In light of the current economic conditions and given significant government intervention such as the Federal Reserve’s Operation Twist, we have revisited our forecasts for MetLife (NYSE:MET) and have adjusted our price estimate from $48 to $37, which is still about 35% ahead of the current market price. These conservative investments include retirement annuities sold by insurance companies such as AIG (NYSE:AIG) and The Hartford (NYSE:HIG) and Prudential (NYSE:PRU).
We highlight the changes to our forecasts below.
Yield on Fixed Maturity Investments Likely to Decline
Operation Twist, through which the Fed is selling short-term securities and buying longer-term securities, will have a direct impact on MetLife’s yield on fixed maturity investments. The $400 billion program has already caused the yield on 10-year treasury bonds to drop below 2%. Over the next two years, we believe that the Fed is unlikely to raise interest rates and insurance companies such as MetLife will see a decline in their fixed maturity yields. Since MetLife invests more than $300 billion in fixed maturity securities, this decline in yield will have a significant impact on the company’s returns. We expect a gradual increase in interest rates beginning in 2013, and as a result continued improvement in yields thereafter.
Apart from the yield on fixed maturity securities, MetLife’s yield on mortgage loans and other investments will also be negatively impacted by the low interest rate environment.
Life and Health Insurance Margins Will Narrow
Competition in the U.S. life and health insurance industry has increased over the years with no single insurer controlling more than 7% of the market and little product differentiation among insurance companies. Additionally, the weak economic outlook is pressuring prices of insurance policies. As a result, we believe it will be difficult for MetLife to increase its operating margin from the current 9.4% to 12.5% as previously estimated. Accordingly, we are now projecting flat operating margins throughout our forecast period.