those assumed in the original pricing of these contracts. For the Retail Annuities business, future policy benefits are comprised mainly of liabilities for life-contingent income annuities, and liabilities for the variable annuity guaranteed minimum benefits accounted for as insurance.
Group, Voluntary & Worksite Benefits
With the exception of our property & casualty products, future policy benefits for our Group and Voluntary & Worksite businesses are comprised mainly of liabilities for disabled lives under disability waiver of premium policy provisions, liabilities for survivor income benefit insurance, LTC policies, active life policies and premium stabilization and other contingency liabilities held under life insurance contracts. For our property & casualty products, future policy benefits include unearned premium reserves and liabilities for unpaid claims and claim expenses and represent the amount estimated for claims that have been reported but not settled and claims incurred but not reported. Liabilities for unpaid claims are estimated based upon assumptions such as rates of claim frequencies, levels of severities, inflation, judicial trends, legislative changes or regulatory decisions. Assumptions are based upon our historical experience and analyses of historical development patterns of the relationship of loss adjustment expenses to losses for each line of business, and consider the effects of current developments, anticipated trends and risk management programs, reduced for anticipated salvage and subrogation.
Corporate Benefit Funding
Liabilities for this segment are primarily related to payout annuities, including pension closeouts and structured settlement annuities. There is no interest rate crediting flexibility on these liabilities. As a result, a sustained low interest rate environment could negatively impact earnings; however, we have employed various ALM strategies, including the use of various derivative positions, primarily interest rate floors and interest rate swaps, to mitigate the risks associated with such a scenario. 177
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Future policy benefits for this segment are held primarily for immediate annuities inChile ,Argentina andMexico and traditional life contracts mainly inBrazil andMexico . There are also reserves held for total return pass-through provisions included in certain universal life and savings products inMexico . Factors impacting these liabilities include sustained periods of lower yields than rates established at policy issuance, lower than expected asset reinvestment rates, and mortality and lapses different than expected. We mitigate our risks by implementing an ALM policy and through the development of periodic experience studies.Asia Future policy benefits for this segment are held primarily for traditional life, endowment, annuity and accident & health contracts. They are also held for total return pass-through provisions included in certain universal life and savings products. They include certain liabilities for variable annuity and variable life guarantees of minimum death benefits, and longevity guarantees. Factors impacting these liabilities include sustained periods of lower yields than rates established at policy issuance, lower than expected asset reinvestment rates, market volatility, actual lapses resulting in lower than expected income, and actual mortality or morbidity resulting in higher than expected benefit payments. We mitigate our risks by implementing an ALM policy and through the development of periodic experience studies.
EMEA
Future policy benefits for this segment include unearned premium reserves for group life and credit insurance contracts. Future policy benefits are also held for traditional life, endowment and annuity contracts with significant mortality risk and accident & health contracts. Factors impacting these liabilities include sustained periods of lower yields than rates established at issue, lower than expected asset reinvestment rates, market volatility, actual lapses resulting in lower than expected income, and actual mortality or morbidity resulting in higher than expected benefit payments. We mitigate our risks by having premiums which are adjustable or cancellable in some cases, implementing an asset/liability matching policy and through the development of periodic experience studies.
Corporate & Other
Future policy benefits primarily include liabilities for quota-share reinsurance agreements for certain run-off LTC and workers' compensation business written by MICC. Additionally, future policy benefits includes liabilities for variable annuity guaranteed minimum benefits assumed from a former operating joint venture inJapan that are accounted for as insurance.
Policyholder Account Balances
PABs are generally equal to the account value, which includes accrued interest credited, but excludes the impact of any applicable surrender charge that may be incurred upon surrender. See "- Industry Trends - Interest Rate Stress Scenario" included in the 2012 Annual Report and "- Variable Annuity Guarantees." See also Notes 1 and 4 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report for additional information.
Retail
Life & Other PABs are held for retained asset accounts, universal life policies and the fixed account of variable life insurance policies. For Annuities, PABs are held for fixed deferred annuities, the fixed account portion of variable annuities, and non-life contingent income annuities. PABs are credited interest at a rate set by us, which is influenced by current market rates. A sustained low interest rate environment could negatively impact earnings as a result of the minimum credited rate guarantees present in most of these PABs. We have 178
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various derivative positions, primarily interest rate floors, to partially mitigate the risks associated with such a scenario. Additionally, PABs are held for variable annuity guaranteed minimum living benefits that are accounted for as embedded derivatives.
The table below presents the breakdown of account value subject to minimum guaranteed crediting rates for Retail:
June 30, 2013 Account Account Value at Guaranteed Minimum Crediting Rate Value (1) Guarantee (1) (In millions) Life & Other: Greater than 0% but less than 2% $ 83 $ 83
Equal to 2% but less than 4%
Equal to or greater than 4%
Annuities:
Greater than 0% but less than 2% $ 3,434 $ 2,108
Equal to 2% but less than 4%
Equal to or greater than 4% $ 2,766 $ 2,690
(1) The table above is not adjusted for policy loans.
As a result of acquisitions, we establish additional liabilities known as excess interest reserves for policies with credited rates in excess of market rates as of the applicable acquisition dates. AtJune 30, 2013 , excess interest reserves were$139 million and$379 million for Life & Other and Annuities, respectively.
Group, Voluntary & Worksite Benefits
PABs in this segment are held for retained asset accounts, universal life policies, the fixed account of variable life insurance policies and specialized life insurance products for benefit programs. PABs are credited interest at a rate set by us, which are influenced by current market rates. A sustained low interest rate environment could negatively impact earnings as a result of the minimum credited rate guarantees present in most of these PABs. We have various derivative positions, primarily interest rate floors, to partially mitigate the risks associated with such a scenario.
The table below presents the breakdown of account value subject to minimum guaranteed crediting rates for Group, Voluntary & Worksite Benefits:
June 30, 2013 Account Account Value at Guaranteed Minimum Crediting Rate Value (1) Guarantee (1) (In millions)
Greater than 0% but less than 2%
Equal to 2% but less than 4%
Equal to or greater than 4% $ 607 $
582
(1) The table above is not adjusted for policy loans.
Corporate Benefit Funding
PABs in this segment are comprised of funding agreements. Interest crediting rates vary by type of contract, and can be fixed or variable. Variable interest crediting rates are generally tied to an external index, most 179
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commonly (1-month or 3-month) London Inter-Bank Offered Rate ("LIBOR"). We are exposed to interest rate risks, as well as foreign currency exchange rate risk when guaranteeing payment of interest and return of principal at the contractual maturity date. We may invest in floating rate assets or enter into receive-floating interest rate swaps, also tied to external indices, as well as caps, to mitigate the impact of changes in market interest rates. We also mitigate risks by implementing an ALM policy and seek to hedge all foreign currency exchange rate risk through the use of foreign currency hedges, including cross currency swaps.
PABs in this segment are held largely for deferred annuities mainly inMexico andBrazil , and for universal life products mainly inMexico . Some of the deferred annuities inBrazil are unit-linked-type funds that do not meet the GAAP definition of separate accounts. The rest of the deferred annuities have minimum credited rate guarantees, and these liabilities and the universal life liabilities are generally impacted by sustained periods of low interest rates. Liabilities for unit-linked-type funds are impacted by changes in the fair value of the associated investments, as the return on assets is generally passed directly to the policyholder.
