MetLife 2011 Annual Report Download - page 83

benefits. The Company also manages equity market risk exposure in its investment portfolio through the use of derivatives. Equity exposures associated
with other limited partnership interests are excluded from this section as they are not considered financial instruments under GAAP.
Management of Market Risk Exposures
The Company uses a variety of strategies to manage interest rate, foreign currency exchange rate and equity market risk, including the use of
derivative instruments.
Interest Rate Risk Management. To manage interest rate 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, including derivative instruments. These
projections involve evaluating the potential gain or loss on most of the Company’s in-force business under various increasing and decreasing interest
rate environments. The Department of Financial Services regulations require that MetLife perform some of these analyses annually as part of MetLife’s
review of the sufficiency of its regulatory reserves. For several of its legal entities, the Company maintains segmented operating and surplus asset
portfolios for the purpose of ALM and the allocation of investment income to product lines. For each segment, invested assets greater than or equal to
the GAAP liabilities less the DAC asset and any non-invested assets allocated to the segment are maintained, with any excess swept to the surplus
segment. The business segments may reflect differences in legal entity, statutory line of business and any product market characteristic which may drive
a distinct investment strategy with respect to duration, liquidity or credit quality of the invested assets. Certain smaller entities make use of unsegmented
general accounts for which the investment strategy reflects the aggregate characteristics of liabilities in those entities. The Company measures relative
sensitivities of the value of its assets and liabilities to changes in key assumptions utilizing Company models. These models reflect specific product
characteristics and include assumptions based on current and anticipated experience regarding lapse, mortality and interest crediting rates. In addition,
these models include asset cash flow projections reflecting interest payments, sinking fund payments, principal payments, bond calls, mortgage
prepayments and defaults.
Common industry metrics, such as duration and convexity, are also used to measure the relative sensitivity of assets and liability values to changes
in interest rates. In computing the duration of liabilities, consideration is given to all policyholder guarantees and to how the Company intends to set
indeterminate policy elements such as interest credits or dividends. Each asset portfolio has a duration target based on the liability duration and the
investment objectives of that portfolio. Where a liability cash flow may exceed the maturity of available assets, as is the case with certain retirement and
non-medical health products, the Company may support such liabilities with equity investments, derivatives or curve mismatch strategies.
Foreign Currency Exchange Rate Risk Management. Foreign currency exchange rate risk is assumed primarily in three ways: investments in foreign
subsidiaries, purchases of foreign currency denominated investments in the investment portfolio and the sale of certain insurance products.
‰The Company’s Treasury Department is responsible for managing the exposure to investments in foreign subsidiaries. Limits to exposures are
established and monitored by the Treasury Department and managed by the Investment Department.
‰The Investment Department is responsible for managing the exposure to foreign currency investments. Exposure limits to unhedged foreign
currency investments are incorporated into the standing authorizations granted to management by the Board of Directors and are reported to the
Board of Directors on a periodic basis.
‰The lines of business are responsible for establishing limits and managing any foreign exchange rate exposure caused by the sale or issuance of
insurance products.
MetLife uses foreign currency swaps and forwards to mitigate the liability exposure, risk of loss and the volatility of net income associated with its
investments in foreign subsidiaries, foreign currency denominated fixed income investments and the sale of certain insurance products.
Equity Market Risk Management. Equity market risk exposure through the issuance of variable annuities is managed by the Company’s Asset/
Liability Management Unit in partnership with the Investment Department. Equity market risk is realized through its investment in equity securities and is
managed by its Investment Department. MetLife uses derivatives to mitigate its equity exposure both in certain liability guarantees such as variable
annuities with guaranteed minimum benefit and equity securities. These derivatives include exchange-traded equity futures, equity index options
contracts and equity variance swaps. The Company also employs reinsurance to manage these exposures.
Hedging Activities. MetLife uses derivative contracts primarily to hedge a wide range of risks including interest rate risk, foreign currency risk, and
equity risk. Derivative hedges are designed to reduce risk on an economic basis while considering their impact on accounting results and GAAP and
Statutory capital. The construction of the Company’s derivative hedge programs vary depending on the type of risk being hedged. Some hedge
programs are asset or liability specific while others are portfolio hedges that reduce risk related to a group of liabilities or assets. The Company’s use of
derivatives by major hedge programs is as follows:
‰Risks Related to Living Guarantee Benefits — The Company uses a wide range of derivative contracts to hedge the risk associated with variable
annuity living guarantee benefits. These hedges include equity and interest rate futures, interest rate swaps, currency futures/forwards, equity
indexed options and interest rate option contracts and equity variance swaps.
‰Minimum Interest Rate Guarantees — For certain Company liability contracts, the Company provides the contractholder a guaranteed minimum
interest rate. These contracts include certain fixed annuities and other insurance liabilities. The Company purchases interest rate floors to reduce
risk associated with these liability guarantees.
‰Reinvestment Risk in Long Duration Liability Contracts — Derivatives are used to hedge interest rate risk related to certain long duration liability
contracts, such as deferred annuities. Hedges include zero coupon interest rate swaps and swaptions.
‰Foreign Currency Risk — The Company uses currency swaps and forwards to hedge foreign currency risk. These hedges primarily swap foreign
currency denominated bonds, investments in foreign subsidiaries or equity exposures to U.S. dollars.
‰General ALM Hedging Strategies — In the ordinary course of managing the Company’s asset/liability risks, the Company uses interest rate
futures, interest rate swaps, interest rate caps, interest rate floors and inflation swaps. These hedges are designed to reduce interest rate risk or
inflation risk related to the existing assets or liabilities or related to expected future cash flows.
Risk Measurement: Sensitivity Analysis
The Company measures market risk related to its market sensitive assets and liabilities based on changes in interest rates, equity prices and foreign
currency exchange rates utilizing a sensitivity analysis. This analysis estimates the potential changes in estimated fair value based on a hypothetical 10%
change (increase or decrease) in interest rates, equity market prices and foreign currency exchange rates. The Company believes that a 10% change
(increase or decrease) in these market rates and prices is reasonably possible in the near-term. In performing the analysis summarized below, the
Company used market rates at December 31, 2011. The sensitivity analysis separately calculates each of the Company’s market risk exposures
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