For purposes of this discussion, "MICC," the "Company," "we," "our" and "us"
refer to MetLife Insurance Company of Connecticut, a Connecticut corporation
incorporated in 1863, and its subsidiaries, including MetLife Investors USA
Insurance Company ("MLI-USA"). MetLife Insurance Company of Connecticut is a
wholly- owned subsidiary of MetLife, Inc. ("MetLife"). Management's narrative
analysis of the results of operations is presented pursuant to General
Instruction H(2)(a) of Form 10-Q. This discussion should be read in conjunction
with MetLife Insurance Company of Connecticut's Annual Report on Form 10-K for
the year ended December 31, 2011, as revised by MetLife Insurance Company of
Connecticut's Current Report on Form 8-K filed with the U.S. Securities and
Exchange Commission on May 31, 2012 (as revised, the "2011 Annual Report"), the
forward-looking statement information included below, the "Risk Factors" set
forth in Part II, Item 1A, and the additional risk factors referred to therein,
and the Company's interim condensed consolidated financial statements included
elsewhere herein.
This narrative analysis may contain or incorporate by reference information that
includes or is based upon forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Forward-looking statements
give expectations or forecasts of future events. These statements can be
identified by the fact that they do not relate strictly to historical or current
facts. They use words such as "anticipate," "estimate," "expect," "project,"
"intend," "plan," "believe" and other words and terms of similar meaning in
connection with a discussion of future operating or financial performance. In
particular, these include statements relating to future actions, prospective
services or products, future performance or results of current and anticipated
services or products, sales efforts, expenses, the outcome of contingencies such
as legal proceedings, trends in operations and financial results. Any or all
forward-looking statements may turn out to be wrong. Actual results could differ
materially from those expressed or implied in the forward-looking statements.
See "Note Regarding Forward-Looking Statements."
The following discussion includes references to our performance measure,
operating earnings, that is not based on accounting principles generally
accepted in the United States of America ("GAAP"). Operating earnings is the
measure of segment profit or loss we use to evaluate segment performance and
allocate resources. Consistent with GAAP accounting guidance for segment
reporting, operating earnings is our measure of segment performance.
Operating earnings is defined as operating revenues less operating expenses,
both net of income tax.
Operating revenues excludes net investment gains (losses) and net derivative
gains (losses). The following additional adjustments are made to GAAP revenues,
in the line items indicated, in calculating operating revenues:
• Universal life and investment-type product policy fees excludes the
amortization of unearned revenue related to net investment gains (losses) and
net derivative gains (losses) and certain variable annuity guaranteed minimum
income benefits ("GMIB") fees ("GMIB Fees"); and
• Net investment income: (i) includes amounts for scheduled periodic settlement
payments and amortization of premium on derivatives that are hedges of
investments but do not qualify for hedge accounting treatment, (ii) excludes
certain amounts related to contractholder-directed unit-linked investments,
and (iii) excludes certain amounts related to securitization entities that
are variable interest entities ("VIEs") consolidated under GAAP.
The following adjustments are made to GAAP expenses, in the line items
indicated, in calculating operating expenses:
• Policyholder benefits and claims excludes: (i) amounts associated with
periodic crediting rate adjustments based on the total return of a
contractually referenced pool of assets, (ii) benefits and hedging costs
related
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to GMIBs ("GMIB Costs"), and (iii) market value adjustments associated with
surrenders or terminations of contracts ("Market Value Adjustments");
• Interest credited to policyholder account balances includes adjustments for
scheduled periodic settlement payments and amortization of premium on
derivatives that are hedges of policyholder account balances ("PABs") but do
not qualify for hedge accounting treatment and excludes amounts related to
net investment income earned on contractholder-directed unit-linked
investments;
• Amortization of deferred policy acquisition costs ("DAC") and value of
business acquired ("VOBA") excludes amounts related to: (i) net investment
gains (losses) and net derivative gains (losses), (ii) GMIB Fees and GMIB
Costs, and (iii) Market Value Adjustments;
• Interest expense on debt excludes certain amounts related to securitization
entities that are VIEs consolidated under GAAP; and
• Other expenses excludes costs related to implementation of new insurance
regulatory requirements and acquisition and integration costs.
