MetLife Inc

NYSE:MET

Earnings Call Transcript 2019-Q2

[Operator]

Welcome to the MetLife Second Quarter 2019 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. As a reminder, this call is being recorded. Before we get started, I refer you to the cautionary note on the forward-looking statements in yesterday's earnings release.

With that, I will turn the call over to John Hall, Head of Investor Relations.

[John Hall, Head of Investor Relations]

Welcome to MetLife's second quarter 2019 earnings call. Before we begin, I refer you to the information on non-GAAP measures on the Investor Relations portion of metlife.com in our earnings release and in our quarterly financial supplements, which you should review.

Joining me this morning on the call are Michel Khalaf, President and Chief Executive Officer; and John McCallion, Chief Financial Officer. Also here with us today to participate in the discussions are other members of senior management.

Last night, we released an expanded set of supplemental slides. They are available on our website. John McCallion will speak to those supplemental slides in his prepared remarks if you wish to follow along. The content for the slides begins following the romanette pages that feature a number of GAAP reconciliations. After prepared remarks, we will have a Q&A session that, given the busy earnings call scheduled this morning will extend no longer than the top of the hour. In fairness to all participants, please limit yourself to one question and one follow-up. After Q&A, Michel will conclude with some closing remarks.

With that, I'll turn the call over to Michel.

[Michel Khalaf, President & Chief Executive Officer]

Thank you, John. Good morning, everyone. During my first 90 days as President and CEO of MetLife, we have worked to reinforce the connection between our purpose and our strategy while strengthening our focus on consistent execution. For more than 150 years, this company has been helping people protect their families and their finances so that they can realize their full potential. We are committed to strong financial performance so that we can continue fulfilling this noble purpose for decades to come.

MetLife had an excellent start to 2019 and last night, we reported strong second quarter results as well. Quarterly adjusted earnings totaled $1.3 billion or $1.38 per share, up from $1.30 per share in the second quarter of 2018. Excluding notable items, we reported quarterly adjusted earnings of $1.46 per share compared with $1.36 per share a year ago. Net income of $1.7 billion exceeded adjusted earnings, primarily due to interest rate-driven gains in our derivative portfolio. Net income totaled $845 million a year ago. Market conditions were mixed overall. Strong equity markets fueled the rebound in variable investment income. These gains were offset by the impact of falling interest rates on recurring investment margins and by the strengthening of the U.S. dollar.

Although, the interest rate environment remains challenging, our results demonstrate that we have become a less market-sensitive company. John McCallion will discuss the interest rate environment in greater detail. MetLife's direct expense ratio benefited from solid revenue growth, favorable items and continued expense discipline. Excluding notable items and pension risk transfers, our direct expense ratio was 12.3% compared with 13% a year ago. Notable items in the quarter included the expenses associated with our unit cost initiative, which reduced adjusted earnings by $70 million. This initiative remains on track to deliver $800 million of annual pre-tax margin improvement by 2020, underscoring our commitment to expense discipline. Finally, MetLife's book value per share, a key indicator of shareholder value was $47.09, up 10% from a year ago.

Moving to specific business highlights. Our flagship Group Benefits business reported strong adjusted earnings results in the second quarter, driven by volume growth and expense margins. Group Benefits sales are up 12% year-to-date, with growth across all markets. Voluntary products continue to see a particularly strong sales momentum.

Adjusted earnings for our Retirement and Income Solutions business matched a strong quarter year ago, with higher variable investment income and favorable underwriting offsetting weaker recurring investment margins. Adjusted earnings for our Property & Casualty segment benefited from favorable underwriting, primarily lower incurred catastrophe losses, reflecting the re-underwriting of our homeowners business.

Adjusted earnings for our Asia business were essentially flat, relative to a strong result a year ago. The negative impact of a strong U.S. dollar relative to most Asian currencies was offset by strong volume growth. Competition in the Japanese foreign currency denominated product market pressured FX sales from a year ago. This was partially offset by higher accident and health sales in Japan, as well as continued strong sales in China.

Our Latin America business reported an 18% increase in adjusted earnings year-over-year. This was mostly due to strong Chilean encaje returns and good volume growth. For our EMEA business, adjusted earnings were down 10% from a very strong second quarter of 2018, but they were in line with our expectations on a constant currency basis. Sales strength was evident in the group business in the U.K. and credit life in Turkey.

Overall, it was another strong quarter for our company. I believe we are making steady progress towards establishing a track record of consistent execution. One of my top 2019 priorities, as President and CEO of MetLife, is to complete the strategic review of our businesses. All our executive group members, along with many other leaders across the company are fully engaged in this process. I am pleased with the progress we are making on this next horizon of our strategy and we look forward to sharing the full results with investors on December 12.

Our strategic changes are more likely to be evolutionary than revolutionary. We remain firmly committed to certain bedrock principles around deploying capital efficiently, generating strong risk-adjusted returns and driving profitable growth. Just as important, we are strengthening our efficiency mindset so that expense discipline and continuous improvement become embedded in our company's DNA. Consistent with our principles, we are taking steps to optimize our portfolio so that we can maximize the value of our highest potential businesses.