PABs in this segment are held largely for fixed income retirement and savings plans, fixed deferred annuities, interest sensitive whole life products, universal life and, to a lesser degree, liability amounts for unit-linked-type funds that do not meet the GAAP definition of separate accounts. Also included are certain liabilities for retirement and savings products sold in certain countries inAsia that generally are sold with minimum credited rate guarantees. Liabilities for guarantees on certain variable annuities inAsia are accounted for as embedded derivatives and recorded at estimated fair value and are also included within PABs. These liabilities are generally impacted by sustained periods of low interest rates, where there are interest rate guarantees. We mitigate risks by implementing an ALM policy and with reinsurance. Liabilities for unit-linked-type funds are impacted by changes in the fair value of the associated underlying investments, as the return on assets is generally passed directly to the policyholder.
The table below presents the breakdown of account value subject to minimum guaranteed crediting rates for
June 30, 2013 Account Account Value at Guaranteed Minimum Crediting Rate (1) Value (2) Guarantee (2) (In millions) Annuities:
Greater than 0% but less than 2%
Equal to 2% but less than 4%$ 1,040 $
473
Equal to or greater than 4% $ 2 $
2
Life & Other:
Greater than 0% but less than 2%
Equal to 2% but less than 4%$ 16,062 $
4,825
Equal to or greater than 4% $ 259 $ -
(1) The table above excludes negative VOBA liabilities of
instances where the estimated fair value of contract obligations exceeded the
book value of assumed insurance policy liabilities in the ALICO acquisition.
These negative liabilities were established primarily for decreased market
interest rates subsequent to the issuance of the policy contracts.
(2) The table above is not adjusted for policy loans.
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EMEA
PABs in this segment are held mostly for universal life, deferred annuity, pension products, and unit-linked-type funds that do not meet the GAAP definition of separate accounts. They are also held for endowment products without significant mortality risk. Where there are interest rate guarantees, these liabilities are generally impacted by sustained periods of low interest rates. We mitigate risks by implementing an asset/liability matching policy. Liabilities for unit-linked-type funds are impacted by changes in the fair value of the associated investments, as the return on assets is generally passed directly to the policyholder.
Corporate & Other
PABs in Corporate & Other are held for variable annuity guaranteed minimum benefits assumed from a former operating joint venture in
Variable Annuity Guarantees
We issue, directly and through assumed reinsurance, certain variable annuity products with guaranteed minimum benefits that provide the policyholder a minimum return based on their initial deposit (i.e., the benefit base) less withdrawals. In some cases, the benefit base may be increased by additional deposits, bonus amounts, accruals or optional market value resets. See Notes 1 and 4 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report for additional information. Certain guarantees, including portions thereof, have insurance liabilities established that are included in future policy benefits. Guarantees accounted for in this manner include guaranteed minimum death benefits ("GMDBs"), the life-contingent portion of certain guaranteed minimum withdrawal benefits ("GMWBs"), and the portion of guaranteed minimum income benefits ("GMIBs") that requires annuitization. These liabilities are accrued over the life of the contract in proportion to actual and future expected policy assessments based on the level of guaranteed minimum benefits generated using multiple scenarios of separate account returns. The scenarios are based on best estimate assumptions consistent with those used to amortize DAC. When current estimates of future benefits exceed those previously projected or when current estimates of future assessments are lower than those previously projected, liabilities will increase, resulting in a current period charge to net income. The opposite result occurs when the current estimates of future benefits are lower than that previously projected or when current estimates of future assessments exceed those previously projected. At each reporting period, we update the actual amount of business remaining in-force, which impacts expected future assessments and the projection of estimated future benefits resulting in a current period charge or increase to earnings. Certain guarantees, including portions thereof, accounted for as embedded derivatives, are recorded at estimated fair value and included in PABs. Guarantees accounted for as embedded derivatives include guaranteed minimum accumulation benefits ("GMABs"), the non life-contingent portion of GMWBs and the portion of certain GMIBs that do not require annuitization. The estimated fair values of guarantees accounted for as embedded derivatives are determined based on the present value of projected future benefits minus the present value of projected future fees. The projections of future benefits and future fees require capital market and actuarial assumptions including expectations concerning policyholder behavior. A risk neutral valuation methodology is used to project the cash flows from the guarantees under multiple capital market scenarios to determine an economic liability. The reported estimated fair value is then determined by taking the present value of these risk-free generated cash flows using a discount rate that incorporates a spread over the risk free rate to reflect our nonperformance risk and adding a risk margin. For more information on the determination of estimated fair value, see Note 8 of the Notes to the Interim Condensed Consolidated Financial Statements. 181
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The table below contains the carrying value for guarantees at:
Future Policy Policyholder Benefits Account Balances June 30, December 31, June 30, December 31, 2013 2012 2013 2012 (In millions)Americas : GMDB $ 396 $ 343 $ - $ - GMIB 1,481 1,432 (878) 200 GMAB - - 10 23 GMWB 35 30 30 428 Asia: GMDB 34 54 - - GMAB - - 7 11 GMWB 177 183 119 190 EMEA: GMDB 7 6 - - GMAB - - 15 28 GMWB 19 20 (39) 43 Corporate & Other: GMDB 10 39 - - GMAB - - 187 387 GMWB 93 95 1,483 2,195 Total $ 2,252 $ 2,202 $ 934 $ 3,505 The carrying amounts for guarantees included in PABs above include nonperformance risk adjustments of$562 million and$1.2 billion atJune 30, 2013 andDecember 31, 2012 , respectively. These nonperformance risk adjustments represent the impact of including a credit spread when discounting the underlying risk neutral cash flows to determine the estimated fair values. The nonperformance risk adjustment does not have an economic impact on us as it cannot be monetized given the nature of these policyholder liabilities. The change in valuation arising from the nonperformance risk adjustment is not hedged. The carrying values of these guarantees can change significantly during periods of sizable and sustained shifts in equity market performance, equity volatility, interest rates or foreign currency exchange rates. Carrying values are also impacted by our assumptions around mortality, separate account returns and policyholder behavior including lapse rates. As discussed below, we use a combination of product design, reinsurance, hedging strategies, and other risk management actions to mitigate the risks related to these benefits. Within each type of guarantee, there is a range of product offerings reflecting the changing nature of these products over time. Changes in product features and terms are in part driven by customer demand but, more importantly, reflect our risk management practices of continuously evaluating the guaranteed benefits and their associated asset-liability matching. The sections below provide further detail by total contract account value for certain of our most popular guarantees. Total contract account values include amounts not reported in the consolidated balance sheets from assumed reinsurance, contractholder-directed investments which do not qualify for presentation as separate account assets, and amounts included in our general account. 182
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GMDBs
We offer a range of GMDBs to our contractholders. The table below presents GMDBs, by benefit type, at
Total Contract Account Value (1) Corporate Americas & Other (In millions) Return of premium or five to seven year step-up $ 98,107 $ 16,176 Annual step-up 29,579 - Roll-up and step-up combination 36,772 - Total $ 164,458 $ 16,176
(1) Total contract account value above excludes
no GMDBs and approximately
the EMEA and
Based on total contract account value, less than 40% of our GMDBs included enhanced death benefits such as the annual step-up or roll-up and step-up combination products. We expect the above GMDB risk profile to be relatively consistent for the foreseeable future.
As part of our risk management of the GMDB business, we have been opportunistically reinsuring in-force blocks, taking advantage of favorable capital market conditions. Our approach for such treaties has been to seek coverage for the enhanced GMDBs, such as the annual step-up and the roll-up and step-up combination. These treaties tend to cover long periods until claims start running off, and are written either on a first dollar basis or with a deductible.
