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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to the MetLife's Third Quarter 2018 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 conference is being recorded.
Before we get started, I would like to read the following statement on behalf of MetLife. Except with respect to historical information, statements made in this conference call constitute forward-looking statements within the meaning of the federal securities laws, including statements relating to trends in the company's operations and financial results and the business and the products of the company and its subsidiaries.
MetLife's actual results may differ materially from the results anticipated in the forward-looking statements as a result of risks and uncertainties, including those described from time-to-time in MetLife's filings with the U.S. Securities and Exchange Commission, including in the Risk Factor section of those filings. MetLife specifically disclaims any obligation to update or revise any forward-looking statement, whether as a result of new information, future developments, or otherwise.
With that, I would like to turn the call over to John Hall, Head of Investor Relations.
Thank you, Operator. Good morning, everyone, and welcome to MetLife's third quarter 2018 earnings call. On this call, we will be discussing certain financial measures not based on Generally Accepted Accounting Principles, so-called non-GAAP measures. Reconciliations of these non-GAAP measures and related definitions to the most comparable GAAP measures may be found on the Investor Relations' portion of MetLife.com, in our earnings release, and our quarterly financial supplements.
A reconciliation of forward-looking financial information to the most directly comparable GAAP measure is not accessible because MetLife believes it's not possible to provide a reliable forecast of net investment and net derivative gains and losses, which can fluctuate from period-to-period and may have a significant impact on GAAP net income.
Now, joining me this morning on the call are Steve Kandarian, Chairman, 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, including substantial disclosure in the appendix on our long-term care book of business. The slides are available on our website. John McCallion will speak to the main body of the 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 will extend no longer than the top of the hour. Please limit yourself to one question and one follow-up, in fairness to all participants.
With that, I will turn the call over to Steve.
Thank you, John, and good morning, everyone. MetLife has been engaged in one of the most ambitious transformations in its history. For a number of years, much of our business was characterized by capital-intensive long-tailed liabilities with low levels of free cash flow. Our strategy has been to transform MetLife into a company with a different profile, less capital-intensive, with shorter payback periods, and higher cash flow.
While some of the business we wrote in years past will take time to run off our books, we believe we are now at an inflection point where the heavy lifting of our transformation is just about complete.
We are executing more consistently and the results in the quarter and for the year-to-date 2018 demonstrate that our strategy is working. We delivered third quarter adjusted earnings of $1.4 billion, or $1.38 per share, up from $1.04 per share a year ago. Once again, our business fundamentals were strong: solid underwriting; good investment results; and disciplined expense management across the company. Reflecting our strong results, adjusted return on equity in the quarter rose to 12.9% from 9.1% a year ago.
After notable items, adjusted earnings were $1.53 per share. Notable items in the third quarter included a net charge of $0.07 per share associated with our annual actuarial review and other insurance adjustments, as well as $0.09 per share of costs to support our expense initiative.
MetLife's annual actuarial review, which we completed during the third quarter, examined the actuarial assumptions underpinning our insurance liabilities around the world. Going into the quarter, there was considerable market interest in long-term care. Our LTC review of all assumptions, models and the margin testing process, which incorporated a third-party actuarial review, concluded that no long-term care reserve unlocking was necessary.
Following the review, our long-term care loss recognition testing margin now stands at $2.1 billion. Along with other insurance adjustments, the impact of the actuarial review on adjusted earnings was negative $68 million. The incremental effect of the actuarial review on net income was negative $230 million. None of these amounts were associated with long-term care insurance.
The largest net contributors were assumption updates in Japan and the closed block. John McCallion will provide more detail on the actuarial review in his comments. Net income for the quarter was $880 million compared to a net loss of $97 million, which was driven by the separation of Brighthouse Financial a year ago. The largest items contributing to the difference between net income and adjusted earnings in the quarter, included net derivative losses in the annual actuarial review.
Increasing net interest rates in the U.S. and Japan, a rising U.S. equity market and a weakening yen combined to generate mark-to-market derivative losses of $299 million, while protecting our balance sheet. As I mentioned earlier, the non-adjusted earnings impact from the annual actuarial review totaled $230 million. We continue to focus on delivering results where net income and adjusted earnings are more closely aligned than the past.
Turning to business highlights, Group Benefits reported very good underwriting and solid volume growth, aided by the positive fundamentals of the U.S. economy. Retirement and Income Solutions also reported favorable underwriting and good volume growth. New pension risk transfer deposits in the quarter totaled $1 billion and we are seeing a strong pipeline.
With Property & Casualty, lower catastrophe losses and volume growth contributed to solid adjusted earnings, which were up 69% year-over-year. For our international segments, Asia benefited from volume growth offset by less favorable underwriting. Latin America was aided by business growth, offset by currency headwinds. And EMEA benefited from expense management, while absorbing underwriting and currency weakness.