The recent announcement to sell our Hong Kong business provides a good example. MetLife has strong franchises throughout Asia and we are committed to the region. However, after a thorough review of the Hong Kong business, we did not see a path to scale or risk-adjusted returns above our cost of capital. By selling this business, we will free up additional resources to enhance value creation.

Strong value creation requires the right strategic choices, none more important than how we allocate capital. We always seek to deploy capital to produce the highest risk-adjusted returns whether through organic growth, M&A or returning capital to our shareholders.

In the second quarter, MetLife returned $750 million of capital through share repurchases. For the first two quarters of 2019, we have returned more than $2 billion to shareholders through common dividends and share repurchases. With only $20 million left on our prior authorization, our Board of Directors approved a new $2 billion share repurchase authorization last night. Sound capital management also demands close attention to capital structure.

MetLife, Inc. recently saw an opportunity to issue its first ever yen-denominated senior notes offering, one of the largest ever offerings of yen debt by a U.S. financial services company. We issued nearly $1.4 billion of yen-denominated senior notes and use some of the proceeds to pay down debt with an average coupon well above that of the new yen debt. All in, the payback period on recovering our make-whole fee is only 13 months.

In closing, we think the emerging picture of MetLife is clear. We are a financially strong company with a well-diversified portfolio of businesses that is focused on consistent execution. Our goal is to be a company that can perform well across a variety of economic environments. Our second quarter adjusted earnings results demonstrated that we are less exposed to market factors and that softness in one part of our business can often be offset by strength in another.

Across MetLife, our people feel energized by our performance and excited by our potential. As we develop the next horizon of our strategy, we will continue viewing all major decisions through the lens of value creation for our customers, our people and our shareholders.

With that, I will turn the call over to John McCallion to go through our second quarter results in greater detail.

[John McCallion, Chief Financial Officer]

Thank you, Michel, and good morning. I will begin by discussing the 2Q 2019 supplemental slides that we released last evening, along with our earnings release and quarterly financial supplement.

Starting on page 5, the schedule provides a comparison of net income and adjusted earnings in the second quarter of 2019. In the quarter, net income was $1.7 billion or $365 million higher than adjusted earnings of $1.3 billion. This variance is primarily due to higher net derivative gains resulting from the decline in interest rates in the quarter.

Overall, the results in the investment portfolio and hedging program continue to perform as expected. We had one notable item in the quarter as shown on page 6 and highlighted in our earnings release and quarterly financial supplement. Expenses related to our unit cost initiative decreased adjusted earnings by $70 million after-tax or $0.07 per share. Adjusted earnings excluding the notable item were $1.4 billion or $1.46 per share.

On page 7, you can see the year-over-year adjusted earnings excluding notable items by segment. Excluding all notable items in both periods, adjusted earnings were essentially flat year-over-year and up 2% on a constant currency basis. On a per share basis, adjusted earnings, excluding notable items, were up 7% and 10% on a constant currency basis. The better results on an EPS basis reflect the cumulative impact from share repurchases.

Overall, positive year-over-year drivers included solid volume growth, the impact from strong equity markets, favorable underwriting and better expense margins. Investment margins were modestly higher, as a strong rebound in variable investment income was mostly offset by lower recurring interest margins. In addition, the strengthening of the U.S. dollar against major currencies and higher taxes relative to a favorable 2Q 2018 were partial offsets.

With regards to business performance, Group Benefits adjusted earnings were up 19% year-over-year. The key drivers were better expense margins and solid volume growth. With respect to underwriting, favorable mortality in Group Life was mostly offset by less favorable Non-Medical Health results compared to the prior year. Group Life mortality ratio was 85.3%, which was favorable to the prior year quarter of 87.9% and at the low end of our annual target range of 85% to 90%. Favorable results were primarily due to lower claim severity. The interest adjusted benefit ratio for Non-Medical Health was 75.4%, which is within our target range of 72% to 77%, though this result was less favorable than the prior year quarter of 73.1%, due to higher claim severity and disability.

Group Benefits continues to see strong momentum in the top line. Adjusted PFOs in the quarter were up 5% and year-to-date sales were up 12%, led by the growth in voluntary products across all markets. Retirement and Income Solutions, or RIS, adjusted earnings were up 1% year-on-year. The key drivers were favorable underwriting margins and volume growth. This was mostly offset by lower investment margins as weaker recurring interest margins exceeded the positive contribution from variable investment income for this segment.

