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Low Interest Rates, Sales Environment Are Headwinds for No-Moat MetLifeLow Interest Rates, Sales Environment Are Headwinds for No-Moat MetLife Rajiv Bhatia Equity Analyst Business Strategy and Outlook | by Rajiv Bhatia Updated Feb 17, 2021 MetLife, like other life insurers, has its financial results tied to interest rates. It’s unlikely that interest rates will return to pre-financial-crisis levels, and thus we expect MetLife to face this headwind for the foreseeable future. We expect returns of equity just shy of 10% over the next five years. We like that MetLife has taken steps to simplify its business. In 2017, it spun off Brighthouse, its retail arm focused on variable annuities. MetLife currently serves 44 markets, a third fewer than it did a decade ago. We believe many of the businesses that MetLife has exited have been higher risk. MetLife also is divesting its property and casualty insurance (auto) business, which we believe makes sense as there is minimal strategic benefit to having a small auto insurance business in its portfolio. On the negative side, we believe MetLife’s business is relatively undifferentiated. Whether sold individually or to employers, we believe pricing is the primary driver for MetLife’s customers. Given the relatively low fixed costs of an insurer’s income statement, this does not lend itself to MetLife having a competitive advantage. Some of MetLife’s entries into new markets (such as pet insurance and health savings accounts) are potentially more differentiated, but we believe these are unlikely to be material in the near to medium term. Unlike many of its peers, MetLife does not have a meaningful third-party asset-management business, as historically it focused on its core life insurance operations. However, in 2012, MetLife launched MetLife Investment Management, which currently manages $140 billion of institutional third-party client assets, a fraction of the $450 billion-plus managed through the general account and a fraction of what some of its peers manage. We view asset management as potentially moaty, but given the size of MetLife’s third-party asset management, we don’t view it as material to the firm’s overall financial results. Economic Moat | by Rajiv Bhatia Updated Feb 17, 2021 In general, life insurers do not benefit from favorable competitive positions. Industry competition is fierce, and in many cases the products are commoditized. Furthermore, insurers do not know their cost of goods sold for a number of years, allowing them to underprice policies without knowing it. Managers at firms may have an incentive to chase growth without regard for profitability, a cycle in which competitors are forced to match low prices or risk losing business. We believe it’s especially difficult to develop a moat in life insurance as underwriting risks are easily understood and contract structures are largely homogenous. As an example of how life insurance is commoditized, there are plenty of websites that allow prospective buyers to compare rates for life insurance policies with similar terms. We acknowledge that certain adjacent business such as asset management can have narrow moats but on a consolidated basis, these businesses are rarely large enough for us to have confidence that it will result in consist returns on equity exceeding cost of equity for the whole company. MetLife is the largest life insurer in the U.S., but it’s far from dominant at approximately 14% market share overall. Given that the life insurance business contains few fixed costs, we do not think scale constitutes a meaningful source of advantage. MetLife has averaged returns on equity of approximately mid- to high single digits over the last several years, well below our assumed cost of equity of 11%. MetLife’s U.S. group benefits business sells life, dental, disability, accidental death and dismemberment, vision, accident, and health coverage to and through employers. MetLife’s retirement and income solutions primarily serves institutional customers, and products include stable value products (such as money market funds), pension risk transfer (where an insurer takes on the liabilities of a defined-benefit plan), income annuities, tort settlements, and other solutions. Recent wins include a $6 billion pension risk transfer contract from FedEx in 2018. We expect the pace of pension risk transfer to be reasonably steady in the near to medium term but decline over the long term due to fewer defined-benefit plans being offered. When a plan sponsor is considering derisking a pension, that process is competitive; a request for proposal is typically conducted with five or more insurers with pricing being the primary driver. Finally, about 10% of MetLife’s U.S. business involves property and casualty insurance, including personal auto and homeowner’s insurance. MetLife’s Asia business sells life insurance, accident and health insurance, and savings (annuity) products. MetLife’s largest operation is in Japan, but it also has operations or joint ventures in Korea, India, China, Vietnam, Malaysia, and Australia. Approximately two thirds of the firm’s Asia sales are in Japan. Similar to Prudential, MetLife sells its insurance products in Japan through a variety of channels including through its own agents, independent agencies, banks, and other groups. MetLife is smaller than competitor Prudential in Japan and faces