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 JUNE 30, 2004 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) 200 Park Avenue, New York, NY 10166 (Address of principal (Zip Code) executive offices) (212) 578-2211 (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 [ ] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES [X] NO [ ] At July 29, 2004, 750,141,288 shares of the Registrant's Common Stock, $.01 par value per share, were outstanding. TABLE OF CONTENTS PAGE PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS .................................................................. 4 Unaudited Interim Condensed Consolidated Balance Sheets at June 30, 2004 and December 31, 2003 ........................................................................ 4 Unaudited Interim Condensed Consolidated Statements of Income for the Three Months and Six Months Ended June 30, 2004 and 2003 ...................................................... 5 Unaudited Interim Condensed Consolidated Statement of Stockholders' Equity for the Six Months Ended June 30, 2004 ...................................................................... 6 Unaudited Interim Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003 ........................................................................ 7 Notes to Unaudited Interim Condensed Consolidated Financial Statements ........................ 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS . 36 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ............................ 81 ITEM 4. CONTROLS AND PROCEDURES ............................................................... 81 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS ..................................................................... 82 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES ...... 86 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ................................... 87 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ...................................................... 88 SIGNATURES .................................................................................... 89 2 NOTE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q, including the 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 the 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) MetLife, Inc.'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 results or other consequences from litigation, arbitration or regulatory investigations; (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, financial strength or credit 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) discrepancies between actual experience and assumptions used in establishing liabilities related to other contingencies or obligations; (xiii) the effects of business disruption or economic contraction due to terrorism or other hostilities; (xiv) the Company's ability to identify and consummate on successful terms any future acquisitions, and to successfully integrate acquired businesses with minimal disruption; and (xv) other risks and uncertainties described from time to time in MetLife, Inc.'s filings with the U.S. 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. 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS METLIFE, INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS JUNE 30, 2004 AND DECEMBER 31, 2003 (DOLLARS IN MILLIONS, EXCEPT SHARE AND PER SHARE DATA) JUNE 30, DECEMBER 31, 2004 2003 --------- ------------ ASSETS Investments: Fixed maturities available-for-sale, at fair value (amortized cost: $164,902 and $158,333, respectively) $ 170,192 $ 167,752 Equity securities, at fair value (cost: $1,437 and $1,222, respectively) 1,744 1,598 Mortgage loans on real estate 28,118 26,249 Policy loans 8,766 8,749 Real estate and real estate joint ventures held-for-investment 4,110 3,848 Real estate held-for-sale 44 832 Other limited partnership interests 2,805 2,600 Short-term investments 2,089 1,826 Other invested assets 5,119 4,645 --------- --------- Total investments 222,987 218,099 Cash and cash equivalents 4,459 3,733 Accrued investment income 2,330 2,186 Premiums and other receivables 7,566 7,047 Deferred policy acquisition costs 13,885 12,943 Other assets 7,255 7,077 Separate account assets 79,747 75,756 --------- --------- Total assets $ 338,229 $ 326,841 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Future policy benefits $ 96,021 $ 94,148 Policyholder account balances 79,943 75,901 Other policyholder funds 6,773 6,343 Policyholder dividends payable 1,064 1,049 Policyholder dividend obligation 1,330 2,130 Short-term debt 3,218 3,642 Long-term debt 6,226 5,703 Shares subject to mandatory redemption 277 277 Current income taxes payable 756 652 Deferred income taxes payable 1,931 2,399 Payables under securities loaned transactions 28,132 27,083 Other liabilities 11,495 10,609 Separate account liabilities 79,747 75,756 --------- --------- Total liabilities 316,913 305,692 --------- --------- Stockholders' Equity: Preferred stock, par value $0.01 per share; 200,000,000 shares authorized; none issued -- -- Common stock, par value $0.01 per share; 3,000,000,000 shares authorized; 786,766,664 shares issued at June 30, 2004 and December 31, 2003; 750,056,018 shares outstanding at June 30, 2004 and 757,186,137 shares outstanding at December 31, 2003 8 8 Additional paid-in capital 15,013 14,991 Retained earnings 5,663 4,193 Treasury stock, at cost; 36,710,646 shares at June 30, 2004 and 29,580,527 shares at December 31, 2003 (1,085) (835) Accumulated other comprehensive income 1,717 2,792 --------- --------- Total stockholders' equity 21,316 21,149 --------- --------- Total liabilities and stockholders' equity $ 338,229 $ 326,841 ========= ========= SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 4 METLIFE, INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003 (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, -------------------- --------------------- 2004 2003 2004 2003 -------- -------- -------- -------- REVENUES Premiums $ 5,331 $ 5,083 $ 10,698 $ 9,915 Universal life and investment-type product policy fees 728 603 1,404 1,175 Net investment income 3,117 2,864 6,092 5,737 Other revenues 356 355 709 653 Net investment gains (losses) 47 (42) 163 (294) -------- -------- -------- -------- Total revenues 9,579 8,863 19,066 17,186 -------- -------- -------- -------- EXPENSES Policyholder benefits and claims 5,335 4,970 10,795 9,895 Interest credited to policyholder account balances 751 761 1,494 1,508 Policyholder dividends 471 507 913 1,010 Other expenses 1,916 1,841 3,797 3,580 -------- -------- -------- -------- Total expenses 8,473 8,079 16,999 15,993 -------- -------- -------- -------- Income from continuing operations before provision for income taxes 1,106 784 2,067 1,193 Provision for income taxes 254 212 557 327 -------- -------- -------- -------- Income from continuing operations 852 572 1,510 866 Income from discontinued operations, net of income taxes 95 8 118 76 -------- -------- -------- -------- Income before cumulative effect of a change in accounting 947 580 1,628 942 Cumulative effect of a change in accounting, net of income taxes -- -- (158) -- -------- -------- -------- -------- Net income $ 947 $ 580 $ 1,470 $ 942 ======== ======== ======== ======== Income from continuing operations available to common shareholders per share Basic $ 1.13 $ 0.78 $ 2.00 $ 1.18 ======== ======== ======== ======== Diluted $ 1.12 $ 0.78 $ 1.99 $ 1.18 ======== ======== ======== ======== Net income available to common shareholders per share Basic $ 1.26 $ 0.79 $ 1.95 $ 1.29 ======== ======== ======== ======== Diluted $ 1.25 $ 0.79 $ 1.94 $ 1.29 ======== ======== ======== ======== SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 5 METLIFE, INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2004 (DOLLARS IN MILLIONS) Accumulated Other Comprehensive Income (Loss) ----------------------------------------- Net Foreign Minimum Additional Treasury Unrealized Currency Pension Common Paid-in Retained Stock Investment Translation Liability Stock Capital Earnings at Cost Gains (Losses) Adjustment Adjustment Total ------- ---------- -------- -------- -------------- ----------- ---------- -------- Balance at December 31, 2003 $ 8 $ 14,991 $ 4,193 $ (835) $ 2,972 $ (52) $ (128) $ 21,149 Treasury stock transactions, net 22 (250) (228) Comprehensive income (loss): Net income 1,470 1,470 Other comprehensive income (loss): Unrealized gains (losses) on derivative instruments, net of income taxes 85 85 Unrealized investment gains (losses), net of related offsets, reclassification adjustments and income taxes (1,155) (1,155) Cumulative effect of a change in accounting, net of income taxes 90 90 Foreign currency translation adjustments (95) (95) -------- Other comprehensive income (loss) (1,075) -------- Comprehensive income (loss) 395 ------- -------- ------- -------- ------ -------- -------- -------- Balance at June 30, 2004 $ 8 $ 15,013 $ 5,663 $ (1,085) $1,992 $ (147) $ (128) $ 21,316 ======= ======== ======= ======== ====== ======== ======== ======== SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 6 METLIFE, INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003 (DOLLARS IN MILLIONS) SIX MONTHS ENDED JUNE 30, --------------------- 2004 2003 -------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES $ 3,380 $ 3,201 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Sales, maturities and repayments of: Fixed maturities 36,504 33,578 Equity securities 545 147 Mortgage loans on real estate 1,379 1,611 Real estate and real estate joint ventures 982 253 Other limited partnership interests 278 154 Purchases of: Fixed maturities (41,981) (45,608) Equity securities (596) (22) Mortgage loans on real estate (3,175) (1,766) Real estate and real estate joint ventures (205) (142) Other limited partnership interests (411) (203) Net change in short-term investments (141) (722) Proceeds from sales of businesses 29 -- Net change in payable under securities loaned transactions 1,049 5,166 Other, net (561) (495) -------- -------- Net cash used in investing activities (6,304) (8,049) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Policyholder account balances: Deposits 19,115 17,902 Withdrawals (15,307) (13,064) Net change in short-term debt (425) 2,282 Long-term debt issued 615 161 Long-term debt repaid (91) (51) Treasury stock acquired (275) -- Settlement of common stock purchase contracts -- 1,006 Stock options exercised 18 3 -------- -------- Net cash provided by financing activities 3,650 8,239 -------- -------- Change in cash and cash equivalents 726 3,391 Cash and cash equivalents, beginning of period 3,733 2,323 -------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,459 $ 5,714 ======== ======== Supplemental disclosures of cash flow information: Net cash paid during the period for: Interest $ 176 $ 266 ======== ======== Income taxes $ 142 $ 222 ======== ======== Non-cash transactions during the period: Business dispositions - assets $ 820 $ -- ======== ======== Business dispositions - liabilities $ 820 $ -- ======== ======== Purchase money mortgage on real estate sale $ -- $ 50 ======== ======== MetLife Capital Trust I transactions $ -- $ 1,037 ======== ======== SEE ACCOMPANYING NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 7 METLIFE, INC. NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF ACCOUNTING