RIS investment spreads were 119 basis points in 2Q, 2019, down 10 basis points year-over-year, but up 23 basis points sequentially due to strong private equity returns and prepayment fees in the quarter. Despite the ongoing pressure from the inverted yield curve, we continue to expect full year RIS investment spreads to be in the bottom half of our 2019 guidance range of 100 to 125 basis points. RIS favorable underwriting was largely due to updated claim processes, which contributed approximately $30 million after tax. RIS adjusted PFOs were down 81% year-over-year, due to the strength of the FedEx PRT deal in the second quarter of 2018. Excluding PRTs, RIS PFOs were up 23% due to strong structured settlement sales. As for pension risk transfers, PFOs in the quarter were $556 million. We continue to see the PRT market as attractive, with a strong pipeline.

Property & Casualty, or P&C, adjusted earnings were up 11%, primarily due to favorable underwriting margins. Pre-tax cat losses of $78 million in the quarter were $30 million lower than the prior year quarter. With regards to the top line, P&C adjusted PFOs were up 2%, while sales were up 3% versus 2Q, 2018. Asia adjusted earnings were down 1%, but up 2% on a constant currency basis. The positive year-over-year drivers were favorable volume growth and better investment margins, which includes the impact of a regulatory change in China. These were partially offset by less favorable expense margins and favorable underwriting margins in the prior year quarter.

Asia assets under management, excluding fair value adjustments, grew 11% year-over-year. As part of our enhanced disclosures, we have now included Asia AUM as a key metric in our QFS. Asia sales were down 10% on a constant currency basis. In Japan, sales were down 12% primarily driven by a 32% year-over-year decline in foreign currency denominated annuity products. FX annuity products, which are primarily sold through bank channels, had a challenging quarter, given the drop in U.S. interest rates. We anticipate further challenges for FX annuity products in the second half of the year.

In contrast, we continue to see strong momentum in our A&H sales, which were up 12% year-over-year. A&H sales were aided by the popularity of our dollar-denominated rider, which we launched in November of 2018 and the increase in short-pay A&H products in advance of a tax regulatory change effective in October of this year. Other Asia sales were down 5% as growth in China and India were more than offset by lower sales in Korea.

Latin America adjusted earnings were up 10% and 18% on a constant currency basis. The primary drivers were a favorable impact from capital markets on our Chilean encaje and volume growth across the region. Latin America adjusted PFOs were up 9% and 15% on a constant currency basis, driven by volume growth across the region led by higher annuity sales in Chile. Latin America sales were up 14% on a constant currency basis driven by higher sales in Chile and Mexico, as well as a large group case in Brazil.

EMEA adjusted earnings were down 10% but flat on a constant currency basis. Favorable underwriting, investment margins and volume growth, were offset by favorable expense margins in 2Q of 2018. EMEA adjusted PFOs were up 5% on a constant currency basis, reflecting growth across the region. EMEA sales were up 6% on a constant currency basis due to higher volumes in employee benefits in the United Kingdom and Egypt as well as Credit Life in Turkey. MetLife Holdings adjusted earnings were up 7% primarily due to favorable expense margins.

The benefit from higher variable investment income was entirely offset by lower recurring interest margins. With regards to underwriting, the life interest adjusted benefit ratio was 53.9%, higher than the prior year quarter of 52.6% but within our annual target range of 50% to 55%. Mortality frequency was modestly higher than a year ago.

The LTC block continue to perform well as results were favorable versus the prior year quarter due to improved experience in rate actions. Corporate & Other adjusted loss excluding notable items was $237 million. The higher adjusted loss in the quarter was primarily driven by two items: First, we had a make-whole fee related to early retirement of debt in the quarter of $32 million after-tax; and second, an after-tax adjusted loss of $17 million, regarding a sale of a block of business that had previously been reinsured. Also, please keep in mind that the timing of preferred stock dividends varies by quarter.

In the first and third quarters of the year, we paid $32 million and in the second and fourth quarters, we paid $57 million. The company's effective tax rate on adjusted earnings in the quarter was 18.6% and within our 2019 guidance of 18% to 20%.

Now let's turn to page 8 to discuss variable investment income in more detail. This chart reflects our pre-tax variable investment income for the past six quarters, including $334 million earned in the current quarter. Our private equity portfolio, which is accounted for on a one quarter lag, rebounded strongly this quarter. For the year-to-date VII was $508 million pre-tax and well on track toward meeting our 2019 guidance range of $800 million to $1 billion.

Now I'll discuss recurring investment income. Our new money rate was 4.01% versus a roll-off rate of 4.34% in 2Q, 2019. This compares to a new money rate of 3.98% and a roll-off rate of 4.52% in 2Q, 2018. Although, the gap between the new money rates and roll-off rates has narrowed, we would not expect parity to occur until we have a sustained U.S. 10-year Treasury yield of roughly 3% to 3.25%.

Turning to page 9. This chart shows our direct expense ratio from 2015 through 2018 as well as the first two quarters of 2019. As we have stated previously, our goal is to realize $800 million of pre-tax profit margin improvement by 2020. This would represent an approximate 200 basis point decline in our annual direct expense ratio from the 2015 baseline year. We believe the annual direct expense ratio best reflects the impact on profit margins, as it captures the relationship of revenues and the expenses over which we have the most control. By successfully executing on our expense commitment, it will improve profit margins and provide capacity to fund future growth and innovation.

