SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______________ TO __________________ COMMISSION FILE NUMBER: 001-15787 METLIFE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 13-4075851 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) ONE MADISON AVENUE NEW YORK, NEW YORK 10010-3690 (212) 578-2211 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE, AND REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] At November 9, 2001, 724,773,897 shares of the Registrant's Common Stock, $.01 par value per share, were outstanding.
TABLE OF CONTENTS <TABLE> <CAPTION> PAGE <S> <C> PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Interim Condensed Consolidated Balance Sheets at September 30, 2001 (Unaudited) and December 31, 2000 3 Unaudited Interim Condensed Consolidated Statements of Income for the three months and nine months ended September 30, 2001 and 2000 4 Unaudited Interim Condensed Consolidated Statement of Stockholders' Equity for the nine months ended September 30, 2001 5 Unaudited Interim Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and 2000 6 Notes to Unaudited Interim Condensed Consolidated Financial Statements 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 22 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 63 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 63 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 64 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 65 </TABLE> NOTE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains statements which constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements relating to trends in operations and financial results and the business and the products of the Registrant and its subsidiaries, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "intend" and other similar expressions. "MetLife" or the "Company" refers to MetLife, Inc., a Delaware corporation (the "Holding Company"), and its subsidiaries, including Metropolitan Life Insurance Company ("Metropolitan Life"). Forward-looking statements are made based upon management's current expectations and beliefs concerning future developments and their potential effects on the Company. Such forward-looking statements are not guarantees of future performance. Actual results may differ materially from those included in the forward-looking statements as a result of risks and uncertainties including, but not limited to the following: (i) changes in general economic conditions, including the performance of financial markets and interest rates; (ii) heightened competition, including with respect to pricing, entry of new competitors and the development of new products by new and existing competitors; (iii) unanticipated changes in industry trends; (iv) the Company's primary reliance, as a holding company, on dividends from its subsidiaries to meet debt payment obligations and the applicable regulatory restrictions on the ability of the subsidiaries to pay such dividends; (v) deterioration in the experience of the "closed block" established in connection with the reorganization of Metropolitan Life; (vi) catastrophe losses; (vii) adverse litigation or arbitration results; (viii) regulatory, accounting or tax changes that may affect the cost of, or demand for, the Company's products or services; (ix) downgrades in the Company's and its affiliates' claims paying ability or financial strength ratings; (x) changes in rating agency policies or practices; (xi) discrepancies between actual claims experience and assumptions used in setting prices for the Company's products and establishing the liabilities for the Company's obligations for future policy benefits and claims; (xii) the effects of business disruption or economic contraction due to terrorism or other hostilities; and (xiii) other risks and uncertainties described from time to time in the Company's filings with the Securities and Exchange Commission, including its S-1 and S-3 registration statements. The Company specifically disclaims any obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise. 2
PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS METLIFE, INC. INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2001 (UNAUDITED) AND DECEMBER 31, 2000 (DOLLARS IN MILLIONS) <TABLE> <CAPTION> 2001 2000 --------- --------- <S> <C> <C> ASSETS Investments: Fixed maturities available-for-sale, at fair value $ 117,145 $ 112,979 Equity securities, at fair value 3,036 2,193 Mortgage loans on real estate 22,920 21,951 Real estate and real estate joint ventures 5,476 5,504 Policy loans 8,163 8,158 Other limited partnership interests 1,625 1,652 Short-term investments 1,012 1,269 Other invested assets 3,250 2,821 --------- --------- Total investments 162,627 156,527 Cash and cash equivalents 4,445 3,434 Accrued investment income 2,106 2,050 Premiums and other receivables 8,063 8,343 Deferred policy acquisition costs 10,724 10,618 Other assets 4,310 3,796 Separate account assets 59,620 70,250 --------- --------- Total assets $ 251,895 $ 255,018 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Future policy benefits $ 83,650 $ 81,974 Policyholder account balances 57,199 54,309 Other policyholder funds 5,700 5,705 Policyholder dividends payable 1,219 1,082 Policyholder dividend obligation 973 385 Short-term debt 701 1,094 Long-term debt 2,352 2,426 Current income taxes payable 256 112 Deferred income taxes payable 1,688 752 Payables under securities loaned transactions 13,123 12,301 Other liabilities 7,390 7,149 Separate account liabilities 59,620 70,250 --------- --------- Total liabilities 233,871 237,539 --------- --------- Commitments and contingencies (Note 7) Company-obligated mandatorily redeemable securities of subsidiary trusts 1,096 1,090 --------- --------- Stockholders' Equity: Preferred stock, par value $0.01 per share; 200,000,000 shares authorized; none issued -- -- Series A junior participating preferred stock -- -- Common stock, par value $0.01 per share; 3,000,000,000 shares authorized; 786,766,664 shares issued at September 30, 2001 and December 31, 2000; 725,854,654 shares outstanding at September 30, 2001 and 760,681,913 shares outstanding at December 31, 2000 8 8 Additional paid-in capital 14,926 14,926 Retained earnings 1,790 1,021 Treasury stock, at cost; 60,912,010 shares at September 30, 2001 and 26,084,751 shares at December 31, 2000 (1,630) (613) Accumulated other comprehensive income 1,834 1,047 --------- --------- Total stockholders' equity 16,928 16,389 --------- --------- Total liabilities and stockholders' equity $ 251,895 $ 255,018 ========= ========= </TABLE> SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 3
METLIFE, INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) <TABLE> <CAPTION> THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- --------------------- 2001 2000 2001 2000 -------- -------- -------- -------- <S> <C> <C> <C> <C> REVENUES Premiums $ 4,282 $ 3,969 $ 12,634 $ 11,946 Universal life and investment-type product policy fees 466 450 1,413 1,367 Net investment income 2,975 2,945 8,955 8,653 Other revenues 346 581 1,130 1,762 Net investment losses (net of amounts allocable to other accounts of $28, $25, $107 and $42, respectively) (99) (273) (380) (440) -------- -------- -------- -------- Total revenues 7,970 7,672 23,752 23,288 -------- -------- -------- -------- EXPENSES Policyholder benefits and claims (excludes amounts directly related to net investment losses of $29, $23, $92 and $24, respectively) 4,723 4,133 13,447 12,414 Interest credited to policyholder account balances 745 754 2,228 2,175 Policyholder dividends 547 457 1,567 1,438 Payments to former Canadian policyholders -- -- -- 327 Demutualization costs -- -- -- 230 Other expenses (excludes amounts directly related to net investment losses of $(1), $2, $15 and $18, respectively) 1,716 2,016 5,351 5,955 -------- -------- -------- -------- Total expenses 7,731 7,360 22,593 22,539 -------- -------- -------- -------- Income before provision for income taxes 239 312 1,159 749 Provision for income taxes 77 71 390 387 -------- -------- -------- -------- Net income $ 162 $ 241 $ 769 $ 362 ======== ======== ======== ======== Net income after date of demutualization $ 241 $ 582 ======== ======== Net income per share Basic $ 0.22 $ 0.31 $ 1.03 $ 0.75 ======== ======== ======== ======== Diluted $ 0.21 $ 0.31 $ 0.99 $ 0.74 ======== ======== ======== ======== </TABLE> SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 4
METLIFE, INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 (DOLLARS IN MILLIONS) <TABLE> <CAPTION> ACCUMULATED OTHER COMPREHENSIVE INCOME -------------------------------------- NET UNREALIZED FOREIGN MINIMUM ADDITIONAL TREASURY INVESTMENT CURRENCY PENSION COMMON PAID-IN RETAINED STOCK AND DERIVATIVE TRANSLATION LIABILITY STOCK CAPITAL EARNINGS AT COST GAINS ADJUSTMENT ADJUSTMENT TOTAL ------ ---------- -------- ------- -------------- ----------- ---------- ------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Balance at January 1, 2001 $ 8 $ 14,926 $ 1,021 $ (613) $ 1,175 $ (100) $ (28) $16,389 Net treasury stock acquired (1,017) (1,017) Comprehensive income: Net income 769 769 Other comprehensive income: Cumulative effect of change in accounting for derivatives, net of income taxes 32 32 Unrealized investment gains, net of related offsets, reclassification adjustments and income taxes 788 788 Unrealized gains on derivative instruments, net of income taxes 34 34 Foreign currency translation adjustments (67) (67) ------- Other comprehensive income 787 ------- Comprehensive income 1,556 ------ ---------- -------- ------- --------- ------ -------- ------- Balance at September 30, 2001 $ 8 $ 14,926 $ 1,790 $(1,630) $ 2,029 $ (167) $ (28) $16,928 ====== ========== ======== ======= ========= ====== ======== ======= </TABLE> SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 5
METLIFE, INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (DOLLARS IN MILLIONS) <TABLE> <CAPTION> 2001 2000 -------- -------- <S> <C> <C> NET CASH PROVIDED BY OPERATING ACTIVITIES $ 3,315 $ 889 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Sales, maturities and repayments of: Fixed maturities 41,216 33,205 Equity securities 493 490 Mortgage loans on real estate 1,433 1,614 Real estate and real estate joint ventures 206 434 Other limited partnership interests 334 366 Purchases of: Fixed maturities (42,827) (38,766) Equity securities (1,449) (557) Mortgage loans on real estate (2,433) (1,862) Real estate and real estate joint ventures (294) (337) Other limited partnership interests (363) (539) Net change in short-term investments 252 1,229 Net change in policy loans (5) (211) Purchase of businesses, net of cash received (16) (416) Proceeds from sales of business 81 121 Net change in payables under securities loaned transactions 822 4,716 Other, net (378) (623) -------- -------- Net cash used in investing activities (2,928) (1,136) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Policyholder account balances: Deposits 21,782 17,732 Withdrawals (19,674) (17,764) Net change in short-term debt (393) (2,379) Long-term debt issued 105 204 Long-term debt repaid (179) (31) Common stock issued -- 4,009 Net proceeds from issuance of company-obligated mandatorily redeemable securities of subsidiary trusts -- 969 Net treasury stock acquired (1,017) (407) Cash payments for eligible policyholders -- (2,550) -------- -------- Net cash provided by (used in) financing activities 624 (217) -------- -------- Change in cash and cash equivalents 1,011 (464) Cash and cash equivalents, beginning of period 3,434 2,789 -------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,445 $ 2,325 ======== ======== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 257 $ 304 ======== ======== Income taxes $ 183 $ 279 ======== ======== Non-cash transactions during the period: Policy credits to eligible policyholders $ -- $ 408 ======== ======== Business acquisitions - assets $ 90 $ 23,729 ======== ======== Business acquisitions - liabilities $ 76 $ 22,482 ======== ======== Business dispositions - assets $ 102 $ 12 ======== ======== Business dispositions - liabilities $ 44 $ 39 ======== ======== Real estate acquired in satisfaction of debt $ 13 $ 17 ======== ======== </TABLE> SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 6
METLIFE, INC. NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS MetLife, Inc. (the "Holding Company") and its subsidiaries (together with the Holding Company, "MetLife" or the "Company") is a leading provider of insurance and financial services to a broad section of individual and institutional customers. The Company offers life insurance, annuities and mutual funds to individuals and group insurance, reinsurance and retirement and savings products and services to corporations and other institutions. BASIS OF PRESENTATION The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The most significant estimates include those used in determining deferred policy acquisition costs, investment allowances, liability for litigation matters and liability for future policyholder benefits. Actual results could differ from those estimates. The accompanying unaudited interim condensed consolidated financial statements include the accounts of the Holding Company and its subsidiaries, partnerships and joint ventures in which the Company has a majority voting interest or general partner interest with limited removal rights by limited partners. Closed block assets, liabilities, revenues and expenses are combined on a line by line basis with the assets, liabilities, revenues and expenses outside the closed block based on the nature of the particular item. Intercompany accounts and transactions have been eliminated. The Company uses the equity method to account for its investments in real estate joint ventures and other limited partnership interests in which it does not have a controlling interest, but has more than a minimal interest. Minority interest related to consolidated entities included in other liabilities is $375 million and $409 million at September 30, 2001 and December 31, 2000, respectively. Certain amounts in the prior years' unaudited interim condensed consolidated financial statements have been reclassified to conform with the 2001 presentation. The accompanying unaudited interim condensed consolidated financial statements reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the consolidated financial position of the Company and its consolidated results of operations and cash flows for the periods presented. Interim results are not necessarily indicative of full year performance. These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company for the year ended December 31, 2000 included in MetLife, Inc.'s 2000 Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC"). DEMUTUALIZATION AND INITIAL PUBLIC OFFERING On April 7, 2000 (the "date of demutualization"), Metropolitan Life Insurance Company ("Metropolitan Life") converted from a mutual life insurance company to a stock life insurance company and became a wholly-owned subsidiary of MetLife, Inc. The conversion was pursuant to an order by the New York Superintendent of Insurance ("Superintendent") approving Metropolitan Life's plan of reorganization, as amended (the "plan"). On the date of demutualization, policyholders' membership interests in Metropolitan Life were extinguished and eligible policyholders received, in exchange for their interests, trust interests representing 494,466,664 shares of common stock of MetLife, Inc. to be held in a trust, cash payments aggregating $2,550 million and adjustments to their policy values in the form of policy credits aggregating $408 million, as provided in the plan. In addition, Metropolitan Life's Canadian branch made cash payments of $327 million in the second quarter of 2000 to holders of certain policies transferred to Clarica Life Insurance Company in connection with the sale of a substantial portion of Metropolitan Life's Canadian operations in 1998, as a result of a commitment made in connection with obtaining Canadian regulatory approval of that sale. 7
FEDERAL INCOME TAXES Federal income taxes for interim periods have been computed using an estimated annual effective tax rate. This rate is revised, if necessary, at the end of each successive interim period to reflect the current estimate of the annual effective tax rate. The income tax provision for 2000 includes amounts for surplus tax applicable to mutual life insurance companies. APPLICATION OF ACCOUNTING PRONOUNCEMENTS Effective December 31, 2000, the Company early adopted Statement of Position ("SOP") 00-3, Accounting by Insurance Enterprises for Demutualizations and Formations of Mutual Insurance Holding Companies and for Certain Long-Duration Participating Contracts ("SOP 00-3"). SOP 00-3 provides guidance on accounting by insurance enterprises for demutualizations and the formation of mutual insurance holding companies, including the emergence of earnings from and the financial statement presentation of the closed block formed as a part of a demutualization. As a result of SOP 00-3, the assets, liabilities, revenues and expenses of the closed block were combined with those outside the closed block. The adoption of SOP 00-3 had no material impact on the Company's consolidated financial statements, other than the reclassification of demutualization costs as operating expenses rather than as an extraordinary item. Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment to FASB Statement No. 133 ("SFAS 138"). SFAS 133 and SFAS 138 established new accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The cumulative effect of the adoption of SFAS 133 and SFAS 138, as of January 1, 2001, resulted in a $32 million increase in other comprehensive income, net of income taxes of $19 million, and had no material impact on net income. The increase to other comprehensive income is attributable to net gains on cash flow-type hedges at transition. Also at transition, the amortized cost of fixed income securities decreased and other invested assets increased by $33 million, representing the fair value of certain interest rate swaps that were accounted for prior to SFAS No. 133 using fair value-type settlement accounting. Approximately $18 million of the pre-tax gain reported in accumulated other comprehensive income at transition is expected to be reclassified into net income during the twelve months ending December 31, 2001 as the underlying investments mature or expire according to their original terms. The Financial Accounting Standards Board ("FASB") continues to issue additional guidance relating to the accounting for derivatives under SFAS 133 and SFAS 138. Until this accounting guidance is finalized, the Company cannot determine the ultimate impact it may have on the Company's consolidated financial statements. Effective April 1, 2001, the Company adopted certain additional accounting and reporting requirements of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities -- a replacement of FASB Statement No. 125, relating to the derecognition of transferred assets and extinguished liabilities and the reporting of servicing assets and liabilities. The adoption of these requirements had no material impact on the Company's unaudited interim condensed consolidated financial statements. Effective April 1, 2001, the Company adopted Emerging Issues Task Force Issue No. 99-20, Recognition of Interest Income and Impairment on Certain Investments ("EITF 99-20"). This pronouncement requires investors in certain asset-backed securities to record changes in their estimated yield on a prospective basis and to apply specific evaluation methods to these securities for an other-than-temporary decline in value. The adoption of EITF 99-20 had no material impact on the Company's unaudited interim condensed consolidated financial statements. In June 2001, the FASB issued SFAS No. 141, Business Combinations ("SFAS 141"), and SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS No. 141, which was generally effective July 1, 2001, requires the purchase method of accounting for all business combinations and separate recognition of intangible assets apart from goodwill if such intangible assets meet certain criteria. SFAS No. 142, effective for fiscal years beginning after December 15, 2001, eliminates the systematic amortization and establishes criteria for measuring the impairment of goodwill and certain other intangible assets. Amortization of goodwill and other intangible assets was $12 million and $25 million for the three months ended September 30, 2001 and 2000, respectively, and $37 million and $73 million for the nine months ended September 30, 2001 and 2000, respectively. These amounts are not necessarily indicative of the amortization that will not be recorded in future periods in accordance with SFAS 142. The Company has not yet determined the effect, if any, on its consolidated financial statements of applying the new impairment guidance to goodwill and intangible assets that will be required upon adoption of SFAS 142. 8
In July 2001, the SEC released Staff Accounting Bulletin No. 102, Selected Loan Loss Allowance and Documentation Issues ("SAB 102"). SAB 102 summarizes certain of the SEC's views on the development, documentation and application of a systematic methodology for determining allowances for loan and lease losses. The application of SAB 102 by the Company did not have a material impact on the Company's unaudited interim condensed consolidated financial statements. In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"). SFAS 144 provides a single model for accounting for long-lived assets to be disposed of by superceding SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of ("SFAS 121"), and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions ("APB 30"). Under SFAS 144, discontinued operations are measured at the lower of carrying value or fair value less costs to sell rather than on a net realizable value basis. Future operating losses relating to discontinued operations are also no longer recognized before they occur. SFAS 144 broadens the definition of a discontinued operation to include a component of an entity (rather than a segment of a business). SFAS 144 also requires long-lived assets to be disposed of other than by sale to be considered held and used until disposed. SFAS 144 retains the basic provisions of (i) APB 30 regarding the presentation of discontinued operations in the statements of income, (ii) SFAS 121 relating to recognition and measurement of impaired long-lived assets (other than goodwill) and (iii) SFAS 121 relating to the measurement of long-lived assets classified as held for sale. SFAS 144 must be adopted beginning January 1, 2002. The adoption of SFAS 144 by the Company is not expected to have a material impact on the Company's consolidated financial statements. 2. SEPTEMBER 11, 2001 TRAGEDIES On September 11, 2001 a terrorist attack occurred in New York, Washington D.C. and Pennsylvania (collectively, the "tragedies") triggering a significant loss of life and property which may have a continuing adverse impact on certain of the Company's businesses. The Company has direct exposures to these tragedies with claims arising from its Individual, Institutional, Reinsurance and Auto & Home insurance coverages. As of September 30, 2001, the Company estimated the total after-tax insurance losses related to the tragedies to be $208 million. This estimate is subject to revision in subsequent periods as claims are received from insureds and claims to reinsurers are processed. Any subsequent revisions will be reported in operations in the period of revision. However, reinsurance recoveries are dependent on the continued creditworthiness of the reinsurers, which may be adversely affected by their other reinsured losses. The long-term effects of the tragedies on the Company's businesses cannot be assessed at this time. The tragedies have had significant adverse effects on the general economic, market and political conditions, increasing many of the Company's business risks. In particular, the declines in share prices experienced after the tragedies have contributed, and may continue to contribute, to a decline in separate account assets, which in turn could have an adverse effect on fees earned in the Company's businesses. In addition, the Institutional segment may receive disability claims from individuals suffering from mental and nervous disorders resulting from the tragedies. This may lead to a revision in the Company's estimated insurance losses related to the tragedies. The general account investment portfolios include investments, primarily composed of fixed maturity securities, in industries the Company believes may be adversely affected by the tragedies, including airline, other travel and lodging, and insurance. The effect of the tragedies on the valuation of these investments is uncertain and could lead to increased impairments. 9
3. CLOSED BLOCK On the date of demutualization, Metropolitan Life established a closed block for the benefit of holders of certain individual life insurance policies of Metropolitan Life. Closed block liabilities and assets designated to the closed block are as follows: <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------- ------------ (DOLLARS IN MILLIONS) <S> <C> <C> CLOSED BLOCK LIABILITIES Future policy benefits $ 39,949 $ 39,415 Other policyholder funds 313 278 Policyholder dividends payable 824 740 Policyholder dividend obligation 973 385 Payables under securities loaned transactions 3,453 3,268 Other 174 78 -------- -------- Total closed block liabilities 45,686 44,164 -------- -------- ASSETS DESIGNATED TO THE CLOSED BLOCK Investments: Fixed maturities available-for-sale, at fair value (amortized cost: $25,898 and $25,657, respectively) 26,712 25,634 Equity securities, at fair value (amortized cost: $50 and $52, respectively) 54 54 Mortgage loans on real estate 6,189 5,801 Policy loans 3,885 3,826 Short-term investments 104 223 Other invested assets 139 248 -------- -------- Total investments 37,083 35,786 Cash and cash equivalents 1,293 661 Accrued investment income 576 557 Deferred income taxes 1,126 1,234 Premiums and other receivables 122 158 -------- -------- Total assets designated to the closed block 40,200 38,396 -------- -------- Excess of closed block liabilities over assets designated to to the closed block 5,486 5,768 -------- -------- Amounts included in accumulated other comprehensive loss: Net unrealized investment gains (losses), net of deferred income tax expense (benefit) of $286 and $(9), respectively 527 (14) Unrealized derivative gains, net of deferred income tax of $11 20 -- Allocated to policyholder dividend obligation, net of deferred income tax of $343 and $143, respectively (630) (242) -------- -------- (83) (256) -------- -------- Maximum future earnings to be recognized from closed block assets and liabilities $ 5,403 $ 5,512 ======== ======== </TABLE> Information regarding the policyholder dividend obligation is as follows: <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------ ----------- (DOLLARS IN MILLIONS) <S> <C> <C> Balance at beginning of period (1) $ 385 $ -- Impact on net income before losses allocable to policyholder dividend obligation 92 85 Net investment losses (92) (85) Change in unrealized investment and derivative gains 588 385 ----- ----- Balance at end of period $ 973 $ 385 ===== ===== </TABLE> - ---------------------- (1) For the period ended at December 31, 2000, the beginning of the period is April 7, 2000. See Note 1 "Summary of Significant Accounting Policies -- Demutualization and Initial Public Offering." 10
Closed block revenues and expenses are as follows: <TABLE> <CAPTION> FOR THE PERIOD FOR THE THREE FOR THE THREE FOR THE NINE APRIL 7, 2000 MONTHS ENDED MONTHS ENDED MONTHS ENDED THROUGH SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2001 2000 2001 2000 ------------- ------------- ------------ -------------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> REVENUES Premiums $ 863 $ 893 $ 2,638 $ 1,829 Net investment income 692 622 2,021 1,248 Net investment losses (net of amounts allocable to the policyholder dividend obligation of $29, $28, $92 and $21, respectively) (9) 4 (53) (16) ------- ------- ------- ------- Total revenues 1,546 1,519 4,606 3,061 ------- ------- ------- ------- EXPENSES Policyholder benefits and claims 939 913 2,784 1,831 Policyholder dividends 384 369 1,150 745 Change in policyholder dividend obligation (excludes -- amounts directly related to net investment losses of $29, $28, $92 and $21, respectively) 29 16 92 43 Other expenses 117 129 409 272 ------- ------- ------- ------- Total expenses 1,469 1,427 4,435 2,891 ------- ------- ------- ------- Revenues net of expenses before income taxes 77 92 171 170 Income taxes 27 33 62 62 ------- ------- ------- ------- Revenues net of expenses and income taxes $ 50 $ 59 $ 109 $ 108 ======= ======= ======= ======= </TABLE> The change in maximum future earnings of the closed block is as follows: <TABLE> <CAPTION> FOR THE PERIOD FOR THE THREE FOR THE THREE FOR THE NINE APRIL 7, 2000 MONTHS ENDED MONTHS ENDED MONTHS ENDED THROUGH SEPTEMBER 30, 2001 SEPTEMBER 30, 2000 SEPTEMBER 30, 2001 SEPTEMBER 30, 2000 ------------------ ------------------ ------------------ ------------------ <S> <C> <C> <C> <C> (DOLLARS IN MILLIONS) Beginning of period $ 5,453 $ 5,579 $ 5,512 $ 5,628 End of period 5,403 5,520 5,403 5,520 -------- -------- -------- -------- Change during the period $ (50) $ (59) $ (109) $ (108) ======== ======== ======== ======== </TABLE> Many of the derivative instrument strategies used by the Company are also used for the closed block. The cumulative effect of the adoption of SFAS 133 and SFAS 138, as of January 1, 2001, resulted in $11 million of other comprehensive income, net of income taxes of $6 million, and an immaterial amount of revenue for the closed block. For the three months and nine months ended September 30, 2001, the closed block recognized net investment losses of $4 million and net investment gains of $5 million, respectively, primarily relating to non-speculative derivative uses that are permitted by the New York Insurance Department but that have not met the requirements of SFAS 133 to qualify for hedge accounting. Excluding the transition adjustment, the changes in other comprehensive income for the three months and nine months ended September 30, 2001 were immaterial. 11