Living Benefit Guarantees
The table below presents our living benefit guarantees based on total contract account values at
Total Contract Account Value (1) Corporate Americas & Other (In millions) GMIB $ 91,531 $ - GMWB - non-life contingent 7,097
3,827 GMWB - life-contingent 17,585 10,133 GMAB 404 2,216 $ 116,617 $ 16,176
(1) Total contract account value above excludes
no living benefit guarantees and approximately
account value in the EMEA and
In terms of total contract account value, GMIBs are our most significant living benefit guarantee. Our primary risk management strategy for our GMIB products is our derivatives hedging program as discussed below. Additionally, we have engaged in certain reinsurance treaties covering some of our GMIB business. As part of our overall risk management approach for living benefit guarantees, we continually monitor the reinsurance markets for the right opportunity to purchase additional coverage for our GMIB business. 183
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The table below presents our GMIBs, by their guaranteed payout basis, atJune 30, 2013 : Total Contract Account Value (In millions) 7-year setback, 2.5% interest rate $
34,934
7-year setback, 1.5% interest rate
5,677
10-year setback, 1.5% interest rate
19,113
10-year mortality projection, 10-year setback, 1.0% interest rate
27,630
10-year mortality projection, 10-year setback, 0.5% interest rate 4,177 $ 91,531 The annuitization interest rates on GMIBs have been decreased from 2.5% to 0.5% over time, partially in response to the low interest rate environment, accompanied by an increase in the setback period from seven years to 10 years and the recent introduction of the 10-year mortality projection. We expect new contracts to have comparable guarantee features for the foreseeable future. Additionally, 29% of the$91.5 billion of GMIB total contract account value has been invested in managed volatility funds as ofJune 30, 2013 . These funds seek to manage volatility by adjusting the fund holdings within certain guidelines based on capital market movements. Such activity reduces the overall risk of the underlying funds while maintaining their growth opportunities. These risk mitigation techniques translate to a reduction or elimination of the need for us to manage the funds' volatility through hedging or reinsurance. We expect the proportion of total contract account value invested in these funds to increase for the foreseeable future, as new contracts with GMIBs are required to invest in these funds. Our GMIB products typically have a waiting period of 10 years to be eligible for annuitization. As ofJune 30, 2013 , only 4.4% of our contracts with GMIBs were eligible for annuitization. The remaining contracts are not eligible for annuitization for an average of 6.2 years. Once eligible for annuitization, contractholders would only be expected to annuitize if their contracts were in-the-money. We calculate in-the-moneyness with respect to GMIBs consistent with net amount at risk as discussed in Note 4 of the Notes to the Interim Condensed Consolidated Financial Statements, by comparing the contractholders' income benefits based on total contract account values and current annuity rates versus the guaranteed income benefits. For those contracts with GMIB, the table below presents details of contracts that are in-the-money and out-of-the-money atJune 30, 2013 : In-the- Total Contract Moneyness Account Value % of Total (In millions) In-the-money 30% + $ 2,635 2.9% 20% to 30% 2,947 3.2% 10% to 20% 5,517 6.0% 0% to 10% 8,261 9.0% 19,360 Out-of-the-money -10% to 0% 12,948 14.2% -20% to -10% 8,586 9.4% -20% + 50,637 55.3% 72,171 Total GMIBs $ 91,531 184
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Derivatives Hedging Variable Annuity Guarantees
In addition to reinsurance and our risk mitigating steps described above, we have a hedging strategy that uses various over the counter and exchanged traded derivatives. The table below presents the gross notional amount, estimated fair value and primary underlying risk exposure of the derivatives hedging our variable annuity guarantees: June 30, 2013 December 31, 2012 Primary Underlying Notional Estimated Fair Value Notional Estimated Fair Value Risk Exposure Instrument Type Amount Assets Liabilities Amount Assets Liabilities (In millions) Interest rate Interest rate swaps$ 25,483 $ 1,255 $ 567$ 24,041 $ 1,973 $ 614 Interest rate futures 6,808 11 13 8,913 1 25 Interest rate options 11,440 163 174 11,440 303 58 Foreign currency exchange rate Foreign currency forwards 2,269 27 44 2,281 1 177 Foreign currency futures 245 - 2 518 4 - Equity market Equity futures 5,968 11 54 6,993 14 132 Equity options 28,481 2,028 610 21,759 2,824 356 Variance swaps 21,888 114 442 19,830 122 310 Total rate of return swaps 3,736 82 44 3,092 5 103 Total$ 106,318 $ 3,691 $ 1,950 $ 98,867 $ 5,247 $ 1,775
The change in estimated fair values of our derivatives is recorded in policyholder benefits and claims if they are hedging guarantees included in future policy benefits, and in net derivative gains (losses) if they are hedging guarantees included in PABs.
Our hedging strategy involves the significant use of static longer-term derivative instruments to avoid the need to execute transactions during periods of market disruption or higher volatility. We continually monitor the capital markets for opportunities to adjust our liability coverage, as appropriate. Futures are also used to dynamically adjust the daily coverage levels as markets and liability exposures fluctuate. We remain liable for the guaranteed benefits in the event that reinsurers or derivative counterparties are unable or unwilling to pay. Certain of our reinsurance agreements and most derivative positions are collateralized and derivatives positions are subject to master netting agreements, both of which significantly reduce the exposure to counterparty risk. In addition, we are subject to the risk that hedging and other risk management actions prove ineffective or that unanticipated policyholder behavior or mortality, combined with adverse market events, produces economic losses beyond the scope of the risk management techniques employed.
Liquidity and Capital Resources
Overview
Our business and results of operations are materially affected by conditions in the global capital markets and the economy generally. Stressed conditions, volatility and disruptions in global capital markets, particular markets, or financial asset classes can have an adverse effect on us, in part because we have a large investment portfolio and our insurance liabilities are sensitive to changing market factors. The global markets and economy continue to experience volatility that may affect our financing costs and market interest for our debt or equity securities. For further information regarding market factors that could affect our ability to meet liquidity and capital needs, see "- Industry Trends" and "- Investments - Current Environment." 185
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Liquidity Management
Based upon the strength of our franchise, diversification of our businesses, strong financial fundamentals and the substantial funding sources available to us as described herein, we continue to believe we have access to ample liquidity to meet business requirements under current market conditions and reasonably possible stress scenarios. Short-term Liquidity. We maintain a substantial short-term liquidity position, which was$15.9 billion and$24.1 billion atJune 30, 2013 andDecember 31, 2012 , respectively. Short-term liquidity includes cash and cash equivalents and short-term investments, excluding: (i) amounts related to cash collateral received under our securities lending program, and (ii) amounts related to cash collateral received from counterparties in connection with derivatives. We continuously monitor and adjust our liquidity and capital plans forMetLife, Inc. and its subsidiaries in light of changing needs and opportunities. Liquid Assets. An integral part of our liquidity management includes managing our level of liquid assets, which was$267.8 billion and$292.2 billion atJune 30, 2013 andDecember 31, 2012 , respectively. Liquid assets include cash and cash equivalents, short-term investments and publicly-traded securities, excluding: (i) amounts related to cash collateral received under our securities lending program; (ii) amounts related to cash collateral received from counterparties in connection with derivatives; (iii) cash and cash equivalents, short-term investments and securities on deposit with regulatory agencies; and (iv) securities held in trust in support of collateral financing arrangements and pledged in support of funding agreements, derivatives and short sale agreements.