We believe the presentation of operating earnings, as we measure it for
management purposes, enhances the understanding of our performance by
highlighting the results of operations and the underlying profitability drivers
of our business. Operating revenues, operating expenses and operating earnings
should not be viewed as substitutes for the following financial measures
calculated in accordance with GAAP: GAAP revenues, GAAP expenses and GAAP net
income, respectively. Reconciliations of these measures to the most directly
comparable GAAP measures are included in "- Results of Operations."
In this discussion, we sometimes refer to sales activity for various products.
These sales statistics do not correspond to revenues under GAAP, but are used as
relevant measures of business activity.
Business
As announced in November 2011, MetLife reorganized its business into three broad
geographic regions. As a result, in the first quarter of 2012, MICC reorganized
into two segments: Retail and Corporate Benefit Funding. In addition, the
Company reports certain of its results of operations in Corporate & Other.
Management continues to evaluate the Company's segment performance and allocated
resources and may adjust such measurements in the future to better reflect
segment profitability.
Our Retail segment offers a broad range of protection products and a variety of
annuities primarily to individuals, and is organized into two businesses:
Annuities and Life. Annuities include a variety of variable and fixed annuities
which provide for both asset accumulation and asset distribution needs. Our Life
insurance products include variable life, universal life, term life and whole
life products. Additionally, through our broker-dealer affiliates, we offer a
full range of mutual funds and other securities products.
Our Corporate Benefit Funding segment includes an array of annuity and
investment products, including guaranteed interest products and other stable
value products, income annuities, and separate account contracts for the
investment management of defined benefit and defined contribution plan assets.
This segment also includes certain products to fund company-, bank- or
trust-owned life insurance used to finance non-qualified benefit programs for
executives.
Corporate & Other contains the excess capital not allocated to the segments,
run-off business, the Company's ancillary international operations and
non-medical health business, interest expense related to the majority of the
Company's outstanding debt, expenses associated with certain legal proceedings
and income tax audit issues. Corporate & Other also includes the elimination of
intersegment amounts.
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Also in the first quarter of 2012, the Company adopted new guidance regarding
accounting for DAC. See Note 1 of the Notes to the Interim Condensed Financial
Statements for further information. As a result, prior period results have been
revised in connection with MetLife's reorganization and the retrospective
application of the first quarter 2012 adoption of new guidance regarding
accounting for DAC.
Summary of Critical Accounting Estimates
The preparation of financial statements in conformity with GAAP requires
management to adopt accounting policies and make estimates and assumptions that
affect amounts reported in the Interim Condensed Consolidated Financial
Statements. The most critical estimates include those used in determining:
(i) estimated fair values of investments in the absence of quoted market
values;
(ii) investment impairments;
(iii) estimated fair values of freestanding derivatives and the recognition
and estimated fair value of embedded derivatives requiring bifurcation;
(iv) capitalization and amortization of DAC and the establishment and
amortization of VOBA;
(v) measurement of goodwill and related impairment, if any;
(vi) liabilities for future policyholder benefits and the accounting for
reinsurance;
(vii) measurement of income taxes and the valuation of deferred tax assets; and
(viii) liabilities for litigation and regulatory matters.
In applying the Company's accounting policies, we make subjective and complex
judgments that frequently require estimates about matters that are inherently
uncertain. Many of these policies, estimates and related judgments are common in
the insurance and financial services industries; others are specific to the
Company's business and operations. Actual results could differ from these
estimates.
The above critical accounting estimates are described in "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Summary of Critical Accounting Estimates" and Note 1 of the Notes to the
Consolidated Financial Statements included in the 2011 Annual Report.
Also, for a discussion of the new accounting guidance on DAC, see Note 1 of the
Notes to the Interim Condensed Consolidated Financial Statements.
Economic Capital
Economic capital is an internally developed risk capital model, the purpose of
which is to measure the risk in the business and to provide a basis upon which
capital is deployed. The economic capital model accounts for the unique and
specific nature of the risks inherent in MetLife's business.