4. EARNINGS AFTER DATE OF DEMUTUALIZATION AND EARNINGS PER SHARE Net income after the date of demutualization is based on the results of operations after March 31, 2000, adjusted for the payments to the former Canadian policyholders and costs of demutualization recorded in April 2000 which are applicable to the period prior to April 7, 2000. The following presents a reconciliation of the weighted average shares used in calculating basic earnings per share to those used in calculating diluted earnings per share. <TABLE> <CAPTION> NET PER SHARE INCOME SHARES AMOUNTS ------- ----------- ------------ (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) <S> <C> <C> <C> FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 Amounts for basic earnings per share $ 162 735,662,211 $ 0.22 ======= ============ Incremental shares from assumed conversion of forward purchase contracts 25,553,409 ----------- Amounts for diluted earnings per share $ 162 761,215,620 $ 0.21 ======= =========== ============ FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000 Amounts for basic earnings per share $ 241 773,302,147 $ 0.31 ------- ------------ Incremental shares from assumed conversion of forward purchase contracts 15,957,841 ----------- Amounts for diluted earnings per share $ 241 789,259,988 $ 0.31 ======= =========== ============ FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 Amounts for basic earnings per share $ 769 747,236,338 $ 1.03 ======= ============ Incremental shares from assumed: Conversion of forward purchase contracts 26,593,205 Exercise of stock options 93,614 ----------- Amounts for diluted earnings per share $ 769 773,923,156 $ 0.99 ======= =========== ============ FOR THE PERIOD APRIL 7, 2000 THROUGH SEPTEMBER 30, 2000 Amounts for basic earnings per share $ 582 775,860,641 $ 0.75 ------- ------------ Incremental shares from assumed conversion of forward purchase contracts 10,070,045 ----------- Amounts for diluted earnings per share $ 582 785,930,686 $ 0.74 ======= =========== ============ </TABLE> Earnings per share amounts, on a basic and diluted basis, have been calculated based on the weighted average common shares outstanding or deemed to be outstanding only for the period after the date of demutualization. On March 28, 2001, the Holding Company's Board of Directors authorized an additional $1 billion common stock repurchase program. This program began after the completion of an earlier $1 billion repurchase program that was announced on June 27, 2000. Under these authorizations, the Holding Company may purchase common stock from the Metropolitan Life Policyholder Trust, in the open market and in privately negotiated transactions. For the nine months ended September 30, 2001, 34,889,811 shares of common stock have been acquired for $1,019 million. During the same period, 64,620 of these shares were reissued for $2 million. 5. DERIVATIVE INSTRUMENTS The Company primarily uses derivative instruments to reduce the risk associated with variable cash flows related to the Company's financial assets and liabilities or to changing market values. This objective is achieved through one of two principal risk management strategies: hedging the variable cash flows of assets, liabilities or forecasted transactions or hedging the changes in fair value of 12
financial assets, liabilities or firm commitments. Hedged forecasted transactions, other than the receipt or payment of variable interest payments, are not expected to occur more than 12 months after hedge inception. On the date the Company enters into a derivative contract, management designates the derivative as a hedge of the identified exposure (fair value, cash flow or foreign currency). If a derivative does not qualify as a hedge, according to SFAS 133, the derivative is recorded at fair value and changes in its fair value are reported in net investment gains or losses. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. In this documentation, the Company specifically identifies the asset, liability, firm commitment, or forecasted transaction that has been designated as a hedged item and states how the hedging instrument is expected to hedge the risks related to the hedged item. The Company formally measures effectiveness of its hedging relationships both at the hedge inception and on an ongoing basis in accordance with its risk management policy. The Company generally determines hedge effectiveness based on total changes in fair value of a derivative instrument. The Company discontinues hedge accounting prospectively when: (i) it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item, (ii) the derivative expires or is sold, terminated, or exercised, (iii) the derivative is dedesignated as a hedge instrument, (iv) it is probable that the forecasted transaction will not occur, (v) a hedged firm commitment no longer meets the definition of a firm commitment, or (vi) management determines that designation of the derivative as a hedge instrument is no longer appropriate. The Company's derivative hedging strategy employs a variety of instruments, including financial futures, financial forwards, interest rate, credit and foreign currency swaps, foreign exchange contracts, and options, including caps and floors. The Company designates and accounts for the following as cash flow hedges, when they have met the effectiveness requirements of SFAS 133 and SFAS 138: (i) various types of interest rate swaps to convert floating rate investments to fixed rate investments, (ii) receive U.S. dollar fixed on foreign currency swaps to hedge the foreign currency cash flow exposure of foreign currency denominated investments, (iii) foreign currency forwards to hedge the exposure of future payments or receipts in foreign currencies, and (iv) other instruments to hedge the cash flows of various other anticipated transactions. For all qualifying and highly effective cash flow hedges, the effective portion of changes in fair value of the derivative instrument are reported in other comprehensive income or loss. The ineffective portion of changes in fair value of the derivative instrument is reported in net investment gains or losses. The Company designates and accounts for the following as fair value hedges when they have met the effectiveness requirements of SFAS 133 and SFAS 138: (i) various types of interest rate swaps to convert fixed rate investments to floating rate investments, (ii) receive US dollar floating on foreign currency swaps to hedge the foreign currency fair value exposure of foreign currency denominated investments, and (iii) other instruments to hedge various other fair value exposures of investments. For all qualifying and highly effective fair value hedges, the changes in fair value of the derivative instrument are reported as net investment gains or losses. In addition, changes in fair value attributable to the hedged portion of the underlying instrument are reported in net investment gains and losses. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, the derivative will continue to be carried on the balance sheet at its fair value, but the hedged asset or liability will no longer be adjusted for changes in fair value. When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the derivative will continue to be carried on the balance sheet at its fair value, and any asset or liability that was recorded pursuant to recognition of the firm commitment will be removed from the balance sheet and recognized as a net investment gain or loss in the current period. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in other comprehensive income or loss will be recognized immediately in net investment gains or losses. When the hedged forecasted transaction is no longer probable, but is reasonably possible, the accumulated gain or loss remains in other comprehensive income or loss and will be recognized when the transaction affects net income or loss; however, prospective hedge accounting for the transaction is terminated. In all other situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the consolidated balance sheet, with changes in its fair value recognized in current period net investment gains or losses. The Company may enter into contracts that are not themselves derivative instruments but contain embedded derivatives. For each contract, the Company assesses whether the economic characteristics of the embedded derivative are clearly and closely related to those of the host contract and determines whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When it is determined that the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and that a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract and accounted for as a stand-alone derivative. Such embedded derivatives are recorded on the consolidated balance sheet at fair value and changes in their 13
fair value are recorded currently in net investment gains or losses. If the Company is unable to properly identify and measure an embedded derivative for separation from its host contract, the entire contract is carried on the consolidated balance sheet at fair value. The Company also uses derivatives to synthetically create investments that are either more expensive or otherwise unavailable in the cash markets. These securities, called replication synthetic asset transactions ("RSATs"), are a combination of a derivative and a cash security to synthetically create a third replicated security. As of September 30, 2001, three such RSATs have been created through the combination of a credit default swap and a U.S. Treasury security. The notional amounts are insignificant. For the three months and nine months ended September 30, 2001, the Company recognized net investment gains of $30 million and $75 million, respectively, relating to derivatives. The amounts recognized relate primarily to non-speculative derivative uses that are permitted by the New York Insurance Department but that have not met the requirements of SFAS 133 to qualify for hedge accounting. The amounts relating to the ineffective portion of cash flow and fair value hedges were immaterial. The amounts relating to the effective portion of fair value hedges and the amounts relating to the changes in fair value attributable to the hedged portion of the underlying instruments were immaterial losses. For the three months and nine months ended September 30, 2001, the Company recognized other comprehensive income of $15 million and $53 million, respectively, relating to the effective portion of cash flow hedges. During the three months and nine months ended September 30, 2001, net unrealized investment gains of $10 million and $15 million, respectively, included in other comprehensive income related to hedged items were reclassified into net investment losses. 6. NET INVESTMENT LOSSES Net investment losses, including changes in valuation allowances, are as follows: <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- ---------------------- 2001 2000 2001 2000 ---- ---- ---- ---- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> Fixed maturities $ (87) $(349) $(427) $(593) Equity securities 5 25 30 104 Mortgage loans on real estate (44) (20) (49) (14) Real estate and real estate joint ventures (25) 30 (1) 57 Other limited partnership interests (32) 11 (130) 8 Sales of businesses 25 -- 25 3 Other 31 5 65 (47) ----- ----- ----- ----- (127) (298) (487) (482) Amounts allocable to: Deferred policy acquisition costs (1) 2 15 18 Participating contracts -- (5) -- 3 Policyholder dividend obligation 29 28 92 21 ----- ----- ----- ----- Total investment losses $ (99) $(273) $(380) $(440) ===== ===== ===== ===== </TABLE> Investment gains and losses have been reduced by (1) deferred policy acquisition cost amortization to the extent that such amortization results from investment gains and losses, (2) additions to participating contractholders' accounts when amounts equal to such investment gains and losses are credited to the contractholders' accounts, and (3) adjustments to the policyholder dividend obligation resulting from investment gains and losses. This presentation may not be comparable to presentations made by other insurers. 14
7. COMMITMENTS AND CONTINGENCIES Metropolitan Life is currently a defendant in approximately 515 lawsuits raising allegations of improper marketing and sales of individual life insurance policies or annuities. These lawsuits are generally referred to as "sales practices claims." On December 28, 1999, after a fairness hearing, the United States District Court for the Western District of Pennsylvania approved a class action settlement resolving a multidistrict litigation proceeding involving alleged sales practices claims. No appeal was taken, and the settlement is final. The settlement class includes most of the owners of permanent life insurance policies and annuity contracts or certificates issued pursuant to individual sales in the United States by Metropolitan Life, Metropolitan Insurance and Annuity Company or Metropolitan Tower Life Insurance Company between January 1, 1982 and December 31, 1997. The class includes owners of approximately six million in-force or terminated insurance policies and approximately one million in-force or terminated annuity contracts or certificates. In addition to dismissing the consolidated class actions, the District Court's order also bars sales practices claims by class members with respect to policies or annuities issued by the defendant insurers during the class period, effectively resolving all pending sales practices class actions against these insurers in the United States. Under the terms of the order, only those class members who excluded themselves from the settlement may continue an existing, or start a new, sales practices lawsuit against Metropolitan Life, Metropolitan Insurance and Annuity Company or Metropolitan Tower Life Insurance Company for policies or annuities issued during the class period. Approximately 20,000 class members elected to exclude themselves from the settlement. At September 30, 2001, approximately 350 lawsuits brought by "opt-outs" have been filed. Metropolitan Life expects that the total cost of the settlement will be approximately $957 million. This amount is equal to the amount of the increase in liabilities for the death benefits provided for in the class action settlement and policy adjustments and the present value of expected cash payments to be provided to included class members, as well as attorneys' fees and expenses and estimated other administrative costs, but does not include the cost of litigation with policyholders who are excluded from the settlement. The Company believes that the cost to it of the settlement will be substantially covered by available reinsurance and the provisions made in its unaudited interim condensed consolidated financial statements, and thus will not have a material adverse effect on its business, results of operations or financial position. Metropolitan Life has made some recoveries under those reinsurance agreements and, although there is no assurance that other reinsurance claim submissions will be paid, Metropolitan Life believes payment is likely to occur. The Company believes it has made adequate provision in its unaudited interim condensed consolidated financial statements for all probable losses for sales practices claims, including litigation costs involving policyholders who are excluded from the settlement, as well as for the two class action settlements described in the following two paragraphs. Separate from the Metropolitan Life class action settlement, similar sales practices class action litigation against New England Mutual Life Insurance Company ("New England Mutual"), with which Metropolitan Life merged in 1996, and General American Life Insurance Company ("General American"), which was acquired in 2000, has been settled. The New England Mutual case, a consolidated multidistrict litigation in the United States District Court for the District of Massachusetts, involves approximately 600,000 life insurance policies sold during the period January 1, 1983 through August 31, 1996. The settlement of this case was approved by the District Court in October 2000 and is not being appealed. Implementation of the class action settlement is proceeding. The Company expects that the total cost of this settlement will be approximately $160 million. Approximately 2,400 class members opted-out of the settlement. As of September 30, 2001, New England Mutual was a defendant in approximately 40 opt-out lawsuits involving sales practices claims. A Mississippi federal court dismissed on abstention grounds a declaratory judgment action filed by Metropolitan Life, as successor to New England Mutual. The lawsuit named as defendants Mississippi residents who opted out of the New England Mutual class action settlement. Metropolitan Life, as successor to New England Mutual, has sought leave to appeal the dismissal and intends to vigorously defend itself against these opt-out lawsuits. The settlement of the consolidated multidistrict sales practices class action case against General American was approved by the United States District Court for the Eastern District of Missouri. The General American case involves approximately 250,000 life insurance policies sold during the period January 1, 1982 through December 31, 1996. On appeal, the settlement was affirmed by the United States Court of Appeals for the Eighth Circuit in October 2001. The Company expects that the approximate cost of the settlement will be $55 million, not including legal fees and costs for plaintiffs' counsel. Implementation of the settlement is proceeding. The District Court recently awarded legal fees and costs of $12.1 million. Approximately 700 class members have elected to exclude themselves from the General American settlement. As of September 30, 2001, General American was a defendant in approximately 38 opt-out lawsuits involving sales practices claims. 15
The Metropolitan Life class action settlement did not resolve two putative class actions involving sales practices claims filed against Metropolitan Life in Canada. In October 2001, the United States District Court for the Southern District of New York approved the settlement of a class action alleging improper sales abroad that was brought against Metropolitan Life, Metropolitan Insurance and Annuity Company, Metropolitan Tower Life Insurance Company and various individual defendants. An appeal may be filed. The settlement is within amounts previously recorded by the Company. In the past, some individual sales practices claims have been resolved through settlement, won by dispositive motions, or, in a few instances, have gone to trial. Most of the current cases seek substantial damages, including in some cases punitive and treble damages and attorneys' fees. Additional litigation relating to the Company's marketing and sales of individual life insurance may be commenced in the future. The Company believes adequate provision has been made in its unaudited interim condensed consolidated financial statements for all reasonably probable and estimable losses for sales practices claims. See Note 10 of Notes to Consolidated Financial Statements for the year ended December 31, 2000 included in MetLife, Inc.'s Annual Report on Form 10-K filed with the SEC for information regarding reinsurance contracts related to sales practices claims. Regulatory authorities in a small number of states have had investigations or inquiries relating to Metropolitan Life's, New England Mutual's or General American's sales of individual life insurance policies or annuities. Over the past several years, these and a number of investigations by other regulatory authorities were resolved for monetary payments and certain other relief. The Company may continue to resolve investigations in a similar manner. Metropolitan Life is also a defendant in numerous lawsuits seeking compensatory and punitive damages for personal injuries allegedly caused by exposure to asbestos or asbestos-containing products. Metropolitan Life has never engaged in the business of manufacturing, producing, distributing or selling asbestos or asbestos-containing products. Rather, these lawsuits, currently numbering in the thousands, have principally been based upon allegations relating to certain research, publication and other activities of one or more of Metropolitan Life's employees during the period from the 1920's through approximately the 1950's and alleging that Metropolitan Life learned or should have learned of certain health risks posed by asbestos and, among other things, improperly publicized or failed to disclose those health risks. Legal theories asserted against Metropolitan Life have included negligence, intentional tort claims and conspiracy claims concerning the health risks associated with asbestos. While Metropolitan Life believes it has meritorious defenses to these claims, and has not suffered any adverse judgments in respect of these claims, most of the cases have been resolved by settlements. Metropolitan Life intends to continue to exercise its best judgment regarding settlement or defense of such cases, including when trials of these cases are appropriate. The number of such cases that may be brought or the aggregate amount of any liability that Metropolitan Life may ultimately incur is uncertain. Significant portions of amounts paid in settlement of such cases have been funded with proceeds from a previously resolved dispute with Metropolitan Life's primary, umbrella and first level excess liability insurance carriers. See Note 10 of Notes to Consolidated Financial Statements for the year ended December 31, 2000 included in MetLife, Inc.'s Annual Report on Form 10-K filed with the SEC for information regarding historical asbestos claims information and insurance policies obtained in 1998 related to asbestos-related claims. The Company believes adequate provision has been made in its unaudited interim condensed consolidated financial statements for all reasonably probable and estimable losses for asbestos-related claims. Estimates of the Company's asbestos exposure can be uncertain due to the limitations of available data and the difficulty of predicting with any certainty numerous variables that can affect liability estimates, including the number of future claims, the cost to resolve claims and the impact of any possible future adverse verdicts and their amounts. Recent bankruptcies of other companies involved in asbestos litigation, as well as advertising by plaintiffs' asbestos lawyers, may be resulting in an increase in the number of claims and the cost of resolving claims, as well as the number of trials and possible verdicts Metropolitan Life may experience. Plaintiffs are seeking additional funds from defendants, including Metropolitan Life, in light of such recent bankruptcies by certain other defendants. As reported in MetLife, Inc.'s Annual Report on Form 10-K, Metropolitan Life received approximately 54,500 asbestos-related claims in 2000. During the first nine months of 2001, Metropolitan Life received approximately 49,500 asbestos-related claims. Metropolitan Life is studying its recent claims experience and numerous variables that can affect its asbestos liability exposure, including the recent bankruptcies of other companies involved in asbestos litigation and legislative and judicial developments, to identify trends and to assess their impact on the previously recorded asbestos liability. It is reasonably possible that the Company's total exposure to asbestos claims may be greater than the liability recorded by the Company in its consolidated financial statements and that future charges to income may be necessary. While the potential future charges could be material in particular quarterly or annual periods in which they are recorded, based on information 16
currently known by management, it does not believe any such charges are likely to have a material adverse effect on the Company's consolidated financial position. A purported class action suit involving policyholders in four states has been filed in a Rhode Island state court against a Metropolitan Life subsidiary, Metropolitan Property and Casualty Insurance Company, with respect to claims by policyholders for the alleged diminished value of automobiles after accident-related repairs. The trial court denied a motion by Metropolitan Property and Casualty Insurance Company for summary judgment. In a more significant ruling, the trial court denied plaintiffs' motion for class certification. The plaintiffs recently dismissed the lawsuit with prejudice. Similar "diminished value" purported class action suits have been filed in Texas and Tennessee against Metropolitan Property and Casualty Insurance Company. A purported class action has been filed against Metropolitan Property and Casualty Insurance Company's subsidiary, Metropolitan Casualty Insurance Company, in Florida by a policyholder. The complaint alleges breach of contract and unfair trade practices with respect to allowing the use of parts not made by the original manufacturer to repair damaged automobiles. Discovery is ongoing and a motion for class certification is pending. A two-plaintiff individual lawsuit brought in federal court in Alabama alleged that Metropolitan Property and Casualty Insurance Company and CCC, a valuation company, violated state law and the Federal RICO statute by conspiring to fail to pay the proper amounts for a motor vehicle that sustained a total loss. Plaintiffs recently filed a voluntary dismissal of this claim. Plaintiffs also filed a new lawsuit alleging breach of contract and bad faith and did not assert a Federal RICO claim. A Pennsylvania state court purported class action lawsuit filed in August 2001 alleges that Metropolitan Property and Casualty Insurance Company improperly took depreciation on partial homeowner losses where the insured replaced the covered item. Preliminary objections have been filed and discovery has not yet commenced. Thirty-two other insurers in Pennsylvania also are defendants in similar actions. In addition, in Florida, Metropolitan Property and Casualty Insurance Company has been named in a class action alleging that it improperly established preferred provider organizations. Discovery has commenced. Metropolitan Property and Casualty Insurance Company and Metropolitan Casualty Insurance Company are vigorously defending themselves against these allegations. In 2000, Metropolitan Life completed a tender offer to purchase the shares of Conning Corporation that it had not already owned. After Metropolitan Life had announced its intention to make a tender offer, three putative class actions were filed by Conning shareholders alleging that the prospective offer was inadequate and constituted a breach of fiduciary duty. In September 2001, the Supreme Court, New York County approved a settlement of the actions. There will be no appeal. Several lawsuits were brought in 2000 challenging the fairness of Metropolitan Life's plan of reorganization and the adequacy and accuracy of Metropolitan Life's disclosure to policyholders regarding the plan. These actions name as defendants some or all of Metropolitan Life, the Holding Company, the individual directors, the New York Superintendent of Insurance and the underwriters for MetLife, Inc.'s initial public offering, Goldman Sachs & Company and Credit Suisse First Boston. Five purported class actions pending in the Supreme Court of the State of New York for New York County have been consolidated within the commercial part. Metropolitan Life has moved to dismiss these consolidated cases on a variety of grounds. In addition, there remains a separate purported class action in New York state court in New York County that Metropolitan Life also has moved to dismiss. Another purported class action in New York state court in Kings County has been voluntarily held in abeyance by plaintiffs. The plaintiffs in the state court class actions seek injunctive, declaratory and compensatory relief, as well as an accounting and, in some instances, punitive damages. Some of the plaintiffs in the above described actions also have brought a proceeding under Article 78 of New York's Civil Practice Law and Rules challenging the Opinion and Decision of the New York Superintendent of Insurance that approved the plan. In this proceeding, petitioners seek to vacate the Superintendent's Opinion and Decision and enjoin him from granting final approval of the plan. This case also is being held in abeyance by plaintiffs. Another purported class action is pending in the Supreme Court of the State of New York for New York County and has been brought on behalf of a purported class of beneficiaries of Metropolitan Life annuities purchased to fund structured settlements claiming that the class members should have received common stock or cash in connection with the demutualization. Metropolitan Life has moved to dismiss this case on a variety of grounds. Three purported class actions were filed in the United States District Court for the Eastern District of New York claiming violation of the Securities Act of 1933. The plaintiffs in these actions, which have been consolidated, claim that the Policyholder Information Booklets relating to the plan failed to disclose certain material facts and seek rescission and compensatory damages. Metropolitan Life's motion to dismiss these three cases was denied on July 23, 2001. A purported class action also was filed in the United States District Court for the Southern District of New York seeking damages from Metropolitan Life and the Holding Company for alleged violations of various provisions of the Constitution of the United States in connection with the plan of reorganization. On July 9, 2001, pursuant to a motion to dismiss filed by Metropolitan Life, this case was dismissed by the District Court. Plaintiffs have since noticed an appeal to the United States Court of Appeals for the Second Circuit. Metropolitan Life, the Holding Company and the individual defendants believe they have meritorious defenses to the plaintiffs' claims and are contesting vigorously all of the plaintiffs' claims in these actions. In September 2001, Metropolitan Life received a statement of claim, which apparently had been filed in the Superior Court of Justice, Ontario, Canada in April 2001, on behalf of a proposed class of certain former Canadian policyholders against the Holding Company, Metropolitan Life, and Metropolitan Life 17
Insurance Company of Canada. Plaintiffs' allegations concern the way that their policies were treated in connection with the demutualization of Metropolitan Life; they seek damages, declarations, and other non-pecuniary relief. The defendants believe they have meritorious defenses to the plaintiffs' claims and will contest vigorously all of plaintiffs' claims in this matter. A total of four purported class action lawsuits were also filed against Metropolitan Life in 2000 and 2001 in the United States District Courts for the Southern District of New York, for the Eastern District of Louisiana, for the District of Kansas, and for the Southern District of Illinois alleging racial discrimination in the marketing, sale, and administration of life insurance policies, including "industrial" life insurance policies sold by Metropolitan Life decades ago. Metropolitan Life successfully transferred the Louisiana, Kansas and Illinois actions to the Southern District of New York where the four cases have been consolidated. The plaintiffs in these actions seek unspecified monetary damages, punitive damages, reformation, imposition of a constructive trust, a declaration that the alleged practices are discriminatory and illegal, injunctive relief requiring Metropolitan Life to discontinue the alleged discriminatory practices and adjust policy values, and other relief. Discovery has been underway since late 2000. At the outset of discovery, Metropolitan Life moved for summary judgment on statute of limitations grounds. On June 27, 2001, the District Court denied that motion, citing, among other things, ongoing discovery on relevant subjects. The ruling does not prevent Metropolitan Life from continuing to pursue a statute of limitations defense. Plaintiffs have moved for certification of a class consisting of all non-Caucasian policyholders who were purportedly harmed by the practices alleged in the complaint. Metropolitan Life has opposed the class certification motion. These cases are scheduled for trial in April 2002. Metropolitan Life believes it has meritorious defenses and is contesting vigorously plaintiffs' claims. Insurance Departments in a number of states initiated inquiries in 2000 about possible race-based underwriting of life insurance. These inquiries generally have been directed to all life insurers licensed in their respective states, including Metropolitan Life and certain of its subsidiaries. The New York Insurance Department has commenced examinations of certain domestic life insurance companies, including Metropolitan Life, concerning possible past race-based underwriting practices. Metropolitan Life is cooperating fully with that inquiry, which is ongoing. In March 2001, a putative class action was filed against Metropolitan Life in the United States District Court for the Southern District of New York alleging gender discrimination and retaliation in the MetLife Financial Services unit of the Individual segment. The plaintiffs seek unspecified compensatory damages, punitive damages, a declaration that the alleged practices are discriminatory and illegal, injunctive relief requiring Metropolitan Life to discontinue the alleged discriminatory practices, an order restoring class members to their rightful positions (or appropriate compensation in lieu thereof), and other relief. Metropolitan Life is vigorously defending itself against these allegations. Various litigation, claims and assessments against the Company, in addition to those discussed above and those otherwise provided for in the Company's unaudited interim condensed consolidated financial statements, have arisen in the course of the Company's business, including, but not limited to, in connection with its activities as an insurer, employer, investor, investment advisor and taxpayer. Further, state insurance regulatory authorities and other Federal and state authorities regularly make inquiries and conduct investigations concerning the Company's compliance with applicable insurance and other laws and regulations. It is not feasible to predict or determine the ultimate outcome of all pending investigations and legal proceedings or provide reasonable ranges of potential losses. In some of the matters referred to above, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Although in light of these considerations it is possible that an adverse outcome in certain cases could have a material adverse effect upon the Company's consolidated financial position, based on information currently known by the Company's management, in its opinion, the outcomes of such pending investigations and legal proceedings are not likely to have such an effect. However, given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company's operating results or cash flows in particular quarterly or annual periods. 18