Capital Management
We have established several senior management committees as part of our capital management process. These committees, including the Capital Management Committee and the Enterprise Risk Committee, regularly review actual and projected capital levels (under a variety of scenarios including stress scenarios) and our capital plan in accordance with our capital policy. The Capital Management Committee is comprised of members of senior management, includingMetLife, Inc.'s Chief Financial Officer, Treasurer and Chief Risk Officer. The Enterprise Risk Committee is also comprised of members of senior management, includingMetLife, Inc.'s Chief Financial Officer, Chief Risk Officer and Chief Investment Officer. Our Board and senior management are directly involved in the development and maintenance of our capital policy. The capital policy sets forth, among other things, minimum and target capital levels and the governance of the capital management process. All capital actions, including proposed changes to the capital plan, capital targets or capital policy, are reviewed by theFinance and Risk Committee of the Board prior to obtaining full Board approval. The Board approves the capital policy and the annual capital plan and authorizes capital actions, as required. See "Risk Factors - Capital-Related Risks - We Have Been, and May Continue to be, Prevented from Repurchasing Our Stock and Paying Dividends at the Level We Wish as a Result of Regulatory Restrictions and Restrictions Under the Terms of Certain of Our Securities" included in the 2012 Annual Report and Note 16 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report for information regarding restrictions on payment of dividends and stock repurchases. The Company Liquidity Liquidity refers to a company's ability to generate adequate amounts of cash to meet its needs. In the event of significant cash requirements beyond anticipated liquidity needs, we have various alternatives available 186
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depending on market conditions and the amount and timing of the liquidity need. These options include cash flows from operations, the sale of liquid assets, global funding sources and various credit facilities.
Capital
We manage our capital position to maintain our financial strength and credit ratings. Our capital position is supported by our ability to generate strong cash flows within our operating companies and borrow funds at competitive rates, as well as by our demonstrated ability to raise additional capital to meet operating and growth needs despite adverse market and economic conditions.
Summary of Primary Sources and Uses of Liquidity and Capital
Our primary sources and uses of liquidity and capital are summarized as follows: Six Months Ended June 30, 2013 2012 (In millions) Sources: Net cash provided by operating activities$ 7,314 $ 12,102 Net cash provided by changes in policyholder account balances -
4,335
Net cash provided by changes in payables for collateral under securities loaned and other transactions
-
6,586
Net cash provided by changes in bank deposits 8 -
Net change in liability for securitized reverse residential mortgage loans
-
1,116
Net cash provided by other, net - 32 Total sources 7,322 24,171 Uses: Net cash used in investing activities 7,853
12,777
Net cash used for changes in policyholder account balances 4,345 -
Net cash used for changes in payables for collateral under securities loaned and other transactions
440 - Net cash used for changes in bank deposits -
3,717
Net cash used for short-term debt repayments - 585 Long-term debt repaid 356
1,022
Collateral financing arrangements repaid - 349 Cash paid in connection with collateral financing arrangements - 44 Dividends on preferred stock 61 61 Dividends on common stock 505 - Net cash used in other, net 91 - Effect of change in foreign currency exchange rates on cash and cash equivalents balances 225 42 Total uses 13,876 18,597 Net increase (decrease) in cash and cash equivalents$ (6,554)
Cash Flows from Operations. The principal cash inflows from our insurance activities come from insurance premiums, annuity considerations and deposit funds. The principal cash outflows relate to the liabilities associated with various life insurance, property & casualty, annuity and group pension products, operating expenses and income tax, as well as interest on outstanding debt obligations. A primary liquidity concern with respect to these cash flows is the risk of early contractholder and policyholder withdrawal. 187
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Cash Flows from Investments. The principal cash inflows from our investment activities come from repayments of principal on invested assets, proceeds from maturities of invested assets, sales of invested assets, settlements of freestanding derivatives and net investment income. The principal cash outflows relate to purchases of investments, issuances of policy loans and settlements of freestanding derivatives. Additional cash outflows include those related to our securities lending activities. We typically have a net cash outflow from investing activities because cash inflows from insurance operations are reinvested in accordance with our ALM discipline to fund insurance liabilities. We closely monitor and manage these risks through our credit risk management process. The primary liquidity concerns with respect to these cash flows are the risk of default by debtors and market disruption. Financing Cash Flows. The principal cash inflows from our financing activities come from issuances of debt, issuances ofMetLife, Inc.'s securities, and deposit funds associated with PABs. The principal cash outflows come from repayments of debt, payments of dividends onMetLife, Inc.'s securities and withdrawals associated with PABs. A primary liquidity concern with respect to these cash flows is the risk of early contractholder and policyholder withdrawal.
Liquidity and Capital Sources
In addition to the general description of liquidity and capital sources in "- Summary of Primary Sources and Uses of Liquidity and Capital," the following additional information is provided regarding our primary sources of liquidity and capital: Global Funding Sources. Liquidity is provided by a variety of funding sources, including funding agreements, credit facilities and commercial paper. Capital is provided by a variety of funding sources, including short-term and long-term debt, collateral financing arrangements, junior subordinated debt securities, preferred securities and equity and equity-linked securities. The diversity of our funding sources enhances our funding flexibility, limits dependence on any one market or source of funds and generally lowers the cost of funds. Our primary global funding sources include: Common Stock. During the six months endedJune 30, 2013 and 2012,MetLife, Inc. issued 4,914,813 and 4,229,541 new shares of its common stock for$155 million and$135 million , respectively, to satisfy various stock option exercises and other stock-based awards. Commercial Paper, Reported in Short-term Debt.MetLife, Inc. andMetLife Funding, Inc. ("MetLife Funding") each have commercial paper programs supported by$4.0 billion in general corporate credit facilities (see "- Credit and Committed Facilities"). MetLife Funding, a subsidiary ofMetropolitan Life Insurance Company ("MLIC"), serves as our centralized finance unit.MetLife Funding raises cash from its commercial paper program and uses the proceeds to extend loans, throughMetLife Credit Corp. , another subsidiary of MLIC, toMetLife, Inc. , MLIC and other affiliates in order to enhance the financial flexibility and liquidity of these companies. Outstanding balances for the commercial paper program fluctuate in line with changes to affiliates' financing arrangements. Federal Home Loan Bank Funding Agreements, Reported in PABs. Certain of our domestic insurance subsidiaries are members of a regionalFHLB . During the six months endedJune 30, 2013 and 2012, we issued$8.0 billion and$13.2 billion , respectively, and repaid$8.4 billion and$10.3 billion , respectively, under funding agreements with certainFHLB regional banks. AtJune 30, 2013 andDecember 31, 2012 , total obligations outstanding under these funding agreements were$15.0 billion and$15.4 billion , respectively. See Note 4 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report. Special Purpose Entity Funding Agreements, Reported in PABs. We issue fixed and floating rate funding agreements, which are denominated in either U.S. dollars or foreign currencies, to certain special purpose entities ("SPEs") that have issued either debt securities or commercial paper for which payment of interest and principal is secured by such funding agreements. During the six months endedJune 30, 2013 and 2012, we issued 188
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$18.6 billion and$20.6 billion , respectively, and repaid$17.8 billion and$17.3 billion , respectively, under such funding agreements. AtJune 30, 2013 andDecember 31, 2012 , total obligations outstanding under these funding agreements were$30.6 billion and$30.0 billion , respectively. See Note 4 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report. Federal Agricultural Mortgage Corporation Funding Agreements, Reported in PABs. We have issued funding agreements to the Federal Agricultural Mortgage Corporation ("Farmer Mac"), as well as to certain SPEs that have issued debt securities for which payment of interest and principal is secured by such funding agreements, and such debt securities are also guaranteed as to payment of interest and principal by Farmer Mac. The obligations under all such funding agreements are secured by a pledge of certain eligible agricultural real estate mortgage loans and may, under certain circumstances, be secured by other qualified collateral. There were no issuances or repayments under such funding agreements during the six months endedJune 30, 2013 and 2012. At bothJune 30, 2013 andDecember 31, 2012 , total obligations outstanding under these funding agreements were$2.8 billion . See Note 4 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report. Remarketing ofSenior Debt Securities and Settlement of Stock Purchase Contracts. InSeptember 2013 ,MetLife, Inc. plans to remarket$1.0 billion of senior debt securities underlying common equity units issued inNovember 2010 in connection with the acquisition of ALICO.MetLife, Inc. will not receive any proceeds from the remarketing. Common equity unit holders will use the remarketing proceeds to settle their payment obligations under the applicable stock purchase contracts. The subsequent settlement of the stock purchase contracts will provide proceeds toMetLife, Inc. of$1.0 billion in exchange for shares ofMetLife, Inc.'s common stock.MetLife, Inc. will deliver between 22.6 million and 28.3 million shares of its newly issued common stock to settle the stock purchase contracts. See Notes 12 and 15 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report for additional information. Credit and Committed Facilities. We maintain unsecured credit facilities and committed facilities, which aggregated$4.0 billion and$12.4 billion , respectively, atJune 30, 2013 . When drawn upon, these facilities bear interest at varying rates in accordance with the respective agreements. The unsecured credit facilities are used for general corporate purposes, to support the borrowers' commercial paper programs and for the issuance of letters of credit. AtJune 30, 2013 , we had outstanding$2.2 billion in letters of credit and no drawdowns against these facilities. Remaining unused commitments were$1.8 billion atJune 30, 2013 . The committed facilities are used for collateral for certain of our affiliated reinsurance liabilities. AtJune 30, 2013 ,$6.5 billion in letters of credit and$2.8 billion in aggregate drawdowns were outstanding against these facilities. Remaining unused commitments were$3.1 billion atJune 30, 2013 .