Moving to total company investments, recurring investment income was up 6.7% from a year ago. Asset growth and higher interest rates account for the increase. In the quarter, our global new money yield was 4.04% in comparison to an average roll-off rate of 4.37%. Our new money rate was up 51 basis points from a year ago, reflecting higher interest rates.
Pre-tax variable investment income totaled $280 million in the quarter, driven by strong private equity returns and higher prepayment activity. Pre-tax variable investment income is above our quarterly guidance range of $200 million to $250 million and on target to meet our full year guidance.
Notwithstanding the recent market turmoil and concerns over geopolitical issues such as trade, MetLife's business growth has been helped by the favorable economic environment in the United States. GDP growth is on track to exceed 3% for 2018 and the U.S. unemployment rate in September dropped to the lowest level since 1969, a positive for our Group business.
In addition, higher interest rates are strengthening our recurring investment yields. It is difficult at this stage to know that if stock market is signaling an economic downturn. But as we have said before, our refreshed strategy was designed to allow MetLife to perform well across economic cycles.
Moving to capital management, we repurchased $636 million of our common shares during the third quarter. Combined with our common dividend, total capital returned to shareholders in the quarter came to more than $1 billion. We have $470 million remaining on our current $1.5 billion authorization, which we expect to complete by year-end.
Also, we announced last night that our board of directors authorized an additional $2 billion of share repurchases, bringing our current authorized buyback capacity to almost $2.5 billion. Over the three-year period from 2016 through 2018, MetLife will return close to $12 billion to our shareholders through share repurchases and common dividends.
During that same timeframe, our share count will be down by more than 10%. The cumulative impact of our share repurchase program has had a meaningful and growing positive impact on our financial metrics, including earnings per share and return on equity. In the current quarter alone, share repurchases contributed $0.08 to earnings per share compared to $0.04 a year ago.
I would like to spend a moment talking about our Asia business. As many of you know, we hosted an Asia Investor Day in Tokyo at the end of September. Asia is our largest business segment outside the U.S. We have a strong franchise in the region, with a significant opportunity to generate growth and value for our shareholders. We have pursued a multi-year effort through Accelerating Value initiative to improve returns and capital efficiency.
Among the more nimble actions was our transition from yen-denominated Whole Life products in Japan to dollar-denominated products. Importantly, this transition was aligned with our enterprise strategy to deliver the right solutions for the right customers.
Over the past three years, MetLife has more effectively deployed capital in Asia at higher internal rates of return with shorter payback periods, which we expect will generate more value for our shareholders over time.
As I noted at the start of today's call, this is the approach we are pursuing across the company. We believe the attributes of a new MetLife are becoming clearer; leaner; less capital-intensive; more digital; more profitable, with strong free cash flow. This is our plan to grow long-term shareholder value. And we believe the results are clear in MetLife's improved performance. On December 14, we will host our 2018 outlook call and share our three-year roadmap for MetLife.
With that, I will turn the call over to John to discuss our quarterly financial results in detail.
Thank you, Steve, and good morning. I will begin by discussing the 3Q 2018 supplemental slides that we released last evening, along with our earnings release and quarterly financial supplement. These slides cover our third quarter 2018 financial results, including our actuarial assumption review and other insurance adjustments as well as business highlights. In addition, we are offering a deeper dive into our long-term care block, given its focus with analysts and investors.
Starting on page 4, this schedule provides a comparison of net income and adjusted earnings in the third quarter. Net income was $880 million, or roughly $500 million below adjusted earnings of $1.4 billion. The primary drivers for this variance were net derivative losses and the non-adjusted earnings impact from the actuarial assumption review.
Higher interest rates, strong U.S. equity markets, and the weakening of the yen combined to drive the net derivative loss. Overall, the results in the investment portfolio and hedging program performed as expected.
Now, let's turn to page 5. We have completed our annual actuarial assumption review during the third quarter. Before I speak to the total review, I would like to first address the review as it pertains to long-term care.
During the quarter, our actuarial team reviewed all LTC assumptions, models, and the loss recognition testing process. Our review was supplemented by a third-party actuarial review. The short-form conclusion was that no long-term care reserve unlocking was needed. We continue to have a substantial loss recognition testing margin associated with long-term care. As of September 30, this was $2.1 billion.
In addition, we increased the amount of disclosure regarding our long-term care block of business. The disclosure can be found in the appendix to the supplemental slides. Along with the granular detail on the long-term care block, we have provided the assumptions underlying our base GAAP and statutory reserves, as well as the assumptions supporting our GAAP loss recognition testing and our statutory asset adequacy testing.
