MetLife 2012 Annual Report Download - page 25

The composition of the investment portfolio of each business segment is tailored to the specific characteristics of its insurance liabilities, causing
certain portfolios to be shorter in duration and others to be longer in duration. Accordingly, certain portfolios are more heavily weighted in longer duration,
higher yielding fixed maturity securities, or certain sub-sectors of fixed maturity securities, than other portfolios.
Investments are purchased to support our insurance liabilities and not to generate net investment gains and losses. However, net investment gains
and losses are incurred and can change significantly from period to period due to changes in external influences, including changes in market factors
such as interest rates, foreign currency exchange rates, credit spreads and equity markets; counterparty specific factors such as financial performance,
credit rating and collateral valuation; and internal factors such as portfolio rebalancing. Changes in these factors from period to period can significantly
impact the levels of both impairments and realized gains and losses on investments sold.
We use freestanding interest rate, equity, credit and currency derivatives to hedge certain invested assets and insurance liabilities. Certain of these
hedges are designated and qualify as accounting hedges, which reduce volatility in earnings. For those hedges not designated as accounting hedges,
changes in market factors lead to the recognition of fair value changes in net derivative gains (losses) generally without an offsetting gain or loss
recognized in earnings for the item being hedged.
Certain variable annuity products with minimum benefit guarantees contain embedded derivatives that are measured at estimated fair value
separately from the host variable annuity contract, with changes in estimated fair value recorded in net derivative gains (losses). The Company uses
freestanding derivatives to hedge the market risks inherent in these variable annuity guarantees. The valuation of these embedded derivatives includes a
nonperformance risk adjustment, which is unhedged and can be a significant driver of net derivative gains (losses) but does not have an economic
impact on the Company.
The variable annuity embedded derivatives and associated freestanding derivative hedges are collectively referred to as “VA program derivatives” in
the following table. All other derivatives that are economic hedges of certain invested assets and insurance liabilities are referred to as “non-VA program
derivatives” in the following table. The table below presents the impact on net derivative gains (losses) from non-VA program derivatives and VA program
derivatives:
Years Ended
December 31,
Change2012 2011
(In millions)
Non-VA program derivatives
Interest rate ..................................................................................... $ 271 $2,536 $(2,265)
Foreign currency exchange rate ..................................................................... (426) 171 (597)
Credit .......................................................................................... (105) 173 (278)
Equity .......................................................................................... 1 6 (5)
Non-VA embedded derivatives ...................................................................... (61) 17 (78)
Total non-VA program derivatives .................................................................. (320) 2,903 (3,223)
VA program derivatives
Market and other risks in embedded derivatives ......................................................... 2,959 (3,123) 6,082
Nonperformance risk on embedded derivatives ......................................................... (1,659) 1,822 (3,481)
Total embedded derivatives ....................................................................... 1,300 (1,301) 2,601
Freestanding derivatives hedging embedded derivatives .................................................. (2,899) 3,222 (6,121)
Total VA program derivatives ...................................................................... (1,599) 1,921 (3,520)
Net derivative gains (losses) ..................................................................... $(1,919) $ 4,824 $(6,743)
The unfavorable change in net derivative gains (losses) on non-VA program derivatives was $3.2 billion ($2.1 billion, net of income tax). This was
primarily due to long-term interest rates increasing in the current period but decreasing in the prior period, unfavorably impacting receive-fixed interest
rate swaps, long interest rate floors and receiver swaptions. These freestanding derivatives are primarily hedging long duration liability portfolios. The
weakening of the U.S. dollar and Japanese yen relative to other key currencies unfavorably impacted foreign currency forwards and swaps, which
primarily hedge certain foreign denominated bonds. Additionally, the narrowing of credit spreads in the current period compared to widening in the prior
period unfavorably impacted credit default swaps hedging certain bonds. Because certain of these hedging strategies are not designated or do not
qualify as accounting hedges, the changes in the estimated fair value of these freestanding derivatives are recognized in net derivative gains (losses)
without an offsetting gain or loss recognized in earnings for the item being hedged.
The unfavorable change in net derivative gains (losses) on VA program derivatives was $3.5 billion ($2.3 billion, net of income tax). This was due to
an unfavorable change of $3.5 billion ($2.3 billion, net of income tax) related to the change in the nonperformance risk adjustment on embedded
derivatives and by an unfavorable change of $39 million ($25 million, net of income tax) on market and other risks in embedded derivatives, net of the
impact of freestanding derivatives hedging those risks.
The unfavorable change of $39 million is comprised of a $6.1 billion ($4.0 billion, net of income tax) unfavorable change in freestanding derivatives
that hedge market risks in embedded derivatives, which was offset by a $6.1 billion ($4.0 billion, net of income tax) favorable change in market and
other risks in our embedded derivatives, which was primarily driven by changes in market factors. The primary changes in market factors are
summarized as follows:
‰Long-term interest rates increased in the current period but decreased in the prior period and contributed to an unfavorable change in our
freestanding derivatives and favorable changes in our embedded derivatives.
‰Key equity index levels improved in the current period but decreased in the prior period, and equity volatility decreased in the current period but
generally increased in the prior period. These changes contributed to an unfavorable change in our freestanding derivatives and a favorable
change in our embedded derivatives.
‰Changes in foreign currency exchange rates contributed to an unfavorable change in our freestanding derivatives and favorable changes in our
embedded derivatives.
MetLife, Inc. 19