See Note 12 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report for further information about these facilities.
We have no reason to believe that our lending counterparties will be unable to fulfill their respective contractual obligations under these facilities. As commitments associated with letters of credit and financing arrangements may expire unused, these amounts do not necessarily reflect our actual future cash funding requirements. 189
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Outstanding Debt Under Global Funding Sources. The following table summarizes our outstanding debt at: June 30, 2013 December 31, 2012 (In millions) Short-term debt $ 100 $ 100 Long-term debt (1) $ 16,451 $ 16,535 Collateral financing arrangements $ 4,196 $
4,196
Junior subordinated debt securities $ 3,193 $ 3,192
(1) Excludes
2012, respectively, of long-term debt relating to CSEs (see Note 6 of the
Notes to the Interim Condensed Consolidated Financial Statements).
Dispositions. Cash proceeds from dispositions during the six months endedJune 30, 2013 and 2012 were$373 million and$0 , respectively. During the six months endedJune 30, 2013 , the sale ofMetLife Bank's depository business resulted in cash outflows of$6.4 billion as a result of the buyer's assumption of the bank deposits liability in exchange for our cash payment. See Note 3 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report for information regarding the 2013 proceeds and Note 3 of the Notes to the Interim Condensed Consolidated Financial Statements for information regarding the sale ofMetLife Bank's depository business.
Liquidity and Capital Uses
In addition to the general description of liquidity and capital uses in "- Summary of Primary Sources and Uses of Liquidity and Capital," the following additional information is provided regarding our primary uses of liquidity and capital: Common Stock Dividends. InJanuary 2013 ,MetLife, Inc. , which previously paid common stock dividends annually, transitioned to paying common stock dividends quarterly. Accordingly,MetLife, Inc. did not pay common stock dividends during the six months endedJune 30, 2012 . The table below presents declaration, record and payment dates, as well as per share and aggregate dividend amounts, for common stock dividends paid during the six months endedJune 30, 2013 : Dividend Declaration Date Record Date Payment Date Per Share Aggregate (In millions, except per share data) April 23, 2013 May 9, 2013 June 13, 2013 $ 0.275 $ 302 January 4, 2013 February 6, 2013 March 13, 2013 $ 0.185 203 $ 505 The declaration and payment of common stock dividends is subject to the discretion of our Board of Directors, and will depend onMetLife, Inc.'s financial condition, results of operations, cash requirements, future prospects, regulatory restrictions on the payment of dividends byMetLife, Inc.'s other insurance subsidiaries and other factors deemed relevant by the Board. OnJune 25, 2013 ,MetLife, Inc. declared a third quarter 2013 common stock dividend of$0.275 per share payable onSeptember 13, 2013 to shareholders of record as of <chron>August 9, 2013.MetLife, Inc. estimates the aggregate dividend payment to be$303 million , which was included in other liabilities atJune 30, 2013 . 190
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Preferred Stock Dividends. Information on the declaration, record and payment dates, as well as per share and aggregate dividend amounts, for preferred stock was as follows for the six months endedJune 30, 2013 and 2012: Dividend Series A Series A Series B Series B Declaration Date Record Date Payment Date Per Share Aggregate Per Share Aggregate (In millions, except per share data) May 15, 2013 May 31, 2013 June 17, 2013$ 0.256 $ 7 $ 0.406 $ 24 March 5, 2013 February 28, 2013 March 15, 2013$ 0.250 6 $ 0.406 24 $ 13 $ 48 May 15, 2012 May 31, 2012 June 15, 2012$ 0.256 $ 7 $ 0.406 $ 24 March 5, 2012 February 29, 2012 March 15, 2012$ 0.253 6 $ 0.406 24 $ 13 $ 48
Preferred stock dividends are paid quarterly in accordance with the terms of
Dividend Restrictions. The payment of dividends and other distributions byMetLife, Inc. to its security holders may be subject to regulation by theFederal Reserve Board , if, in the future,MetLife, Inc. is designated as a non-bank SIFI. See "- Industry Trends - Regulatory Developments - Potential Regulation as a Non-Bank SIFI." The payment of dividends is also subject to restrictions under the terms of our preferred stock and junior subordinated debentures in situations where we may be experiencing financial stress. See "Risk Factors - Capital-Related Risks - We Have Been, and May Continue to be, Prevented from Repurchasing Our Stock and Paying Dividends at the Level We Wish as a Result of Regulatory Restrictions and Restrictions Under the Terms of Certain of Our Securities" in the 2012 Annual Report and Note 16 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report. Debt and Facility Covenants. Certain of our debt instruments, credit facilities and committed facilities contain various administrative, reporting, legal and financial covenants. We believe we were in compliance with all such covenants atJune 30, 2013 . Debt Repurchases. We may from time to time seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for other securities, in open market purchases, privately negotiated transactions or otherwise. Any such repurchases or exchanges will be dependent upon several factors, including our liquidity requirements, contractual restrictions, general market conditions, and applicable regulatory, legal and accounting factors. Whether or not to repurchase any debt and the size and timing of any such repurchases is determined at our discretion. Support Agreements.MetLife, Inc. and several of its subsidiaries (each, an "Obligor") are parties to various capital support commitments, guarantees and contingent reinsurance agreements with certain subsidiaries ofMetLife, Inc. Under these arrangements, each Obligor, with respect to the applicable entity, has agreed to cause such entity to meet specified capital and surplus levels, has guaranteed certain contractual obligations or has agreed to provide, upon the occurrence of certain contingencies, reinsurance for such entity's insurance liabilities. We anticipate that in the event that these arrangements place demands upon us, there will be sufficient liquidity and capital to enable us to meet anticipated demands. InJuly 2012 , in connection with an operating agreement with the OCC governingMetLife Bank's operations during its wind-down process,MetLife Bank andMetLife, Inc. entered into a capital support agreement with theOCC andMetLife, Inc. andMetLife Bank entered into an indemnification and capital maintenance agreement under which agreementsMetLife, Inc. will provide financial and other support toMetLife Bank to ensure thatMetLife Bank can wind down its operations in a safe and sound manner.