8. COMPREHENSIVE INCOME Comprehensive income is as follows: <TABLE> <CAPTION> FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- ----------------------- 2001 2000 2001 2000 ----- ----- ------- ----- <S> <C> <C> <C> <C> (Dollars in millions) Net loss before date of demutualization $ -- $ -- $ -- $(220) Net income after date of demutualization 162 241 769 582 Accumulated other comprehensive income: Cumulative effect of change in accounting for derivatives, net of income taxes -- -- 32 -- Unrealized investment gains, net of related offsets, reclassification adjustments and income taxes 546 610 788 518 Unrealized gains on derivative instruments, net of income taxes 9 -- 34 -- Foreign currency translation adjustments (46) (18) (67) (10) ----- ----- ------- ----- Accumulated other comprehensive income 509 592 787 508 ----- ----- ------- ----- Comprehensive income $ 671 $ 833 $ 1,556 $ 870 ===== ===== ======= ===== </TABLE> 19
9. BUSINESS SEGMENT INFORMATION <TABLE> <CAPTION> Auto Asset Corpo- Indi- Institu- Rein- & Man- Interna- rate For the three months ended September 30, 2001 vidual tional surance Home agement tional & Other Total - ---------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Premiums $ 1,093 $ 1,896 $ 392 $692 $-- $ 210 $ (1) $ 4,282 Universal life and investment-type product policy fees 319 139 -- -- -- 8 -- 466 Net investment income 1,625 1,028 103 48 18 63 90 2,975 Other revenues 119 155 12 6 42 4 8 346 Net investment (losses) gains (43) (37) (12) -- 25 (9) (23) (99) Income (loss) before provision for income taxes 216 (3) 13 28 29 9 (53) 239 - ---------------------------------------------------------------------------------------------------------------------------------- </TABLE> <TABLE> <CAPTION> Auto Asset Corpo- Indi- Institu- Rein- & Man- Interna- rate For the three months ended September 30, 2000 vidual tional surance Home agement tional & Other Total - ---------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Premiums $ 1,140 $ 1,678 $327 $ 664 $ -- $162 $ (2) $ 3,969 Universal life and investment-type product policy fees 300 135 -- -- -- 15 -- 450 Net investment income 1,590 1,020 95 49 21 62 108 2,945 Other revenues 166 157 9 5 217 2 25 581 Net investment (losses) gains (41) (175) 2 (6) -- 1 (54) (273) Income (loss) before provision for income taxes 270 66 27 (3) 15 12 (75) 312 - ---------------------------------------------------------------------------------------------------------------------------------- </TABLE> <TABLE> <CAPTION> Auto Asset Corpo- Indi- Institu- Rein- & Man- Interna- rate For the nine months ended September 30, 2001 vidual tional surance Home agement tional & Other Total - ---------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Premiums $ 3,306 $ 5,503 $1,197 $ 2,047 $ -- $583 $ (2) $ 12,634 Universal life and investment-type product policy fees 942 443 -- -- -- 28 -- 1,413 Net investment income 4,886 3,112 288 150 54 189 276 8,955 Other revenues 384 485 28 18 154 10 51 1,130 Net investment (losses) gains (157) (154) 2 (6) 25 19 (109) (380) Income (loss) before provision for income taxes 683 494 78 (9) 39 69 (195) 1,159 - ---------------------------------------------------------------------------------------------------------------------------------- </TABLE> <TABLE> <CAPTION> Auto Asset Corpo- Indi- Institu- Rein- & Man- Interna- rate For the nine months ended September 30, 2000 vidual tional surance Home agement tional & Other Total - ---------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Premiums $ 3,393 $ 5,055 $ 1,055 $ 1,965 $ -- $ 481 $ (3) $ 11,946 Universal life and investment-type product policy fees 920 408 -- -- -- 39 -- 1,367 Net investment income 4,766 2,902 278 132 63 190 322 8,653 Other revenues 477 501 20 23 651 7 83 1,762 Net investment (losses) gains (98) (216) (1) -- -- 9 (134) (440) Income (loss) before provision for income taxes(1) 818 475 77 (12) 55 (284) (380) 749 - ---------------------------------------------------------------------------------------------------------------------------------- </TABLE> (1) Payments made to former Canadian policyholders and demutualization costs of $327 million and $230 million, respectively, are included in the International and Corporate & Other results, respectively. <TABLE> <CAPTION> At September 30, At December 31, 2001 2000 -------- -------- <S> <C> <C> Assets Individual $130,386 $132,433 Institutional 89,994 90,279 Reinsurance 7,664 7,280 Auto & Home 4,649 4,511 Asset Management 249 418 International 3,959 5,119 Corporate & Other 14,994 14,978 -------- -------- Total $251,895 $255,018 ======== ======== </TABLE> The Individual segment included an equity ownership interest in Nvest, L.P. and Nvest Companies, L.P. ("Nvest") under the equity method of accounting. Prior to its sale in October 2000, Nvest was included within the Asset Management segment due to the types of products and strategies employed by the entity. The Individual segment's equity in earnings of Nvest, which is included in net investment income, was $8 million and $29 million for the three months and nine months ended September 30, 2000, respectively. 20
In addition, prior to its sale in July 2001, Conning Corporation was included within the Asset Management segment due to the types of products and strategies employed by the entity. The Company received $108 million in the transaction and reported a gain of approximately $16 million, net of income taxes of $9 million, in the third quarter of 2001. The sale price is subject to an adjustment under certain provisions of the sale contract. The Corporate & Other segment consists of various start-up entities, including Grand Bank, N.A. ("Grand Bank"), and run-off entities, as well as the elimination of all intersegment amounts. In addition, the elimination of the Individual segment's ownership interest in Nvest is included for the three months and nine months ended September 30, 2000. The principal component of the intersegment amounts relates to intersegment loans, which bear interest rates commensurate with related borrowings. Revenues derived from any customer did not exceed 10% of consolidated revenues. Revenues from U.S. operations were $7,694 million and $7,430 million for the three months ended September 30, 2001 and 2000, respectively, which represented 97% of consolidated revenues for both the three months ended September 30, 2001 and 2000. Revenues from U.S. operations were $22,923 million and $22,562 million for the nine months ended September 30, 2001 and 2000, respectively, which represented 97% of consolidated revenues for both the nine months ended September 30, 2001 and 2000. 10. STOCK OPTIONS AND STOCK GRANTS During the nine months ended September 30, 2001, MetLife, Inc. granted approximately 12.2 million non-qualified stock options pursuant to its 2000 Stock Incentive Plan. During the same period, MetLife, Inc. granted to its non-employee directors an aggregate of approximately 19,000 non-qualified stock options and 6,000 shares of common stock pursuant to its 2000 Directors Stock Plan. All options granted have an exercise price equal to the fair market value of the Company's common stock on the date of grant. For a further discussion of the stock plans referenced above, see Note 15 of Notes to Consolidated Financial Statements included in MetLife, Inc.'s 2000 Annual Report on Form 10-K filed with the SEC. 11. SUBSEQUENT EVENTS MANAGEMENT INITIATIVES On October 22, 2001, the Company announced several key management initiatives, which are focused on cutting expenses and building long-term value for its shareholders and customers. The initiatives include the discontinuance of its Institutional stand-alone 401(k) recordkeeping services and externally managed guaranteed index separate accounts. In addition, management announced a reduction of approximately 1,600 non-sales employees within the Individual, Institutional and Auto & Home segments. This reduction includes employees associated with the 401(k) recordkeeping business. These actions will result in charges of approximately $281 million, net of income taxes of $158 million, in the fourth quarter of 2001. POLICYHOLDER LIABILITY On October 22, 2001, the Company also announced the establishment of a $118 million policyholder liability with respect to certain group annuity contracts. This action will result in the distribution of accumulated investment experience associated with such contracts in accordance with the commitment made to the Commonwealth of Massachusetts Division of Insurance at the time of Metropolitan Life's merger with New England Mutual Life Insurance Company in 1996. COMMON STOCK CASH DIVIDEND On October 23, 2001, the Company announced the declaration by its Board of Directors of a dividend of $0.20 per common share payable on December 14, 2001 to shareholders of record on November 6, 2001. REINSURANCE GROUP OF AMERICA Reinsurance Group of America ("RGA") is currently evaluating the reserve adequacy associated with certain reinsurance treaties for the privatized pension program in Argentina. RGA anticipates additional reserves in the range of $25 million to $35 million may be necessary to absorb additional claims development associated with the run-off of these treaties. Metropolitan Life is a majority shareholder of RGA and, as such, any expense that may result from the completion of the aforementioned analysis will be recognized in proportion to the Company's ownership interest. 21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For purposes of this discussion, the terms "MetLife" or the "Company" refer, at all times prior to the date of demutualization (as hereinafter defined), to Metropolitan Life Insurance Company, a mutual life insurance company organized under the laws of the State of New York ("Metropolitan Life"), and its subsidiaries, and at all times on and after the date of demutualization, to MetLife, Inc. (the "Holding Company"), a Delaware corporation, and its subsidiaries, including Metropolitan Life. Following this summary is a discussion addressing the consolidated results of operations and financial condition of the Company for the periods indicated. This discussion should be read in conjunction with the Company's unaudited interim condensed consolidated financial statements included elsewhere herein. SEPTEMBER 11, 2001 TRAGEDIES On September 11, 2001 a terrorist attack occurred in New York, Washington D.C. and Pennsylvania (collectively, the "tragedies") triggering a significant loss of life and property which may have a continuing adverse impact on certain of the Company's businesses. The Company has exposures to this event with claims arising from its Individual, Institutional, Reinsurance and Auto & Home insurance coverages. The Company has performed a detailed analysis of contracts it believes are exposed to this event based on information available as of October 22, 2001. The Company estimates the total expected after-tax insurance losses related to the tragedies to be $208 million. It is very early in the claims process, and these estimates are subject to revision in subsequent quarterly periods, as claims are received from insureds and the claims to reinsurers are identified and processed. Any revisions to the estimates of gross losses and reinsurance recoveries in subsequent quarters will affect income from continuing operations before taxes and net income in such quarters. Reinsurance recoveries are dependent on the continued creditworthiness of the reinsurers, which may be adversely affected by their other reinsured losses in connection with the tragedies. The long-term effects of the tragedies on the Company's businesses can not be assessed at this time. The tragedies have had significant adverse affects on the general economic, market and political conditions, increasing many of the Company's business risks. This may have a negative effect on the Company's businesses and results of operations over time. In particular, the declines in share prices experienced after the reopening of the United States equity markets following the tragedies have contributed, and may continue to contribute, to a decline in separate account assets, which in turn could have an adverse effect on fees earned in the Company's businesses. In addition, the Institutional segment may receive disability claims from individuals suffering from mental and nervous disorders resulting from the tragedies. This may lead to a revision in the Company's estimated insurance losses related to the tragedies. The majority of the Company's disability policies include the provision that such claims be submitted within two years of the traumatic event. The general account investment portfolios include investments, primarily comprised of fixed maturity securities, in industries the Company believes may be adversely affected by the tragedies including airline, other travel and lodging and insurance, with a total carrying value of approximately $2 billion. It should be noted that most of the Company's property and casualty insurance exposure is in large, diversified insurance companies or companies that focus more on the personal than the commercial side of the business. Exposures exist to hotels through mortgage loans and direct equity investments as part of the real estate portfolio with a combined carrying value of approximately $1 billion. The effect of the tragedies on the valuation of these investments is uncertain and could lead to increased impairments. The future cost and availability of reinsurance covering terrorist attacks for the Company's businesses may be adversely impacted. Although the Company's ratings have not been affected by the tragedies, the rating agencies may reexamine their view of the insurance industry and the Company. THE DEMUTUALIZATION On April 7, 2000 (the "date of demutualization"), pursuant to an order by the New York Superintendent of Insurance ("Superintendent") approving its plan of reorganization, as amended (the "plan"), Metropolitan Life converted from a mutual life insurance company to a stock life insurance company and became a wholly-owned subsidiary of the Holding Company. In conjunction therewith, each policyholder's membership interest was extinguished and each eligible policyholder received, in exchange for that interest, trust interests representing shares of Common Stock held in the Metropolitan Life Policyholder Trust, cash or an adjustment to their policy values in the form of policy credits, as provided in the plan. In addition, Metropolitan Life's Canadian 22
branch made cash payments to holders of certain policies transferred to Clarica Life Insurance Company in connection with the sale of a substantial portion of Metropolitan Life's Canadian operations in 1998, as a result of a commitment made in connection with obtaining Canadian regulatory approval of that sale. The payments, which were recorded in the second quarter of 2000, were determined in a manner that was consistent with the treatment of, and fair and equitable to, eligible policyholders of Metropolitan Life. On the date of demutualization, the Holding Company conducted an initial public offering of 202,000,000 shares of its Common Stock and concurrent private placements of an aggregate of 60,000,000 shares of its Common Stock at an offering price of $14.25 per share. The shares of Common Stock issued in the offerings are in addition to 494,466,664 shares of Common Stock of the Holding Company distributed to the Metropolitan Life Policyholder Trust for the benefit of policyholders of Metropolitan Life in connection with the demutualization. On April 10, 2000, the Holding Company issued 30,300,000 additional shares of its Common Stock as a result of the exercise of over-allotment options granted to underwriters in the initial public offering. Concurrently with these offerings, MetLife, Inc. and MetLife Capital Trust I, a Delaware statutory business trust wholly-owned by MetLife, Inc., issued 20,125,000 8.00% equity security units for an aggregate offering price of $1,006 million. Each unit consists of (i) a contract to purchase shares of Common Stock, and (ii) a capital security of MetLife Capital Trust I. On the date of demutualization, Metropolitan Life established a closed block for the benefit of holders of certain individual life insurance policies of Metropolitan Life. See Note 3 of Notes to unaudited interim condensed consolidated financial statements. ACQUISITIONS AND DISPOSITIONS On July 2, 2001, the Company completed its sale of Conning Corporation ("Conning"), an affiliate acquired in the acquisition of GenAmerica Financial Corporation ("GenAmerica"). Conning specializes in asset management for insurance company investment portfolios and investment research. The Company received $108 million in the transaction and reported a gain of approximately $16 million, net of income taxes of $9 million, in the third quarter of 2001. The sale price is subject to adjustment under certain provisions of the sale contract. On February 28, 2001, the Holding Company consummated the purchase of Grand Bank, N.A. ("Grand Bank"). Grand Bank, with assets of approximately $90 million, provides banking services to individuals and small businesses in the Princeton, New Jersey area. On February 12, 2001, the Federal Reserve Board approved the Holding Company's application for bank holding company status and to become a financial holding company upon its acquisition of Grand Bank. In October 2000, the Company completed the sale of its 48% ownership interest in its affiliates, Nvest, L.P. and Nvest Companies L.P. (collectively, "Nvest"). This transaction resulted in an investment gain of $663 million. In July 2000, the Company acquired the workplace benefits division of Business Men's Assurance Company ("BMA"), a Kansas City, Missouri-based insurer. 23
RESULTS OF OPERATIONS THE COMPANY The following table presents summary consolidated financial information for the Company for the periods indicated: <TABLE> <CAPTION> FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ---------------------- ---------------------- 2001 2000 2001 2000 -------- -------- -------- -------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> REVENUES Premiums $ 4,282 $ 3,969 $ 12,634 $ 11,946 Universal life and investment-type product policy fees 466 450 1,413 1,367 Net investment income 2,975 2,945 8,955 8,653 Other revenues 346 581 1,130 1,762 Net investment losses (net of amounts allocable to other accounts of $28, $25, $107 and $42, respectively) (99) (273) (380) (440) -------- -------- -------- -------- Total revenues 7,970 7,672 23,752 23,288 -------- -------- -------- -------- EXPENSES Policyholder benefits and claims (excludes amounts directly related to net investment losses of $29, $23, $92 and $24, 4,723 4,133 13,447 12,414 respectively) Interest credited to policyholder account balances 745 754 2,228 2,175 Policyholder dividends 547 457 1,567 1,438 Payments to former Canadian policyholders -- -- -- 327 Demutualization costs -- -- -- 230 Other expenses (excludes amounts directly related to net investment losses of $(1), $2, $15 and $18, respectively) 1,716 2,016 5,351 5,955 -------- -------- -------- -------- Total expenses 7,731 7,360 22,593 22,539 -------- -------- -------- -------- Income before provision for income taxes 239 312 1,159 749 Provision for income taxes 77 71 390 387 -------- -------- -------- -------- Net income $ 162 $ 241 $ 769 $ 362 ======== ======== ======== ======== </TABLE> THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2000 Premiums grew by $313 million, or 8%, to $4,282 million for the three months ended September 30, 2001 from $3,969 million for the comparable 2000 period. This variance is primarily attributable to increases in the Institutional, Reinsurance, International and Auto & Home segments, partially offset by a decline in the Individual segment. A rise of $218 million in the Institutional segment is due, in most part, to sales growth and continued favorable policyholder retention in this segment's dental, disability and long-term care businesses. Significant premiums received from several existing group life customers in 2001 also contributed to this variance. New premiums from facultative and automatic treaties and renewal premiums on existing blocks of business all contributed to a $65 million increase in the Reinsurance segment. An increase of $48 million in the International segment is due to growth in Mexico, South Korea, Taiwan and Spain. Higher average premiums resulting from rate increases is the primary driver of a $28 million increase in the Auto & Home segment. A $47 million decrease in the Individual segment is attributable to a decline in sales of traditional life insurance policies, which reflects a continued shift in customer preference from those policies to variable life products, and a reduction in sales of supplementary contracts with life contingencies and single premium immediate annuity business. The remaining variance is attributable to minor fluctuations in other segments. Universal life and investment-type product policy fees improved by $16 million, or 4%, to $466 million for the three months ended September 30, 2001 from $450 million for the comparable 2000 period. This variance is attributable to increases in the Individual and Institutional segments, partially offset by a decline in the International segment. A rise of $19 million in the Individual segment is primarily due to higher cost of insurance charges, partially offset by a reduction in policy fees from annuity and investment-type products. Cost of insurance charges and policy fees from annuity and investment-type products have opposite relationships to average asset base. As average asset levels decline, cost of insurance charges increase and policy fees from investment-type products decrease. Growth in sales and deposits of group universal life products resulted in a $4 million improvement 24
in the Institutional segment. A decrease of $7 million in the International segment is primarily due to a reduction in fees in Spain resulting from fewer assets under management. This is the result of a planned cessation of product lines offered through the joint venture with Banco Santander Central Hispano, S.A. ("Banco Santander"). Net investment income increased by $30 million, or 1%, to $2,975 million for the three months ended September 30, 2001 from $2,945 million for the three months ended September 30, 2000. This change is primarily due to higher income from (i) mortgage loans on real estate of $38 million, or 9%, (ii) other invested assets of $20 million, or 34%, (iii) cash and short-term investments of $11 million, or 16%, and (iv) interest on policy loans of $2 million, or 2%. These positive variances are partially offset by lower income from (i) equity securities and other limited partnership interests of $11 million, or 35%, (ii) fixed maturities of $6 million, (iii) real estate and real estate joint ventures of $5 million, or 3%, and (iv) higher investment expenses of $19 million, or 44%. The growth in income from mortgage loans on real estate to $458 million from $420 million is predominately the result of higher mortgage production volume and increases in prepayments and contingent interest. The rise in income from other invested assets to $79 million from $59 million is primarily due to derivative transactions. Larger average cash positions during the quarter is the primary driver of the increase in income from cash and short-term investments to $80 million from $69 million. The decrease in income from equity securities and other limited partnership interests to $20 million from $31 million is mainly attributable to fewer sales of underlying assets held in corporate partnerships, coupled with losses in underlying portfolios. The increase in net investment income is largely attributable to the Individual, Institutional and Reinsurance segments, offset by a decline in the Corporate & Other segment. Net investment income for the Individual and Institutional segments rose by $35 million and $8 million, respectively. These positive variances are predominately the result of a more active securities lending program and increases in mortgage prepayments and contingent interest. Rebate expenses related to securities lending activity are included in other expenses. Net investment income for the Reinsurance segment increased by $8 million, primarily due to a rise in funds withheld with interest. Net investment income for the Corporate & Other segment decreased by $18 million due to fewer sales of underlying assets held in corporate limited partnerships and an increase in losses in its portfolio. Due to the nature and timing of certain investment transactions, including sales of underlying assets held in corporate partnerships, past investment performance is not necessarily indicative of future performance. The remainder of the variance is attributable to minor fluctuations in other segments. Other revenues decreased by $235 million, or 40%, to $346 million for the three months ended September 30, 2001 from $581 million for the comparable 2000 period. This variance is primarily due to the Asset Management, Individual and Corporate & Other segments. The sales of Nvest and Conning on October 30, 2000 and July 2, 2001, respectively, are the primary drivers of a $175 million decrease in the Asset Management segment. A decrease of $47 million in the Individual segment is primarily due to a reduction in commission and fee income associated with lower sales in the broker/dealer and other subsidiaries. Other revenues in the Corporate & Other segment decreased by $17 million, largely due to the sale of NaviSys Incorporated ("NaviSys") in 2000. The remaining variance is due to minor fluctuations in other segments. The Company's investment gains and losses are net of related policyholder amounts. The amounts netted against investment gains and losses are (i) amortization of deferred policy acquisition costs attributable to the increase or decrease in product gross margins or profits resulting from investment gains and losses, (ii) liabilities for those participating contracts in which the policyholders' accounts are increased or decreased by the related investment gains or losses, and (iii) adjustments to the policyholder dividend obligation resulting from investment gains and losses. Net investment losses decreased by $174 million, or 64%, to $99 million for the three months ended September 30, 2001 from $273 million for the comparable 2000 period. The net reduction is primarily due to a decline in gross investment losses of $171 million along with changes in the offsets for participating contracts and changes in the policyholder dividend obligation of $5 million and $1 million, respectively. These variances are reduced by the change in the offset for amortization of deferred policy acquisition costs of $3 million. Although the Company continues to recognize losses from deteriorating credits through asset sales and writedowns, the recognition of losses through asset sales has slowed progressively over the past year resulting in a decrease in gross investment losses for the three months ended September 30, 2001 versus the comparable 2000 period. 25