MetLife's economic capital model aligns segment allocated equity with emerging
standards and consistent risk principles. Segment net investment income is
credited or charged based on the level of allocated equity; however, changes in
allocated equity do not impact the Company's consolidated net investment income,
operating earnings or net income.
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Disposition
During June 2012, the Company disposed of its wholly-owned subsidiary, MetLife
Europe Limited ("MetLife Europe") to MetLife. As a result of this disposition,
the net worth maintenance agreement between MetLife Insurance Company of
Connecticut and MetLife Europe terminated automatically in accordance with its
terms. See Note 2 of the Notes to the Interim Condensed Consolidated Financial
Statements for further information.
Results of Operations
Six Months Ended June 30, 2012 Compared with the Six Months Ended June 30, 2011
Consolidated Results
We have experienced growth and an increase in market share, specifically, in our
variable and universal life and term life businesses. Pension closeout sales in
the United Kingdom remain strong, however, premiums decreased $183 million,
before income tax, due to a significant sale in the prior period. While premiums
for this business were almost entirely offset by the related change in
policyholder benefits, the favorable results contributed to the growth in our
investment portfolio. Sales of annuities declined $2.5 billion, before income
tax, or 28% compared to the prior period, in response to actions taken to manage
sales volume in order to strike the right balance among growth, profitability
and risk.
Six Months
Ended
June 30,
2012 2011 Change % Change
(In millions)
Revenues
Premiums $ 786 $ 777 $ 9 1.2 %
Universal life and investment-type
product policy fees 1,119 948 171 18.0 %
Net investment income 1,548 1,581 (33) (2.1) %
Other revenues 248 261 (13) (5.0) %
Net investment gains (losses) 75 (41)
116
Net derivative gains (losses) 143 (23) 166
Total revenues 3,919 3,503 416 11.9 %
Expenses
Policyholder benefits and claims 1,225 1,145 80 7.0 %
Interest credited to policyholder
account balances 606 591 15 2.5 %
Capitalization of DAC (494) (631) 137 21.7 %
Amortization of DAC and VOBA 454 402 52 12.9 %
Interest expense on debt 119 220 (101) (45.9) %
Other expenses 1,265 1,263 2 0.2 %
Total expenses 3,175 2,990 185 6.2 %
Income (loss) before provision for
income tax 744 513 231 45.0 %
Provision for income tax expense
(benefit) 227 154 73 47.4 %
Net income $ 517 $ 359 $ 158 44.0 %
During the six months ended June 30, 2012, income (loss) before provision for
income tax, increased $231 million ($158 million, net of income tax) over the
prior period primarily driven by a favorable change in net derivative gains
(losses) and a favorable change in net investment gains (losses).
We manage our investment portfolio using disciplined Asset/Liability Management
principles, focusing on cash flow and duration to support our current and future
liabilities. Our intent is to match the timing and amount of liability cash
outflows with invested assets that have cash inflows of comparable timing and
amount, while optimizing risk-adjusted net investment income and risk-adjusted
total return. Our investment portfolio is heavily
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weighted toward fixed income investments, with over 80% of our portfolio
invested in fixed maturity securities and mortgage loans. These securities and
loans have varying maturities and other characteristics which cause them to be
generally well suited for matching the cash flow and duration of insurance
liabilities. Other invested asset classes including, but not limited to, equity
securities, other limited partnership interests and real estate and real estate
joint ventures, provide additional diversification and opportunity for long-term
yield enhancement in addition to supporting the cash flow and duration
objectives of our investment portfolio. We also use derivatives as an integral
part of our management of the investment portfolio to hedge certain risks,
including changes in interest rates, foreign currencies, credit spreads and
equity market levels. Additional considerations for our investment portfolio
include current and expected market conditions and expectations for changes
within our specific mix of products and business segments. In addition, the
general account investment portfolio included, within other securities,
contractholder-directed unit-linked investments supporting variable annuity type
liabilities, which did not qualify as separate account assets. The returns on
these contractholder-directed unit-linked investments, which can vary
significantly period to period, included changes in estimated fair value
subsequent to purchase, inure to contractholders and are offset in earnings by a
corresponding change in PABs through interest credited to policyholder account
balances. During June 2012, the Company disposed of MetLife Europe, which held
these contractholder-directed unit-linked investments.