We have made consistent progress towards achieving our target by 2020. As the chart illustrates, we have already achieved 140 basis point improvement in the annual direct expense ratio from 2015 to 2018. For 2Q, 2019, we posted another strong result, as the direct expense ratio, excluding notable items and PRTs, came in at 12.3%. This was aided by favorable items including; lower interest on tax reserves and lower employee benefit costs related to market movements in the second quarter. Overall, these favorable items totaled roughly 20 basis points and followed 60 to 70 basis points of favorable items in 1Q, 2019.

Now let's turn to page 10. Given the drop in interest rates this quarter, we decided to add to this page on potential impacts to our income statement and balance sheet from low rates. First, we can confirm that the 2019 to 2021 adjusted earnings sensitivity that we previously provided is largely unchanged. Second, we expect our average 2019 and 2020 free cash flow ratio target of 65% to 75% to hold between a range of 1.5% to 4.5% on the 10-year U.S. Treasury. This is an update from our prior sensitivity guidance of 2% to 4.5%. And finally, the table at the bottom of page 10 provides the estimated impacts if we were to lower our long-term U.S. actuarial interest rate assumption of 4.25% by 25, 50 or 75 basis points. In each hypothetical scenario, we would not trigger GAAP loss recognition and would incur a relatively modest impact to net income.

I will now discuss our cash and capital position on page 11. Cash and liquid assets at the holding companies were approximately $4.2 billion at June 30, which is up from $3.2 billion at March 31. Holdco cash was elevated this quarter due to the timing of subsidiary dividends as well as the incremental debt issuance that Michel noted.

Next, I'd like to provide you with an update on our capital position. As a reminder, for our U.S. companies, our 2018 combined NAIC RBC ratio was 402%, which compares to our new target ratio of 360% following U.S. tax reform. For our U.S. companies, preliminary second quarter 2019 statutory operating earnings were approximately $2.4 billion, and net earnings were approximately $1.9 billion. Statutory operating earnings decreased by $438 million from the prior year quarter, primarily due to the impact of a prior year dividend from the investment subsidiary, partially offset by lower VA rider reserves and improved underwriting results.

We estimate that our total U.S. statutory adjusted capital was approximately $18.1 billion as of June 30, down 1% compared to December 31, 2018. Net earnings were more than offset by dividends paid to the holding company. Finally, the Japan solvency margin ratio was 890% as of March 31, which is the latest public data.

Overall, MetLife had another strong quarter driven primarily by good fundamentals, growth in our businesses, solid underwriting and expense discipline. In addition, our cash and capital position as well as our balance sheet remains strong. Finally, we are confident that the actions we are taking will continue to create long-term sustainable value for our customers and our shareholders.

And with that, I'll turn the call back to the operator for your questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Erik Bass from Autonomous. Please go ahead.

[Erik Bass, Autonomous]

Hi. Good morning. Thank you. Can you talk about the outlook for expenses as we move into the second half of the year? You mentioned some favorable items in the first half, so should we expect the expense ratio to move a little bit higher given timing and seasonal factors? And if that's the case, are there any businesses where they should be more evident?

[Michel Khalaf, President & Chief Executive Officer]

Hey, good morning, Erik. I would definitely reiterate that. That was kind of our commentary last year that we had some seasonality in expenses in the second half of the year. We tend to see those expenses rise in places like group in terms of as we go through the enrollment process. And as we mentioned in the script, the first quarter, we saw some benefits that we didn't expect to recur similar to the second quarter so we want to normalize for those things anyway in addition to just the seasonality point.

[Erik Bass, Autonomous]

Got it. Thank you. And then you mentioned that there haven't been any material changes to your low interest scenario guidance that you've given in the 10-K. Can you talk about any potential actions that you can take to mute the impact particularly as we look out to 2020 or 2021?

[Michel Khalaf, President & Chief Executive Officer]

Yes. Look, I think we've been spending quite a bit of time over the last several years. I think if you go back to, let's start with, why is the impact muted, first, I think we've been trying to shift our risk profile for some time now, and that's starting to take effect. Obviously, when you think about those results, we have some good ALM discipline and I think that's coming through in sensitivities that we have.

In terms of further actions, I think, yeah, look we're always considering, we're constantly reevaluating our ALM practices, looking at outlook in terms of interest rates and where the forward curve may be and things like that. So there are actions we can take, but everything is kind of on the margin. The most important thing we have is, price the business appropriately. And I think that's starting to come through and you can see that in that page.

[Erik Bass, Autonomous]

Got it. Thank you.

[Operator]

Your next question comes from the line of Andrew Kligerman from Credit Suisse. Please go ahead.

