A Gargantuan Plan

• TBA - Writer
• October 2017
• 

The reflections danced across the wet pavement in streaks of teal and green.

Brighthouse Financial's signature colors cut through the morning gloom, projecting from a towering Times Square video board. The life insurer's logo bounced off puddles. Damp umbrellas. The windshields of passing cars beneath a gray Manhattan sky.

Tourists stopped and stared as Eric Steigerwalt posed for photos under that imprint on the giant Nasdaq MarketSite screen. Some gawkers snapped their own photos just in case its chief executive was someone they were supposed to know.

"It was like Brighthouse 3-D," Steigerwalt said of the scene following the Aug. 7 Nasdaq opening bell ceremony honoring the carrier's inaugural trading session. "The tourists didn't know who we were, but they were taking pictures of us anyway. It was a long day, but it was unbelievably rewarding. It was the fulfillment of 21 months of work."

But that work has only just begun.

The launch of Brighthouse Financial as an independent, publicly traded spinoff of MetLife marked the official debut of the Charlotte, North Carolina-based company. Almost overnight, it became one of the largest life/annuity carriers in the industry based on its $224 billion in total assets, even if it has only operated under its own name since March.

The nascent insurer found itself born into a challenging U.S. retail market--one that MetLife was vacating through the separation. It is Steigerwalt's job to navigate Brighthouse Financial through the considerable headwinds.

"As you can imagine, there's a gargantuan plan," he said. "There's a million different branches off the main tree, and you're trying to figure out all the things you have to do to put yourself in the best position. There is a real uniqueness to being a spinoff."

Brighthouse Financial understands what it is: a domestic-only, wholesale business sold through third-party distributors. It knows what it wants: It envisions growing into a nimble and transparent financial solutions carrier in both product offerings and culture.

And it knows how to get there--or at least, it believes it does. The strategic priorities in Brighthouse Financial's crucial first two years are to establish itself as an independent company and brand, rebuild its life insurance product line and digitally transform its operations technology.

But it will not be easy.

The Brighthouse spinoff is part of a larger transformation of the life insurance industry, a mature, crowded market facing significant pressures. The phenomenon has been triggered by a series of factors: the low interest rate environment weighing down investment yields and driving up expenses through product guarantees; rising regulatory compliance costs; largely stagnant industry sales; and investor wariness of variable annuity exposure.

Analysts and a host of insurers are closely watching how the separation unfolds for both MetLife and its former U.S. retail life operations unit, possibly exploring their own divestitures.

Brighthouse Financial was launched amid "The Great Restructuring" of the global life space, according to Sean Dargan, director and senior financial services equity analyst at Wells Fargo Securities.

"Life insurance companies are focusing on lines of business in which they can generate returns in excess of their cost of capital," he said. "When they can't do that, they are going to increasingly make hard decisions about what lines of business they're going to stay in.

"In the case of MetLife, the management felt its market valuation was weighed down by the businesses within Brighthouse, and they made a difficult decision to spin it out," Dargan continued. "I think we may see more of that in the future."

Axa already has announced plans to sell off a stake of its U.S. life operations, focused on investing in higher growth markets. And Manulife reportedly is exploring a spinoff or initial public offering of its John Hancock Financial Services unit as it seeks to expand globally. They will measure not just Brighthouse's performance and stock value, but also MetLife's valuation.

The early volatility in Brighthouse's stock value reflected that unease, with its shares tumbling about 12% in the month following its opening at $62.75. Some anticipated the bearish debut, especially with no capital return expected for a few years and many MetLife investors choosing to not retain shares.

But where some see challenges, Steigerwalt sees opportunity.

His optimism on the summer day that announced Brighthouse's official arrival--commencing with a live CNBC interview before moving to the opening bell ceremony and concluding some 650 miles away in Charlotte where he joined 800 employees celebrating the close of its first trading session--remains firm.

"Yes, rates are still at historic lows," said Steigerwalt, who previously served as head of MetLife's North American retail business. "It puts pressure on all of us with respect to earnings. Spreads continue to compress as investments in the portfolio roll off, and you replace them with lower-yielding investments. But that is an industrywide phenomenon that we just have to deal with, no different than any of our peer companies.

"We feel well-positioned to do that," he continued. "We are well-capitalized, and our strategy is to be even more well-capitalized over the next couple of years before we return capital to shareholders. If we can continue to grow our products, then we would be in very good shape going forward."

Blazing a Path

Establish the brand.

Among all the priorities Brighthouse Financial faces in its inaugural year, that is the first order of business.

"They are going to spend quite a bit on advertising and brand awareness," said Michael Adams, senior financial analyst, A.M. Best.

Brighthouse posters wrapped home delivery copies of The Wall Street Journal twice during the week it debuted. And the company launched a TV advertising campaign in the spring that it plans to resume this fall.

It is all part of the plan formulated when MetLife proposed spinning off its U.S. retail unit in January 2016, and then rebranded it six months later as Brighthouse Financial. The separation officially was completed Aug. 4.

A simple theme arose from market research conducted among distributors, advisers and consumers: "Make the name come to life so we can grab onto it and understand exactly who you are," Steigerwalt said.

So the company came up with the tagline, "Brighthouse Financial, established by MetLife" and owns the rights for 18 months to establish name recognition.

"We need to season this company," Steigerwalt said. "Over the next five to six quarters, we just have to perform as an upstanding corporate citizen and get a cadence for being a solid public company."

The good news, he says, is it remains essentially unchanged. Brighthouse Financial is the same entity that was a large division within MetLife.

It has more than 2.8 million annuity contracts and life insurance policies in-force and relationships with more than 400 distributors. It boasts $86.3 billion in general account investments and cash. But now it is free to concentrate on its customers and its own business model as an independent carrier, not a unit beholden to a parent company.