additional competition from Japan-based firms such as Nippon and Japan Post; therefore, we do not believe it has a meaningful advantage over its competitors. MetLife’s Latin American business sells life insurance, accident and health insurance, and savings (annuity) products. MetLife is the largest life insurer in Mexico with approximately 15% market share. In addition, MetLife has strong market share numbers in Chile, Argentina, Uruguay, and Ecuador. MetLife does have a presence in Brazil, the largest market in South America, but doesn’t have meaningful share there. MetLife’s holdings segment consists primarily of the products it no longer actively markets in the United States. This includes life insurance marketed directly through retail channels, whole life insurance, variable annuities, long-term care, and certain annuities. Over time, we expect revenue and profits to decrease in this segment as these products roll off the firm's financial statements. Fair Value and Profit Drivers | by Rajiv Bhatia Updated Feb 17, 2021 After adjusting our financial model following MetLife's release of fourth-quarter financial results, we are increasing our fair value estimate to $48 per share from $42 to reflect the time value of money and higher investment income. Our fair value estimate equates to 1.1 times tangible book value and about 8 times our 2021 GAAP earnings per share forecast. After a challenging 2020, we expect modest EPS growth driven by higher variable investment income, continued expense control, and a lower share count. During 2020, MetLife delivered GAAP returns on equity just shy of 8%. Given the tough interest-rate environment we expect mid- to high-single-digit returns during the next few years. Risk and Uncertainty | by Rajiv Bhatia Updated Feb 17, 2021 As of Dec. 31, 2020, MetLife had $355 billion in fixed-income securities on its balance sheet, classified as available for sale. Over 95% of these were rated as investment grade with over 70% having a rating of A or higher. MetLife has approximately $52 billion of commercial mortgage loans that are well diversified in terms of geographic and subsector. Although the fair value of its fixed-income assets can increase from low interest rates, sustained low interest rates ultimately hurt profitability as MetLife has to invest cash flows in lower-yielding securities. A 100-basis-point decrease in MetLife's long-term interest-rate scenario results in a $300 million decline to annualized net income. MetLife currently faces meaningful regulatory risk. Its reorganization plans in response to regulatory issues create some uncertainty, as MetLife has divested a substantial portion of its operations. Further, the recent announcement of its issues with payments to missing or unresponsive annuity and pension recipients raises legal risks. The SEC has made an inquiry into the matter. Stewardship | by Rajiv Bhatia Updated Feb 17, 2021 Overall, we believe MetLife merits a Standard stewardship rating. This assessment was conducted using our prior stewardship methodology. We will be transitioning our assessment mechanism for our stock coverage to a capital allocation methodology by the end of September. Steve Kandarian retired as CEO in May 2019 and was replaced by Michel Khalaf, former president of the U.S. business and EMEA. We don’t foresee any major strategic shifts as a result of this change. In the wake of the 2008-09 financial crisis, a step-up in risk management was necessary, but we believe Kandarian went further and made material strides in lowering the company’s risk profile in more recent years, with the largest move being the spin-off of Brighthouse. While we don’t necessarily view this evolution as value-creative, we think a moat is out of reach for life insurers such as MetLife, given industry dynamics, and we appreciate Kandarian's efforts to attempt to put the company on a more stable footing. We view the overarching strategy of moving MetLife toward more transparent operations and steadier cash flow generation under Kandarian’s tenure favorably. While the recent actions to sell off the retail advisor business and spin off parts of the company's retail operations seem to be in response to a potential change in regulations, we give Kandarian credit for crafting a reasonable plan to adjust to a changing situation and believe the resulting entity is more attractive from a long-term perspective. MetLife was also much more aggressive than peers in contesting the nonbank SIFI designation, which bore fruit, with a judge declaring that the tag was unwarranted and the government stance softening. On the negative side, while we believe that management responded appropriately after it was alerted to recent issues around payments to missing or unresponsive annuity and pension recipients, this situation raises questions about management's ability to effectively control its operations. We have mixed feelings about the company's international expansion. While international markets provide opportunities for growth, it remains to be seen whether this growth will be value-creative or -destructive over the long term. Given industry returns and the experience of other life insurers' international expansion efforts, we think some skepticism on this front is warranted. A greater focus on improving domestic operations would be more likely to create value for shareholders, in our view. |
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