The composition of the investment portfolio of each business segment is tailored
to the specific characteristics of its insurance liabilities, causing certain
portfolios to be shorter in duration and others to be longer in duration.
Accordingly, certain portfolios are more heavily weighted in longer duration,
higher yielding fixed maturity securities, or certain sub-sectors of fixed
maturity securities, than other portfolios.
Investments are purchased to support our insurance liabilities and not to
generate net investment gains and losses. However, net investment gains and
losses are incurred and can change significantly from period to period due to
changes in external influences, including changes in market factors such as
interest rates, foreign currencies, credit spreads and equity markets;
counterparty specific factors such as financial performance, credit rating and
collateral valuation; and internal factors such as portfolio rebalancing.
Changes in these factors from period to period can significantly impact the
levels of both impairments and realized gains and losses on investments sold.
We use freestanding interest rate, equity, credit and currency derivatives to
hedge certain invested assets and insurance liabilities. Certain of these hedges
are designated and qualify as accounting hedges, which reduce volatility in
earnings. For those hedges not designated as accounting hedges, changes in
market factors lead to the recognition of fair value changes in net derivative
gains (losses) generally without an offsetting gain or loss recognized in
earnings for the item being hedged.
Certain direct or assumed variable annuity products with minimum benefit
guarantees contain embedded derivatives that are measured at estimated fair
value separately from the host variable annuity contract, with changes in
estimated fair value recorded in net derivative gains (losses). The Company
hedges certain of the market risks inherent in these variable annuity guarantees
through a combination of reinsurance and freestanding derivatives. Ceded
reinsurance of direct or assumed variable annuity products with minimum benefit
guarantees generally contain embedded derivatives that are measured at estimated
fair value separately from the host variable annuity contract, with changes in
estimated fair value recorded in net derivative gains (losses). The valuation of
these embedded derivatives includes a nonperformance risk adjustment, which is
unhedged, and can be a significant driver of net derivative gains (losses) but
does not have an economic impact on the Company.
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Direct, assumed, and ceded variable annuity embedded derivatives and the
associated freestanding derivative hedges are collectively referred to as "VA
program derivatives" in the following table. All other derivatives that are
economic hedges of certain invested assets and insurance liabilities are
referred to as "non-VA program derivatives" in the following table. The table
below presents the impact on net derivative gains (losses) from non-VA program
derivatives and VA program derivatives:
Six Months
Ended
June 30,
2012 2011 Change
(In millions)
Non-VA program derivatives
Interest rate $ 55 $ (28) $ 83
Foreign currency 2 (55) 57
Credit 15 4 11
Total non-VA program derivatives 72 (79) 151
VA program derivatives
Embedded derivatives-direct/assumed guarantees:
Market and other risks 327 262 65
Nonperformance risk (102) (28) (74)
Total 225 234 (9)
Embedded derivatives-ceded reinsurance:
Market and other risks (82) (185) 103
Nonperformance risk 39 23 16
Total (43) (162) 119
Freestanding derivatives hedging direct/assumed
embedded derivatives (111) (16) (95)
Total VA program derivatives 71 56 15
Net derivative gains (losses) $ 143 $ (23) $ 166
The favorable change in net derivative gains (losses) on non-VA program
derivatives was $151 million ($98 million, net of income tax). This reflects
long-term interest rates decreasing more in the current period than in the prior
period, which primarily impacted receive-fixed interest rate swaps, long
interest rate floors and long interest rate futures, partially offset by lower
interest rates in the U.K. which impacted our pay-fixed inflation swaps. These
freestanding derivatives are primarily hedging interest rate risk in long
duration liability portfolios and hedging inflation-indexed liabilities. In
addition, a strengthening of the U.S. dollar relative to other key currencies
favorably impacted foreign currency swaps and forwards, which primarily hedge
certain foreign denominated bonds. Because certain of these hedging strategies
are not designated or do not qualify as accounting hedges, the changes in the
estimated fair value of these freestanding derivatives are recognized in net
derivative gains (losses) without an offsetting gain or loss recognized in
earnings for the item being hedged.