The goal is to become a simple, transparent 1,500 employee-strong insurer.

"We want simplicity as part of the DNA of the company," Steigerwalt said.

To realize that vision, Brighthouse Financial is "rebuilding" its life insurance product line over the next 18 to 24 months. The revamp includes constructing "a more robust life portfolio" and abandoning participating whole life products, Steigerwalt said.

Meanwhile, Brighthouse is undergoing an internal digital transformation that will include building a cloud-based technology stack to replace MetLife's legacy systems. The upgrade will help drive efficiency as it anticipates cutting $150 million in expenses without reducing staff.

"Built into this spinoff has been an opportunity to get out of our legacy systems over the next couple of years and create a new IT environment. Companies don't get to do that too often," Steigerwalt said. "This new IT environment will be a part of the value proposition for us and will also allow a little more freedom to innovate within the broader life insurance and annuity industry."

Familial Connection

Whether that will be enough for it to reach its target operating return on equity of 9% remains to be seen.

Brighthouse--which holds a Best's Financial Strength Rating of A (Excellent)--reported second-quarter operating earnings of $283 million, down 5% year over year. Operating premiums, fees and other revenues decreased 13% to $1.3 billion due to lower annuity and life sales.

Earnings were depressed by some legacy hedge issues from the separation, and revenue was affected by the MetLife sale of its retail adviser network in 2016 to MassMutual.

Another concern is how public markets value variable annuities. The product's sales declined 21.6% industrywide in 2016. Brighthouse holds a sizable variable annuities book, which has contributed to volatile earnings due to its sensitivity to equity markets and interest rates.

"Companies that sell variable annuities tend to trade below where you think they would, given their reported ROE," Wells Fargo's Dargan said. "A lot of that is due to the low rate environment. I view it as something like an anchor on valuation. Public equity investors do not want to pay for variable annuity exposure."

But Brighthouse Financial holds a $2.3 billion "buffer" above its standard actuarial risk calculation, which would allow it to absorb losses stemming from equity market and interest rate changes without impacting its financial strength ratings, according to Steigerwalt. It aims to grow that total to $3 billion. "So I do see our ROE in the 8 1/2% to 9% area, but it will be stable for a while before we can grow GAAP return on equity," he said.

For MetLife, the spinoff was "the centerpiece" of its own strategic, multiyear project that is nearing completion, CEO Steve Kandarian said in a statement. The strategic repositioning aims to increase return through lower expenses, improve free cash flow and reduce its capital intensity as it fights its designation as a systemically important financial institution under the Dodd-Frank Act.

However, the familial connection between Brighthouse and its former parent company remains.

MetLife--the biggest U.S. life insurer by assets before ceding the top spot to Prudential Financial in the spinoff--initially retained a 19.9% stake in Brighthouse. It plans to dispose of it "as soon as practicable" and within five years, according to a filing. Under the terms of the separation, MetLife shareholders received a distribution of one share of Brighthouse common stock for every 11 shares of MetLife.

About 75% of the Brighthouse management and staff hail from MetLife. The new company also is responsible for a large segment of "runoff" business that MetLife sold. And Brighthouse has agreements with its former parent for call centers and for MetLife Asset Management to manage $80 billion of its assets, Kandarian said.

'There's Clearly Momentum'

As it moves forward on its own, the new company is offering new products.

In the first half of 2017, it sold $1 billion worth of its flagship Shield annuities, which are designed for consumers concerned with equity market volatility. Sales of the hybrid product, part variable annuity and part indexed annuity, rose 28% in the second quarter year-over-year to $570 million. It had risen 25% in the first quarter.

"There's clearly momentum here," Steigerwalt said. "Now we want to build out the rest of that product portfolio around it."

Brighthouse added to its annuity product line (variable, fixed, index-linked and income) in August, unveiling new offerings with the Department of Labor's fiduciary rule in mind.

It introduced Shield Level Selection three-year and six-year annuity contracts as well as the Shield Level Select Access Annuity. The Access annuity contract is a simplified Shield Selector product designed specifically to meet the needs of fee-based advisers.

"They want to move away from selling variable annuities with living benefits because that's what introduces a lot of volatility to your balance sheet and income statement," Dargan said.

On the life insurance side, Brighthouse sells term and its Premier Accumulator Universal Life policies as it rebuilds the line.

"They reduced the risk within their product portfolio," said A.M. Best's Adams. "They're putting profitability over new sales. They're having some success with their fixed-index annuity product.

"But sales have been declining," he continued. "Will they be able to stay competitive with their current product offering? That's yet to be seen."

Some of that decline stems from the loss of MetLife's distribution network and mutual fund giant Fidelity suspending sales of MetLife annuities just after the spinoff announcement. Brighthouse Financial depends on brokerage firms, financial advisers and outside agent groups to distribute its products, although it also will sell annuities through MassMutual's enlarged sales force.

As of now, there are no plans to sell direct-to-consumer products.

"They're not as strong as MetLife's U.S. retail business was prior to MetLife selling its adviser network," Dargan said. "The combination of losing the MetLife advisers and one of the largest third-party annuity distributors in Fidelity was not helpful. Their sales rankings in both annuities and life insurance have fallen versus where it was two years ago.

"So it's going to take some time to get the Brighthouse name recognition to a level where advisers are comfortable selling it," he continued. "Time will tell."

So the industry will continue to watch how Brighthouse and MetLife perform. And so will Wall Street analysts.

"Brighthouse is as close to a pure-play variable annuity stock as exists in the U.S.," Dargan said. "If interest rates and equity markets rise in tandem, the stock should do well. If they don't, it's going to be tough for the stock to work."

By Jeff Roberts, senior associate editor; jeff.roberts@ambest.com