Further, we provided a set of sensitivities associated with our GAAP loss recognition testing margin. Keep in mind that MetLife is not in loss recognition, so our LTC sensitivities relate to our loss recognition testing margin, rather than our base reserves.
Following the review, we continue to reflect improving morbidity in our loss recognition testing assumptions at a rate of 50 basis points per year. This judgment is supported by a third-party review of our actual morbidity experience, which is tracking at an annual rate of improvement of roughly 2%, more than the assumed rate, but still building statistical significance. It is important to note the removal of this assumption would be fully covered by our loss recognition testing margin.
Our statutory long-term care reserves total $14.7 billion. They do not assume any improvement in morbidity in the formulation of base reserves or in the statutory asset adequacy testing process.
Our statutory LTC reserves are $2.6 billion greater than our GAAP LTC reserves, which speaks to the strength of the protection provided to our long-term care policyholders. We take in roughly $750 million of long-term care premium each year, which is an important contributor to reserve growth and loss recognition testing margin over time. Importantly, premiums grew last year by 7% from rate increases. And we've achieved another 3% in rate increases year-to-date, which serves to better support our LTC block of business.
I will now briefly discuss the balance of our actuarial assumption review on page 6. During the quarter, the actuarial assumption review and other insurance adjustments reduced adjusted earnings by $68 million. There were a number of pieces that were largely offsetting and each segment was modestly impacted. Among the larger contributors were: lapse assumption updates in Asia and MetLife Holdings; as well as mortality updates; closed block refinements; and other life insurance reserve adjustments in MetLife Holdings.
The non-adjusted earnings portion of the assumption review was a negative $230 million and was driven by some of the same factors. We had two notable items in the quarter as shown on page 7 and highlighted in our earnings release and quarterly financial supplement. First, the actuarial assumption review and other insurance adjustments decreased adjusted earnings by $68 million after-tax, or $0.07 per share. Second, expenses related to our unit cost initiative decreased adjusted earnings by $88 million after-tax, or $0.09 per share. Adjusted earnings, excluding notable items, were $1.5 billion, or $1.53 per share.
On page 8, you can see the year-over-year adjusted earnings, excluding total notable items, by segment. Excluding all notable items in both periods, adjusted earnings were up 29% year-over-year and 32% on a constant currency basis.
On a per share basis, adjusted earnings were up 39%, and up 40% 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 in the quarter included: favorable underwriting; solid volume growth; better expense and investment margins, as well as lower taxes primarily due to U.S. tax reform. With respect to investment margins, pre-tax variable investment income was $280 million, up $44 million versus the prior-year quarter, driven by higher private equity and prepayment income.
With regards to business performance, Group Benefits adjusted earnings, excluding notable items in both periods, were up 38% year-over-year, primarily driven by: favorable underwriting margins; volume growth; better expense margins; and the benefit from U.S. tax reform. Underwriting results were particularly strong in non-medical health. The interest adjusted benefit ratio for non-medical health was 68.1% and 71.6%, excluding a favorable insurance adjustment. This result was favorable to the prior-year quarter of 74.7% and well below the target range of 75% to 80%.
Non-medical health's favorable underwriting experience was primarily driven by disability, which had strong renewal results, lower incidence and favorable claim recoveries versus the prior-year quarter. The Group Life mortality ratio was 85%, which was in line with the prior-year quarter and at the low end of the target range of 85% to 90%.
Group Benefits continues to see strong momentum in its top line. Adjusted PFOs were up 6% year-over-year, with growth across all markets and product lines. Year-to-date 2018 sales were down 2% relative to the first three quarters of 2017, which had record jumbo cases.
Voluntary products continued its momentum, with sales up double digits year-to-date in 2018 versus the prior-year period. In addition, we also continue to grow downmarket, as regional and small market sales were strong and above our year-to-date target.
Adjusted earnings in Retirement and Income Solutions, or RIS, were up 37%. The key drivers were favorable underwriting and volume growth, as well as lower taxes due to U.S. tax reform. This was partially offset by investment margins, as we had lower variable investment income in RIS compared to the prior year.
While the flatter yield curve has put some pressure on RIS adjusted earnings, this was more than offset by higher general account balances, which were up 7% versus the prior-year quarter. In addition, we have been able to maintain investment spreads, which were 125 basis points in 3Q and within our outlook call range of 110 to 135.
As we noted on our 2Q analyst call, earnings from interest rate caps contributed to spreads once again in the quarter. Excluding VII, RIS spreads were 104 basis points, which was up 5 basis points year-over-year, but down 9 basis points sequentially. RIS adjusted PFOs were $1.7 billion, down from $2.5 billion in the prior-year quarter, due to lower pension risk transfer sales.