The favorable change in net derivative gains (losses) on VA program derivatives
was $15 million ($10 million, net of income tax). This was due to a favorable
change of $73 million ($47 million, net of income tax) related to market and
other risks on direct and assumed variable annuity embedded derivatives, net of
the impact of market and other risks on the ceded reinsurance embedded
derivatives and net of freestanding derivatives hedging these risks; partially
offset by a net unfavorable change of $58 million ($38 million, net of income
tax) related to the changes in the nonperformance risk adjustment on the direct,
assumed, and ceded variable annuity embedded derivatives.
Generally, a higher portion of the ceded reinsurance for GMIBs is accounted for
as an embedded derivative as compared to the direct guarantees since the
settlement provisions of the reinsurance contracts generally meet the
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accounting criteria of "net settlement." This mismatch in accounting can lead to
significant volatility in earnings, even though the risks inherent in these
direct guarantees are fully covered by the ceded reinsurance.
The foregoing favorable change of $73 million ($47 million, net of income tax)
was driven by changes in market factors. As discussed in the preceding
paragraph, changes in market and other risks lead to volatility in earnings due
to the mismatch in accounting on GMIBs. The primary changes in market factors
are summarized as follows:
• Equity index levels improved more in the current period than in the prior
period and equity volatility decreased more in the current period than in the
prior period. These changes contributed to an unfavorable change in our ceded
reinsurance asset and our freestanding equity derivatives and favorable
changes in our embedded derivatives; and
• Long-term interest rates decreased more in the current period than in the prior period and contributed to a favorable change in our ceded reinsurance
asset and our freestanding interest rate derivatives and unfavorable changes
in our embedded derivatives.
The favorable change in net investment gains of $116 million ($75 million, net
of income tax) was primarily due to higher net gains on sales of fixed maturity
securities.
Income tax expense for the six months ended June 30, 2012 was $227 million, or
31% of income (loss) before provision for income tax, compared with income tax
expense of $154 million, or 30% of income (loss) before provision for income
tax, for the prior period. The Company's 2012 and 2011 effective tax rates
differ from the U.S. statutory rate of 35% primarily due to the impact of
certain permanent tax differences, including non-taxable investment income and
tax credits for investments in low income housing, in relation to income (loss)
before provision for income tax.
As more fully described in the discussion of performance measures above, we use
operating earnings, which does not equate to net income, as determined in
accordance with GAAP, to analyze our performance, evaluate segment performance,
and allocate resources. We believe that the presentation of operating earnings,
as we measure it for management purposes, enhances the understanding of our
performance by highlighting the results of operations and the underlying
profitability drivers of the business. Operating earnings should not be viewed
as a substitute for GAAP net income. Operating earnings increased $26 million,
net of income tax, to $480 million, net of income tax, for the six months ended
June 30, 2012 from $454 million, net of income tax, in the prior period.
Reconciliation of net income to operating earnings
Six Months
Ended
June 30,
2012 2011
(In millions)
Net income $ 517 $ 359
Less: Net investment gains (losses) 75 (41)
Less: Net derivative gains (losses) 143 (23)
Less: Other adjustments to net income (1) (147) (76)
Less: Provision for income tax (expense) benefit (34) 45
Operating earnings $ 480 $ 454
(1) See definitions of operating revenues and operating expenses for the
components of such adjustments.