The Company believes its policy of netting related policyholder amounts against investment gains and losses provides important information in evaluating its operating performance. Investment gains and losses are often excluded by investors when evaluating the overall financial performance of insurers. The Company believes its presentation enables readers of its unaudited interim condensed consolidated statements of income to easily exclude investment gains and losses and the related effects on the unaudited interim condensed consolidated statements of income when evaluating its operating performance. The Company's presentation of investment gains and losses, net of policyholder amounts, may be different from the presentation used by other insurance companies and, therefore, amounts in its unaudited interim condensed consolidated statements of income may not be comparable with amounts reported by other insurers. Policyholder benefits and claims increased by $590 million, or 14%, to $4,723 million for the three months ended September 30, 2001 from $4,133 million for the comparable 2000 period. This variance reflects total gross policyholder benefits and claims of $4,694 million, growth of $584 million, or 14%, from $4,110 million in 2000, before the offsets for reductions in participating contractholder accounts of $(5) million in 2000 and changes in the policyholder dividend obligation of $29 million in 2001 and $28 million in 2000, directly related to net investment losses. The net variance in policyholder benefits and claims is attributable to increases in the Institutional, Individual, Reinsurance, Auto & Home and International segments. Claims related to the September 11, 2001 tragedies account for $291 million of the $437 million increase in the Institutional segment. The remaining variance in the Institutional segment is attributable to growth in the group life, dental, disability and long-term care insurance businesses, commensurate with the increase in premiums. A $64 million rise in the Individual segment is primarily due to an increase in the liabilities for future policy benefits commensurate with growth in general account policyholder account balances. In addition, $24 million in liabilities and claims associated with the September 11, 2001 tragedies and an increase of $13 million in the policyholder dividend obligation contributed to this variance. Policyholder benefits and claims for the Reinsurance segment increased by $47 million, primarily due to growth in the business, commensurate with the premium growth discussed above. In addition, claims arising from the September 11, 2001 tragedies of approximately $16 million, net of amounts recoverable from reinsurers and before minority interest adjustment, contributed to the variance. A $27 million increase in the Auto & Home segment is predominately the result of growth in the auto business and higher average claim costs. The International segment's policyholder benefits and claims increased by $19 million as a result of growth in Mexico, Taiwan and South Korea, partially offset by declines in Spain and Portugal. The growth in Mexico, Taiwan and South Korea is commensurate with the increase in premiums. The decreases in Spain and Portugal are a result of a planned cessation of product lines offered through the joint venture with Banco Santander. The remainder of the variance is attributable to minor fluctuations in other segments. Interest credited decreased by $9 million, or 1%, to $745 million for the three months ended September 30, 2001 from $754 million for the comparable 2000 period. This variance is attributable to a decrease in the Institutional segment, partially offset by increases in the Individual and Reinsurance segments. A decrease of $40 million in the Institutional segment is primarily due to an overall decline in crediting rates in 2001 as a result of the current interest rate environment. Growth in policyholder account balances is the primary driver of a $23 million increase in the Individual segment. An $8 million increase in the Reinsurance segment is due to an increase of the interest credited on a certain block of annuities, the crediting rate of which is determined by the performance of the underlying assets. Policyholder dividends increased by $90 million, or 20%, to $547 million for the three months ended September 30, 2001 from $457 million for the comparable 2000 period, due to increases of $76 million and $13 million in the Institutional and Individual segments, respectively. The rise in the Institutional segment's policyholder dividends is primarily attributable to favorable experience on a large group life participating contract in 2001. These policyholder dividends vary from period to period based on participating contract experience. The increase in the Individual segment is reflective of the growth in the assets supporting policies associated with this segment's aging block of traditional life insurance business. The remainder of the variance is due to a $1 million increase in the International segment. Other expenses decreased by $300 million, or 15%, to $1,716 million for the three months ended September 30, 2001 from $2,016 million for the comparable 2000 period. Excluding the capitalization and amortization of deferred policy acquisition costs, which are discussed below, other expenses declined by $226 million, or 11%, to $1,870 million in 2001 from $2,096 million in 2000. This variance is attributable to reductions in the Asset Management, Individual, Auto & Home, Corporate & Other and Institutional segments, partially offset by increases in the Reinsurance and International segments. A decrease of $167 million in the Asset Management segment is predominately the result of the sales of Nvest and Conning on October 30, 2000 and July 2, 2001, respectively. The Individual segment's expenses declined by $65 million due to reductions in volume-related commission expenses in the broker/dealer and other subsidiaries and rebate expenses associated with the Company's securities lending program. Income associated with securities lending activity is recorded in net investment income. In addition, lower direct spending on compensation and benefits, associated with a reduction in headcount, as well as travel, printing and advertising expenses contributed to the variance. These positive variances are partially offset by severance costs of $12 million and start-up and transition costs associated with the 26
expansion of one of the annuity distribution channels. A $27 million decrease in the Auto & Home segment is attributable to a reduction in integration costs associated with the acquisition of the standard personal lines property and casualty insurance operations of The St. Paul Companies in September 1999 ("St. Paul acquisition"). The Corporate & Other segment's expenses declined by $21 million due to the sale of NaviSys, as well as an $11 million decrease in interest expense associated with a reduction in borrowing levels and a lower interest rate environment in 2001. The Institutional segment's expenses are lower by $9 million, primarily due to expense management initiatives and lower rebate expenses associated with the Company's securities lending program. These decreases are partially offset by increases of $36 million and $27 million in the Reinsurance and International segments, respectively. An increase in allowances paid under reinsurance treaties was the primary contributor to the increase in other expenses for the Reinsurance segment. The variance in the International segment's expenses is predominately the result of growth in South Korea, Mexico and Taiwan and higher expenses in Spain due to higher advertising expenses and investments in technology. Deferred policy acquisition costs are principally amortized in proportion to gross margins or profits, including investment gains or losses. The amortization is allocated to investment gains and losses to provide consolidated statement of income information regarding the impact of investment gains and losses on the amount of the amortization, and to other expenses to provide amounts related to gross margins or profits originating from transactions other than investment gains and losses. Capitalization of deferred policy acquisition costs increased slightly to $435 million for the three months ended September 30, 2001 from $431 million for the comparable 2000 period. This variance is attributable to increases in the International, Institutional and Auto & Home segments, partially offset by declines in the Reinsurance and Individual segments. The increases in the International, Institutional and Auto & Home segments are commensurate with growth in those businesses. The variance in Reinsurance is primarily due to fluctuations in allowances paid to ceding companies as a result of a change in product mix. The decrease in the Individual segment is predominately the result of lower sales of traditional life insurance policies, partially offset by higher sales from new annuity and investment-type product offerings during 2001. Total amortization of deferred policy acquisition costs decreased to $282 million in 2001 from $349 million in 2000. Amortization of deferred policy acquisition costs of $281 million and $351 million are allocated to other expenses in 2001 and 2000, respectively, while the remainder of the amortization in each year is allocated to investment losses. The decrease in amortization of deferred policy acquisition costs allocated to other expenses is attributable to declines in the Reinsurance, Individual and Institutional segments, partially offset by increases in the Auto & Home and International segments. The variance in Reinsurance is primarily due to fluctuations in allowances paid to ceding companies as a result of a change in product mix. The decrease in the Individual segment is predominately the result of refinements implemented in the third quarter of 2001 relating to the estimation of future market performance in determining estimated gross margins and profits. The decline in the Institutional segment is primarily attributable to a reduction of amortization in the defined contribution business. Increases in the Auto & Home and International segments are consistent with growth in those businesses. Income tax expense for the three months ended September 30, 2001 was $77 million, or 32% of income before provision for income taxes, compared with $71 million, or 23%, for the comparable 2000 period. The 2001 effective tax rate differs from the corporate tax rate of 35% primarily due to the impact of non-taxable investment income. The 2000 effective tax rate differs from the corporate tax rate of 35% primarily due to a reduction in prior year taxes on capital gains recorded in the third quarter of 2000. This reduction is associated with the previous sale of a business. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2000 Premiums grew by $688 million, or 6%, to $12,634 million for the nine months ended September 30, 2001 from $11,946 million for the comparable 2000 period. This variance is attributable to increases in the Institutional, Reinsurance, International and Auto & Home segments, partially offset by a decline in the Individual segment. An increase of $448 million in the Institutional segment is predominately the result of sales growth and continued favorable policyholder retention in this segment's dental, disability and long-term care businesses. In addition, significant premiums received from several existing group life customers in 2001 and the BMA acquisition resulted in higher premiums. These positive variances are partially offset by additional insurance coverages purchased in 2000 by existing customers with funds received in the demutualization and higher premiums received in 2000 from existing retirement and savings customers. New premiums from facultative and automatic treaties and renewal premiums on existing blocks of business contributed to a $142 million increase in the Reinsurance segment. An improvement of $102 million in the International segment is due to growth in Mexico, South Korea, Taiwan and Spain. Higher average premium resulting from rate increases is the primary driver of an $82 million rise in the Auto & Home segment. An $87 million decline in the Individual segment is attributable to lower sales of traditional life insurance policies, which reflects a continued shift in customer preference from those policies to variable life products, and a reduction in sales of supplementary contracts with life contingencies and single premium immediate annuity business. The remaining variance is attributable to a $1 million increase in the Corporate & Other segment. 27
Universal life and investment-type product policy fees increased by $46 million, or 3%, to $1,413 million for the nine months ended September 30, 2001 from $1,367 million for the comparable 2000 period. This variance is due to improvements in the Institutional and Individual segments, partially offset by a decline in the International segment. Growth in sales and deposits of group universal life and corporate-owned life insurance products resulted in a $35 million increase in the Institutional segment. A $22 million rise in the Individual segment is primarily due to an increase in cost of insurance charges, partially offset by a reduction in policy fees from annuity and investment-type products. Cost of insurance charges and policy fees from annuity and investment-type products have opposite relationships to average asset base. As average asset levels decline, cost of insurance charges increase and policy fees from investment-type products decrease. A decline of $11 million in the International segment is primarily due to a reduction in fees in Spain resulting from fewer assets under management. This is a result of a planned cessation of product lines offered through the joint venture with Banco Santander. Net investment income increased by $302 million, or 3%, to $8,955 million for the nine months ended September 30, 2001 from $8,653 for the nine months ended September 30, 2000. This change is primarily due to higher income from (i) fixed maturities of $154 million, or 2%, (ii) mortgage loans on real estate of $127 million, or 10%, (iii) other invested assets of $77 million, or 70%, (iv) interest on policy loans of $19 million, or 5%, (v) cash and short-term investments of $13 million, or 6%, and (vi) lower investment expenses of $8 million, or 4%. These positive variances are partially offset by lower income from (i) equity securities and other limited partnership interests of $87 million, or 54%, and (ii) real estate and real estate joint ventures of $9 million, or 2%. The increase in income from fixed maturities to $6,414 million from $6,260 million was primarily due to a more active securities lending program. The rise in income from mortgage loans on real estate to $1,381 million from $1,254 million is predominately the result of higher mortgage production volume and increases in prepayments and contingent interest. The increase in income from other invested assets to $187 million from $110 million is primarily due to derivative transactions. The decrease in income from equity securities and other limited partnership interests to $74 million from $161 million is primarily due to fewer sales of underlying assets held in corporate partnerships, coupled with losses in underlying portfolios. The increase in net investment income is largely attributable to the Institutional and Individual segments. Net investment income for the Institutional and Individual segments grew by $210 million and $120 million, respectively. These increases are predominantly due to a higher volume of securities lending activity and increases in mortgage prepayments and contingent interest. Rebate expenses related to securities lending activity are included in other expenses. The remainder of the variance is attributable to fluctuations in the Corporate & Other and Auto & Home segments. Other revenues decreased by $632 million, or 36%, to $1,130 million for the nine months ended September 30, 2001 from $1,762 million for the comparable 2000 period. This variance is mainly attributable to decreases in the Asset Management, Individual, Corporate & Other and Institutional segments. The sales of Nvest and Conning on October 30, 2000 and July 2, 2001, respectively, are the primary drivers of a $497 million decrease in the Asset Management segment. A decrease of $93 million in the Individual segment is primarily due to reduced commission and fee income associated with lower sales in the broker/dealer and other subsidiaries. Other revenues in the Corporate & Other segment decreased by $32 million, largely due to the sales of NaviSys and Farmers National Company ("Farmers National") in 2000. A decrease of $16 million in the Institutional segment's other revenues is predominately attributable to lower fees on index-guaranteed separate accounts as a result of a depressed equity market and a large withdrawal by an existing customer. Index-guaranteed separate accounts have been discontinued in the fourth quarter of 2001; accordingly, a continued decline in fees relating to this product should be expected. The remainder of the variance is attributable to minor fluctuations in other segments. The Company's investment gains and losses are net of related policyholder amounts. The amounts netted against investment gains and losses are (i) amortization of deferred policy acquisition costs attributable to the increase or decrease in product gross margins or profits resulting from investment gains and losses, (ii) liabilities for those participating contracts in which the policyholders' accounts are increased or decreased by the related investment gains or losses, and (iii) adjustments to the policyholder dividend obligation resulting from investment gains and losses. Net investment losses decreased by $60 million, or 14%, to $380 million for the nine months ended September 30, 2001 from $440 million for the comparable 2000 period. This net decline is predominately the result of a variance in the offset for changes in the policyholder dividend obligation of $71 million. This variance is partially reduced by an increase in gross investment losses of $5 million and changes of $3 million in the offsets for participating contracts and deferred policy acquisition costs. 28
The Company believes its policy of netting related policyholder amounts against investment gains and losses provides important information in evaluating its operating performance. Investment gains and losses are often excluded by investors when evaluating the overall financial performance of insurers. The Company believes its presentation enables readers of its unaudited interim condensed consolidated statements of income to easily exclude investment gains and losses and the related effects on the unaudited interim condensed consolidated statements of income when evaluating its operating performance. The Company's presentation of investment gains and losses, net of policyholder amounts, may be different from the presentation used by other insurance companies and, therefore, amounts in its unaudited interim condensed consolidated statements of income may not be comparable with amounts reported by other insurers. Policyholder benefits and claims increased by $1,033 million, or 8%, to $13,447 million for the nine months ended September 30, 2001 from $12,414 million for the comparable 2000 period. This variance reflects total gross policyholder benefits and claims of $13,355 million, an increase of $965 million, or 8%, from $12,390 million in 2000, before the offsets for reductions in participating contractholder accounts of $3 million in 2000 and changes in the policyholder dividend obligation of $92 million and $21 million in 2001 and 2000, respectively, directly related to net investment losses. The net increase in policyholder benefits and claims is mainly attributable to increases in the Institutional, Individual, Reinsurance, Auto & Home and International segments. Claims related to the September 11, 2001 tragedies account for $291 million of the $615 million increase in the Institutional segment. The remaining variance in the Institutional segment is attributable to growth in the group life, dental, disability and long-term care insurance businesses, commensurate with the increase in premiums, partially offset by a decrease in policyholder benefits and claims related to the retirement and savings business. This decline is commensurate with the decrease in retirement and savings premiums discussed above. A $131 million increase in the Individual segment is primarily due to an increase in the liabilities for future policy benefits commensurate with growth in general account policyholder account balances. In addition, an increase of $49 million in the policyholder dividend obligation and $24 million in liabilities and claims associated with the September 11, 2001 tragedies contributed to the variance. Policyholder benefits and claims for the Reinsurance segment increased by $127 million, primarily due to unfavorable mortality experience during the first quarter of 2001 and growth in the business, commensurate with the premium growth discussed above. In addition, claims arising from the September 11, 2001 tragedies of approximately $16 million, net of amounts recoverable from reinsurers and before minority interest adjustments, contributed to the variance. A $110 million increase in the Auto & Home segment is predominately the result of inflationary pressures on auto claim severity, growth in the auto business and increased non-catastrophe weather-related losses, partially offset by a decrease in catastrophe losses. International policyholder benefits and claims increased by $52 million as a result of growth in Mexico, South Korea and Taiwan, partially offset by a decrease in Argentina. The growth in Mexico, South Korea and Taiwan is commensurate with the increase in premiums previously discussed. The decrease in Argentina is due to a reduction in life sales as a result of a recession in that country. The remaining variance is attributable to minor fluctuations in other segments. Interest credited increased by $53 million, or 2%, to $2,228 million for the nine months ended September 30, 2001 from $2,175 million for the comparable 2000 period. This variance is mainly attributable to an $83 million increase in the Individual segment, partially offset by a $33 million decrease in the Institutional segment. Growth in policyholder account balances is the primary driver of the increase in the Individual segment. The decrease in the Institutional segment is primarily due to an overall decline in crediting rates in 2001 as a result of the current interest rate environment, partially offset by an increase in average customer account balances stemming from asset growth. The remainder of the variance is attributable to minor fluctuations in the International and Reinsurance segments. Policyholder dividends increased by $129 million, or 9%, to $1,567 million for the nine months ended September 30, 2001 from $1,438 million for the comparable 2000 period, primarily due to increases of $99 million and $24 million in the Institutional and Individual segments, respectively. The rise in the Institutional segment's policyholder dividends is primarily attributable to favorable experience on a large group life participating contract in 2001. These policyholder dividends vary from period to period based on participating contract experience. The increase in the Individual segment reflects growth in the assets supporting policies associated with this segment's aging block of traditional life insurance business. The remaining variance is due to minor fluctuations in the International and Reinsurance segments. Payments of $327 million were made during the second quarter of 2000, as part of Metropolitan Life's demutualization, to holders of certain policies transferred to Clarica Life Insurance Company in connection with the sale of a substantial portion of the Canadian operations in 1998. Demutualization costs of $230 million were incurred during the nine months ended September 30, 2000. These costs are related to Metropolitan Life's demutualization on April 7, 2000. 29
Other expenses decreased by $604 million, or 10%, to $5,351 million for the nine months ended September 30, 2001 from $5,955 million for the comparable 2000 period. Excluding the capitalization and amortization of deferred policy acquisition costs, which are discussed below, other expenses decreased by $402 million, or 7%, to $5,767 million in 2001 from $6,169 million in 2000. This variance is attributable to decreases in the Asset Management, Individual and Auto & Home segments, partially offset by increases in the Institutional, Reinsurance and International segments. A decrease of $465 million in the Asset Management segment is predominately the result of the sales of Nvest and Conning on October 30, 2000 and July 2, 2001, respectively. The Individual segment's expenses decreased by $87 million due to decreases in volume-related commission expenses in the broker/dealer and other subsidiaries and rebate expenses associated with the Company's securities lending program. Income associated with securities lending activity is recorded in net investment income. In addition, lower direct spending on compensation and benefits, associated with a reduction in headcount, as well as travel, printing and advertising expenses contributed to the variance. These decreases are partially offset by severance costs of $12 million and start-up and transition costs associated with the expansion of one of the annuity distribution channels. A $29 million decrease in the Auto & Home segment is attributable to a reduction of integration costs associated with the St. Paul acquisition. These decreases are partially offset by increases of $93 million, $55 million and $36 million in the Institutional, Reinsurance and International segments, respectively. The Institutional segment's expenses increased by $93 million, primarily due to costs incurred in connection with initiatives focused on improving service delivery through investments in technology as well as an increase in non-deferrable variable expenses associated with premium growth. These negative variances are partially offset by lower expenses in retirement and savings resulting from expense management initiatives. The acquisition of RGA Financial Group during the second half of 2000 contributed to the overall increase in other expenses for the Reinsurance segment. The increase in the International segment's expenses is predominately the result of growth in South Korea and Mexico. The remainder of the variance is attributable to a minor decrease in the Corporate & Other segment. Deferred policy acquisition costs are principally amortized in proportion to gross margins or profits, including investment gains or losses. The amortization is allocated to investment gains and losses to provide consolidated statement of income information regarding the impact of investment gains and losses on the amount of the amortization, and other expenses to provide amounts related to gross margins or profits originating from transactions other than investment gains and losses. Capitalization of deferred policy acquisition costs increased to $1,304 million for the nine months ended September 30, 2001 from $1,263 million for the comparable 2000 period. This variance is primarily attributable to increases in the Institutional and International segments, partially offset by a decrease in the Individual segment. The increases in the Institutional and International segments are commensurate with growth in those businesses. The decline in the Individual segment is due to lower sales of traditional life insurance policies and annuity and investment-type products, resulting in a reduction of commissions and other deferrable expenses. Total amortization of deferred policy acquisition costs decreased to $873 million in 2001 from $1,031 million in 2000. Amortization of deferred policy acquisition costs of $888 million and $1,049 million are allocated to other expenses in 2001 and 2000, respectively, while the remainder of the amortization in each year is allocated to investment losses. The variance in amortization of deferred policy acquisition costs allocated to other expenses is attributable to decreases in the Individual, Reinsurance and Institutional segments, partially offset by increases in the International and Auto & Home segments. The decline in the Individual segment is predominately the result of refinements in the calculation of estimated gross margins and profits, as well as the impact of a product replacement program for universal life policies initiated in the first quarter of 2000. The decrease in Reinsurance is primarily due to fluctuations in allowances paid to ceding companies as a result of a change in product mix. The decrease in the Institutional segment is primarily attributable to a reduction of amortization in the defined contribution business. The increases in the International and Auto & Home segments are consistent with the growth in those businesses. Income tax expense for the nine months ended September 30, 2001 was $390 million, or 34% of income before provision for income taxes, compared with $387 million, or 52%, for the comparable 2000 period. The 2001 effective tax rate differs from the corporate tax rate of 35% primarily due to the impact of non-taxable investment income. The 2000 effective tax rate differs from the corporate tax rate of 35% primarily due to the payments made in the second quarter of 2000 to former Canadian policyholders in connection with the demutualization, the impact of surplus tax and a reduction in prior year taxes on capital gains recorded in the third quarter of 2000. This reduction is associated with the previous sale of a business. Prior to its demutualization, the Company was subject to surplus tax imposed on mutual life insurance companies under Section 809 of the Internal Revenue Code. The surplus tax results from the disallowance of a portion of a mutual life insurance company's policyholder dividends as a deduction from taxable income. 30
INDIVIDUAL SEGMENT The following table presents summary consolidated financial information for the Individual segment for the periods indicated: <TABLE> <CAPTION> FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- --------------------- 2001 2000 2001 2000 -------- -------- -------- -------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> REVENUES Premiums $ 1,093 $ 1,140 $ 3,306 $ 3,393 Universal life and investment-type product policy fees 319 300 942 920 Net investment income 1,625 1,590 4,886 4,766 Other revenues 119 166 384 477 Net investment losses (43) (41) (157) (98) -------- -------- -------- -------- Total revenues 3,113 3,155 9,361 9,458 -------- -------- -------- -------- EXPENSES Policyholder benefits and claims 1,297 1,233 3,773 3,642 Interest credited to policyholder account balances 445 422 1,333 1,250 Policyholder dividends 441 428 1,327 1,303 Other expenses 714 802 2,245 2,445 -------- -------- -------- -------- Total expenses 2,897 2,885 8,678 8,640 -------- -------- -------- -------- Income before provision for income taxes 216 270 683 818 Provision for income taxes 79 103 265 296 -------- -------- -------- -------- Net income $ 137 $ 167 $ 418 $ 522 ======== ======== ======== ======== </TABLE> THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2000 - INDIVIDUAL SEGMENT Premiums decreased by $47 million, or 4%, to $1,093 million for the three months ended September 30, 2001 from $1,140 million for the comparable 2000 period. Premiums from insurance products declined by $35 million. This decrease is primarily due to a decline in sales of traditional life insurance policies, which reflects a continued shift in customer preference from those policies to variable life products. Premiums from annuity and investment-type products decreased by $12 million, due to lower sales of supplementary contracts with life contingencies and single premium immediate annuity business. Universal life and investment-type product policy fees increased by $19 million, or 6%, to $319 million for the three months ended September 30, 2001 from $300 million for the comparable 2000 period. Policy fees from insurance products rose by $51 million. This growth is due to cost of insurance charges, which typically increase as the value of average separate account asset balances supporting the underlying minimum death benefit decline. Increased volume at a wholly-owned subsidiary, MetLife Advisors, LLC, also contributed to the variance. During the second quarter of 2001, the operations of MetLife Advisors LLC were expanded to include all distribution channels and all variable-type products. In the comparable 2000 period, a portion of the fees generated by this subsidiary were included in the annuities line of business. Policy fees from annuity and investment-type products decreased by $32 million, resulting from a lower average separate account asset base and the aforementioned fees associated with MetLife Advisors, LLC. Policy fees from annuity and investment-type products are typically calculated as a percentage of average assets. Such assets can fluctuate depending on equity market performance. If average separate account asset levels continue to remain below prior year levels, management expects fees will continue to be adversely impacted. Other revenues decreased by $47 million, or 28%, to $119 million for the three months ended September 30, 2001 from $166 million for the comparable 2000 period, primarily due to reduced commission and fee income associated with lower sales in the broker/dealer and other subsidiaries. Policyholder benefits and claims increased by $64 million, or 5%, to $1,297 million for the three months ended September 30, 2001 from $1,233 million for the comparable 2000 period. Policyholder benefits and claims for insurance products increased by $69 million. This increase is primarily due to an increase in the liabilities for future policy benefits commensurate with growth in general account policyholder account balances. In addition, $24 million in liabilities and claims associated with the September 11, 31