Year-to-date, PRT sales are well ahead of 2017. And we continue to win deals, highlighted by two transactions in 3Q 2018 totaling $1 billion. Excluding PRT deals in both quarters, adjusted PFOs were up 2% year-over-year, primarily due to structured settlements and income annuities.
Property & Casualty, or P&C, adjusted earnings, excluding notable items in the prior-year quarter, were up 41%, primarily due to lower catastrophes in the current quarter. Pre-tax cat losses were $49 million in the quarter, which was $37 million lower than the prior year. With regards to the top-line, P&C adjusted PFOs were up 2%, while sales were up 23% versus 3Q 2017. We continue to see strong sales momentum in 2018.
Asia adjusted earnings, excluding notable items, were up 11% and up 12% on a constant currency basis. The key driver was volume growth, which was partially offset by less favorable underwriting. Asia sales were up 29% on a constant currency basis. In Japan, sales were up 38%, primarily driven by strong foreign currency-denominated annuities, as well as Accident & Health sales. FX in A&H products remain our primary focus in Japan and we continue to see strong momentum in the market.
Other Asia sales were up 16%, primarily driven by China and a group case in Australia. Latin America adjusted earnings, excluding notable items, were down 4%, but on a constant currency basis were up 4%.
The impact from U.S. tax reform has dampened Latin America earnings. For example, if we exclude notable items and the impact of tax reform, Latin America adjusted earnings were up 3% and up 13% on a constant currency basis. The key drivers were solid volume growth, higher interest margins, and favorable underwriting.
Latin America adjusted PFOs were down 1%, but up 7% on a constant currency basis, driven by volume growth across the region led by Chile. Latin America sales were up 2% on a constant currency basis, due to higher direct marketing and group sales.
EMEA adjusted earnings, excluding notable items, were down 1%, but up 5% on a constant currency basis, primarily due to expense margin improvement. This was partially offset by less favorable underwriting margins.
EMEA adjusted PFOs were flat versus the prior year and up 3% on a constant currency basis, reflecting growth in Western Europe and Turkey. EMEA sales were down 22% on a constant currency basis, due to lower volumes in the Gulf and the exit of the UK wealth management business in mid-2017.
MetLife Holdings' adjusted earnings, excluding notable items, were up 45% year-over-year, primarily driven by favorable underwriting, improved expense margins, and the benefits from U.S. tax reform.
With regards to underwriting, LTC was favorable versus the prior year quarter and remained consistent with expectations as we continue to execute on our rate action plan. MetLife Holdings' adjusted earnings were aided by several items in the quarter of approximately $30 million, which are not expected to repeat.
Corporate & Other adjusted loss, excluding notable items, was $149 million compared to an adjusted loss of $152 million in 3Q 2017. The primary drivers were higher variable investment income and favorable expense margins. This was mostly offset by the impact from U.S. tax reform and lower interest margins.
Overall, the company's effective tax rate in the quarter was 17.2%. Excluding a positive one-time tax item of $12 million, the company's effective tax rate was 17.9%, a fraction below our guidance of 18% to 20%.
Turning to page 9, this chart shows our direct expense ratio from 2015 through 2017, as well as the first three quarters of 2018. As we have stated previously, we believe this 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.
We have also noted that we need to bring down our direct expense ratio by approximately 200 basis points from 14.3% in 2015, which was the baseline year, to realize $800 million of pre-tax profit margin improvement.
For this quarter, the direct expense ratio was 13.1%, excluding notable items and pension risk transfers. This is modestly higher than the first two quarters of 2018. As we have previously mentioned, we would expect our direct expense ratio to tick-up slightly in 4Q given business seasonality, but anticipate the full year direct expense ratio falling below the 2017 ratio of 13.3%.
I will now discuss our cash and capital position. Cash and liquid assets at the holding companies were approximately $4.5 billion at September 30, which is down from $5.4 billion at June 30. The $900 million decrease in cash in the quarter reflects the net effects of subsidiary dividends, share repurchases, payment of our common dividend, holding company expenses and liability management actions.
Next, I would like to provide you with an update on our capital position. For our U.S. companies, preliminary year-to-date third quarter statutory operating earnings were approximately $3.6 billion and net earnings were approximately $3.1 billion. Statutory operating earnings increased by $1.1 billion from the prior-year period, primarily due to dividends received from an investment subsidiary which had a corresponding offset in statutory adjusted capital, as well as the positive impact of U.S. tax reform.
We estimate that our total U.S. statutory adjusted capital was approximately $18 billion as of September 30, 2018, down 3% compared to December 31, 2017. Net earnings were more than offset by dividends paid to the holding company and by investment losses. Finally, the Japan solvency margin ratio was 808% as of June 30, which is the latest public data.
Overall, MetLife generated another very strong quarter in 2018, driven by solid business fundamentals. The highlights in 3Q included favorable underwriting, volume growth and improving margins. In addition, our cash and capital position, as well as our balance sheet, remain strong.