POLICIES BUSINESS "MetLife" or the "Company" refers to MetLife, Inc., a Delaware corporation (the "Holding Company"), and its subsidiaries, including Metropolitan Life Insurance Company ("Metropolitan Life"). MetLife is a leading provider of insurance and other financial services to a broad spectrum of individual and institutional customers. The Company offers life insurance, annuities, automobile and homeowners insurance and mutual funds and retail banking services to individuals, as well as 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 ("GAAP") requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the unaudited interim condensed consolidated financial statements. The most critical estimates include those used in determining: (i) investment impairments; (ii) the fair value of investments in the absence of quoted market values; (iii) the fair value of derivatives; (iv) the capitalization and amortization of deferred policy acquisition costs; (v) the liability for future policyholder benefits; (vi) the liability for litigation and regulatory matters; and (vii) accounting for reinsurance transactions, derivatives and employee benefit plans. In applying these policies, management makes subjective and complex judgments that frequently require estimates about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company's businesses and operations. Actual results could differ from those estimates. The accompanying unaudited interim condensed consolidated financial statements include the accounts of (i) the Holding Company and its subsidiaries; (ii) partnerships and joint ventures in which the Company has control; and (iii) variable interest entities ("VIEs") for which the Company is deemed to be the primary beneficiary. 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 (See Note 5). The 2004 financial statement presentation includes assets, liabilities, revenues and expenses relating to certain separate accounts and are also combined with the assets, liabilities, revenues and expenses of the general account. See "-- Application of Recent Accounting Pronouncements." Intercompany accounts and transactions have been eliminated. The Company uses the equity method of accounting for investments in equity securities, real estate joint ventures and other limited partnership interests in which it has more than a minor equity interest or more than minor influence over the partnership's operations, but does not have a controlling interest and is not the primary beneficiary. The Company uses the cost method of accounting for interests in which it has a minor equity investment and virtually no influence over the partnership's operations. Minority interest related to consolidated entities included in other liabilities was $951 million and $950 million at June 30, 2004 and December 31, 2003, respectively. Certain amounts in the prior year period's unaudited interim condensed consolidated financial statements have been reclassified to conform with the 2004 presentation. The accompanying unaudited interim condensed consolidated financial statements reflect all adjustments (including normal recurring adjustments) necessary to present fairly the consolidated financial position of the Company at June 30, 2004, its consolidated results of operations for the three months and six months ended June 30, 2004 and 2003, its consolidated cash flows for the six months ended June 30, 2004 and 2003 and its consolidated statement of stockholders' equity for the six months ended June 30, 2004, in accordance with GAAP. 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, 2003 included in MetLife, Inc.'s 2003 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission ("SEC"). 8 FEDERAL INCOME TAXES Federal income taxes for interim periods have been computed using an estimated annual effective income 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 income tax rate. APPLICATION OF RECENT ACCOUNTING PRONOUNCEMENTS In March 2004, the Emerging Issues Task Force ("EITF") reached further consensus on Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments ("EITF 03-1"). EITF 03-1 provides accounting guidance regarding the determination of when an impairment of debt and marketable equity securities and investments accounted for under the cost method should be considered other-than-temporary and recognized in income. An EITF 03-1 consensus reached in November 2003 also requires certain quantitative and qualitative disclosures for debt and marketable equity securities classified as available-for-sale or held-to-maturity under Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities, that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The disclosure requirements of EITF 03-1 were effective December 31, 2003. The accounting guidance of EITF 03-1 will be effective in the third quarter of 2004 and is not expected to have a material impact on the Company's unaudited interim condensed consolidated financial statements. In March 2004, the EITF reached consensus on Issue No. 