2001 tragedies and an increase of $13 million in the policyholder dividend obligation contributed to this variance. This increase is partially offset by a decline in policyholder benefits and claims for annuity and investment-type products commensurate with the decline in premiums mentioned above. Interest credited to policyholder account balances increased by $23 million, or 5%, to $445 million for the three months ended September 30, 2001 from $422 million for the comparable 2000 period. Interest on insurance products rose by $16 million, primarily due to growth in policyholder account balances. Interest on annuity and investment-type products increased by $7 million, due to growth in policyholder account balances from sales of products with a dollar cost averaging-type feature. Policyholder dividends increased by $13 million, or 3%, to $441 million for the three months ended September 30, 2001 from $428 million for the comparable 2000 period. This change is reflective of the growth in the assets supporting policies associated with this segment's aging block of traditional life insurance business. Other expenses declined by $88 million, or 11%, to $714 million for the three months ended September 30, 2001 from $802 million for the comparable 2000 period. Excluding the capitalization and amortization of deferred policy acquisition costs that are discussed below, other expenses decreased by $65 million, or 8%, to $781 million in 2001 from $846 million in 2000. Other expenses related to insurance products are lower by $74 million due to reductions in (i) volume-related commission expenses in the broker/dealer and other subsidiaries, (ii) rebate expenses associated with the Company's securities lending program, which are more than offset in net investment income, (iii) lower direct spending on compensation and benefits associated with a reduction in headcount, and (iv) lower direct spending on travel, printing and advertising. These decreases are partially offset by severance costs of $12 million. Other expenses related to annuity and investment-type products increased by $9 million primarily as a result of start-up and transition costs associated with the expansion of one of the annuity distribution channels. Deferred policy acquisition costs and value of business acquired are principally amortized in proportion to gross margins or gross profits, including investment gains or losses. The amortization is allocated to investment gains and losses to provide consolidated statement of income information regarding the impact of investment gains and losses on the amount of the amortization, and to other expenses to provide amounts related to gross margins or profits originating from transactions other than investment gains and losses. Capitalization of deferred policy acquisition costs decreased by $6 million, or 3%, to $221 million for the three months ended September 30, 2001 from $227 million for the comparable 2000 period. Capitalization related to insurance products declined by $12 million due to lower sales of traditional life insurance policies. This was offset by an increase of $6 million in annuity and investment-type products largely due to higher sales from new product offerings during 2001. Total amortization of deferred policy acquisition costs decreased by $28 million, or 15%, to $155 million in 2001 from $183 million in 2000. Amortization of deferred policy acquisition costs of $154 million and $183 million is allocated to other expenses in 2001 and 2000, respectively, while the remainder of the amortization in each year is allocated to investment gains and losses. Amortization of deferred policy acquisition costs allocated to other expenses related to insurance products declined by $5 million due to refinements in the calculation of estimated gross margins and profits. Amortization of deferred policy acquisition costs allocated to other expenses related to annuity and investment-type products is lower by $24 million. This variance is predominately the result of refinements implemented in the third quarter of 2001 relating to the estimation of future market performance in determining estimated gross profits. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2000 - INDIVIDUAL SEGMENT Premiums decreased by $87 million, or 3%, to $3,306 million for the nine months ended September 30, 2001 from $3,393 million for the comparable 2000 period. Premiums from insurance products declined by $79 million. This decrease is primarily due to lower sales of traditional life insurance policies, which reflects a continued shift in customer preference from those policies to variable life products. Premiums from annuity and investment-type products declined by $8 million, due to lower sales of supplementary contracts with life contingencies and single premium immediate annuity business. Universal life and investment-type product policy fees increased by $22 million, or 2%, to $942 million for the nine months ended September 30, 2001 from $920 million for the comparable 2000 period. Policy fees from insurance products rose by $102 million. This growth is due to cost of insurance charges, which typically increase as the value of average separate account asset balances supporting the underlying minimum death benefit decline. Increased volume at a wholly-owned subsidiary, MetLife Advisors LLC, also contributed to the variance. During the second quarter of 2001, the operations of this subsidiary were expanded to include all distribution channels and all variable-type products. In the comparable 2000 period, a portion of the fees generated by MetLife Advisors LLC were included in the annuities line of business. Policy fees from annuity and investment-type products decreased by $80 million, primarily resulting from a lower average separate account asset base and the aforementioned fees associated with MetLife 32
Advisors, LLC. Policy fees from annuity and investment-type products are typically calculated as a percentage of average assets. Such assets can fluctuate depending on equity market performance. If average separate account asset levels continue to remain below prior year levels, management expects fees will continue to be adversely impacted. Other revenues decreased by $93 million, or 19%, to $384 million for the nine months ended September 30, 2001 from $477 million for the comparable 2000 period, primarily due to reduced commission and fee income associated with lower sales in the broker/dealer and other subsidiaries. Policyholder benefits and claims increased by $131 million, or 4%, to $3,773 million for the nine months ended September 30, 2001 from $3,642 million for the comparable 2000 period. Policyholder benefits and claims for insurance products rose by $142 million primarily due to an increase in the liabilities for future policy benefits commensurate with growth in general account policyholder account balances. In addition, increases of $49 million and $24 million in the policyholder dividend obligation and liabilities and claims associated with the September 11, 2001 tragedies, respectively, contributed to the variance. Partially offsetting these variances is a reduction of $11 million in policyholder benefits and claims for annuity and investment products. This decline is commensurate with the decrease in premiums mentioned above. Interest credited to policyholder account balances rose by $83 million, or 7%, to $1,333 million for the nine months ended September 30, 2001 from $1,250 million for the comparable 2000 period. Interest on insurance products increased by $54 million, primarily due to growth in policyholder account balances. Interest on annuity and investment products grew by $29 million due to slightly higher crediting rates and higher policyholder account balances stemming from sales of products with a dollar cost averaging-type feature. Policyholder dividends increased by $24 million, or 2%, to $1,327 million for the nine months ended September 30, 2001 from $1,303 million for the comparable 2000 period. This is largely attributable to the growth in the assets supporting policies associated with this segment's aging block of traditional life insurance business. Other expenses decreased by $200 million, or 8%, to $2,245 for the nine months ended September 30, 2001 from $2,445 million for the comparable 2000 period. Excluding the capitalization and amortization of deferred policy acquisition costs that are discussed below, other expenses are reduced by $87 million, or 3%, to $2,399 million in 2001 from $2,486 million in 2000. Other expenses related to insurance products decreased by $116 million due to lower (i) volume-related commission expenses in the broker/dealer and other subsidiaries, (ii) rebate expenses associated with the Company's securities lending program, which are more than offset in net investment income, (iii) direct spending on compensation and benefits associated with a reduction in headcount, and (iv) direct spending on travel, printing and advertising. These decreases are partially offset by severance costs of $12 million. Other expenses related to annuity and investment-type products increased by $29 million primarily as a result of increased start-up and transition costs associated with the expansion of one of the annuity distribution channels. Partially offsetting these variances are lower commissions, deferrable costs, and premium taxes from lower sales. Deferred policy acquisition costs and value of business acquired are principally amortized in proportion to gross margins or gross profits, including investment gains or losses. The amortization is allocated to investment gains and losses to provide consolidated statement of income information regarding the impact of investment gains and losses on the amount of the amortization, and to other expenses to provide amounts related to gross margins or profits originating from transactions other than investment gains and losses. Capitalization of deferred policy acquisition costs decreased by $29 million, or 4%, to $637 million for the nine months ended September 30, 2001 from $666 million for the comparable 2000 period. This decline is due to lower sales of traditional life insurance policies and annuity and investment-type products, resulting in reduced commissions and other deferrable expenses. Total amortization of deferred policy acquisition costs declined by $141 million, or 23%, to $467 million in 2001 from $608 million in 2000. Amortization of deferred policy acquisition costs of $483 million and $625 million is allocated to other expenses in 2001 and 2000, respectively, while the remainder of the amortization in each year is allocated to investment gains and losses. Amortization of deferred policy acquisition costs allocated to other expenses related to insurance products is lower by $119 million due to refinements in the calculation of estimated gross margins and profits. In addition, the impact of a product replacement program for universal life policies initiated in the first quarter of 2000 contributed to this variance. Amortization of deferred policy acquisition costs allocated to other expenses related to annuity and investment products declined by $23 million primarily due to refinements relating to the estimation of future market performance in determining estimated gross profits. 33
INSTITUTIONAL SEGMENT The following table presents summary consolidated financial information for the Institutional segment for the periods indicated: <TABLE> <CAPTION> FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------- -------- -------- -------- 2001 2000 2001 2000 -------- -------- -------- -------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> REVENUES Premiums $ 1,896 $ 1,678 $ 5,503 $ 5,055 Universal life and investment-type product policy fees 139 135 443 408 Net investment income 1,028 1,020 3,112 2,902 Other revenues 155 157 485 501 Net investment losses (37) (175) (154) (216) -------- -------- -------- -------- Total revenues 3,181 2,815 9,389 8,650 -------- -------- -------- -------- EXPENSES Policyholder benefits and claims 2,438 2,001 6,632 6,017 Interest credited to policyholder account balances 249 289 770 803 Policyholder dividends 91 15 195 96 Other expenses 406 444 1,298 1,259 -------- -------- -------- -------- Total expenses 3,184 2,749 8,895 8,175 -------- -------- -------- -------- Income (Loss) before provision (benefit) for income taxes (3) 66 494 475 Provision (Benefit) for income taxes (12) 18 163 166 -------- -------- -------- -------- Net income $ 9 $ 48 $ 331 $ 309 ======== ======== ======== ======== </TABLE> THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2000 - INSTITUTIONAL SEGMENT Premiums increased by $218 million, or 13%, to $1,896 million for the three months ended September 30, 2001 from $1,678 million for the comparable 2000 period. Group insurance premiums rose by $224 million, due, in most part, to sales growth and continued favorable policyholder retention in this segment's dental, disability and long-term care businesses. Significant premiums received from several existing group life customers in 2001 also contributed to this variance. Retirement and savings premiums decreased $6 million, as a result of higher premiums received in 2000 from several existing customers. Universal life and investment-type product policy fees increased by $4 million, or 3%, to $139 million for the three months ended September 30, 2001 from $135 million for the comparable 2000 period. This rise in fees reflects growth in sales and deposits in group universal life products resulting from a change in customer preference for group universal life over optional term life products. Other revenues decreased by $2 million, or 1%, to $155 million for the three months ended September 30, 2001 from $157 million for the comparable 2000 period. Retirement and savings' other revenues fell by $13 million as a consequence of a depressed equity market, which led to lower fees on index-guaranteed separate accounts. Index-guaranteed separate accounts have been discontinued in the fourth quarter of 2001, and consequently, a continued decline in fees relating to this product should be expected. This decline is partially offset by an $11 million increase stemming from sales growth in this segment's dental and disability administrative businesses. This growth is dampened by an $11 million final settlement on several cases in 2000 relating to Metropolitan Life's former medical business. Policyholder benefits and claims increased by $437 million, or 22%, to $2,438 million for the three months ended September 30, 2001 from $2,001 million for the comparable 2000 period. Group insurance expenses grew by $427 million primarily due to $291 million in claims related to the September 11, 2001 tragedies. The balance of the group variance is largely attributable to growth in this segment's group life, dental, disability and long-term care insurance businesses, commensurate with the premium variance discussed above. The continued accumulation of interest on liabilities relating to this segment's large block of non-participating annuity business accounted for the majority of a $10 million increase in retirement and savings. 34
Interest credited to policyholders decreased by $40 million, or 14%, to $249 million for the three months ended September 30, 2001 from $289 million for the comparable 2000 period. An overall decline in crediting rates in 2001 as a result of the current interest rate environment is mostly responsible for reductions of $18 million and $22 million in group life and retirement and savings, respectively. Policyholder dividends increased by $76 million, or 507%, to $91 million for the three months ended September 30, 2001 from $15 million for the comparable 2000 period. The rise in dividends is primarily attributable to favorable experience on a large group life participating contract in 2001. Policyholder dividends vary from period to period based on participating contract experience. Other expenses decreased by $38 million, or 9%, to $406 million for the three months ended September 30, 2001 from $444 million in the comparable 2000 period. Other expenses related to retirement and savings fell by $54 million as a result of expense management initiatives and lower rebate expenses associated with the Company's securities lending program. The income associated with securities lending activity is included in net investment income. This expense decline is partially offset by a $16 million increase in group insurance expenses, stemming from higher non-deferrable variable expenses associated with premium growth. Non-deferrable variable expenses include premium taxes, commissions and administrative expenses for the dental and disability businesses. The effective income tax rate for the three months ended September 30, 2001 differs from the corporate tax rate of 35% primarily due to the impact of tax-preferred investment income. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2000 - INSTITUTIONAL SEGMENT Premiums increased by $448 million, or 9%, to $5,503 million for the nine months ended September 30, 2001 from $5,055 million for the comparable 2000 period. Group insurance premiums rose by $635 million, due, in most part, to sales growth and continued favorable policyholder retention in this segment's dental, disability and long-term care businesses. In addition, significant premiums received from several existing group life customers in 2001 and the BMA acquisition contributed to this variance. This growth is reduced by the impact of $101 million in additional insurance coverage purchased in 2000 by existing customers with funds received in the demutualization. Retirement and savings premiums decreased $187 million, as a result of higher premiums received in 2000 from several existing customers. Universal life and investment-type product policy fees increased by $35 million, or 9%, to $443 million for the nine months ended September 30, 2001 from $408 million for the comparable 2000 period. This rise in fees reflects growth in sales and deposits in group universal life and corporate-owned life insurance products. Higher fees in group universal life products represent a change in customer preference for group universal life over optional term life products. The increase in corporate-owned life insurance represents a significant deposit received in 2001 from an existing customer. Other revenues decreased by $16 million, or 3%, to $485 million for the nine months ended September 30, 2001 from $501 million for the comparable 2000 period. Retirement and savings' other revenues fell by $19 million predominately as a consequence of a depressed equity market, which led to lower fees on index-guaranteed separate accounts. Index-guaranteed separate accounts have been discontinued in the fourth quarter of 2001, and consequently, a continued decline in fees relating to this product should be expected. In addition, a large withdrawal by an existing customer contributed to this variance. This decline is partially offset by a $3 million rise in other revenues stemming from sales growth in this segment's dental and disability administrative businesses and higher management fees from group life and long-term care separate accounts. This increase is partially offset by final settlements in 2000 on several cases related to the term life and former medical business. Policyholder benefits and claims increased by $615 million, or 10%, to $6,632 million for the nine months ended September 30, 2001 from $6,017 million for the comparable 2000 period. Group insurance expenses grew by $800 million, primarily due to $291 million in claims related to the September 11, 2001 tragedies. The balance of the increase is largely attributable to growth in this segment's group life, dental, disability and long-term care insurance businesses, commensurate with the premium variance discussed above. Partially offsetting this increase is a $185 million decline in retirement and savings, commensurate with the premium variance discussed above. Interest credited to policyholders decreased by $33 million, or 4%, to $770 million for the nine months ended September 30, 2001 from $803 million for the comparable 2000 period. A $4 million decline in group life is largely attributable to an overall decline in crediting rates in 2001 as a result of the current interest rate environment. The expense savings in group life was partially dampened by an increase in average customer account balances stemming from asset growth, resulting in $19 million in additional expenses. 35
Retirement and savings decreased $29 million due to an overall decline in crediting rates in 2001 as a result of the current interest rate environment. Policyholder dividends increased by $99 million, or 103%, to $195 million for the nine months ended September 30, 2001 from $96 million for the comparable 2000 period. The rise in dividends is primarily attributable to favorable experience on a large group life participating contract in 2001. Policyholder dividends vary from period to period based on participating contract experience. Other expenses increased by $39 million, or 3%, to $1,298 million for the nine months ended September 30, 2001 from $1,259 million in the comparable 2000 period. Group insurance expenses grew by $94 million due primarily to costs incurred in connection with initiatives focused on improving service delivery through investments in technology and higher rebate expenses associated with the Company's securities lending program. The income associated with securities lending activity is included in net investment income. In addition, a rise in non-deferrable variable expenses associated with premium growth contributed to the group insurance variance. Non-deferrable variable expenses include premium taxes, commissions and administrative expenses for the dental and disability businesses. Other expenses related to retirement and savings decreased by $55 million as a result of expense management initiatives and lower rebate expenses associated with the Company's securities lending program. 36
REINSURANCE SEGMENT The following table presents summary consolidated financial information for the Reinsurance segment for the periods indicated: <TABLE> <CAPTION> FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------- -------- -------- -------- 2001 2000 2001 2000 -------- -------- -------- -------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> REVENUES Premiums $ 392 $ 327 $ 1,197 $ 1,055 Net investment income 103 95 288 278 Other revenues 12 9 28 20 Net investment (losses) gains (12) 2 2 (1) -------- -------- -------- -------- Total revenues 495 433 1,515 1,352 -------- -------- -------- -------- EXPENSES Policyholder benefits and claims 318 271 972 845 Interest credited to policyholder account balances 36 28 84 79 Policyholder dividends 5 5 16 15 Other expenses 106 81 309 279 -------- -------- -------- -------- Total expenses 465 385 1,381 1,218 -------- -------- -------- -------- Income before provision for income taxes 30 48 134 134 Provision for income taxes 4 11 30 33 Minority interest 17 21 56 57 -------- -------- -------- -------- Net income $ 9 $ 16 $ 48 $ 44 ======== ======== ======== ======== </TABLE> THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2000 - REINSURANCE SEGMENT Premiums increased by $65 million, or 20%, to $392 million for the three months ended September 30, 2001 from $327 million for the comparable 2000 period. New premiums from facultative and automatic treaties and renewal premiums on existing blocks of business all contributed to the premium growth. Premium levels are significantly influenced by large transactions and reporting practices of ceding companies and, as a result, can fluctuate from period to period. Other revenues increased by $3 million, or 33%, to $12 million for the three months ended September 30, 2001 from $9 million for the comparable 2000 period. Other revenues can fluctuate period to period depending on the level of earned fees on financial reinsurance. Financial reinsurance agreements represent low mortality risk business, which is assumed and subsequently retroceded. The net fee earned is recorded in other revenues. Policyholder benefits and claims increased by $47 million, or 17%, to $318 million for the three months ended September 30, 2001 from $271 million for the comparable 2000 period. Claims experience for the three months ended September 30, 2001 include claims arising from the September 11, 2001 tragedies of approximately $16 million, net of amounts recoverable from reinsurers and before minority interest adjustments. This amount represents the best estimate of the Reinsurance segment's ultimate exposure to the September 11, 2001 tragedies claims development to date, however it will take several more months before claims are fully developed and therefore this estimate is subject to change. Mortality is expected to vary from period to period, but generally remains fairly constant over the long-term. Interest credited to policyholder account balances increased by $8 million, or 29%, to $36 million for the three months ended September 30, 2001 from $28 million for the comparable 2000 period. Interest credited to policyholder account balances relates to amounts credited on deposit-type contracts and certain cash value contracts. The increase is primarily related to an increase in the interest credited on a certain block of annuities, the crediting rate of which is based on the performance of the underlying assets. 37
Therefore, any fluctuations in interest credited related to this block is generally offset by a corresponding change in net investment income. Additionally, interest credited to policyholder account balances includes amounts credited to a block of single premium deferred annuity contracts reinsured during the third quarter of 2001. Policyholder dividends are unchanged at $5 million for the three months ended September 30, 2001 and 2000. Other expenses increased by $25 million, or 31%, to $106 million for the three months ended September 30, 2001 from $81 million for the comparable 2000 period. An increase in allowances paid under reinsurance treaties is the primary contributor to the increase in other expenses. Other expenses, which include underwriting, acquisition and insurance expenses, were 21% of consolidated revenues in 2001 compared with 19% in 2000. This percentage fluctuates depending on the mix of the underlying insurance products being reinsured. Minority interest reflects third-party ownership interests in Reinsurance Group of America, Incorporated. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2000 - REINSURANCE SEGMENT Premiums increased by $142 million, or 13%, to $1,197 million for the nine months ended September 30, 2001 from $1,055 million for the comparable 2000 period. New premiums from facultative and automatic treaties and renewal premiums on existing blocks of business all contributed to the premium growth. Premium levels are significantly influenced by large transactions and reporting practices of ceding companies and, as a result, can fluctuate from period to period. Other revenues increased by $8 million, or 40%, to $28 million for the nine months ended September 30, 2001 from $20 million for the comparable 2000 period. This increase is primarily due to the acquisition during the second half of 2000 of the remaining 60% of RGA/Swiss Financial Group, L.L.C., which was subsequently renamed RGA Financial Group, L.L.C. ("RGA Financial Group"). Policyholder benefits and claims increased by $127 million, or 15%, to $972 million for the nine months ended September 30, 2001 from $845 million for the comparable 2000 period. Policyholder benefits and claims were 81% of premiums in 2001 compared with 80% in 2000. Claims arising from the September 11, 2001 tragedies, of approximately $16 million, net of amounts recoverable from reinsurers and before minority interest adjustments, and unfavorable mortality experience, primarily in the U.S. traditional business, during the first quarter of 2001 contributed to the increase in policy benefits and claims as a percentage of premiums. Mortality is expected to vary from period to period, but generally remains fairly constant over the long term. Analysis of the claims activity during the nine months ended September 30, 2001 suggested no significant variances by cause of death, client company, or issue year which would indicate any pricing or profitability problems. Interest credited to policyholder account balances increased by $5 million, or 6%, to $84 million for the nine months ended September 30, 2001 from $79 million for the comparable 2000 period. Interest credited to policyholder account balances relates to amounts credited on deposit-type contracts and certain cash value products. The increase is primarily related to an increase in the interest credited on newly assumed and previously existing blocks of annuities whose crediting rate is based on the performance of the underlying assets. Therefore, any fluctuations in interest credited related to these blocks are generally offset by a corresponding change in net investment income. Policyholder dividends are essentially unchanged at $16 million for the nine months ended September 30, 2001 versus $15 million for the comparable 2000 period. Other expenses increased by $30 million, or 11%, to $309 million for the nine months ended September 30, 2001 from $279 million for the comparable 2000 period. Other expenses, which include underwriting, acquisition and insurance expenses, were 20% of consolidated revenues in 2001 compared with 21% in 2000. This percentage fluctuates depending on the mix of the underlying insurance products being reinsured as the amount paid can vary significantly based on the type of business and the reinsurance treaty. The acquisition of RGA Financial Group during the second half of 2000 contributed to the overall increase in other expenses. Minority interest reflects third-party ownership interests in Reinsurance Group of America, Incorporated. 38