Yesterday's announcement of a new $2 billion buyback authorization is further evidence of MetLife's financial strength and our commitment to return excess capital to our shareholders. Finally, we remain confident that the actions we are taking to implement our strategy will drive free cash flow and create long-term sustainable value to our shareholders.
And with that, I will turn the call back to the operator for questions.
Thank you. Your first question comes from the line of Ryan Krueger from KBW. Please go ahead.
Hi, thanks. Good morning. I had a question on Group Benefits. The underwriting performance has been very strong this year, for both MetLife and pretty much the entire industry. Can you give us some additional perspective on what you're seeing and, I guess, if we continue to stay in a good economic environment, if you think results can continue to trend more favorably than you would typically expect longer term?
Yeah, hi, Ryan. This is Michel. So, as Steve mentioned in his opening, obviously, the favorable economic environment does help in terms of the underwriting performance. If you think about disability, for example, where we've seen very good results this quarter, lower incidence, high recovery experience. So that's one factor.
We always like to be cautious and guide towards the range that we provide for our underwriting experience, but we do think that some of the benefit could be sustainable. I would also point out that if you look at our results over the last three quarters, the diversity of our business is an important factor.
In the first quarter, our dental performance was strong. Q2, life underwriting was strong. Q3, disability in particular, but also if you look at our life mortality, it's at the lower end of the range. So we think some of this is sustainable. I would also point out in non-medical health, in particular, that our shift towards voluntary benefits, accident & health, in particular, should over time also help lower our benefit ratio there.
Thanks. And then, just one on the interest rate caps in retirement, John, could you give us some kind of perspective on just how much that's contributing right now to spreads, so we can think about the impacts when it runs off?
Sure. So as I said last quarter, our interest rate caps, given where LIBOR is today, is providing a offset. And it's effectively neutralized the sensitivities we gave back in December of last year in terms of the outlook call. And I think the other aspect, we also said there were certain management actions we took in terms of how we manage the liability side of the balance sheet as well. So the combination of those has probably helped us in, call it, the 5 to 7 basis point range.
Okay, great. Thank you.
Your next question comes from the line of Tom Gallagher from Evercore. Please go ahead.
Good morning. Just a few long-term care questions, can you comment on what's going on with underlying long-term care claim trends? I know, John, you had mentioned you're seeing favorable experience. That probably puts you in the minority in terms of from everyone else we're hearing from on underlying claim trends. Is it frequency, severity, claim durations? Can you give a little color in terms of what you're seeing on the claims side?
Yes, sure. I would probably just keep it pretty simple. I don't know if we're seeing favorable. I'd say they're in line with expectations. And I think just overall, the underwriting profit in the business is performing as expected. I'm not so sure I'd say they are favorable relative to expectations.
Okay. And then, just on the disclosure that you put out for long-term care, I guess a few things that stand out is the fact that you're not in loss recognition testing and your loss recognition testing margin is over 10%. But is there anything other than those that you would point out that you feel like where your block stands out is less risky or in better shape than others?
Yes. I think I would probably reiterate things we said in the past. We believe the profile of the block is in decent shape. Obviously, our relationship of group to individual, the amount of lifetime benefits we have, things like that and kind of things we've reiterated before. And then, I'd say the second thing that we talked about is just the work we've done on rate increases over the years has been beneficial. We have $750 million of premium in this block that we receive every year. We got a 7% increase last year. We've got another 3% through nine months this year. So, I think those probably at a high level are the two factors I would point to.
Okay. Thanks.
Your next question comes from the line of Jimmy Bhullar from JPMorgan. Please go ahead.
Hi, good morning. I just had a question on your expectations for spreads, given what's happened with rates. Where do you think rates need to go for spread compression to sort of cease?
And then if you could quantify how much of a benefit you are getting from interest rate protection and any color on how these expire over time?
Hey, Jimmy, let me take the first one. This is Steve Goulart. And we'll just talk a little bit about spreads. Steve gave some of the statistics for what's happening in our overall portfolio. We've talked a lot in the past about the roll-off reinvest dilemma and we continue to see that spread narrowing as we see interest rates climbing. That's the outcome that we expected and obviously an outcome that we're very pleased to see happening.
So, we continue to see that happening. I think if we see interest rates behave as, say, the forward curve or our plan projects, we continue to see that gap narrowing and I think it's favorable. I think I'd even go so far as to say that in several quarters, we're likely to basically be at breakeven.
And, Jimmy, this is John. I'll take the second one. So, I would probably go back to the response to Ryan's comment. So, we certainly have some interest rate caps today, given where LIBOR has rose to and it hasn't changed much in the last three months. Those caps we have that are giving that protection today and really neutralizing the sensitivity in our RIS business, they will roll-off into the fourth quarter and the first quarter of 2019.