See "-
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Insurance Liabilities. Liabilities arising from our insurance activities primarily relate to benefit payments under various life insurance, property & casualty, annuity and group pension products, as well as payments for policy surrenders, withdrawals and loans. For annuity or deposit type products, surrender or lapse product behavior differs somewhat by segment. In the Retail segment, which includes individual annuities, lapses and surrenders tend to occur in the normal course of business. During the six months endedJune 30, 2013 and 2012, general account surrenders and withdrawals from annuity products were$2.0 billion and$2.3 billion , respectively. In the Corporate Benefit Funding segment, which includes pension closeouts, bank-owned life insurance and other fixed annuity contracts, as well as funding agreements and other capital market products, most of the products offered have fixed maturities or fairly predictable surrenders or withdrawals. With regard to the Corporate Benefit Funding segment liabilities that provide customers with limited rights to accelerate payments, there were$2.4 billion atJune 30, 2013 of funding agreements and other capital market products that could be put back to the Company after a period of notice. Of these liabilities,$135 million were subject to a notice period of 90 days. The remaining liabilities are subject to a notice period of five months or greater. Pledged Collateral. We pledge collateral to, and have collateral pledged to us by, counterparties in connection with our derivatives. AtJune 30, 2013 andDecember 31, 2012 , we were obligated to return cash collateral under our control of$3.2 billion and$6.0 billion , respectively. AtJune 30, 2013 andDecember 31, 2012 , we had pledged cash collateral of$2 million and$1 million , respectively for over-the-counter bilateral derivative contracts between two counterparties ("OTC-bilateral") in a net liability position. With respect to OTC-bilateral derivatives in a net liability position that have credit contingent provisions, a one-notch downgrade in the Company's credit rating would require$19 million of additional collateral be provided to our counterparties as ofJune 30, 2013 . See Note 7 of the Notes to the Interim Condensed Consolidated Financial Statements for additional information about collateral pledged to us, collateral we pledge and derivatives subject to credit contingent provisions. In addition, we have pledged collateral and have had collateral pledged to us, and may be required from time to time to pledge additional collateral or be entitled to have additional collateral pledged to us, in connection with collateral financing arrangements related to the reinsurance of closed block liabilities and universal life secondary guarantee liabilities. Securities Lending. We participate in a securities lending program whereby blocks of securities are loaned to third parties, primarily brokerage firms and commercial banks. We obtain collateral, usually cash, from the borrower, which must be returned to the borrower when the loaned securities are returned to us. Under our securities lending program, we were liable for cash collateral under our control of$30.1 billion and$27.7 billion atJune 30, 2013 andDecember 31, 2012 , respectively. Of these amounts,$7.0 billion and$5.0 billion atJune 30, 2013 andDecember 31, 2012 , respectively, were on open, meaning that the related loaned security could be returned to us on the next business day requiring the immediate return of cash collateral we hold. The estimated fair value of the securities on loan related to the cash collateral on open atJune 30, 2013 was$6.8 billion , of which$6.6 billion were U.S. Treasury and agency securities which, if put to us, can be immediately sold to satisfy the cash requirements to immediately return the cash collateral. See Note 6 of the Notes to the Interim Condensed Consolidated Financial Statements for further information. Litigation. Putative or certified class action litigation and other litigation, and claims and assessments against us, in addition to those discussed elsewhere herein and those otherwise provided for in the consolidated financial statements, have arisen in the course of our business, including, but not limited to, in connection with our activities as an insurer, employer, investor, investment advisor, taxpayer and formerly a mortgage lending bank. Further, state insurance regulatory authorities and other federal and state authorities regularly make inquiries and conduct investigations concerning our compliance with applicable insurance and other laws and regulations. See Note 14 of the Notes to the Interim Condensed Consolidated Financial Statements. We establish liabilities for litigation and regulatory loss contingencies when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. For material matters where a loss is believed to be reasonably possible but not probable, no accrual is made but we disclose the nature of the contingency and an aggregate estimate of the reasonably possible range of loss in excess of amounts accrued, 192
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when such an estimate can be made. It is not possible to predict or determine the ultimate outcome of all pending investigations and legal proceedings. In some of the matters referred to herein, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Although in light of these considerations, it is possible that an adverse outcome in certain cases could have a material adverse effect upon our financial position, based on information currently known by us, in our opinion, the outcome of such pending investigations and legal proceedings are not likely to have such an effect. However, given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on our consolidated net income or cash flows in particular quarterly or annual periods. Acquisitions. During each of the six months endedJune 30, 2013 and 2012, there were no cash outflows for acquisitions. See Note 3 of the Notes to the Interim Condensed Consolidated Financial Statements for information regarding a pending acquisition.
Contractual Obligations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - The Company - Contractual Obligations" included in the 2012 Annual Report for additional information on the Company's contractual obligations.
Liquidity Management and Capital Management
Liquidity and capital are managed to preserve stable, reliable and cost-effective sources of cash to meet all current and future financial obligations and are provided by a variety of sources, including a portfolio of liquid assets, a diversified mix of short- and long-term funding sources from the wholesale financial markets and the ability to borrow through credit and committed facilities. Liquidity is monitored through the use of internal liquidity risk metrics, including the composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, access to the financial markets for capital and debt transactions and exposure to contingent draws onMetLife, Inc.'s liquidity.MetLife, Inc. is an active participant in the global financial markets through which it obtains a significant amount of funding. These markets, which serve as cost-effective sources of funds, are critical components ofMetLife, Inc.'s liquidity and capital management. Decisions to access these markets are based upon relative costs, prospective views of balance sheet growth and a targeted liquidity profile and capital structure. A disruption in the financial markets could limitMetLife, Inc.'s access to liquidity.MetLife, Inc.'s ability to maintain regular access to competitively priced wholesale funds is fostered by its current credit ratings from the major credit rating agencies. We view our capital ratios, credit quality, stable and diverse earnings streams, diversity of liquidity sources and our liquidity monitoring procedures as critical to retaining such credit ratings. Liquid Assets. AtJune 30, 2013 andDecember 31, 2012 ,MetLife, Inc. and otherMetLife holding companies had$6.5 billion and$5.7 billion , respectively, in liquid assets. Of these amounts,$5.9 billion and$5.0 billion were held byMetLife, Inc. and$0.6 billion and$0.7 billion were held by otherMetLife holding companies, atJune 30, 2013 andDecember 31, 2012 , respectively. Liquid assets include cash and cash equivalents, short-term investments and publicly-traded securities, excluding: (i) amounts related to cash collateral received under our securities lending program, and (ii) amounts related to cash collateral received from counterparties in connection with derivatives; and (iii) securities held in trust in support of collateral financing arrangements and pledged in support of derivatives. Liquid assets held in non-U.S. holding companies are generated in part through dividends from non-U.S. insurance operations determined to be available after application of local insurance regulatory requirements, as discussed in "-MetLife, Inc. - Liquidity and Capital Sources - Dividends from Subsidiaries." The 193
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cumulative earnings of certain active non-U.S. operations have been reinvested indefinitely in such non-U.S. operations, as described in Note 19 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report. Under current tax laws, should we repatriate such earnings, we may be subject to additional U.S. income taxes and foreign withholding taxes.