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Reconciliation of GAAP revenues to operating revenues and GAAP expenses to
operating expenses
Six Months
Ended
June 30,
2012 2011
(In millions)
Total revenues $ 3,919 $ 3,503
Less: Net investment gains (losses) 75 (41)
Less: Net derivative gains (losses) 143
(23)
Less: Adjustments related to net investment gains (losses)
and net derivative gains (losses)
1
(2)
Less: Other adjustments to revenues (1) 141 219
Total operating revenues $ 3,559 $ 3,350
Total expenses $ 3,175
$ 2,990
Less: Adjustments related to net investment gains (losses)
and net derivative gains (losses)
68
51
Less: Other adjustments to expenses (1) 221 242
Total operating expenses $ 2,886 $ 2,697
(1) See definitions of operating revenues and operating expenses for the
components of such adjustments.
Consolidated Results - Operating
Six Months
Ended
June 30,
2012 2011 Change % Change
(In millions)
OPERATING REVENUES
Premiums $ 786 $ 777 $ 9 1.2 %
Universal life and investment-type
product policy fees 1,057 907 150 16.5 %
Net investment income 1,468 1,405 63 4.5 %
Other revenues 248 261 (13) (5.0)%
Total operating revenues 3,559 3,350 209 6.2 %
OPERATING EXPENSES
Policyholder benefits and claims 1,136 1,115 21 1.9 %
Interest credited to policyholder
account balances 561 579 (18) (3.1)%
Capitalization of DAC (494) (631) 137 21.7 %
Amortization of DAC and VOBA 388 349 39 11.2 %
Interest expense on debt 34 33 1 3.0 %
Other expenses 1,261 1,252 9 0.7 %
Total operating expenses 2,886 2,697 189 7.0 %
Provision for income tax expense
(benefit) 193 199 (6) (3.0)%
Operating earnings $ 480 $ 454 $ 26 5.7 %
Unless otherwise stated, all amounts discussed below are net of income tax.
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The $26 million increase in operating earnings was driven by growth in most of
our businesses, which increased our policy fees, favorable impacts from changes
in market factors and a higher income tax benefit, partially offset by increased
expenses.
Positive net cash flows, generated from the majority of our businesses, were the
primary driver of increases in both invested assets and separate account assets.
This growth in separate account assets, in turn, generated an increase in
operating earnings of $90 million, primarily from higher policy fees and other
revenues from our annuity business. In our variable annuity products, policy
fees are calculated as a percentage of the average assets in separate accounts.
In addition to positive net cash flows, invested assets increased from higher
collateral posted by our derivative counterparties, which, combined, generated
higher net investment earnings of $12 million. Consistent with our increase in
invested assets, the growth in insurance liabilities resulted in higher interest
credited on long-duration contracts and on our PABs, which resulted in a
decrease in operating earnings of $8 million. Reduced annuity sales in the
current period resulted in lower DAC capitalization, which was offset by a
decline in deferrable expenses. However, strong annuity sales in the prior
period significantly increased our in-force business which contributed to an
increase in non-deferrable expenses of $66 million.
Market factors, including improved real estate markets on our real estate joint
venture investments, net of lower returns on our private equity investments,
favorably impacted investment yields and contributed a $29 million increase in
operating earnings. As a result of the decline in interest rates, average
crediting rates on annuity fixed rate funds declined, contributing an increase
of $5 million to operating earnings. The favorable equity market performance
increased our average separate account balances, triggering an increase in
policy fees and other revenues, most notably in our annuity business, resulting
in a $5 million increase in operating earnings.
The aforementioned business growth, combined with favorable market impacts,
resulted in a $25 million increase in DAC, VOBA and deferred sales inducements
amortization and a $27 million increase in affiliated reinsurance-related
expenses. In addition, we experienced favorable mortality in our life, pension
and structured settlement businesses, which improved operating earnings by $3
million, while certain insurance-related liabilities and reserve refinements
decreased operating earnings by $7 million.
The Company also benefited from a higher income tax benefit in the first half of
2012 of $13 million over the prior period, as a result of a higher utilization
of tax-preferenced investments which provided tax credits and deductions.
Adoption of New Accounting Pronouncements
See Note 1 of the Notes to the Interim Condensed Consolidated Financial
Statements.
Future Adoption of New Accounting Pronouncements
See Note 1 of the Notes to the Interim Condensed Consolidated Financial
Statements.
