Life insurers were supposed to win big from the US election result in November. So investors were taken off guard when MetLife, the largest US life insurer by assets, this month unveiled its biggest quarterly loss in at least a decade.
Donald Trump’s victory and the prospect of reflationary economic policies sent long-term interest rates sharply higher — offering relief to insurers, whose profits have been hurt by ultra-low bond yields.
But instead of bolstering MetLife’s earnings, the swings in financial markets forced the company to book a $3.2bn hit in its derivatives portfolio and pushed it to a $2.1bn net loss for the fourth quarter.
John Hele, chief financial officer, sought to reassure investors that accounting “noise” was largely to blame.
“Rising interest rates remain favourable for MetLife over the longer term,” he said. The results nevertheless knocked $3.1bn off the group’s market capitalisation.
MetLife was not the only US life insurer whose earnings were hurt by the post-election market movements.
Prudential Financial, the second biggest, took a $1.28bn hit, largely related to an opaque charge in its annuities business that several analysts said had little or no real bearing on the business. It pushed net income down from $740m a year ago to $293m.
The red ink throws into sharp relief problems with accounting in the sector. Fund managers, analysts and executives complain financial results are often not very meaningful — especially as measured by the standard US framework, generally accepted accounting principles.
“A lot depends on assumptions — such as how long people are going to live, and the return on the assets,” said Chris Davis, chairman of Davis Advisors, an investment management house with more than $25bn in assets under management.
“A lot of investors don’t want to do the work to understand insurance accounting, especially in life.”
Rick Sojkowski, insurance partner at Deloitte & Touche, said: “There’s some level of apprehension about investing in the industry, given the models and complexity of understanding the accounting.”
To be sure, MetLife’s loss, which was much bigger than anything it booked during the financial crisis, cannot be dismissed entirely as an accounting eccentricity. The difficulty for investors is working out how much of it reflects reality.
The $3.2bn charge arose because the insurer has made extensive use of derivatives to minimise the pain caused by depressed bond yields.
These hedging positions have protected MetLife’s profits in the post-crisis era of easy money and generate about $200m of pre-tax income per quarter, according to Wells Fargo Securities. As yields rise, however, the derivatives produce less income.
Mr Hele told investors that even if interest rates were to increase 1 percentage point, which should boost insurers’ bottom lines by increasing the income they get from their investments, MetLife’s operating profits would be flat this year.
Earnings would not benefit from such a rate rise until 2018. For critics, that is a problem. The company is now reviewing its hedging strategy.
At the same time, there is no dispute that the accounting has made the phenomenon appear much bigger than it actually is.
Different accounting standards apply to insurers’ derivatives and their liabilities — the policies they have written, such as life insurance and annuities.
Derivatives are marked to market, meaning the values booked on insurers’ balance sheets can swing from quarter to quarter.
In contrast, liabilities appear on the books to be a lot more static. In accounting for liabilities, insurers are required to lock in assumptions that were made when the contracts were written, on a range of variables ranging from death rates to interest rates.
The discrepancy means that when interest rates rise, the costs to insurers — lower derivative values — show up in GAAP net income, but the benefits do not. In reality, insurers benefit from rising interest rates, but the accounts may not reflect it.
Such is the indifference on Wall Street about the value of insurers’ GAAP net income that few sellside analysts normally pay much attention to it.
For MetLife, only one broker provided estimates for the metric to Bloomberg for the quarter. The analyst had pencilled in a profit of $1.38bn — a forecast that turned out to be wildly inaccurate.
In contrast, 10 sellside brokers gave figures for “adjusted” fourth quarter net income, which strips out several accounting items.
“There’s so many things that cause swings and in some cases they are not representative of the real earnings power of the company,” said Ryan Krueger, analyst at Keefe, Bruyette & Woods.
Still, Erik Bass, partner at Autonomous Research, said: “This past quarter, below-the-line noise has re-emerged as a concern for some insurance investors.”
Reforms are on the cards that could make GAAP figures more meaningful. The Financial Accounting Standards Board put forward proposals in September that would revamp accounting practices in the sector.
Under the mooted changes, the assumptions that underpin the value of the insurance liabilities would need to be tracked in the accounts on a more regular basis.
Big questions remain about how that would work in practice, however — particularly how the assumptions should be calculated.
The danger, said Robert Falzon, Prudential Financial’s chief financial officer, is that the proposals could end up replacing “one level of noise for another”.
“The concept makes a lot of sense,” Mr Hele of MetLife added. “The devil’s in the details.”
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