AUTO & HOME SEGMENT The following table presents summary consolidated financial information for the Auto & Home segment for the periods indicated: <TABLE> <CAPTION> FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------- -------- -------- -------- 2001 2000 2001 2000 -------- -------- -------- -------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> REVENUES Premiums $ 692 $ 664 $ 2,047 $ 1,965 Net investment income 48 49 150 132 Other revenues 6 5 18 23 Net investment losses -- (6) (6) -- -------- -------- -------- -------- Total revenues 746 712 2,209 2,120 -------- -------- -------- -------- EXPENSES Policyholder benefits and claims 512 485 1,605 1,495 Other expenses 206 230 613 637 -------- -------- -------- -------- Total expenses 718 715 2,218 2,132 -------- -------- -------- -------- Income (Loss) before provision for income taxes 28 (3) (9) (12) Provision (Benefit) for income taxes 6 (9) (14) (17) -------- -------- -------- -------- Net income $ 22 $ 6 $ 5 $ 5 ======== ======== ======== ======== </TABLE> THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2000 - AUTO & HOME SEGMENT Premiums increased by $28 million, or 4%, to $692 million for the three months ended September 30, 2001 from $664 million for the comparable 2000 period. Auto premiums grew by $27 million primarily due to higher average premiums resulting from rate increases. Property premiums were unchanged, as the impact of rate increases has been entirely offset by a decrease in retention resulting from certain underwriting actions. Premiums from other personal lines improved by $1 million. Other revenues were essentially unchanged at $6 million for the three months ended September 30, 2001 as compared to $5 million for the three months ended September 30, 2000. Policyholder benefits and claims increased by $27 million, or 6%, to $512 million for the three months ended September 30, 2001 from $485 million for the comparable 2000 period. Auto policyholder benefits and claims are higher by $27 million due to growth in the business and increased average claim costs. Property policyholder benefits and claims declined by $3 million due to decreased catastrophes, partially offset by increases in severity and non-catastrophe weather related losses. The property loss ratio decreased to 78.0% in 2001 from 78.6% in 2000. Catastrophes represented 7.8% of the loss ratio in 2001 compared to 24.2% in 2000. Other policyholder benefits and claims increased by $3 million. Other expenses decreased by $24 million, or 10%, to $206 million, for the three months ended September 30, 2001, from $230 million for the comparable 2000 period. This variance is primarily the result of a reduction in integration costs associated with the St. Paul acquisition. The expense ratio decreased to 29.6% in 2001 from 34.6% in 2000. The effective income tax rates for the three months ended September 30, 2001 and 2000 differ from the corporate tax rate of 35% due to the impact of non-taxable investment income. 39
NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2000 - AUTO & HOME SEGMENT Premiums grew by $82 million, or 4%, to $2,047 million for the nine months ended September 30, 2001 from $1,965 million for the comparable 2000 period. Auto and property premiums improved by $71 million and $11 million, respectively, primarily due to higher average premiums resulting from rate increases. Premiums from other personal lines were unchanged at $33 million for both the nine months ended September 30, 2001 and 2000. Other revenues decreased by $5 million, or 22%, to $18 million for the nine months ended September 30, 2001 from $23 million for the comparable 2000 period. This decline was primarily due to the revision of an estimate for a reinsurance recoverable, related to the disposition of this segment's reinsurance business in 1990, recorded in the first quarter of 2000. Policyholder benefits and claims increased by $110 million, or 7%, to $1,605 million for the nine months ended September 30, 2001 from $1,495 million for the comparable 2000 period. Auto policyholder benefits and claims increased by $65 million due to inflationary pressures on claim severity and growth in the business. Correspondingly, the auto loss ratio was 75.4% in 2001 as compared to 74.6% in 2000. Property policyholder benefits and claims increased by $33 million due to higher non-catastrophe weather related losses in 2001, partially offset by a decline in catastrophe losses. The property loss ratio rose to 87.2% in 2001 from 82.0% in 2000. Catastrophes represented 16.0% of the loss ratio in 2001 compared to 20.0% in 2000. Other policyholder benefits and claims grew by $12 million, primarily due to an increase in high liability personal umbrella claims. This segment tends to be very volatile in the shorter-term versus a longer-term business cycle due to low premium volume and high liability limits. Other expenses decreased by $24 million, or 4%, to $613 million for the nine months ended September 30, 2001 from $637 million for the comparable period in 2000 due to a reduction in integration costs associated with the St. Paul acquisition. The expense ratio declined to 29.9% in 2001 from 32.4% in 2000. The effective income tax rates for the nine months ended September 30, 2001 and 2000 differ from the corporate tax rate of 35% due to the impact of non-taxable investment income. 40
ASSET MANAGEMENT SEGMENT The following table presents summary consolidated financial information for the Asset Management segment for the periods indicated: <TABLE> <CAPTION> FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- -------------------- 2001 2000 2001 2000 -------- -------- -------- -------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> REVENUES Net investment income $ 18 $ 21 $ 54 $ 63 Other revenues 42 217 154 651 Net investment gains 25 -- 25 -- ------ ------ ------ ------ Total revenues 85 238 233 714 ------ ------ ------ ------ OTHER EXPENSES 56 213 194 625 ------ ------ ------ ------ Income before provision for income taxes and minority interest 29 25 39 89 Provision for income taxes 11 6 14 24 Minority interest -- 10 -- 34 ------ ------ ------ ------ Net income $ 18 $ 9 $ 25 $ 31 ====== ====== ====== ====== </TABLE> THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2000 - ASSET MANAGEMENT SEGMENT Other revenues, which primarily comprise management and advisory fees, decreased by $175 million, or 81%, to $42 million in 2001 from $217 million in 2000. The most significant factors contributing to this decline are the sales of Nvest and Conning which occurred on October 30, 2000 and July 2, 2001, respectively. These events reduced other revenues by $155 million and $19 million, respectively. Excluding the impact of these two transactions, other revenues decreased by $1 million, or 2%, to $42 million in 2001 from $43 million in 2000. This is attributable to lower average assets under management during the period. Assets under management decreased to $51 billion as of September 30, 2001 from $58 billion as of September 30, 2000. The decline in assets under management occurred as a result of the downturn in the equity market and Institutional customer withdrawals of fixed income investments. The impact of these events is partially mitigated by higher assets under management resulting from increased equity mutual fund sales and the acquisition of the management of a $2 billion real estate portfolio in the first half of 2001. Management and advisory fees are typically calculated based on a percentage of assets under management, and are not necessarily proportionate to average assets managed due to changes in account mix. Other expenses decreased by $157 million, or 74%, to $56 million in 2001 from $213 million in 2000. The sales of Nvest and Conning reduced other expenses by $137 million and $22 million, respectively. Excluding the impact of these transactions, other expenses increased slightly to $56 million in 2001 from $54 million in 2000, due to additions of distribution and servicing employees to build infrastructure for future growth. Minority interest, principally reflecting third-party ownership interest in Nvest, decreased by $10 million, or 100%, due to the sale of Nvest. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2000 - ASSET MANAGEMENT SEGMENT Other revenues, which primarily comprise management and advisory fees, decreased by $497 million, or 76%, to $154 million in 2001 from $651 million in 2000. The most significant factors contributing to this decline are the sales of Nvest and Conning. These events reduced other revenues by $472 million and $30 million, respectively. Excluding the impact of these transactions, other revenues increased by $5 million, or 4%, to $123 million in 2001 from $118 million in 2000, primarily due to higher assets under management resulting from increased equity mutual fund sales and 41
the acquisition of the management of a $2 billion real estate portfolio in the first half of 2001. Management and advisory fees are typically calculated based on a percentage of assets under management, and are not necessarily proportionate to average assets managed due to changes in account mix. Other expenses decreased by $431 million, or 69%, to $194 million in 2001 from $625 million in 2000. The sales of Nvest and Conning reduced other expenses by $409 million and $33 million, respectively. Excluding the impact of these transactions, other expenses increased by $11 million, or 7%, to $160 million in 2001 from $149 million in 2000. This variance is attributable to an additional $8 million in compensation and benefits expense due to addition of distribution and servicing employees to build infrastructure for future growth. In addition, other general and administrative expenses increased by $3 million, or 4%, to $76 million in 2001 from $73 million in 2000, primarily due to a rise in discretionary expenses. Minority interest, principally reflecting third-party ownership interest in Nvest, decreased by $34 million, or 100%, due to the sale of Nvest. 42
INTERNATIONAL SEGMENT The following table presents summary consolidated financial information for the International segment for the periods indicated: <TABLE> <CAPTION> FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> REVENUES Premiums $ 210 $ 162 $ 583 $ 481 Universal life and investment-type product policy fees 8 15 28 39 Net investment income 63 62 189 190 Other revenues 4 2 10 7 Net investment (losses) gains (9) 1 19 9 -------- -------- -------- -------- Total revenues 276 242 829 726 -------- -------- -------- -------- EXPENSES Policyholder benefits and claims 158 139 463 411 Interest credited to policyholder account balances 15 15 41 43 Policyholder dividends 10 9 29 24 Payments to former Canadian policyholders -- -- -- 327 Other expenses 84 67 227 205 -------- -------- -------- -------- Total expenses 267 230 760 1,010 -------- -------- -------- -------- Income (Loss) before provision for income taxes 9 12 69 (284) Provision for income taxes 4 5 10 12 -------- -------- -------- -------- Net income (loss) $ 5 $ 7 $ 59 $ (296) ======== ======== ======== ======== </TABLE> THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2000 - INTERNATIONAL SEGMENT Premiums increased by $48 million, or 30%, to $210 million for the three months ended September 30, 2001 from $162 million for the comparable 2000 period. Mexico's premiums grew by $24 million due to additional sales in group life and individual life products. Protection-type product sales fostered by the continued expansion of the professional sales force in South Korea mostly accounted for an additional $10 million in premiums. Higher individual life sales resulting from anticipated price increases spurred an additional $10 million in Taiwanese premiums. A $3 million increase in Spain's premiums is primarily due to the continued growth in the direct auto business. The remainder of the variance is attributable to minor fluctuations in several countries. Universal life and investment-type product policy fees decreased by $7 million, or 47%, to $8 million for the three months ended September 30, 2001 from $15 million for the comparable 2000 period. This decline is largely attributable to a reduction in fees in Spain resulting from a decrease in assets under management. This is a result of a planned cessation of product lines offered through a joint venture with Banco Santander. Other revenues increased by $2 million, or 100%, to $4 million for the three months ended September 30, 2001 from $2 million for the comparable 2000 period. Spain's other revenues rose by $1 million due largely to an outsourcing agreement with Banco Santander for the use of space and software during the planned termination of the joint venture discussed above. The remainder of the increase is attributable to minor variances in several countries. Policyholder benefits and claims increased by $19 million, or 14%, to $158 million for the three months ended September 30, 2001 from $139 million for the comparable 2000 period. Mexico's, Taiwan's and South Korea's policyholder benefits and claims grew by $20 million, $6 million and $5 million, respectively, commensurate with the overall premium variance discussed above. Policyholder benefits and claims decreased by $10 million in Spain. This decline is a result of a planned cessation of product lines offered through the joint venture discussed above. The remainder of the variance is attributable to minor fluctuations in several countries. 43
Interest credited to policyholder account balances remained unchanged at $15 million for the three months ended September 30, 2001 and 2000. Policyholder dividends increased by $1 million, or 11%, to $10 million for the three months ended September 30, 2001 from $9 million for the comparable 2000 period, largely due to the aforementioned growth in Mexico's group life sales. Other expenses increased by $17 million, or 25%, to $84 million for the three months ended September 30, 2001 from $67 million in the comparable 2000 period. Advertising expenses and investments in technology are the primary contributors to a $7 million rise in Spain's expenses. South Korea's, Mexico's, and Taiwan's other expenses increased by $6 million, $2 million and $2 million, respectively, primarily due to growth in business in these countries. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2000 - INTERNATIONAL SEGMENT Premiums increased by $102 million, or 21%, to $583 million for the nine months ended September 30, 2001 from $481 million for the comparable 2000 period. Mexico's premiums grew by $51 million due to additional sales in group life and individual life products. Protection-type product sales fostered by the continued expansion of the professional sales force in South Korea mostly accounted for an additional $26 million in premiums. Spain's premiums rose by $15 million primarily due to continued growth in the direct auto business. Higher individual life sales resulting from anticipated price increases spurred an additional $13 million in Taiwanese premiums. The remainder of the variance is attributable to minor fluctuations in several countries. Universal life and investment-type product policy fees decreased by $11 million, or 28%, to $28 million for the nine months ended September 30, 2001 from $39 million for the comparable 2000 period. This decline is primarily due to a reduction in fees in Spain attributable to a reduction in assets under management. This is a result of a planned cessation of product lines offered through a joint venture with Banco Santander. Other revenues increased by $3 million, or 43%, to $10 million for the nine months ended September 30, 2001 from $7 million for the comparable 2000 period due in large part to a $2 million adjustment resulting from the required accounting for foreign currency translation fluctuations in Indonesia, a highly inflationary economy. The remainder of the increase is attributable to minor variances in several countries. Policyholder benefits and claims increased by $52 million, or 13%, to $463 million for the nine months ended September 30, 2001 from $411 million for the comparable 2000 period. Mexico's, South Korea's and Taiwan's policyholder benefits and claims increased by $36 million, $14 million and $8 million, respectively, commensurate with the overall premium variance discussed above. These negative variances are partially offset by a $7 million decrease in Argentina's life sales as a result of a recession in that country. The remainder of the variance is attributable to minor fluctuations in several countries. Interest credited to policyholder account balances decreased by $2 million, or 5%, to $41 million for the nine months ended September 30, 2001 from $43 million for the comparable 2000 period. An overall decline in crediting rates in 2001 caused by the current interest rate environment is primarily responsible for a $5 million reduction in South Korea. Spain's interest credited dropped $4 million mostly due to a reduction in assets under management. This is a result of a planned cessation of product lines offered through a joint venture with Banco Santander. These negative variances were partially offset by a $3 million increase in Mexico, commensurate with the overall premium variance discussed above. The remainder of the variance is attributable to minor fluctuations in several countries. Policyholder dividends increased by $5 million, or 21%, to $29 million for the nine months ended September 30, 2001 from $24 million for the comparable 2000 period, largely due to the aforementioned growth in Mexico's group life sales. Other expenses increased by $22 million, or 11%, to $227 million for the nine months ended September 30, 2001 from $205 million in the comparable 2000 period. South Korea's and Mexico's other expenses grew by $11 million and $7 million, respectively, primarily due to the growth in business in these countries. Advertising expenses and investments in technology are the primary contributors to a $3 million rise in Spain's expenses. In addition, the introduction of a private pension product accounted for a $2 million rise in Argentina's other expenses. The remainder of the variance is attributable to minor fluctuations in several countries. 44
THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2000 - CORPORATE & OTHER Total revenues, which consist of net investment income, other revenues and net investment losses that are not allocated to other business segments, decreased by $3 million, or 4%, to $74 million for the three months ended September 30, 2001 from $77 million for the comparable 2000 period. Net investment income declined $18 million as a result of fewer sales in the underlying assets held in corporate limited partnerships. In addition, a $17 million decrease in other revenues contributed to this variance. The decrease in other revenues is due, in part, to the sale of NaviSys in 2000. These decreases are partially offset by a $31 million reduction in net investment losses in connection with the Company's strategy in 2000 to reposition its portfolio in order to provide a higher operating return on its invested assets. Total expenses decreased by $25 million, or 16%, to $127 million in 2001 from $152 million for the comparable 2000 period. The decrease in expenses is largely attributable to the sale of NaviSys in 2000, as well as an $11 million decrease in interest expense associated with a reduction in borrowing levels and a lower interest rate environment in 2001. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2000 - CORPORATE & OTHER Total revenues, which consist of net investment income, other revenues and net investment losses that are not allocated to other business segments, decreased by $52 million, or 19%, to $216 million for the nine months ended September 30, 2001 from $268 million for the comparable 2000 period. This variance is primarily due to a $46 million decrease in net investment income resulting principally from sales, in 2000, of underlying assets held in corporate limited partnerships. In addition, a $32 million reduction in other revenues associated with the sales of NaviSys and Farmers National in 2000, contributed to this variance. These decreases are partially offset by a $25 million reduction in net investment losses in connection with the Company's strategy in 2000 to reposition its portfolio in order to provide a higher operating return on its invested assets. Total expenses decreased by $237 million, or 37%, to $411 million in 2001 from $648 million for the comparable 2000 period. This decline is largely attributable to a $230 million decrease in expenses associated with the Company's demutualization, which was completed on April 7, 2000. LIQUIDITY AND CAPITAL RESOURCES THE HOLDING COMPANY The primary uses of liquidity of the Holding Company include the payment of common stock dividends, interest payments on debentures issued to MetLife Capital Trust I and other debt servicing, contributions to subsidiaries, payment of general operating expenses and the repurchase of the Company's common stock. The primary source of the Holding Company's liquidity is dividends it receives from Metropolitan Life and the interest received from Metropolitan Life under the capital note described in Note 9 of Notes to Consolidated Financial Statements for the year ended December 31, 2000 included in MetLife, Inc.'s Annual Report on Form 10-K filed with the SEC. In addition, sources of liquidity also include programs for short- and long-term borrowing, as needed, arranged through the Holding Company and MetLife Funding, Inc., a subsidiary of Metropolitan Life. In addition, the Holding Company filed a shelf registration statement, effective June 1, 2001, with the SEC which permits the registration and issuance of debt and equity securities as described more fully therein. See "--The Company -- Financing" below. The Company anticipates issuing debt securities under this registration statement by December 31, 2001. Under the New York Insurance Law, Metropolitan Life is permitted without prior insurance regulatory clearance to pay a stockholder dividend to the Holding Company as long as the aggregate amount of all such dividends in any calendar year does not exceed the lesser of (i) 10% of its surplus to policyholders as of the immediately preceding calendar year, and (ii) its statutory net gain from operations for the immediately preceding calendar year (excluding realized capital gains). Metropolitan Life will be permitted to pay a stockholder dividend to the Holding Company in excess of the lesser of such two amounts only if it files notice of its intention to declare such a dividend and the amount thereof with the New York Superintendent of Insurance (the "Superintendent") and the Superintendent does not disapprove the distribution. Under the New York Insurance Law, the Superintendent has broad discretion in determining whether the financial condition of a stock life insurance company would support the payment of such dividends to its stockholders. The New York Insurance Department has established informal guidelines for such determinations. The guidelines, among other things, focus on the insurer's overall financial condition and profitability under statutory accounting practices. Management of the Company cannot provide assurance that Metropolitan Life will have statutory earnings to support payment of dividends to the Holding Company in an amount sufficient to fund its cash requirements and pay cash dividends or that the Superintendent will not disapprove any dividends that Metropolitan Life must submit for the Superintendent's consideration. MetLife's other insurance subsidiaries are also subject to restrictions on the payment of dividends to their respective parent companies. 45
The dividend limitation is based on statutory financial results. Statutory accounting practices differ in certain respects from accounting principles used in financial statements prepared in conformity with accounting principles generally accepted in the United States of America. The significant differences relate to deferred policy acquisition costs, deferred income taxes, required investment reserves, reserve calculation assumptions, goodwill and surplus notes. In connection with the contribution of the net proceeds from the initial public offering, the private placements and the offering of equity security units in 2000, Metropolitan Life issued to the Holding Company a $1,006 million 8.00% mandatorily convertible capital note due 2005. The Superintendent approved the issuance of the capital note on April 4, 2000. If the payment of interest is prevented by application of the payment restrictions described in Note 9 in Notes to Consolidated Financial Statements for the year ended December 31, 2000 included in MetLife, Inc.'s Annual Report on Form 10-K filed with the SEC, the interest on the capital note will not be available as a source of liquidity for the Holding Company. Based on the historic cash flows and the current financial results of Metropolitan Life, subject to any dividend limitations which may be imposed upon Metropolitan Life or its subsidiaries by regulatory authorities, management believes that cash flows from operating activities, together with the dividends Metropolitan Life is permitted to pay without prior insurance regulatory clearance and the interest received on the capital note from Metropolitan Life will be sufficient to enable the Holding Company to make payments on the debentures issued to MetLife Capital Trust I, make dividend payments on its Common Stock, pay all operating expenses and meet its other obligations. On March 28, 2001, the Holding Company's Board of Directors authorized an additional $1 billion common stock repurchase program. This program began after the completion of an earlier $1 billion repurchase program that was announced on June 27, 2000. Under these authorizations, the Holding Company may purchase its common stock from the Metropolitan Life Policyholder Trust, in the open market and in privately negotiated transactions. During the nine months ended September 30, 2001, 34,889,811 shares of common stock have been acquired for $1,019 million. On August 7, 2001, the Company purchased 10 million shares of its common stock as part of the sale of 25 million shares of MetLife stock by Santusa Holdings, S.L., an affiliate of Banco Santander Central Hispano, S.A. The sale by Santusa Holdings, S.L. was made pursuant to a shelf registration statement, effective June 29, 2001. RESTRICTIONS AND LIMITATIONS ON BANK HOLDING COMPANIES AND FINANCIAL HOLDING COMPANIES - CAPITAL. MetLife, Inc. and its insured depository institution subsidiaries are subject to risk-based capital and leverage guidelines issued by the federal banking regulatory agencies for banks and financial holding companies. The federal banking regulatory agencies are required by law to take specific prompt corrective actions with respect to institutions that do not meet minimum capital standards. At September 30, 2001 MetLife, Inc. and its insured depository institution subsidiaries were in compliance with the aforementioned guidelines. As a "financial holding company" and "bank holding company" under the federal banking laws, the Company is required to obtain the prior approval of the Board of Governors of the Federal Reserve System for the changes of control. A change of control is conclusively presumed upon acquisitions of 25% or more of any class of voting securities and rebuttably presumed upon acquisitions of 10% or more of any class voting securities. Further, as a result of MetLife, Inc.'s ownership of MetLife Bank, N.A., a national bank, the Office of the Comptroller of the Currency's approval would be required in connection with a change of control (generally presumed upon the acquisition of 10% or more of any class of voting securities) of MetLife, Inc. THE COMPANY LIQUIDITY SOURCES. The Company's principal cash inflows from its insurance activities come from life insurance premiums, annuity considerations and deposit funds. A primary liquidity concern with respect to these cash inflows is the risk of early contractholder and policyholder withdrawal. The Company seeks to include provisions limiting withdrawal rights on many of its products, including general account institutional pension products (generally group annuities, including guaranteed interest contracts and certain deposit fund liabilities) sold to employee benefit plan sponsors. The Company's principal cash inflows from its investment activities result from repayments of principal, proceeds from maturities and sales of invested assets and investment income. The primary liquidity concerns with respect to these cash inflows are the risks of default by debtors, interest rate and other market volatilities. The Company closely monitors and manages these risks. Additional sources of liquidity to meet unexpected cash outflows are available from the Company's portfolio of liquid assets. These liquid assets include substantial holdings of U.S. Treasury securities, short-term investments, common stocks and marketable fixed maturity securities. The Company's available portfolio of liquid assets was approximately $107 billion and $101 billion at September 30, 2001 and December 31, 2000, respectively. Sources of liquidity also include programs for short- and long-term borrowing, as needed, arranged through the Holding Company and MetLife Funding, Inc., a subsidiary of Metropolitan Life. See "--Financing" below. 46
LIQUIDITY USES. The Company's principal cash outflows primarily relate to the liabilities associated with its various life insurance, annuity and group pension products, operating expenses, income taxes, as well as principal and interest on its outstanding debt obligations. Liabilities arising from its insurance activities primarily relate to benefit payments under the above-named products, as well as payments for policy surrenders, withdrawals and loans. The Company's management believes that its sources of liquidity are more than adequate to meet its current cash requirements. LITIGATION. Various litigation, claims and assessments against the Company have arisen in the course of the Company's business, including, but not limited to, in connection with its activities as an insurer, employer, investor, investment advisor and taxpayer. Further, state insurance regulatory authorities and other federal and state authorities regularly make inquiries and conduct investigations concerning the Company's compliance with applicable insurance and other laws and regulations. It is not feasible to predict or determine the ultimate outcome of all pending investigations and legal proceedings or provide reasonable ranges of potential losses. In some of the matters referred to above, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Although in light of these considerations it is possible that an adverse outcome in certain cases could have a material adverse effect upon the Company's consolidated financial position. Based on information currently known by the Company's management, in its opinion, the outcomes of such pending investigations and legal proceedings are not likely to have such an effect. However, given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company's operating results or cash flows in particular quarterly or annual periods. See Note 7 of Notes to unaudited interim condensed consolidated financial statements and "Legal Proceedings" in Part II, Item 1 herein. LEGISLATIVE DEVELOPMENTS. On May 26, 2001, President Bush signed into law the Economic Growth and Taxpayer Relief Reconciliation Act, which includes the repeal of the Federal estate tax over a ten-year period. While it is possible that the repeal of the Federal estate tax could result in reduced sales of some of the Company's estate planning products, including survivorship/second to die life insurance policies, the Company does not expect the repeal to have a material adverse impact on its overall business. RISK-BASED CAPITAL ("RBC"). Section 1322 of the New York Insurance Law requires that New York domestic life insurers report their RBC based on a formula calculated by applying factors to various asset, premium and statutory reserve items. The formula takes into account the risk characteristics of the insurer, including asset risk, insurance risk, interest rate risk and business risk. Section 1322 gives the Superintendent explicit regulatory authority to require various actions by, or take various actions against, insurers whose total adjusted capital does not exceed certain RBC levels. At September 30, 2001, Metropolitan Life's and each of its U.S. insurance subsidiaries' total adjusted capital was in excess of each of the RBC levels required by each state of domicile. The National Association of Insurance Commissioners' ("NAIC") Codification of Statutory Accounting Principles ("Codification"), which is intended to standardize regulatory accounting and reporting to state insurance departments, became effective January 1, 2001. However, statutory accounting principles will continue to be established by individual state laws and permitted practices. Effective January 1, 2001, the New York Insurance Department also adopted Codification with certain modifications. The adoption of Codification in accordance with NAIC guidance and Codification, as modified by the New York Insurance Department, increased Metropolitan Life's statutory capital and surplus by approximately $1.5 billion and $35 million, respectively, on January 1, 2001. Further modifications by state insurance departments may impact the effect of Codification on Metropolitan Life's statutory surplus and capital. FINANCING. MetLife Funding, Inc. ("MetLife Funding") serves as a centralized finance unit for Metropolitan Life. Pursuant to a support agreement, Metropolitan Life has agreed to cause MetLife Funding to have a tangible net worth of at least one dollar. At September 30, 2001 and December 31, 2000, MetLife Funding had a tangible net worth of $10.6 million and $10.3 million, respectively. MetLife Funding raises funds from various funding sources and uses the proceeds to extend loans to the Holding Company, Metropolitan Life and other affiliates. MetLife Funding manages its funding sources to enhance the financial flexibility and liquidity of Metropolitan Life. At September 30, 2001 and December 31, 2000, MetLife Funding had total outstanding liabilities of $154 million and $1.1 billion, respectively, consisting primarily of commercial paper. The Holding Company is authorized to raise funds from various funding sources and uses the proceeds for general corporate purposes. At September 30, 2001, the Holding Company had total outstanding short-term debt of $306 million, consisting primarily of commercial paper. The Holding Company anticipates issuing debt securities under a shelf registration statement, effective June 1, 2001, which permits the registration and issuance of debt and equity securities as described more fully therein, by December 31, 2001. 47