[Andrew Kligerman, Credit Suisse]

Hey, good morning. I'd like to talk a bit about the favorable - well, maybe low end of guidance, benefit ratios. So you came in at 85.3 on Group Life. And then, with the non-medical and you're guiding to 72 to 77. You came in at 75.4. That's after 72.9 last quarter and then 72.6 in 2018, so both of them are pretty much in the more favorable end of the guidance ranges. Can you talk a bit about the competitive environment out there and the ability to kind of stay in that kind of lower quadrant of your guidance?

[Ramy Tadros, President, U.S. Business]

Good morning, Andrew. It's Ramy here. As you know, we do operate in a competitive environment, but the group business is a business that we've been investing in, in a disciplined way over time and we're seeing that strategy materialize. And I would say, in general, we look to differentiate beyond price. We look at the product set and the right product set that we have, our service capabilities our distribution reach.

So having said all of that, this is still insurance and you'd expect to see quarter-on-quarter volatility. So the mortality loss ratio, we did come in at the lower end of our range, but I would guide you for the full year number that's going to revert back somewhere to the middle of that range from a mortality perspective.

The Non-Medical Health benefit for this quarter was slightly above the midpoint, but if you actually look at it from a year-to-date basis, it was slightly below. So, again, on both of those ratios I would guide you towards the middle of our guidance and we feel confident that we're able to get there.

[Andrew Kligerman, Credit Suisse]

And no competitive pressures out there to kind of lower your prices?

[Ramy Tadros, President, U.S. Business]

We do some - we do see competitive pressures, but we're able to hold our own and we're able to, in some cases, we walk away from business, but -- where we think pricing is irrational, but you could see from a top line perspective, you look at our persistency in our rate actions. Our PFO number is 5% year-on-year, which is smack in the middle of our range. So we have a number of levers at our disposal that we pull to hold our own and maintain both top line and bottom line here.

[Andrew Kligerman, Credit Suisse]

Excellent. And then just a follow-up question. In the Asian operations, so some weakness in Korea and then also some weakness in the FX-denominated sales in Japan. Again, I'm just kind of curious what happened in Korea? What's the competitive landscape like there? And same question with respect to Japan.

[Kishore Ponnavolu, President, Asia]

This is Kishore. Let me take the Korea question first. Year-on-year sales in Korea declined 14%. I want to give you a little bit of context in Korea. We have three channels in Korea. Our Korea agency channel that has held really well. Our general agency channel, which is a significant channel and our MFS channel which is a relatively smaller portion of our sales. In the GA channel, we sell mostly savings in retirement products, and that channel from a market perspective took a hit in the second quarter.

The overall market for savings in retirement products dropped by about 25%, and we believe that's because of the equity market volatility in Korea. So we got that our proportionate share there, but I want to shift to a positive note with regards to Korea is because we have a number of in-market actions. We've actually increased the manpower in our Korea agency. We launched a couple of products, which are actually getting very good traction. So because of that, second half, we expect Korea sales to come back pretty strong. With regards to -- sorry, go ahead.

[Andrew Kligerman, Credit Suisse]

No, no, I was saying in Japan, yes.

[Kishore Ponnavolu, President, Asia]

So, in Japan, if you think quarter-on-quarter, we're down 32% in the annuity sales, right? So let me give you a little bit of context on annuity sales. The vast majority of our annuity sales come through our banker channel. It's a little bit volatile channel, right? If you look at 2018 second quarter sales, we almost had $200 million of sales. And relative to 2017, that was 136% increase year-on-year come off, reinforce the volatility point. So against that high watermark, this year, we're down 32%. And there are two drivers for that, right?

Number one driver is the volumes through the banker channel for foreign denominated products actually came down. So year-on-year, the volume fell 9%. So what's the reason for that? We believe it's U.S. dollar interest rate softening, and that means the value proposition for customers is a little weaker relative as a result of that. Now that's only a 9% decline, okay? There's a second factor.

The second factor is that given that there's a strong interest in this particular segment, there have been some new entrants into the space, and some of them have been very aggressive with their crediting rates. We've been in this business for a long time, and we're very disciplined player, and we refuse to change volume, and so we're going to be leaning on our strength here. We have strong banker relationship, got 120-plus bank relationships. We believe we have advantages on investment management side on the dollar-denominated products that others may or may not have, and so we're going to leverage this. So we're going to see some softness here for the next couple of quarters, as Michel and John referenced, but we believe that the market will come back through the banker channel. And on top of that, we'll get our fair share. I hope that helps.

[Andrew Kligerman, Credit Suisse]

Excellent. Thank you.

[Operator]

Your next question comes from the line of Jimmy Bhullar from JPMorgan. Please go ahead.

[Jimmy Bhullar, JPMorgan]

Hi. Good morning. I had a couple of questions. First, on just Michel your priorities for deploying capital, different stories about you potentially selling your Central European business, the Hong Kong business, and I realize you can't comment on deals. But if you were -- like, what are your priorities in terms of cash that might be generated either through the business or from potential sales between acquisitions, investing in the business and possibly buying back stock?