Now, we have other caps in 2019, although they're at higher strikes. So, I think what we'll do on the outlook call is work through it and maybe a more robust sensitivity for you as we think about the outlook.
And your comments on spreads maybe neutralizing or spread compression neutralizing sometime in the next several quarters, does that take into account the expiration of the caps?
Right, so...
Or is that just a differential between portfolio yields and maturing or new money versus maturing loans?
Yes. So, spreads, I'm focusing on RIS right now.
Yes.
And we gave a sensitivity in the outlook call last December that indicated with a rising LIBOR rate, that we would have a negative spread compression.
And what I'm saying is that the caps, given how fast or how high it has risen, it's some of these out of the money caps are now in the money and they are neutralizing that sensitivity. So, we are not seeing that negative spread compression as a result of the caps and how high LIBOR has risen. That will roll-off, all else equal, in the next few quarters and then we'll have to give you an updated outlook for that.
Your next question comes from the line of Andrew Kligerman from Credit Suisse. Please go ahead.
Hey, morning. First question is on the direct expense ratio. And it looks like you have another, I don't know, 80-plus basis points, 100 basis points to go that would be about $400 million. And this quarter, you spent $88 million on expense cost initiatives.
If the plan is to complete the direct expense ratio reduction in two years, could you talk about the geography of where you're going to see it, the timing of when we're going to see it? Are we going to actually see $400 million drop to the bottom-line?
Right. So, I would just reference back to the direct expense ratio slide. We've used a ratio. We believe that using the ratio of revenues to our fixed cost is an indicator of profit margin expansion. So I would argue that we have seen that already, but not all of it yet. Our target is to get to a net $800 million (39:38) by 2020. So that's roughly a 200 basis point reduction using the same revenues we have today. So I think the answer is yes. We expect to see that drop to the bottom line. And the reason we put the ratio out is to provide a metric that you can track to see that that has actually happened.
So we'll see it within two years. And any particular areas of the company where it will benefit most?
We're focusing on our fixed costs across the firm. And it's everyone's contributing. This is a full team effort. We are obviously having to leverage and our goal here is not just to kind of do these things and then see expenses creep back up. This is a unit cost initiative. Our objective is to improve this direct expense ratio by 200 basis points and keep it there.
Got it. And then...
And to do that, we're making quite a bit of investments around technology to build the platform to leverage that operational leverage.
Got it, thanks. And then, lastly on share repurchases, you've done $2.8 billion year-to-date. Now you've upped the authorization and you have about less than $2.5 billion on it, which is terrific. Do you think you'll do this over the course of now through 2019? Will it all get deployed?
Yes. Our objective is to finish the remainder on the $1.5 billion authorization, which we will do by no later than end of the year. And then we'll reevaluate along the way. I think it's fair to say that the $2 billion would be done no later than end of year next year.
Terrific. Thanks a lot.
Your next question comes from the line of Suneet Kamath from Citi. Please go ahead.
Thanks. And thanks for all the long-term care disclosures. That was helpful. In terms of the loss recognition testing assumptions, did you make any changes to those underlying assumptions as you went through this third quarter review?
Yeah, hi, Suneet, it's John. Yeah, we did make a few changes. So we dropped our ultimate lapse assumption roughly 20 basis points in the aggregate. We were at roughly 1% before. We're down to 80 basis points now. We probably made some changes to utilization, but it varied by block and so there was really probably nothing material in aggregate, but we did make some changes throughout. And I think other than that, those are probably the most material changes.
So that $2.1 billion margin, there is no big change to that in the aggregate?
I would say not material. Yes.
Okay. And then my quick follow-up is just on the morbidity improvement. I think you said in your prepared remarks that you're seeing maybe 2% morbidity improvement, which, again, is quite a bit different from what we're hearing from other companies. So any sense of like how much claims experience you've seen so far maybe relative to inception, and any sense in terms of why you're seeing it versus perhaps some other companies that aren't seeing it yet?
Yes. I think I would reference, we still are building statistical significance in the data. So it's still relatively early. I don't think we could draw a conclusion that would cause us to change our current assumption. But what we're saying is early signs are indicating that it's higher than that. But we need to see the data emerge and kind of build that statistical significance, as I mentioned.
It's hard for me. I'm not going to speculate as to why we're seeing it and others are not. But I think it's important to leverage your own data and make the appropriate conclusions off of that.
Your next question comes from the line of John Nadel from UBS. Please go ahead.