Liquidity
For a summary of
Capital
Potential Restrictions and Limitations on Non-Bank SIFIs.MetLife Bank has terminated itsFederal Deposit Insurance Corporation insurance andMetLife, Inc. de-registered as a bank holding company. As a result,MetLife, Inc. is no longer subject to enhanced supervision and prudential standards as a bank holding company with assets of$50 billion or more. However, if, in the future,MetLife, Inc. is designated by the FSOC as a non-bank SIFI, it could once again be subject to regulation by theFederal Reserve Board and enhanced supervision and prudential standards. In addition, ifMetLife, Inc. is designated as a non-bank SIFI or a G-SII, its ability to pay dividends, repurchase common stock or other securities or engage in other transactions that could affect its capital or need for capital could be reduced by any additional capital requirements that might be imposed. See "- Industry Trends - Regulatory Developments - Potential Regulation as a Non-Bank SIFI" and "- Industry Trends - Regulatory Developments - Regulatory Developments Relating to G-SIIs."
Liquidity and Capital Sources
In addition to the description of liquidity and capital sources in "- The Company - Summary of Primary Sources and Uses of Liquidity and Capital," the following additional information is provided regardingMetLife, Inc.'s primary sources of liquidity and capital: Dividends from Subsidiaries.MetLife, Inc. relies in part on dividends from its subsidiaries to meet its cash requirements.MetLife, Inc.'s insurance subsidiaries are subject to regulatory restrictions on the payment of dividends imposed by the regulators of their respective domiciles. The dividend limitation for U.S. insurance subsidiaries is generally based on the surplus to policyholders at the end of the immediately preceding calendar year and statutory net gain from operations for the immediately preceding calendar year. Statutory accounting practices, as prescribed by insurance regulators of various states in which we conduct business, differ in certain respects from accounting principles used in financial statements prepared in conformity with GAAP. The significant differences relate to the treatment of DAC, certain deferred income tax, required investment liabilities, statutory reserve calculation assumptions, goodwill and surplus notes. The table below sets forth the dividends permitted to be paid by the respective insurance subsidiary without insurance regulatory approval and the respective dividends paid: 2013 Permitted w/o Company Paid Approval (1) (In millions) Metropolitan Life Insurance Company $ 714 $ 1,428 American Life Insurance Company $ - $ 523 MetLife Insurance Company of Connecticut $ 624 $ 1,330 Metropolitan Property and Casualty Insurance Company $ - $ 74 Metropolitan Tower Life Insurance Company $ - $ 77 MetLife Investors Insurance Company $ - $ 129 Delaware American Life Insurance Company $ - $ 7 194
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(1) Reflects dividend amounts that may be paid during 2013 without prior
regulatory approval. However, because dividend tests may be based on dividends previously paid over rolling 12-month periods, if paid before a specified date during 2013, some or all of such dividends may require regulatory approval. The dividend capacity of our non-U.S. operations is subject to similar restrictions established by the local regulators. The non-U.S. regulatory regimes also commonly limit the dividend payments to the parent to a portion of the prior year's statutory income, as determined by the local accounting principles. The regulators of our non-U.S. operations, includingJapan's Financial Services Agency , may also limit or not permit profit repatriations or other transfers of funds to the U.S. if such transfers are deemed to be detrimental to the solvency or financial strength of the non-U.S. operations, or for other reasons. Most of the non-U.S. subsidiaries are second tier subsidiaries which are owned by various non-U.S. holding companies. The capital and rating considerations applicable to the first tier subsidiaries may also impact the dividend flow intoMetLife, Inc. In the second quarter of 2013,MetLife, Inc. announced its plans to merge three of its U.S.-based life insurance companies, MICC,MLI-USA and MLIIC, and Exeter, aCayman Islands reinsurance company and subsidiary ofMetLife, Inc. , in 2014. As a result, aggregate amount of dividends permitted to be paid without insurance regulatory approval may be impacted. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Industry Trends - Regulatory Developments" and "Risk Factors - Capital-Related Risks - As a Holding Company,MetLife, Inc. Depends on the Ability of Its Subsidiaries to Transfer Funds to It to Meet Its Obligations and Pay Dividends" included in the 2012 Annual Report. We actively manage target and excess capital levels and dividend flows on a proactive basis and forecast local capital positions as part of the financial planning cycle. The dividend capacity of certain U.S. and non-U.S. subsidiaries is also subject to business targets in excess of the minimum capital necessary to maintain the desired rating or level of financial strength in the relevant market. We cannot provide assurance thatMetLife, Inc.'s subsidiaries will have statutory earnings to support payment of dividends toMetLife, Inc. in an amount sufficient to fund its cash requirements and pay cash dividends and that the applicable regulators will not disapprove any dividends that such subsidiaries must submit for approval. See "Risk Factors - Capital-Related Risks - As a Holding Company,MetLife, Inc. Depends on the Ability of Its Subsidiaries to Transfer Funds to It to Meet Its Obligations and Pay Dividends" included in the 2012 Annual Report and Note 16 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report. Short-term Debt.MetLife, Inc. maintains a commercial paper program, proceeds of which can be used to finance the general liquidity needs ofMetLife, Inc. and its subsidiaries.MetLife, Inc. had no short-term debt outstanding at bothJune 30, 2013 andDecember 31, 2012 . Credit and Committed Facilities. AtJune 30, 2013 ,MetLife, Inc. , along with MetLife Funding, maintained$4.0 billion in unsecured credit facilities, the proceeds of which are available for general corporate purposes, to support our commercial paper programs and for the issuance of letters of credit. AtJune 30, 2013 ,MetLife, Inc. had outstanding$2.2 billion in letters of credit and no drawdowns against these facilities. Remaining unused commitments were$1.8 billion atJune 30, 2013 .MetLife, Inc. maintains committed facilities with a capacity of$300 million . AtJune 30, 2013 ,MetLife, Inc. had outstanding$300 million in letters of credit and no drawdowns against these facilities. There were no remaining unused commitments atJune 30, 2013 . In addition,MetLife, Inc. is a party to committed facilities of certain of its subsidiaries, which aggregated$12.1 billion atJune 30, 2013 . The committed facilities are used as collateral for certain of the Company's affiliated reinsurance liabilities.
See Note 12 of the Notes to the Consolidated Financial Statements included in the 2012 Annual Report for further discussion of these facilities.
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Long-term Debt Outstanding. The following table summarizes the outstanding long-term debt of
June 30, 2013 December 31, 2012 (In millions) Long-term debt - unaffiliated$ 15,589 $
15,669
Long-term debt - affiliated $ 3,250 $
3,250
Collateral financing arrangements $ 2,797 $
2,797
Junior subordinated debt securities $ 1,748 $
1,748
Dispositions. During each of the six months ended
Liquidity and Capital Uses
In addition to the description of liquidity and capital uses in "- The Company - Liquidity and Capital Uses," the following additional information is provided regardingMetLife, Inc.'s primary uses of liquidity and capital: The primary uses of liquidity ofMetLife, Inc. include debt service, cash dividends on common and preferred stock, capital contributions to subsidiaries, payment of general operating expenses and acquisitions. Based on our analysis and comparison of our current and future cash inflows from the dividends we receive from subsidiaries that are permitted to be paid without prior insurance regulatory approval, our investment portfolio and other cash flows and anticipated access to the capital markets, we believe there will be sufficient liquidity and capital to enableMetLife, Inc. to make payments on debt, make cash dividend payments on its common and preferred stock, contribute capital to its subsidiaries, pay all general operating expenses and meet its cash needs.