[Michel Khalaf, President & Chief Executive Officer]

Yeah. Hi, Jimmy. Well, first of all, let me sort of reiterate, in terms of our capital management philosophy, we believe that excess capital, beyond what we need to fund organic growth and for strategic acquisitions that clear risk-adjusted hurdle rate, belongs to our shareholders in the form of dividends and share repurchases.

As you know, we are conducting a strategic review and I would say that that work is moving along nicely. Without getting into too much detail, strategy is about choices and paramount among them is how we deploy capital, as well as other scarce resources. Our commitment to value creation requires us to exercise discipline across all capital, including capital supporting new business, as well as in-force business, not just excess capital. This means that pricing new product at appropriate internal rates of return with appropriate payback periods. It also means optimizing of our portfolio when and if necessary.

Let me point out that since the MetLife acquired Alico, we've divested more than 20 businesses, some large like our U.S. Retail business and other smaller such as the Hong Kong business. In all cases, we've been careful and deliberate. As the business is not meeting our return hurdles and we do not see a clear runway to doing so within a reasonable time frame, we have to consider alternatives, including divestitures, to free up capital for greater value creation over time. So that's our approach. I think it's consistent with how we've done things to-date. And as I've noted, since the Alico acquisition we've had a number of divestitures, but I would certainly not comment on any particular rumors that have been out there.

[Jimmy Bhullar, JPMorgan]

Okay. And then on -- just for John maybe, on the accounting changes, obviously they were delayed by a year. But do you have any insights on how MetLife would be affected, that you're able to share? And I'm assuming that MetLife Holdings is the most susceptible business to the changes in long-duration accounting contracts. So if you could just comment on, like, if you've got better insights on what the impact of the changes would be on MetLife's balance sheet and/or earnings going forward?

[John McCallion, Chief Financial Officer]

Good morning, Jimmy. Yes we are supportive of the proposed delay, still needs to be voted on, but we are supportive of that. I don't think it changes anything in terms of impact to us in terms of the timing, other than it gives us and the industry a chance to work together on implementation. In terms of which segments are most -- holdings would be one of them. I think wherever we have FAS 60 business, which would be holdings, there're some in RIS or some in Asia, those would also be impacted.

[Jimmy Bhullar, JPMorgan]

And are you planning on sharing the expected impacts anytime in the next few quarters, or is it going to be as we get further - as we get closer to the actual standards going into effect?

[John McCallion, Chief Financial Officer]

Yeah. No, no. I think we - nothing soon. This is a lot of work. It's a complex standard, which is why we support the additional year, and I think it's appropriate for us in the industry to kind of work through this so that we can present these new information in the most effective and efficient way.

[Jimmy Bhullar, JPMorgan]

Okay, thank you.

[Operator]

Our next question comes from the line of Tom Gallagher from Evercore. Please go ahead.

[Tom Gallagher, Evercore]

Good morning. First question is just some on the interest rate sensitivity disclosure you put out there. So the U.S. sensitivity looks pretty low to changes in interest rates for U.S. GAAP. John, is it fair to say that if you also considered the sensitivity to both Japan and EMEA, it would also be modest, or -- and also are those predominantly about the FAS 60 products there, do you have a decent amount of 97 in those regions?

[John McCallion, Chief Financial Officer]

Yes. So just to be clear crystal clear, that sensitivity that's provided there is for changing the U.S. 10-year Treasury rate long-term assumption, right, which is our reversion to, at this point, 4.25%, and as you comment or references, it impacts our U.S. segments. In EMEA, I would say the mix of business doesn't really cause kind of a material number to arrive one way or another. And rates have been pretty low, and we assume that's the case anyway. In Japan, like when we test loss recognition -- for loss recognition there, we use current rates and just assume they don't revert anywhere. They just stay state level. So...

[Tom Gallagher, Evercore]

Got it. So the Japanese interest rate assumption is at current spot rate, like that’s your…

[John McCallion, Chief Financial Officer]

When we do loss recognition testing in Japan, we assume spot and then level from there.

[Tom Gallagher, Evercore]

Got it. That's for loss recognition testing?

[John McCallion, Chief Financial Officer]

Yes.

[Tom Gallagher, Evercore]

Okay. And then my follow-up is just on the new disclosure in the supplement about the Japan assets shows there's been pretty strong asset growth there, and I know you mentioned annuity sales declining. How -- if we're going to be in this lower level of annuity sales, is that -- how did net flows look? Like would you -- because I think it was double-digit growth in assets there based on current sales volumes. Would you still have positive flows there? And would you still get a decent amount of asset growth if we remain around current levels?

[Kishore Ponnavolu, President, Asia]

Tom, this is Kishore. So at the last outlook call at the Investor Day and also at the outlook call, we said high single-digit asset growth for Asia, as a segment. We're sticking to that, and there's no change at this point. If the question is in regards to a slowdown with regards to annuities, certainly I want to remind you that there are other lines which have actually gone the other way. A&H, Michel talked about the 12% increase in A&H. That's the advantage of a multiproduct multi-distribution business.