The Company also maintained approximately $2.4 billion and $2.0 billion in committed credit facilities at September 30, 2001 and December 31, 2000, respectively. At September 30, 2001 and December 31, 2000, there was approximately $156 million and $98 million, respectively, outstanding under these facilities. SUPPORT AGREEMENTS. In addition to its support agreement with MetLife Funding described above, Metropolitan Life has entered into a net worth maintenance agreement with New England Life Insurance Company ("New England"), whereby it is obligated to maintain New England's statutory capital and surplus at the greater of $10 million or the amount necessary to prevent certain regulatory action by Massachusetts, the state of domicile of this subsidiary. The capital and surplus of New England at September 30, 2001 was in excess of the amount that would trigger such an event. In connection with the Company's acquisition of GenAmerica, Metropolitan Life entered into a net worth maintenance agreement with General American Life Insurance Company ("General American"), whereby Metropolitan Life is obligated to maintain General American's statutory capital and surplus at the greater of $10 million or the amount necessary to maintain the capital and surplus of General American at a level not less than 180% of the NAIC Risk-Based Capitalization Model. The capital and surplus of General American at September 30, 2001 was in excess of the required amount. Metropolitan Life has also entered into arrangements with some of its other subsidiaries and affiliates to assist such subsidiaries and affiliates in meeting various jurisdictions' regulatory requirements regarding capital and surplus. Management does not anticipate that these arrangements will place any significant demands upon the Company's liquidity resources. CONSOLIDATED CASH FLOWS. Net cash provided by operating activities was $3,315 million and $889 million for the nine months ended September 30, 2001 and 2000, respectively. The increase in cash provided by the Company's operations in 2001 compared with 2000 is primarily due to the timing in the settlement of other receivables and payables. Operating cash flows in the periods presented have been more than adequate to meet liquidity requirements. Net cash used in investing activities was $2,928 million and $1,136 million for the nine months ended September 30, 2001 and 2000, respectively. Purchases of investments exceeded sales, maturities and repayments by $3,684 million and $5,952 million in 2001 and 2000, respectively. These net purchases were primarily attributable to the investment of collateral received in connection with the securities lending program, which increased by $822 million and $4,716 million, for the nine months ended Septamber 30, 2001 and 2000, respectively. Net cash provided by (used in) financing activities was $624 million and $(217) million for the nine months ended September 30, 2001 and 2000, respectively. Short-term financing decreased by $393 million and $2,379 million in 2001 and 2000, respectively. In 2000, the primary sources of cash from financing activities included cash proceeds from the Company's initial public offering and concurrent private placements in April 2000, as well as the issuance of mandatorily convertible securities in connection with the formation of MetLife Capital Trust I. The primary uses of cash in financing activities include cash payments in 2000 to eligible policyholders in connection with the demutualization and the pay-down of short-term debt and the acquisition of treasury stock through the Company's stock repurchase program. Deposits to policyholders' account balances exceeded withdrawals by $2,108 million for the nine months ended September 30, 2001 and withdrawals from policyholders' account balances exceeded deposits by $32 million for the nine months ended September 30, 2000. EFFECTS OF INFLATION The Company does not believe that inflation has had a material effect on its consolidated results of operations, except insofar as inflation may affect interest rates. 48
ACCOUNTING STANDARDS During 2001, the Company adopted or applied the following accounting standards: (i) Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment to FASB Statement No. 133, (ii) SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities - a replacement of FASB No. 125, (iii) Emerging Issues Task Force Issue No. 99-20, Recognition of Interest Income and Impairment on Certain Investments, (iv) SFAS No. 141, Business Combinations, and (v) Staff Accounting Bulletin No. 102, Selected Loan Loss Allowance and Documentation Issues. Adoption or application of these standards did not have a material impact on the Company's unaudited interim condensed consolidated financial statements. The Financial Accounting Standards Board continues to issue additional guidance relating to the accounting for derivatives under SFAS 133 and SFAS 138. Until this accounting guidance is finalized, the Company cannot determine the ultimate impact it may have on the Company's consolidated financial statements. On January 1, 2002, the Company will adopt SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). The Company has not yet determined the effect, if any, on its consolidated financial statements of applying the new impairment guidance to goodwill and intangible assets that will be required upon adoption of SFAS 142. On January 1, 2002, the Company will adopt SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"). The adoption of SFAS 144 by the Company is not expected to have a material impact on the Company's consolidated financial statements. INVESTMENTS The Company had total cash and invested assets at September 30, 2001 of $167.1 billion. In addition, the Company had $59.6 billion in its separate accounts, for which the Company generally does not bear investment risk. The Company's primary investment objective is to maximize after-tax operating income consistent with acceptable risk parameters. The Company is exposed to three primary sources of investment risk: - credit risk, relating to the uncertainty associated with the continued ability of a given obligor to make timely payments of principal and interest; - interest rate risk, relating to the market price and cash flow variability associated with changes in market interest rates; and - market valuation risk for equity holdings. The Company manages risk through in-house fundamental analysis of the underlying obligors, issuers, transaction structures and real estate properties. The Company also manages credit risk and market valuation risk through industry and issuer diversification and asset allocation. For real estate and agricultural assets, the Company manages credit risk and valuation risk through geographic, property type, and product type diversification and asset allocation. The Company manages interest rate risk as part of its asset and liability management strategies, product design, such as the use of market value adjustment features and surrender charges, and proactive monitoring and management of certain non-guaranteed elements of its products, such as the resetting of credited interest and dividend rates for policies that permit such adjustments. 49
The following table summarizes the Company's cash and invested assets at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, AT DECEMBER 31, 2001 2000 ---------------------- ----------------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL -------- -------- -------- -------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> Fixed maturities available-for-sale, at fair value $117,145 70.1% $112,979 70.7% Mortgage loans on real estate 22,920 13.7 21,951 13.7 Policy loans 8,163 4.9 8,158 5.1 Equity real estate and real estate joint ventures 5,476 3.3 5,504 3.4 Cash and cash equivalents 4,445 2.7 3,434 2.1 Equity securities and other limited partnership interests 4,661 2.8 3,845 2.4 Other invested assets 3,250 1.9 2,821 1.8 Short-term investments 1,012 0.6 1,269 0.8 -------- -------- -------- -------- Total cash and invested assets $167,072 100.0 % $159,961 100.0% ======== ======== ======== ======== </TABLE> 50
INVESTMENT RESULTS The annualized yields on general account cash and invested assets, excluding net investment gains and losses, were 7.5% and 7.6% for the three months ended September 30, 2001 and 2000, respectively, and 7.6% and 7.4% for the nine months ended September 30, 2001 and 2000, respectively. The following table illustrates the annualized yields on average assets for each of the components of the Company's investment portfolio for the three months and nine months ended September 30, 2001 and 2000: <TABLE> <CAPTION> AT OR FOR THE THREE MONTHS ENDED SEPTEMBER 30, AT OR FOR THE NINE MONTHS ENDED SEPTEMBER 30, ---------------------------------------------- --------------------------------------------- 2001 2000 2001 2000 --------------------- --------------------- ------------------- ---------------------- YIELD (1) AMOUNT YIELD (1) AMOUNT YIELD (1) AMOUNT YIELD (1) AMOUNT --------- ------ --------- ------ --------- ------ --------- ------ (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> <C> <C> <C> <C> FIXED MATURITIES: (2) Investment income 7.84% $ 2,132 7.75% $ 2,138 7.80% $ 6,414 7.68% $ 6,260 Net investment losses (87) (349) (427) (593) --------- --------- --------- --------- Total $ 2,045 $ 1,789 $ 5,987 $ 5,667 --------- --------- --------- --------- Ending assets $117,145 $110,408 $117,145 $110,408 --------- --------- --------- --------- MORTGAGE LOANS: (3) Investment income 8.06% $ 458 7.81% $ 420 8.24% $ 1,381 7.81% $ 1,254 Net investment losses (44) (20) (49) (14) --------- --------- --------- --------- Total $ 414 $ 400 $ 1,332 $ 1,240 --------- --------- --------- --------- Ending assets $ 22,920 $ 21,532 $ 22,920 $ 21,532 --------- --------- --------- --------- EQUITY REAL ESTATE AND REAL ESTATE JOINT VENTURES: (4) Investment income, net of expenses 10.22% $ 139 10.89% $ 144 11.16% $ 457 10.89% $ 466 Net investment gains (losses) (25) 30 (1) 57 --------- --------- --------- --------- Total $ 114 $ 174 $ 456 $ 523 --------- --------- --------- --------- Ending assets $ 5,476 $ 5,638 $ 5,476 $ 5,638 --------- --------- --------- --------- POLICY LOANS: Investment income 6.36% $ 129 6.36% $ 127 6.52% $ 398 6.36% $ 379 --------- --------- --------- --------- Ending assets $ 8,163 $ 8,053 $ 8,163 $ 8,053 --------- --------- --------- --------- EQUITY SECURITIES AND OTHER LIMITED PARTNERSHIP INTERESTS: Investment income 1.87% $ 20 3.20% $ 31 2.49% $ 74 5.84% $ 161 Net investment gains (losses) (27) 36 (100) 112 --------- --------- --------- --------- Total $ (7) $ 67 $ (26) $ 273 --------- --------- --------- --------- Ending assets $ 4,661 $ 3,928 $ 4,661 $ 3,928 --------- --------- --------- --------- CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS: Investment income 6.23% $ 80 5.43% $ 69 5.75% $ 217 5.31% $ 204 Net investment gains (losses) -- 3 (5) 1 --------- --------- --------- --------- Total $ 80 $ 72 $ 212 $ 205 --------- --------- --------- --------- Ending assets $ 5,457 $ 4,416 $ 5,457 $ 4,416 --------- --------- --------- --------- OTHER INVESTED ASSETS: Investment income 9.61% $ 79 9.05% $ 59 7.65% $ 187 5.85% $ 110 Net investment gains (losses) 31 2 70 (45) --------- --------- --------- --------- Total $ 110 $ 61 $ 257 $ 65 --------- --------- --------- --------- Ending assets $ 3,250 $ 2,695 $ 3,250 $ 2,695 --------- --------- --------- --------- TOTAL INVESTMENTS: Investment income before expenses and fees 7.70% $ 3,037 7.73% $ 2,988 7.70% $ 9,128 7.60% $ 8,834 Investment expenses and fees (0.16%) (62) (0.13%) (43) (0.15%) (173) (0.16%) (181) ------ --------- ------ --------- ------ --------- ------ --------- Net investment income 7.54% $ 2,975 7.60% $ 2,945 7.55% $ 8,955 7.44% $ 8,653 Net investment losses (152) (298) (512) (482) Adjustments to investment losses (5) 28 25 107 42 Gains from sales of subsidiaries 25 -- 25 -- --------- --------- --------- --------- Total $ 2,876 $ 2,672 $ 8,575 $ 8,213 ========= ========= ========= ========= </TABLE> (1) Yields are based on quarterly average asset carrying values for the three months and nine months ended September 30, 2001 and 2000, excluding recognized and unrealized gains and losses, and for yield calculation purposes, average assets exclude collateral associated with the Company's securities lending program. Fixed maturity investment income has been reduced by rebates paid under the program. (2) Included in fixed maturities are equity-linked notes of $1,125 million and $1,215 million at September 30, 2001 and 2000, respectively, which include an equity component as part of the notes' return. Investment income for fixed maturities includes prepayment fees and income from the securities lending program. 51
(3) Investment income from mortgage loans includes prepayment fees. (4) Equity real estate and real estate joint venture income is shown net of depreciation of $54 million and $56 million for the three months ended September 30, 2001 and 2000, respectively, and $162 million and $166 million for the nine months ended September 30, 2001 and 2000, respectively. (5) Adjustments to investment gains and losses include amortization of deferred policy acquisition costs, charges and credits to participating contracts, and adjustments to the policyholder dividend obligation resulting from investment gains and losses. FIXED MATURITIES Fixed maturities consist principally of publicly traded and privately placed debt securities, and represented 70.1% and 70.7% of total cash and invested assets at September 30, 2001 and December 31, 2000, respectively. Based on estimated fair value, public fixed maturities and private fixed maturities comprised 83.8% and 16.2%, respectively, of total fixed maturities at September 30, 2001 and 83.6% and 16.4%, respectively, at December 31, 2000. The Company invests in privately placed fixed maturities to enhance the overall value of its portfolio, increase diversification and obtain higher yields than can ordinarily be obtained with comparable public market securities. Generally, private placements provide the Company with protective covenants, call protection features and, where applicable, a higher level of collateral. However, the Company may not freely trade its private placements because of restrictions imposed by federal and state securities laws and illiquid trading markets. The Securities Valuation Office of the NAIC evaluates the bond investments of insurers for regulatory reporting purposes and assigns securities to one of six investment categories called "NAIC designations." The NAIC designations parallel the credit ratings of the Nationally Recognized Statistical Rating Organizations for marketable bonds. NAIC designations 1 and 2 include bonds considered investment grade (rated "Baa3" or higher by Moody's Investors Service ("Moody's"), or rated "BBB-" or higher by Standard & Poor's ("S&P")) by such rating organizations. NAIC designations 3 through 6 include bonds considered below investment grade (rated "Ba1" or lower by Moody's, or rated "BB+" or lower by S&P). The following table presents the Company's total fixed maturities by NAIC designation and the equivalent ratings of the Nationally Recognized Statistical Rating Organizations at September 30, 2001 and December 31, 2000, as well as the percentage, based on estimated fair value, that each designation comprises: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 ----------------------------------- ------------------------------------ ESTIMATED ESTIMATED NAIC RATING AGENCY AMORTIZED FAIR % OF AMORTIZED FAIR % OF RATING EQUIVALENT DESIGNATION COST VALUE TOTAL COST VALUE TOTAL ------ ---------------------- ---- ----- ----- ---- ----- ----- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> <C> <C> 1 Aaa/Aa/A $72,860 $76,987 65.8% $72,170 $74,389 65.9% 2 Baa 29,297 30,030 25.6 28,470 28,405 25.1 3 Ba 5,607 5,356 4.6 5,935 5,650 5.0 4 B 3,547 3,203 2.7 3,964 3,758 3.3 5 Caa and lower 507 405 0.3 123 95 0.1 6 In or near default 347 317 0.3 319 361 0.3 -------- -------- ----- -------- -------- ----- Subtotal 112,165 116,298 99.3 110,981 112,658 99.7 Redeemable preferred stock 749 847 0.7 321 321 0.3 -------- -------- ----- -------- -------- ----- Total fixed maturities $112,914 $117,145 100.0% $111,302 $112,979 100.0% ======== ======== ===== ======== ======== ===== </TABLE> Based on estimated fair values, total investment grade public and private placement fixed maturities comprised 91.4% and 91.0% of total fixed maturities in the general account at September 30, 2001 and December 31, 2000, respectively. 52
The following table shows the amortized cost and estimated fair value of fixed maturities, by contractual maturity dates (excluding scheduled sinking funds) at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 --------------------- -------------------- ESTIMATED ESTIMATED AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE ---- ----- ---- ----- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> Due in one year or less $ 4,370 $ 4,408 $ 3,465 $ 3,460 Due after one year through five years 20,026 20,905 21,041 21,275 Due after five years through ten years 22,878 23,271 23,872 23,948 Due after ten years 30,037 31,534 29,564 30,402 -------- -------- -------- -------- Subtotal 77,311 80,118 77,942 79,085 Mortgage-backed and other asset-backed securities 34,854 36,180 33,039 33,573 -------- -------- -------- -------- Subtotal 112,165 116,298 110,981 112,658 Redeemable preferred stock 749 847 321 321 -------- -------- -------- -------- Total fixed maturities $112,914 $117,145 $111,302 $112,979 ======== ======== ======== ======== </TABLE> PROBLEM, POTENTIAL PROBLEM AND RESTRUCTURED FIXED MATURITIES. The Company monitors fixed maturities to identify investments that management considers to be problems or potential problems. The Company also monitors investments that have been restructured. The Company defines problem securities in the fixed maturities category as securities as to which principal or interest payments are in default or are to be restructured pursuant to commenced negotiations, or as securities issued by a debtor that has entered into bankruptcy. The Company defines potential problem securities in the fixed maturity category as securities of an issuer deemed to be experiencing significant operating problems or difficult industry conditions. The Company uses various criteria, including the following, to identify potential problem securities: - debt service coverage or cash flow falling below certain thresholds which vary according to the issuer's industry and other relevant factors; - significant declines in revenues or margins; - violation of financial covenants; - public securities trading at a substantial discount as a result of specific credit concerns; and - other subjective factors. The Company defines restructured securities in the fixed maturities category as securities to which the Company has granted a concession that it would not have otherwise considered but for the financial difficulties of the obligor. The Company enters into a restructuring when it believes it will realize a greater economic value under the new terms rather than through liquidation or disposition. The terms of the restructuring may involve some or all of the following characteristics: a reduction in the interest rate, an extension of the maturity date, an exchange of debt for equity or a partial forgiveness of principal or interest. 53
The following table presents the estimated fair value of the Company's total fixed maturities classified as performing, problem, potential problem and restructured fixed maturities at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 ------------------------- ------------------------ ESTIMATED % OF ESTIMATED % OF FAIR VALUE TOTAL FAIR VALUE TOTAL ---------- ----- ---------- ----- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> Performing $116,573 99.6% $112,371 99.5% Problem 255 0.2 163 0.1 Potential Problem 286 0.2 364 0.3 Restructured 31 0.0 81 0.1 -------- ----- -------- ----- Total $117,145 100.0% $112,979 100.0% ======== ===== ======== ===== </TABLE> The Company classifies all of its fixed maturities as available-for-sale and marks them to market. The Company writes down to fair value fixed maturities that it deems to be other than temporarily impaired. The Company records write-downs as investment losses and adjusts the cost basis of the fixed maturities accordingly. The Company does not change the revised cost basis for subsequent recoveries in value. Such write-downs were $215 million and $84 million for the nine months ended September 30, 2001 and 2000, respectively. FIXED MATURITIES BY SECTOR. The Company diversifies its fixed maturities by security sector. The following table sets forth the estimated fair value of the Company's fixed maturities by sector, as well as the percentage of the total fixed maturities holdings that each security sector comprised at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 DECEMBER 31, 2000 --------------------- ----------------------- ESTIMATED % OF ESTIMATED % OF FAIR VALUE TOTAL FAIR VALUE TOTAL ---------- ----- ---------- ----- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> U.S. treasuries/agencies $ 9,777 8.3% $ 9,634 8.5% Corporate securities 62,503 53.4 56,553 50.1 Foreign government securities 4,785 4.1 5,341 4.7 Mortgage-backed securities 27,903 23.8 25,726 22.8 Asset-backed securities 8,277 7.1 7,847 6.9 Other fixed income assets 3,900 3.3 7,878 7.0 -------- ---------- ---------- ---------- Total $117,145 100.0% $112,979 100.0% ======== ========== ========== ========== </TABLE> 54
CORPORATE FIXED MATURITIES. The table below shows the major industry types that comprise the corporate bond holdings at the dates indicated: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 --------------------- -------------------- ESTIMATED % OF ESTIMATED % OF FAIR VALUE TOTAL FAIR VALUE TOTAL ---------- ----- ---------- ----- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> Industrial $27,423 43.9% $27,199 48.1% Utility 7,414 11.9 7,011 12.4 Finance 13,011 20.8 12,722 22.5 Yankee/Foreign (1) 13,999 22.4 9,291 16.4 Other 656 1.0 330 0.6 ------- ----- ------- ----- Total $62,503 100.0% $56,553 100.0% ======= ===== ======= ===== </TABLE> (1) Includes publicly traded, dollar-denominated debt obligations of foreign obligors, known as Yankee bonds, and other foreign investments. The Company diversifies its corporate bond holdings by industry and issuer. The portfolio has no significant exposure to any single issuer. At September 30, 2001, the Company's combined holdings in the ten issuers to which it had the greatest exposure totaled $4,271 million, which was less than 3% of the Company's total invested assets at such date. The exposure to the largest single issuer of corporate bonds the Company held at September 30, 2001 was $512 million, which was less than 1% of its total invested assets at such date. At September 30, 2001, investments of $6,695 million, or 47.8% of the Yankee/Foreign sector, represented exposure to traditional Yankee bonds. The balance of this exposure was primarily dollar-denominated, foreign private placements and project finance loans. The Company diversifies the Yankee/Foreign portfolio by country and issuer. The Company does not have material exposure to foreign currency risk in its invested assets. In the Company's international insurance operations, both its assets and liabilities are denominated in local currencies. Foreign currency denominated securities supporting U.S. dollar liabilities are generally swapped back into U.S. dollars. MORTGAGE-BACKED SECURITIES. The following table shows the types of mortgage-backed securities the Company held at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 ----------------------- -------------------------- ESTIMATED % OF ESTIMATED % OF FAIR VALUE TOTAL FAIR VALUE TOTAL ---------- --------- ---------- ---------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> Pass-through securities $11,593 41.5% $10,610 41.3% Collateralized mortgage obligations 10,810 38.8 9,866 38.3 Commercial mortgage-backed securities 5,500 19.7 5,250 20.4 ------- --------- --------- ---------- Total $27,903 100.0% $25,726 100.0% ========= ========= ========= ========== </TABLE> At September 30, 2001, pass-through and collateralized mortgage obligations totaled $22,403 million, or 80.3% of total mortgage-backed securities, and a majority of this amount represented agency-issued pass-through and collateralized mortgage obligations guaranteed or otherwise supported by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation or the Government National Mortgage Association. Other types of mortgage-backed securities comprised the balance of such amounts reflected in the table. At September 30, 2001, approximately $2,962 million, or 53.9% of the commercial mortgage-backed securities, and $21,365 million, or 95.4% of the pass-through securities and collateralized mortgage obligations, were rated Aaa/AAA by Moody's or S&P. 55
The principal risks inherent in holding mortgage-backed securities are prepayment and extension risks, which will affect the timing of when cash flow will be received. The Company's active monitoring of its mortgage-backed securities mitigates exposure to losses from cash flow risk associated with interest rate fluctuations. ASSET-BACKED SECURITIES. Asset-backed securities, which include home equity loans, credit card receivables, collateralized debt obligations and automobile receivables, are purchased both to diversify the overall risks of the Company's fixed maturities assets and to provide attractive returns. The Company's asset-backed securities are diversified both by type of asset and by issuer. Home equity loans constitute the largest exposure in the Company's asset-backed securities investments. Except for asset-backed securities backed by home equity loans, the asset-backed securities investments generally have little sensitivity to changes in interest rates. At September 30, 2001, approximately $3,514 million, or 42.5%, of total asset-backed securities were rated Aaa/AAA by Moody's or S&P. The principal risks in holding asset-backed securities are structural, credit and capital market risks. Structural risks include the security's priority in the issuer's capital structure, the adequacy of and ability to realize proceeds from the collateral and the potential for prepayments. Credit risks include consumer or corporate credits such as credit card holders, equipment lessees, and corporate obligors. Capital market risks include the general level of interest rates and the liquidity for these securities in the marketplace. MORTGAGE LOANS The Company's mortgage loans are collateralized by commercial, agricultural and residential properties. Mortgage loans comprised 13.7% and 13.7% of the Company's total cash and invested assets at September 30, 2001 and December 31, 2000, respectively. The carrying value of mortgage loans is stated at original cost net of repayments, amortization of premiums, accretion of discounts and valuation allowances. The following table shows the carrying value of the Company's mortgage loans by type at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 --------------------- -------------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL --------- ------- --------- ------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> Commercial $17,610 76.8% $16,869 76.8% Agricultural 5,161 22.5 4,973 22.7 Residential 149 0.7 109 0.5 ------- ----- ------- ----- Total $22,920 100.0% $21,951 100.0% ======= ===== ======= ===== </TABLE> 56
COMMERCIAL MORTGAGE LOANS. The Company diversifies its commercial mortgage loans by both geographic region and property type, and manages these investments through a network of regional offices overseen by its investment department. The following table presents the distribution across geographic regions and property types for commercial mortgage loans at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 --------------------- -------------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL ------- ----- ------- ----- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> REGION South Atlantic $ 4,731 27.0% $ 4,542 26.9% Pacific 3,406 19.3 3,111 18.4 Middle Atlantic 3,299 18.7 2,968 17.6 East North Central 1,918 10.9 1,822 10.8 West South Central 1,017 5.8 1,169 6.9 New England 1,166 6.6 1,157 6.9 Mountain 745 4.2 753 4.5 West North Central 689 3.9 740 4.4 International 475 2.7 433 2.6 East South Central 164 0.9 174 1.0 ------- ----- ------- ----- Total $17,610 100.0% $16,869 100.0% ======= ===== ======= ===== PROPERTY TYPE Office $ 8,072 45.8% $ 7,577 44.9% Retail 4,065 23.1 4,148 24.6 Apartments 2,566 14.6 2,585 15.3 Industrial 1,814 10.3 1,414 8.4 Hotel 865 4.9 865 5.1 Other 228 1.3 280 1.7 ------- ----- ------- ----- Total $17,610 100.0% $16,869 100.0% ======= ===== ======= ===== </TABLE> The following table presents the scheduled maturities for the Company's commercial mortgage loans at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 --------------------- -------------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL ------- ----- ------- ----- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> Due in one year or less $ 537 3.0% $ 644 3.8% Due after one year through two years 936 5.3 934 5.5 Due after two years through three years 1,385 7.9 830 4.9 Due after three years through four years 1,477 8.4 1,551 9.2 Due after four years through five years 2,349 13.3 1,654 9.8 Due after five years 10,926 62.1 11,256 66.8 ------- ----- ------- ----- Total $17,610 100.0% $16,869 100.0% ======= ===== ======= ===== </TABLE> PROBLEM, POTENTIAL PROBLEM AND RESTRUCTURED MORTGAGE LOANS. The Company monitors its mortgage loan investments on a continual basis. Through this monitoring process, the Company reviews loans that are restructured, delinquent or under foreclosure and identifies those that management considers to be potentially delinquent. These loan classifications are generally consistent with those used in industry practice. 57
