The Many Merits of MetLife

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From Standard & Poor's Equity Research

The reinsurance segment consists of the life-insurance business of Reinsurance Group of America (RGA). As of December 31, 2006, MetLife's ownership stake in RGA was 53%.

Current Trends

The current insurance industry is characterized by consolidation, a low interest environment, and the trend toward retirement-oriented financial products and away from income-protection financial products. According to the American Council of Life Insurers, 1,119 life insurers participate in the industry in the U.S. This staggering number leads us to believe that there's excess capacity.

Furthermore, we believe that only companies that generate earnings from diversified sources will be able to sustain their future growth and profitability. We see a trend of companies buying components of other companies to either strengthen weak areas or to increase scale, as illustrated by MetLife's recent acquisition of Citigroup's international insurance businesses, which greatly enlarged its own international-business segment.

The relatively flat yield curve and low interest rate environment has caused some insurance companies to experience spread compression—when the difference between the yields on assets backing liabilities and the crediting rates on liabilities narrows. With a low or declining interest-rate environment, insurance companies run the risk of reinvesting proceeds from investments that have matured or have been prepaid at lower yields, reducing financial margins. Spread compression affects MetLife's group life and retirement & savings businesses and, to a lesser extent, its annuity business. The company has employed various hedging strategies to mitigate the effect of spread compression on its balance sheet.

The overall aging of the population is turning insurers' attention gradually away from income-protection financial products and toward retirement-oriented financial products. Increasing longevity is also having an influence on insurers, as longer lives bolster the need for greater retirement wealth. For more traditional life insurance products, increasing longevity has helped reduce mortality rates, which can aid insurer profitability in these product lines.

By our analysis, the company is poised to benefit from changing demographics, with aging baby boomers seeking retirement-oriented financial products. MetLife offers a wide range of group, and retirement & savings products and services to corporations and other institutions. We believe the company has a significant competitive advantage in this area, as it's a market leader in its offerings of a broad range of retirement-oriented financial products. In addition, unlike many other insurance companies, we think MetLife possesses a strong brand name, which the company can leverage to gain market share.

Pros and Cons

MetLife's expansion into international markets should significantly contribute to its future profitability growth. In 2006, 5.7% of the company's earnings were derived from its international business, and we believe this percentage will increase significantly as it establishes meaningful positions in growing markets that can provide attractive margins. We see MetLife focusing on building relationships, investing in growth, and upgrading systems. We also believe the company will further expand its international operations by starting and acquiring new businesses.

Since the company switched from a mutual to a stock structure in April, 2000, its price-to-book ratio (excluding other comprehensive income) has ranged from 1 times to 1.6 times. At recent price levels, the stock is trading at about 1.6 times book value (excluding other comprehensive income). Our 12-month target price of $82 is based on 1.9 times our 2007 book value estimate (excluding other comprehensive income).

We believe this multiple expansion is warranted, based on our view of the company's attractive business mix, excess capital, and exposure to high-growth areas, such as retirement-oriented financial products and international markets. Our target price also reflects a price-to-earnings multiple of 14.5 times our 2007 operating EPS of $5.64, which is in line with the company's historical multiples.

We believe MetLife's corporate-governance polices are generally sound, but that there's room for improvement. Positive factors, in our view, are that the board is controlled by a substantial majority (at least 90%) of independent outsiders, and both the nominating and the compensation committees are comprised solely of independent outside directors. In addition, the performance of the board is reviewed regularly, and outside directors meet periodically without the CEO present. Also, there's no dual-class structure in place and all stock-based incentive plans have been approved by shareholders.

However, we view a number of the corporate-governance policies unfavorably. The board of directors is classified, and shareholders don't have cumulative voting rights in director elections. The positions of chairman and CEO are combined, and the board has the authorization to change its size without shareholder approval. Furthermore, the company has a poison pill in place, and the board may amend the bylaws without shareholder approval.

Risks to our recommendation and target price include equity-market risk; credit and interest-rate risk; exposure to asbestos-related liability claims; emerging-market operations; investigations by attorneys general and insurance regulators into insurance broker relationships; and competition for large group insurance policies.

Shafi is an analyst for Standard & Poor's Equity Research Services.