In addition, earlier, I talked about some year-over-year decline for the second quarter with annuities from the bank segment. We expect that to change and obviously moderate over time. And, certainly, we expect to get our fair share back. So this is a quarter or two, but over the medium term we expect to get back to our fair share.

[Tom Gallagher, Evercore]

Okay.

[Michel Khalaf, President & Chief Executive Officer]

I would just add, Tom, to Kishore's comments, also in the foreign-denominated annuity products and other products that we sell, there's a very high persistency there. So just from a net perspective, it's a good statistic to think about.

[Tom Gallagher, Evercore]

Got it. Yeah. That's what I was trying to get at. The -- I presume there're still strong positive flows, even after the decline in annuity sales, but I can circle back for more detail.

[Kishore Ponnavolu, President, Asia]

So the one extra thing to John is also, Tom, a bulk of these annuity sales are single premium. And so, because they're single premium, the full impact of these sales are not necessarily reflected in the A&P and they show up on assets.

[Tom Gallagher, Evercore]

Got you. Thanks.

[Operator]

Your next question comes from the line of Ryan Krueger from KBW. Please go ahead.

[Ryan Krueger, KBW]

Hi. Thanks. Good morning. I have a follow-up question on the strategic review. I know that it includes potential dispositions. I'm curious, I guess as you're doing the strategic review, does it also contemplate the need for potential M&A and other businesses where you feel like you needed additional capabilities or scale?

[Michel Khalaf, President & Chief Executive Officer]

Yes, absolutely, Ryan. We are -- part of our review is looking for also ways to accelerate revenue growth, especially in markets and businesses where -- that we feel are attractive and where we have a competitive advantage. We're always looking at M&A opportunities as a way to further enhance our growth. Clearly, we look for opportunities that are a good fit with our strategy and that are accretive and we have also a consistent way of evaluating many opportunities globally.

We look at value and cash generation. Clearly, those deals need to earn more than their cost of capital. We also evaluate M&A against alternative uses of capital. We consider capital markets the cost of raising capital in our assessments, but we continue to look at M& A as an opportunity for us to drive growth or enhance efficiency in certain businesses and markets.

[Ryan Krueger, KBW]

Thanks. And then on the interest rate scenario to earnings in the 10-K, there's a very minimal impact on 2019, steps up some in 2020 though, though not all that large. I guess, just the delta between, I guess, the reason it's so minimal in 2019 and then steps up in 2020. Does that really to things like interest rate for us, or is there something else going on there?

[John McCallion, Chief Financial Officer]

Yeah. Hey, Ryan. So -- and remember that was 100 basis point parallel shift, right, that we gave you. And I think the punch line, as we said, was that largely intact. It wasn't quite -- it hasn't been quite parallel. Right. The long end has dropped further than the short end, so there's a - that non-parallel shift and we talked about this before, it does have, call it, a negative impact on sec lending.

The reason to your question, the reason why it's smaller in the first year is, it's mainly derivative. It's not necessarily floors, although we have those too, but it's just even the pay lag on our receivers swap, right? So as LIBOR drops, your pay lag and your expense goes down.

[Ryan Krueger, KBW]

Got it. Thank you.

[Operator]

Your next question comes from the line of Suneet Kamath from Citi. Please go ahead.

[Suneet Kamath, Citi]

Thanks. I just wanted to follow up on interest rate question related to the hedges. Can you just quantify what that benefit is that you're getting today and how that should track over the next couple of years?

[John McCallion, Chief Financial Officer]

Yes. We don't have that specifically, Suneet, broken out. I would just again, I think, we would revert back to the kind of the overall. There's a lot of different items going on in there that some things that benefit for from just the drop in LIBOR. There's others that have more of an impact on the longer end, and so that's the part of our, I think, diversified portfolio that benefit here. We do get some offsets from having the short end of the curve drop as well in a positive way, but we haven't broken out each individual component. We just kind of revert back to kind of the aggregate change.

[Suneet Kamath, Citi]

Got it. And the reason I ask is, I am looking at, I think the last time you gave the slide that showed the trajectory of the derivative income was years ago, but it did look like somewhere around 2020, 2021, there was sort of a leg down in terms of the benefit that you get and I know this was pretty bright house I just want to get a sense is that still roughly the picture that we should be expecting going forward?

[John McCallion, Chief Financial Officer]

Yes, I think you're referencing -- I mean it’s probably more than a few years ago, right, the trajectory of the floors. Is that what you're talking about?

[Suneet Kamath, Citi]

Yes, I think it was from your 2016 outlook call but I think that’s the last time we got it. So…

[John McCallion, Chief Financial Officer]

It’s probably pre-John Hall. But, no, I think, certainly, we certainly at one point, those were one major benefit to lower rates, those have probably declined over time in terms of the amount of floors we have. But we've continued at different times to take up -- look, when the risk of rates rising, which was not too long ago was the major risk, we actually took the opportunity to add some floors. And so in our RIS segment, you know, we have talked about spreads and actually if LIBOR continues to drop, that sensitivity to LIBOR is going to start to flip. And that's partly due to the fact that we were opportunistic to buy some additional floors there that have a strike starting at 2%. So it's kind of it evolves over time, and it's not so static.