The Company defines restructured mortgage loans, consistent with industry practice, as loans in which the Company, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. This definition provides for loans to exit the restructured category under certain conditions. The Company defines delinquent mortgage loans, consistent with industry practice, as loans in which two or more interest or principal payments are past due. The Company defines mortgage loans under foreclosure, consistent with industry practice, as loans in which foreclosure proceedings have formally commenced. The Company defines potentially delinquent loans as loans that, in management's opinion, have a high probability of becoming delinquent. The Company reviews all mortgage loans on an annual basis. These reviews may include an analysis of the property financial statements and rent roll, lease rollover analysis, property inspections, market analysis and tenant creditworthiness. The Company also reviews loan-to-value ratios and debt coverage ratios for restructured loans, delinquent loans, loans under foreclosure, potentially delinquent loans, loans with an existing valuation allowance, loans maturing within two years and loans with a loan-to-value ratio greater than 90% as determined in the prior year. The Company establishes valuation allowances for loans that it deems impaired, as determined through its annual review process. The Company defines impaired loans consistent with Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, as loans which it probably will not collect all amounts due according to applicable contractual terms of the agreement. The Company bases valuation allowances upon the present value of expected future cash flows discounted at the loan's original effective interest rate or the value of the loan's collateral. The Company records valuation allowances as investment losses. The Company records subsequent adjustments to allowances as investment gains or losses. The following table presents the amortized cost and valuation allowances for commercial mortgage loans distributed by loan classification at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 ------------------------------------------ ------------------------------------------ % OF % OF AMORTIZED % OF VALUATION AMORTIZED AMORTIZED % OF VALUATION AMORTIZED COST(1) TOTAL ALLOWANCE COST COST(1) TOTAL ALLOWANCE COST ------- ----- --------- ---- ------- ----- --------- ---- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> <C> <C> <C> <C> Performing $17,018 96.1% $ 31 0.2% $16,169 95.5% $ 15 0.1% Restructured 526 3.0 55 10.5% 646 3.8 47 7.3% Delinquent or under foreclosure 6 0.0 3 50.0% 24 0.1 4 16.7% Potentially delinquent 163 0.9 14 8.6% 106 0.6 10 9.4% ------- ----- ------- ------- ----- ------- Total $17,713 100.0% $ 103 0.6% $16,945 100.0% $ 76 0.4% ======= ===== ======= ======= ===== ======= </TABLE> (1) Amortized cost is equal to carrying value before valuation allowances. The following table presents the changes in valuation allowances for commercial mortgage loans for the nine months ended September 30, 2001: <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, 2001 --------------------- (DOLLARS IN MILLIONS) <S> <C> Balance, beginning of period $ 76 Additions 49 Deductions for writedowns and dispositions (22) ------ Balance, end of period $ 103 ====== </TABLE> The principal risks in holding commercial mortgage loans are property specific, supply and demand, financial and capital market risks. Property specific risks include the geographic location of the property, the physical condition of the property, the diversity of tenants and the rollover of their leases and the ability of the property manager to attract tenants and manage expenses. Supply and demand risks include changes in the supply and/or demand for rental space which cause changes in vacancy rates and/or rental rates. Financial risks include the overall level of debt on the property and the amount of principal repaid during the loan term. Capital market risks include the general level of interest rates, the liquidity for these securities in the marketplace and the capital available for loan refinancing. 58
AGRICULTURAL MORTGAGE LOANS. The Company diversifies its agricultural mortgage loans by both geographic region and product type. The Company manages these investments through a network of regional offices and field professionals overseen by its investment department. Approximately 59.9% of the $5,161 million of agricultural mortgage loans outstanding at September 30, 2001 was subject to rate resets prior to maturity. A substantial portion of these loans were successfully renegotiated and remain outstanding to maturity. The process and policies for monitoring the agricultural mortgage loans and classifying them by performance status are generally the same as those for the commercial loans. The following table presents the amortized cost and valuation allowances for agricultural mortgage loans distributed by loan classification at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 ------------------------------------------ ------------------------------------------ % OF % OF AMORTIZED % OF VALUATION AMORTIZED AMORTIZED % OF VALUATION AMORTIZED COST(1) TOTAL ALLOWANCE COST COST(1) TOTAL ALLOWANCE COST ------- ----- ------- ---- ------- ----- ------- ---- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> <C> <C> <C> <C> Performing $ 4,932 95.3% $ -- 0.0% $ 4,771 95.7% $ 1 0.0% Restructured 111 2.1 -- 0.0% 172 3.5 2 1.2% Delinquent or under foreclosure 126 2.4 16 12.7% 24 0.5 4 16.7% Potentially delinquent 10 0.2 2 20.0% 13 0.3 -- 0.0% ------- ----- ------- ------- ----- ------- Total $ 5,179 100.0% $ 18 0.3% $ 4,980 100.0% $ 7 0.1% ======= ===== ======= ======= ===== ======= </TABLE> (1) Amortized cost is equal to carrying value before valuation allowances. The following table presents the changes in valuation allowances for agricultural mortgage loans for the nine months ended September 30, 2001: <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, 2001 --------------------- (DOLLARS IN MILLIONS) <S> <C> Balance, beginning of period $ 7 Additions 16 Deductions for writedowns and dispositions (5) -------- Balance, end of period $ 18 ======== </TABLE> The principal risks in holding agricultural mortgage loans are property specific, supply and demand, and financial and capital market risks. Property specific risks include the geographic location of the property, soil types, weather conditions and other factors that may impact the borrower's guaranty. Supply and demand risks include the supply and demand for the commodities produced on the specific property and the related price for those commodities. Financial risks include the overall level of debt on the property and the amount of principal repaid during the loan term. Capital market risks include the general level of interest rates, the liquidity for these securities in the marketplace and the capital available for loan refinancing. 59
EQUITY REAL ESTATE AND REAL ESTATE JOINT VENTURES The Company's equity real estate and real estate joint venture investments consist of commercial and agricultural properties located throughout the U.S. and Canada. The Company manages these investments through a network of regional offices overseen by its investment department. At September 30, 2001 and December 31, 2000, the carrying value of the Company's equity real estate and real estate joint ventures was $5,476 million and $5,504 million, respectively, or 3.3% and 3.4%, respectively, of total cash and invested assets. The carrying value of equity real estate was stated at depreciated cost net of impairments and valuation allowances. The carrying value of real estate joint ventures was stated at the Company's equity in real estate joint ventures net of impairments and valuation allowances. These holdings consist of equity real estate, interests in real estate joint ventures and real estate acquired upon foreclosure of commercial and agricultural mortgage loans. The following table presents the carrying value of the Company's equity real estate and real estate joint ventures at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 --------------------- -------------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL -------- ----- -------- ----- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> Equity real estate $ 5,094 93.0% $ 5,069 92.1% Real estate joint ventures 333 6.1 369 6.7 ------- ----- ------- ----- Subtotal 5,427 99.1 5,438 98.8 Foreclosed real estate 49 0.9 66 1.2 ------- ----- ------- ----- Total $ 5,476 100.0% $ 5,504 100.0% ======= ===== ======= ===== </TABLE> Office properties representing 63.5% and 66.1% of the Company's equity real estate and real estate joint venture holdings at September 30, 2001 and December 31, 2000, respectively, are well diversified geographically, principally within the United States. The average occupancy level of office properties was 92% and 94% at September 30, 2001 and December 31, 2000, respectively. The Company classifies equity real estate and real estate joint ventures as held-for-investment or held-for-sale. The carrying value of equity real estate and real estate joint ventures held-for-investment was $5,351 million and $5,223 million at September 30, 2001 and December 31, 2000, respectively. The carrying value of equity real estate and real estate joint ventures held-for-sale was $125 million and $281 million at September 30, 2001 and December 31, 2000, respectively. Ongoing management of these investments includes quarterly appraisals, as well as an annual market update and review of each property's budget, financial returns, lease rollover status and the Company's exit strategy. In addition to individual property reviews, the Company employs an overall strategy of selective dispositions and acquisitions as market opportunities arise. The Company adjusts the carrying value of equity real estate and real estate joint ventures held-for-investment for impairments whenever events or changes in circumstances indicate that the carrying value of the property may not be recoverable. The Company writes down impaired real estate to estimated fair value, which it generally computes using the present value of future cash flows from the property, discounted at a rate commensurate with the underlying risks. The Company records write-downs as investment losses and reduces the cost basis of the properties accordingly. The Company does not change the revised cost basis for subsequent recoveries in value. The Company records real estate acquired upon foreclosure of commercial and agricultural mortgage loans at the lower of estimated fair value or the carrying value of the mortgage loan at the date of foreclosure. Once the Company identifies a property to be sold and commences a firm plan for marketing the property, the Company establishes and periodically revises, if necessary, a valuation allowance to adjust the carrying value of the property to its expected sales value, less associated selling costs, if it is lower than the property's carrying value. The Company records allowances as investment losses. The Company records subsequent adjustments to allowances as investment gains or losses. 60
The Company's carrying value of equity real estate and real estate joint ventures held-for-sale, including real estate acquired upon foreclosure of commercial and agricultural mortgage loans, in the amounts of $125 million and $281 million at September 30, 2001 and December 31, 2000, respectively, are net of impairments of $106 million and $97 million, respectively, and net of valuation allowances of $46 million and $39 million, respectively. EQUITY SECURITIES AND OTHER LIMITED PARTNERSHIP INTERESTS The Company's carrying value of equity securities, which primarily consists of investments in common stocks, was $3,036 million and $2,193 million at September 30, 2001 and December 31, 2000, respectively. Substantially all of the common stock is publicly traded on major securities exchanges. The carrying value of the other limited partnership interests which primarily represent ownership interests in pooled investment funds that make private equity investments in companies in the U.S. and overseas was $1,625 million and $1,652 million at September 30, 2001 and December 31, 2000, respectively. The Company classifies its investments in common stocks as available-for-sale and marks them to market except for non-marketable private equities which are generally carried at cost. The Company accounts for its investments in limited partnership interests in which it does not have a controlling interest in accordance with the equity method of accounting. The Company's investments in equity securities represented 1.8% and 1.4% of cash and invested assets at September 30, 2001 and December 31, 2000, respectively. Equity securities include, at September 30, 2001 and December 31, 2000, $321 million and $577 million, respectively, of private equity securities. The Company may not freely trade its private equity securities because of restrictions imposed by Federal and state securities laws and illiquid trading markets. At September 30, 2001 and December 31, 2000 approximately $246 million and $313 million, respectively, of the Company's equity securities holdings were effectively fixed at a minimum value of $195 million and $257 million, respectively, primarily through the use of exchangeable securities. During the nine months ended September 30, 2001, two exchangeable subordinated debt securities matured, resulting in a gross realized gain of $44 million on the equity exchanged in satisfaction of the note. The remaining exchangeable debt security issued by the Company matures in 2002 and the Company may repurchase it earlier at its discretion. The Company makes commitments to fund partnership investments in the normal course of business. The amounts of these unfunded commitments were $1,580 million and $1,311 million at September 30, 2001 and December 31, 2000, respectively. The Company anticipates that these amounts will be invested in the partnerships over the next three to five years. PROBLEM AND POTENTIAL PROBLEM EQUITY SECURITIES AND OTHER LIMITED PARTNERSHIP INTERESTS. The Company monitors its equity securities and other limited partnership interests on a continual basis. Through this monitoring process, the Company identifies investments that management considers to be problems or potential problems. Problem equity securities and other limited partnership interests are defined as securities (i) in which significant declines in revenues and/or margins threaten the ability of the issuer to continue operating or (ii) where the issuer has subsequently entered bankruptcy. Potential problem equity securities and other limited partnership interests are defined as securities issued by a company that is experiencing significant operating problems or difficult industry conditions. Criteria generally indicative of these problems or conditions are (i) cash flows falling below varying thresholds established for the industry and other relevant factors, (ii) significant declines in revenues and/or margins, (iii) public securities trading at a substantial discount as a result of specific credit concerns, and (iv) other information that becomes available. Equity securities or other limited partnership interests which are deemed to be other than temporarily impaired are written down to fair value. Write-downs are recorded as investment losses and the cost basis of the equity securities and other limited partnership interests are adjusted accordingly. The Company does not change the revised cost basis for subsequent recoveries in value. For the nine months ended September 30, 2001 and 2000, such write-downs were $117 million and $10 million, respectively. OTHER INVESTED ASSETS The Company's other invested assets consist principally of leveraged leases and funds withheld at interest of $2.5 billion and $2.3 billion at September 30, 2001 and December 31, 2000, respectively. The leveraged leases are recorded net of non-recourse debt. The Company participates in lease transactions which are diversified by geographic area. The Company regularly reviews residual values and writes down residuals to expected values as needed. Funds withheld represent amounts contractually withheld by ceding companies in accordance with reinsurance agreements. For agreements written on a modified coinsurance basis and certain 61
agreements written on a coinsurance basis, assets equal to the net statutory reserves are withheld and legally owned by the ceding company. Interest accrues to these funds withheld at rates defined by the treaty terms. The Company's other invested assets represented 1.9% and 1.8% of cash and invested assets at September 30, 2001 and December 31, 2000, respectively. DERIVATIVE FINANCIAL INSTRUMENTS The Company primarily uses derivative instruments to reduce the risk associated with variable cash flows related to the Company's financial assets and liabilities or to changing market values. This objective is achieved through one of two principal risk management strategies: (i) hedging the variable cash flows of assets, liabilities or forecasted transactions, or (ii) hedging the changes in fair value of financial assets, liabilities or firm commitments. Hedged forecasted transactions, other than the receipt or payment of variable interest payments, are not expected to occur more than 12 months after hedge inception. The Company's derivative hedging strategy employs a variety of instruments including financial futures, financial forwards, interest rate and foreign currency swaps, foreign exchange contracts, and options, including caps and floors. The Company designates and accounts for the following as cash flow hedges, when they have met the effectiveness requirements of SFAS 133 and SFAS 138: (i) various types of interest rate swaps to convert floating rate investments to fixed rate investments, (ii) receive fixed foreign currency swaps to hedge the foreign currency cash flow exposure of foreign currency denominated investments, (iii) foreign currency forwards to hedge the exposure of future payments in foreign currencies, and (iv) other instruments to hedge the cash flows of various other anticipated transactions. For all qualifying and highly effective cash flow hedges, the effective portion of changes in fair value of the derivative instrument are reported in other comprehensive income. The ineffective portion of changes in fair value of the derivative instrument are reported in net investment gains or losses. The Company designates and accounts for the following as fair value hedges, when they have met the effectiveness requirements of SFAS 133 and SFAS 138: (i) various types of interest rate swaps to convert fixed rate investments to floating rate investments, (ii) receive floating foreign currency swaps to hedge the foreign currency fair value exposure of foreign currency denominated investments, and (iii) other instruments to hedge various other fair value exposures of investments. For all qualifying and highly effective fair value hedges, the changes in fair value of the derivative instrument are reported as net investment gains or losses. In addition, changes in fair value attributable to the hedged portion of the underlying instrument are reported in net investment gains and losses. For the three months and nine months ended September 30, 2001, the Company recognized net investment gains of $30 million and $75 million, respectively, relating to derivatives. The amounts recognized relate primarily to non-speculative derivative uses that are permitted by the New York Insurance Department but that have not met the requirements of SFAS 133 to qualify for hedge accounting. The amounts relating to the ineffective portion of cash flow and fair value hedges were immaterial. The amounts relating to the effective portion of fair value hedges and the amounts relating to the changes in fair value attributable to the hedged portion of the underlying instruments were immaterial. For the three months and nine months ended September 30, 2001, the Company recognized other comprehensive income of $15 million and $53 million, respectively, relating to the effective portion of cash flow hedges. During the three months and nine months ended September 30, 2001, net unrealized investment gains of $10 million and $15 million, respectively, included in other comprehensive income related to hedged items were reclassified into net investment income. 62
The Company held the following positions in derivative financial instruments at September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000 ------------------------------------------ ------------------------------------------ CURRENT MARKET CURRENT MARKET OR FAIR VALUE OR FAIR VALUE CARRYING NOTIONAL -------------------- CARRYING NOTIONAL -------------------- VALUE AMOUNT ASSETS LIABILITIES VALUE AMOUNT ASSETS LIABILITIES ----- ------ ------ ----------- ----- ------ ------ ----------- (DOLLARS IN MILLIONS) <S> <C> <C> <C> <C> <C> <C> <C> <C> Financial futures $ -- $ -- $ -- $ -- $ 23 $ 254 $ 23 $ -- Interest rate swaps 81 1,388 89 8 41 1,549 49 1 Floors 11 325 11 -- -- 325 3 -- Caps 2 7,890 2 -- -- 9,950 -- -- Foreign currency swaps 149 1,845 186 37 (1) 1,469 267 85 Exchange traded options -- 4 -- -- 1 10 -- 1 Foreign currency forwards (1) 208 -- 1 -- -- -- -- Written covered calls -- 40 -- -- -- -- -- -- Credit default swaps -- 30 -- -- -- -- -- -- ------- ------- ------ -------- ------- -------- ------ -------- Total contractual commitments $ 242 $11,730 $ 288 $ 46 $ 64 $ 13,557 $ 342 $ 87 ======= ======= ====== ======== ======= ======== ====== ======== </TABLE> SECURITIES LENDING Pursuant to the Company's securities lending program, it lends securities to major brokerage firms. The Company's policy requires a minimum of 102% of the fair value of the loaned securities as collateral, calculated on a daily basis. The Company's securities on loan at September 30, 2001 and December 31, 2000 had estimated fair values of $13,392 million and $12,289 million, respectively. SEPARATE ACCOUNT ASSETS The Company manages each separate account's assets in accordance with the prescribed investment policy that applies to that specific separate account. The Company establishes separate accounts on a single client and multi-client comingled basis in conformity with insurance laws. Generally, separate accounts are not chargeable with liabilities that arise from any other business of the Company. Separate account assets are subject to claims of the Company's general account claims only to the extent that the value of such assets exceeds the separate account liabilities, as defined by the account's contract. If the Company uses a separate account to support a contract providing guaranteed benefits, the Company must comply with the asset maintenance requirements stipulated under Regulation 128 of the New York Insurance Department. The Company monitors these requirements at least monthly and, in addition, performs cash flow analyses, similar to that conducted for the general account, on an annual basis. The Company reports separately as assets and liabilities investments held in separate accounts and liabilities of the separate accounts. The Company reports substantially all separate account assets at their fair market value. Investment income and gains or losses on the investments of separate accounts accrue directly to contract holders, and, accordingly, the Company does not reflect them in its unaudited interim condensed consolidated statements of income and cash flows. The Company reflects in its revenues fees charged to the separate accounts by the Company, including mortality charges, risk charges, policy administration fees, investment management fees and surrender charges. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has material exposure to interest rate, equity market and foreign exchange risk. The Company analyzes interest rate risk using various models, including multi-scenario cash flow projection models that forecast cash flows of the liabilities and their supporting investments, such as derivative instruments. There have been no material changes in market risk exposures from December 31, 2000, a description of which may be found in MetLife's 2000 Annual Report on Form 10-K filed with the SEC. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The following should be read in conjunction with Note 7 to unaudited interim condensed consolidated financial statements in Part I of this Report ("Note 7"). As previously disclosed, two plaintiffs have jointly brought a lawsuit in Federal court in Alabama alleging that Metropolitan Property and Casualty Insurance Company and CCC, a valuation company, violated state law and the Federal RICO statute by conspiring to fail to pay the proper amounts for a motor vehicle that sustained a total loss. The plaintiffs recently filed a voluntary dismissal of 63
this claim. Plaintiffs also filed a new lawsuit alleging breach of contract and bad faith and did not assert a Federal RICO claim. A Pennsylvania state court purported class action lawsuit, filed in August 2001, alleges that Metropolitan Property and Casualty Insurance Company improperly took depreciation on partial homeowner losses where the insured replaced the covered item. Preliminary objections have been filed and discovery has not yet commenced. Thirty-two other insurers in Pennsylvania also are defendants in similar actions. In addition, in Florida, Metropolitan Property and Casualty Insurance Company has been named in a class action alleging that it improperly established preferred provider organizations. Discovery has commenced. Metropolitan Property and Casualty Insurance Company is vigorously defending itself against all of the allegations described above. In September 2001, the Supreme Court, New York County approved a settlement of the three putative class actions previously brought by shareholders of Conning Corporation in connection with Metropolitan Life's completed tender offer to purchase the shares of Conning that it had not already owned. There will be no appeal. In September 2001, Metropolitan Life received a statement of claim, which apparently had been filed in the Superior Court of Justice, Ontario, Canada in April 2001, on behalf of a proposed class of certain former Canadian policyholders against the Holding Company, Metropolitan Life and Metropolitan Life Insurance Company of Canada. Plaintiffs' allegations concern the way that their policies were treated in connection with the demutualization of Metropolitan Life; they seek damages, declarations and other non-pecuniary relief. The defendants believe they have meritorious defenses to the plaintiffs' claims and will contest vigorously all of the plaintiffs' claims in this matter. As previously disclosed, four purported class action lawsuits have been filed against Metropolitan Life alleging racial discrimination in the marketing, sale and administration of life insurance policies, including "industrial" life insurance policies sold by Metropolitan Life decades ago. Plaintiffs have moved for certification of a class consisting of all non-Caucasian policyholders who were purportedly harmed by the practices alleged in the complaint. Metropolitan Life has opposed the class certification motion. These cases are scheduled for trial in April 2002. Metropolitan Life believes it has meritorious defenses and is contesting vigorously plaintiffs' claims. As previously disclosed, the settlement of the consolidated multidistrict sales practices class action case against General American was approved by the United States District Court for the Eastern District of Missouri. On appeal, the settlement was affirmed by the United States Court of Appeals for the Eighth Circuit in October 2001. In October 2001, the United States District Court for the Southern District of New York approved the settlement of a class action alleging improper sales abroad that was brought against Metropolitan Life, Metropolitan Insurance and Annuity Company, Metropolitan Tower Life Insurance Company and various individual defendants. An appeal may be filed. The settlement is within amounts previously recorded by the Company. Various litigation, claims and assessments against the Company, in addition to those discussed above and those otherwise provided for in the Company's unaudited interim condensed consolidated financial statements, have arisen in the course of the Company's business, including, but not limited to, in connection with its activities as an insurer, employer, investor, investment advisor and taxpayer. Further, state insurance regulatory authorities and other Federal and state authorities regularly make inquiries and conduct investigations concerning the Company's compliance with applicable insurance and other laws and regulations. It is not feasible to predict or determine the ultimate outcome of all pending investigations and legal proceedings or provide reasonable ranges of potential losses. In some of the matters referred to above, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Although in light of these considerations it is possible that an adverse outcome in certain cases could have a material adverse effect upon the Company's consolidated financial position, based on information currently known by the Company's management, in its opinion, the outcomes of such pending investigations and legal proceedings are not likely to have such an effect. However, given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company's operating results or cash flows in particular quarterly or annual periods. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (c) During the nine months ended September 30, 2001, the Company issued an additional 62,552 shares of its common stock to eligible policyholders of Metropolitan Life in connection with Metropolitan Life's demutualization. These shares were issued pursuant to the exemption from registration provided by Section 3(a)(10) of the Securities Act of 1933, as amended, the availability of which was confirmed to the Company by the Securities and Exchange Commission in a no-action letter dated November 17, 1999 (publicly available on November 23, 1999). 64
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (b) Reports on Form 8-K During the three months ended September 30, 2001, the following current reports were filed on Form 8-K: 1. Current Report on Form 8-K filed August 7, 2001 attaching press release dated August 7, 2001 announcing MetLife's second quarter 2001 results. 2. Current Report on Form 8-K filed August 10, 2001 attaching (i) Underwriting Agreement dated August 7, 2001 among MetLife, Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Santusa Holding, S.L., and (ii) Prospectus Supplement dated August 7, 2001 and accompanying Prospectus dated June 29, 2001. 3. Current Report on Form 8-K filed September 19, 2001 attaching press release dated September 14, 2001 regarding estimates of insurance losses related to September 11, 2001 terrorist attacks. 65
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. METLIFE, INC. BY: /S/ VIRGINIA M. WILSON ------------------------------------ SENIOR VICE-PRESIDENT AND CONTROLLER (AUTHORIZED SIGNATORY AND PRINCIPAL ACCOUNTING OFFICER) DATE: NOVEMBER 13, 2001 66
EXHIBIT INDEX <TABLE> <CAPTION> EXHIBIT PAGE NUMBER EXHIBIT NAME NUMBER - ------ ------------ ------ <S> <C> <C> </TABLE> 67