Affiliated Capital Transactions. During the six months ended
MetLife, Inc. lends funds, as necessary, to its subsidiaries, some of which are regulated, to meet their capital requirements.MetLife, Inc. had loans to subsidiaries outstanding of$750 million at bothJune 30, 2013 andDecember 31, 2012 . InApril 2013 ,MetLife Bank's Board of Directors, with prior approval of the OCC, approved the reduction of its permanent capital by$550 million through a purchase of its$300 million of outstanding preferred stock held byMetLife, Inc. and a return of capital of$250 million toMetLife, Inc. InMay 2013 ,MetLife, Inc. received$550 million in cash to settle these transactions.
Debt and Facility Covenants. Certain of
Support Agreements.
InJuly 2012 , in connection with an operating agreement with the OCC governingMetLife Bank's operations during its wind-down process,MetLife Bank andMetLife, Inc. entered into a capital support agreement with theOCC andMetLife, Inc. andMetLife Bank entered into an indemnification and capital maintenance agreement under which agreementsMetLife, Inc. will provide financial and other support to 196
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MetLife Bank to ensure thatMetLife Bank can wind down its operations in a safe and sound manner. Pursuant to the agreements,MetLife, Inc. is required to ensure thatMetLife Bank meets or exceeds certain minimum capital and liquidity requirements and make indemnification payments toMetLife Bank in connection withMetLife Bank's obligation under theApril 2011 consent decree betweenMetLife Bank and the OCC. During the six months endedJune 30, 2013 ,MetLife, Inc. invested$20 million in cash inMetLife Bank in connection with these agreements. InJanuary 2013 ,MetLife, Inc. entered into an 18-month agreement withMetLife Bank to lend up to$500 million toMetLife Bank on a revolving basis. InJanuary 2013 ,MetLife Bank both drew down and repaid$400 million under the agreement, which bore interest at a rate of three-month LIBOR plus 1.75%. InFebruary 2013 , the agreement was amended to reduce borrowing capacity to$100 million . There were no loans outstanding atJune 30, 2013 . Acquisitions. During each of the six months endedJune 30, 2013 and 2012, there were no cash outflows for acquisitions. See Note 3 of the Notes to the Interim Condensed Consolidated Financial Statements for information regarding a pending acquisition. In connection with this pending acquisition, inJuly 2013 ,$2.1 billion was transferred within the Company to indirect wholly-owned subsidiaries, of whichMetLife, Inc. provided$1.7 billion in cash through intercompany loans and a capital contribution.
Adoption of New Accounting Pronouncements
See Note 1 of the Notes to the Interim Condensed Consolidated Financial Statements.
Future Adoption of New Accounting Pronouncements
See Note 1 of the Notes to the Interim Condensed Consolidated Financial Statements.
Non-GAAP and Other Financial Disclosures
Operating earnings is defined as operating revenues less operating expenses, both net of income tax. Operating earnings available to common shareholders is defined as operating earnings less preferred stock dividends.
Operating revenues and operating expenses exclude results of discontinued operations and other businesses that have been or will be sold or exited by
The following additional adjustments are made to GAAP revenues, in the line items indicated, in calculating operating revenues:
• Universal life and investment-type product policy fees excludes the
amortization of unearned revenue related to net investment gains (losses) and
net derivative gains (losses) and certain variable annuity GMIB fees ("GMIB
Fees");
• Net investment income: (i) includes amounts for scheduled periodic settlement
payments and amortization of premium on derivatives that are hedges of investments or that are used to replicate certain investments, but do not qualify for hedge accounting treatment, (ii) includes income from
discontinued real estate operations, (iii) excludes post-tax operating
earnings adjustments relating to insurance joint ventures accounted for under
the equity method, (iv) excludes certain amounts related to
contractholder-directed unit-linked investments, and (v) excludes certain
amounts related to securitization entities that are VIEs consolidated under
GAAP; and
• Other revenues are adjusted for settlements of foreign currency earnings
hedges. 197
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The following additional adjustments are made to GAAP expenses, in the line items indicated, in calculating operating expenses:
• Policyholder benefits and claims and policyholder dividends excludes:
(i) changes in the policyholder dividend obligation related to net investment
gains (losses) and net derivative gains (losses), (ii) inflation-indexed
benefit adjustments associated with contracts backed by inflation-indexed
investments and amounts associated with periodic crediting rate adjustments
based on the total return of a contractually referenced pool of assets,
(iii) benefits and hedging costs related to GMIBs ("GMIB Costs"), and
(iv) market value adjustments associated with surrenders or terminations of
contracts ("Market Value Adjustments");
• Interest credited to policyholder account balances includes adjustments for
scheduled periodic settlement payments and amortization of premium on
derivatives that are hedges of PABs but do not qualify for hedge accounting
treatment and excludes amounts related to net investment income earned on
contractholder-directed unit-linked investments;
• Amortization of DAC and VOBA excludes amounts related to: (i) net investment
gains (losses) and net derivative gains (losses), (ii) GMIB Fees and GMIB
Costs, and (iii) Market Value Adjustments; • Amortization of negative VOBA excludes amounts related to Market Value
Adjustments;
• Interest expense on debt excludes certain amounts related to securitization
entities that are VIEs consolidated under GAAP; and
• Other expenses excludes costs related to: (i) noncontrolling interests,
(ii) implementation of new insurance regulatory requirements, and
(iii) acquisition and integration costs.
Operating earnings also excludes the recognition of certain contingent assets and liabilities that could not be recognized at acquisition or adjusted for during the measurement period under GAAP business combination accounting guidance.
In addition, operating return on common equity is defined as operating earnings available to common shareholders, divided by average GAAP common equity.
We believe the presentation of operating earnings and operating earnings available to common shareholders as we measure it for management purposes enhances the understanding of our performance by highlighting the results of operations and the underlying profitability drivers of our business. Operating revenues, operating expenses, operating earnings, operating earnings available to common shareholders, operating return onMetLife, Inc.'s common equity and operating return onMetLife, Inc.'s common equity, excluding AOCI, should not be viewed as substitutes for the following financial measures calculated in accordance with GAAP: GAAP revenues, GAAP expenses, income (loss) from continuing operations, net of income tax, net income (loss) available toMetLife, Inc.'s common shareholders, return onMetLife, Inc.'s common equity and return onMetLife, Inc.'s common equity, excluding AOCI, respectively. Reconciliations of these measures to the most directly comparable GAAP measures are included in "- Results of Operations." In this discussion, we sometimes refer to sales activity for various products. These sales statistics do not correspond to revenues under GAAP, but are used as relevant measures of business activity. Additionally, the impact of changes in our foreign currency exchange rates is calculated using the average foreign currency exchange rates for the current period and is applied to each of the comparable periods. In this discussion, we also provide forward-looking guidance on an operating, or non-GAAP, basis. A reconciliation of these non-GAAP measures to the most directly comparable GAAP measures is not accessible on a forward-looking basis because we believe it is not possible to provide other than a range of net investment gains and losses and net derivative gains and losses, which can fluctuate significantly within or outside the range and from period to period and may have a significant impact on GAAP net income. 198
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