[Suneet Kamath, Citi]

Maybe an update at some point would be helpful. Thanks.

[Operator]

Your next question comes from the line of Elyse Greenspan from Wells Fargo. Please go ahead.

[Elyse Greenspan, Wells Fargo]

Hi. Good morning. My first question goes back to slide 10 as well. I was wondering if you could -- with the low interest rate sensitivity if you could just give us a sense of what scenario would actually drive a GAAP loss recognition charge. I know you haven't laid it out in any of these assumptions that you have on the slide, probably seems like would have to be a pretty big impact.

[John McCallion, Chief Financial Officer]

Yes, I think that's the punch line. It would need to be a pretty big impact. I mean even beyond. We showed 25, 50 and 75 even beyond that. We have quite a bit of healthy loss recognition testing margins in the U.S. in our FAS 60 business. So to get kind of a full unlocking our loss recognitions impact, it would take quite a bit of a drop in that long-term rate assumption.

[Elyse Greenspan, Wells Fargo]

And then I noticed in footnote three that it says, this includes MetLife Holdings. So does this interest rate scenario assumption, does that includes - incorporate in your LTC block?

[John McCallion, Chief Financial Officer]

Yes it does.

[Elyse Greenspan, Wells Fargo]

Okay. And then, lastly on the PRT side of things, that business is typically been more second half heavy in terms of deals. I know we're obviously dealing with a lower interest rate environment. Have you guys seeing any change in the pipeline of no potential transactions that you might see towards the later stages of this year?

[Michel Khalaf, President & Chief Executive Officer]

Yeah. We actually are still seeing a very robust pipeline in the PRT space. And in particular, we're seeing a pretty robust pipeline on some of the jumbo deals. Clearly, over time, as rates come down, that would impact volumes in this market, but it really depends on the ALM posture of the pension plan.

Some of those plans are already better matched and therefore are more insulated to falling grades and are getting the benefit from rising equity markets. So having said all of that, I think, over time lower rates will be headwind to volumes, but for now we're still seeing a very robust second half pipeline.

[Elyse Greenspan, Wells Fargo]

Okay. Thank you very much.

[Operator]

Your next question comes from the line of Humphrey Lee from Dowling and Partners. Please go ahead.

[Humphrey Lee, Dowling and Partners]

Good morning and thank you for taking my questions. Just a question about the expenses, which have been a very good story, especially in the life holdings. I was just wondering can you take our more expenses from holdings now, or do you see kind of the current level as good as it gets, given some of the favorable expenses that you see in the first half of this year?

[John McCallion, Chief Financial Officer]

Yeah. I think as we go through this unit cost initiatives, a good portion of those initiatives help reduce some of the expenses there in holdings. In addition to just like, I call, BAU and the efforts that we're taking. Obviously, this is a business that will gradually run off. So I think the relationship there in expenses is a pretty good kind of way to think about it. In terms -- over time as the business runs off, we'd also expect the expenses to run down as well.

[Humphrey Lee, Dowling and Partners]

Got it. And then, in terms of the recurring interest margin, you've talked about expecting more towards the lower end of the guidance range, given where rates are. I recall last quarter you talked about your holding a little bit more cash and short-term investments. Have you redeployed those? Are you trying to hold on to those and kind of maybe be more opportunistic down the road?

[John McCallion, Chief Financial Officer]

Yeah, sure. So just to reiterate and this is what I said in my opening remarks, we still expect full year to be within our -- this is for RIS, our 2019 guidance of 100 to 125, albeit at the bottom end of that range. Also, in addition to VII, as you mentioned the sequential improvement was helped by the fact that we did deploy some of that excess cash one hand that we referenced in the first quarter.

So even though interest rates fell, there was -- and there was a further inversion of LIBOR. We were able to improve our spreads sequentially. And I think the last thing I'd point out and it's timely, we had the Fed -- the latest fed rate cut yesterday, the forward curves projecting a steepening from here and so we're starting to see a light at the end of the tunnel for, I'd say, spread compression in that business.

So any improvement won't happen immediately and at these projected levels any benefit would be probably modest, but it starts to put us near or at the bottom of spread compression for this segment for some time.

[Humphrey Lee, Dowling and Partners]

Appreciate the color. Thank you.

[Operator]

And at this time, there are no further questions. I'd now like to turn the call back to Michel.

[Michel Khalaf, President & Chief Executive Officer]

Thank you. Let me close by saying how pleased I am with our second quarter results especially in light of a challenging capital market environment. Overall, we delivered another very good quarter in which our diversified set of businesses demonstrated their fundamental strength.

I want to thank everyone for joining us today on a busy morning, and I look forward to speaking with you again soon. Have a great day.

[Operator]

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