Hi, hey, thank you. Good morning. I guess a couple questions, just thinking about favorability of underwriting results. And I guess in particular on the group side, if you could characterize what portion of better results this quarter, you think, is just akin to more typical seasonal pattern. 3Q, I think, tends to be a little bit better anyway. And how much of that is more difficult to think about trending? And then the second part of the question is just to think about January 1, 2019 renewals. I think there's been an expectation that maybe the positive impact of tax reform and maybe some of the good underwriting results we've seen would maybe put some downward pressure on premium rates for renewal business heading into 2019. And can you sort of talk to what you're seeing, if anything, in that respect.
Yeah, hi, John. This is Michel. So if you think about our favorable underwriting results in the quarter, we mentioned disability. We had favorable renewal results, lower incidence and more favorable claim recovery experience. As I mentioned earlier, the healthy economy may be a contributing factor to this. So certain aspects of that we think are sustainable.
I also mentioned that as we continue to shift our business mix more towards voluntary, we are likely to see over time improvements in our non-medical health benefits ratio. So those are some elements. I should point out here that the return of the health insurance tax, the HIT, in 2018 that was out in 2017. It's back in 2018. It will be out again in 2019. It will create some volatility that helps our non-medical health benefit ratio in 2018.
So those are some of the elements that I will point out to. And on the life side, we mentioned that mortality was at the low end of our guidance range for the year. We think we'll be within that guidance range.
With regards to January 1, 2019, so what I'll say first is that we are, so far, pleased with our renewals and sales and the large case segment for January 1, 2019, where most of the renewals and sales are already done. I think those are in line with expectation. We are winning our fair share of new sales and we are renewing in accordance with expectation. Too early to tell, as far as the med and lower end of the market, but we continue to see very good momentum on the voluntary front. And we think that will continue into January 1, 2019.
As far as the competitive environment is concerned, we are seeing a aggressiveness, particularly in dental, I would say, somewhat in disability. But we continue to be able to compete, especially that we focus on customers and intermediaries that look beyond just the lower price and where our service capabilities, our product set are major factors in our ability to win.
Thank you for that. I mean, if I could just sort of follow it up with what I think is my takeaway from your commentary, Michel. It sounds like we really shouldn't expect any significant difference or shift in margin for the business based on 2019 pricing, really more just the function of overall economic conditions. Is that a fair summary of your comment?
Yes. I mean, I think that the tax will impact the dental business in particular, but other than that, yes, I would say you're spot on.
Thank you.
Your next question comes from the line of Alex Scott from Goldman Sachs. Please go ahead.
Thanks. I guess the first question I had was just on MetLife Holdings, any color you can give around the life business, variable annuities? I guess, in particular, on the life side, if any of the action from reinsurers and repricing is impacting you guys at all?
And then on the variable annuity and fixed annuity side, if there's anything you learned through the actuarial process or just the experience that you can provide color on.
Hey Alex, it's John. So, on the first one, I'd say no, nothing material that we're seeing in terms of the reinsurance pricing question you had.
In terms of the actuarial review, look, as we said before and you saw on the supplemental slide, it's a variety of things and that's no exception for MetLife Holdings. Actually, the largest item in there is the closed block. It was about half of it. And we just had update to our estimated gross margins and that had an impact on DAC that came through. So, it's a little over half of the actuarial update there.
Okay. And then maybe just one quick one on LatAm, I think the growth rates on premiums have been sort of hitting your guide. This quarter, it was a little lower. Any kind of update around how you view that mid to high single-digit growth rate and sort of the impact that the political landscape's having across some of those geographies.
Yeah, Alex, this is Oscar. So, let me start with premiums and fees. So, we have a 7% growth year-over-year on constant currency. But you need to consider the divestiture of our Afore in Mexico a year ago. If you adjust for that, it's one percentage above, which is 8% year-over-year, which we find good according to our expectations. If you go to sales, sales was also affected by the divestiture of Afore, but in this case, it's four percentage points. So, if you adjust for that, our sales growth is approximately 6% year-over-year on constant currency, which we find good.
Remember that our top-line growth, our revenue growth, for us, it's a combination of sales as well as higher persistency. We're putting a lot of attention on persistency.
Now, your second question is about the political landscape. So, I guess, let me answer two-fold. The two countries are weaker more on Chile and Mexico. Chile, the President announced last Sunday, the project for pension reform. We find it very positive in terms of reaffirming the system, reaffirming the private system, the AFPs in general. Now, obviously, this is going to take time, we think probably more than a year. The conversion or process may be 1.5 years. So it's going to be a long process, but this is the first obviously signed development in the Congress. We think it's a good project. (5:41)
Going to Mexico for a minute. In terms of the change in government, as you probably know, the new administration has been focused on fiscal discipline, which we find very positive in general terms. And as part of that, they are planning to reduce government spending. And that includes a reduction of benefits in particularly high senior officers in the government. And, as you know, we provide some solutions that we inherited from the acquisition of Hidalgo more than 15 years ago.
So, we think that it's something worth managing. But, as you know, those contracts have been subject to bidding process over the years. We've lost some. We recovered some. At this point in time, if you want to put a value to this, we think that the federal contracts that may be affected by the government account for less than 5% of LatAm earnings. And, of course, we are working to protect, mitigate that and we think it's going to be lower than that potentially.
All right. Thank you.
Your next question comes from the line of Humphrey Lee from Dowling & Partners. Please go ahead.
Good morning and thank you for taking my question. I have a question related to the unit cost initiatives. So you have $184 million spent year-to-date on an after-tax basis or maybe roughly $230 million pre-tax. I'm just trying to see if you are still on track to your $330 million pre-tax target for the full year of 2018?
Yes, we are, Humphrey.
Okay. And then a quick question for Michel, just to follow-up on the group pricing, you've talked about dental a little bit aggressive and then so is disability. I was just wondering for that aggressiveness, is it aggressive but rational or you are seeing some irrational behavior in the marketplace?
Yeah, hi, Humphrey I think you always do see one or two carriers that are overly aggressive, potentially irrational. That's not unusual. We continue to be disciplined in our approach, selective in avoiding situations where pricing is overly aggressive. So that's been our approach and will continue to be our approach, but there is irrational behavior from time-to-time and, in particular, in dental.
Okay. Got it. Thank you.
Your next question comes from the line of Joshua Shanker from Deutsche Bank. Please go ahead.
Yeah, thank you very much. I was curious about what kind of deployable cash you have on hand right now, the pace of dividends that will come from the subs over the next year. And if we can look out a year or two in advance if your financial leverage is going to change with the buyback.
Hey, Joshua, this is John. I would just reiterate our outlook guidance around free cash flow. It's 65% to 75% over the average of two years. So I would say there's no change to that. In terms of leverage, we've done quite a bit of delevering to-date. The guidance we had given was for 2018, we had net liability management of $1 billion to $2 billion, would take effect this year. We've done about $1 billion and we'll reevaluate whether we do any additional delevering to give ourselves some additional financial flexibility.
And in terms of cash on hand right now?
$4.5 billion as of September 30.
Thank you,
Your next question comes from the line of Randy Binner from B. Riley FBR. Please go ahead.
Yeah, thanks. This is actually picking up on Suneet's line of questioning. And the question is your view as a market leader on how this body of industry data and assumptions is coming together around long-term care disclosure. Your disclosures are good. And we're getting much more granularity and sensitivity from all the carriers. But I'm just curious if you have a view on kind of the progress and quality of the disclosures we're getting. And I think it's important what your view is, because this is become a gating factor for a lot of investors looking at the space. So just want to get your view on how you think the kind of body of industry disclosures coming together on long-term care?
This is Steve speaking. It's difficult for me to opine on other people's processes, but we certainly looked at this very, very carefully. As we mentioned in our comments this morning, we brought in an outside actuarial firm to review what we were doing. We wanted to make sure we had access to benchmarking from others.
We looked at our models. We made sure they were validated. And we examined all of our actuarial and morbidity trend experience and so on. So we know the sensitivity around this issue in the industry with investors, with analysts and that's why we spent the extra time and effort, both internally and bringing an external firm to validate all these measures.
I mean, with that external firm, is your sense that you're conservative to what has become the industry baseline or just are more in line with it?
I'm not going to opine on as to others, but I'll simply say that we benchmarked against others in terms of our own assumptions to make sure that what we were using was appropriate.
All right. Thank you.
Your next question comes from the line of John Barnidge from Sandler O'Neill. Please go ahead.
Thank you. Japan annuity sales essentially doubled in the quarter and has been a material grower recently. Can you talk about why you're comfortable with pricing of that product? Is there something like where participants have exited and you're filling a role and where is the share coming from? Thank you.
Hi, this is Kishore Ponnavolu. If you look at our annuity sales, they're up 91% quarter-over-quarter. And you take the annuity sales and break them out, single premium sales account for 80% of the overall sales. And then, also, the growth rate for single premium is much higher, at least in this quarter, than level premium. And so, let's spend a little bit time about on the single premium products per se. These are five and 10-year products, tightly duration matched. So, if you look at the ALM risk, there's nothing there.
And also, these are foreign currency products. So, these are predominantly U.S. dollar-denominated, where we have considerable experience in terms of investment for matching liability. These policies also have an MVA and that certainly ensures that there's appropriate risk sharing from market risk perspective. So, overall, we are very comfortable with these products.
And at this time, there are no further questions.
Great, that brings us to the top of the hour. Thank you, everyone. We look forward to speaking with you on December 14 for our annual outlook call.
Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Executive TeleConference. You may now disconnect.