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128 ("EITF 03-6"). EITF 03-6 provides guidance in determining whether a security should be considered a participating security for purposes of computing earnings per share and how earnings should be allocated to the participating security. EITF 03-6, which was effective for the Company in the second quarter of 2004, did not have an impact on the Company's earnings per share calculations. In March 2004, the EITF reached consensus on Issue No. 03-16, Accounting for Investments in Limited Liability Companies ("EITF 03-16"). EITF 03-16 provides guidance regarding whether a limited liability company should be viewed as similar to a corporation or similar to a partnership for purposes of determining whether a noncontrolling investment should be accounted for using the cost method or the equity method of accounting. EITF 03-16, which will be effective in the third quarter of 2004, is not expected to have a material impact on the Company's unaudited interim condensed consolidated financial statements. Effective January 1, 2004, the Company adopted Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts ("SOP 03-1"). SOP 03-1 provides guidance on (i) the classification and valuation of long-duration contract liabilities; (ii) the accounting for sales inducements; and (iii) separate account presentation and valuation. At adoption, the Company increased future policyholder benefits for changes in the methodology relating to various guaranteed death and annuitization benefits and for determining reserves for certain universal life insurance contracts by approximately $68 million, which has been reported as a cumulative effect of a change in accounting. This amount is net of corresponding changes in deferred policy acquisition costs ("DAC"), including value of business acquired and unearned revenue liability ("offsets") under certain variable annuity and life contracts and income taxes. In June 2004, the Financial Accounting Standards Board ("FASB") released Staff Position paper No. 97-1, Situations in Which Paragraphs 17(b) and 20 of FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, Permit or Require Accrual of an Unearned Revenue Liability ("FSP 97-1") which included clarification that unearned revenue liabilities should be considered in determining the necessary insurance benefit liability required under SOP 03-1. FSP 97-1 is effective July 1, 2004. However, additional industry guidance related to SOP 03-1 continues to evolve. Although currently evaluating FSP 97-1 and the possible additional accounting guidance, the Company anticipates a reduction of the initial liability established under SOP 03-1 in subsequent accounting periods. Certain other contracts sold by the Company provide for a return through periodic crediting rates, surrender adjustments or termination adjustments based on the total return of a contractually referenced pool of assets owned by the Company. To the extent that such contracts are not accounted for under the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") and not already credited to the contract account balance, under SOP 03-1 the change relating to the fair value of the referenced pool of assets is recorded as a liability through policyholder benefits and claims. Prior to the adoption of SOP 03-1, the Company recorded the change in such liability as other comprehensive income. At adoption, this change decreased net income and increased other comprehensive income by $63 million, net of income taxes, which were recorded as cumulative effects of a change in accounting. Effective with the adoption of SOP 03-1, costs associated with enhanced or bonus crediting rates to contractholders must be deferred and amortized over the life of the related contract using assumptions consistent with the amortization of DAC. Since the Company followed a similar approach prior to adoption of SOP 03-1, the provisions of SOP 03-1 relating to sales inducements had no significant impact on the Company's unaudited interim condensed consolidated financial statements. At adoption, the Company reclassified $155 million of ownership in its own separate accounts from other assets to fixed maturities, equity securities and cash and cash equivalents. This reclassification had no significant impact on net income or other comprehensive income at adoption. In accordance with SOP 03-1's guidance for the reporting of certain separate accounts, at adoption, the Company also reclassified $1.7 billion of separate account assets to general account investments and $1.7 billion of separate account liabilities to future policy benefits and policyholder account balances. This reclassification decreased net income and increased other comprehensive income by $27 million, net of income taxes, which were reported as cumulative effects of a change in accounting. For the three months and six months 9 ended June 30, 2004, the impact of SOP 03-1 increased the Company's net income by $78 million and $64 million, respectively. (See Note 4). In December 2003, FASB revised SFAS No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits -- an Amendment of FASB Statements No. 87, 88 and 106 ("SFAS 132(r)"). SFAS 132(r) retains most of the disclosure requirements of SFAS 132 and requires additional disclosure about assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined postretirement plans. SFAS 132(r) was primarily effective for fiscal years ending after December 15, 2003; however, certain disclosures about foreign plans and estimated future benefit payments are effective for fiscal years ending after June 15, 2004. The Company's adoption of SFAS 132(r) on December 31, 2003 did not have a significant impact on its consolidated financial statements since it only revised disclosure requirements. In May 2004, the FASB issued FASB Staff Position ("FSP") No. 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("FSP 106-2"), which provides accounting guidance to a sponsor of a postretirement health care plan that provides prescription drug benefits. The Company expects to receive subsidies on prescription drug benefits beginning in 2006 under the Medicare Prescription Drug, Improvement and Modernization Act of 2003 based on the Company's determination that the prescription drug benefits offered under certain postretirement plans are actuarially equivalent to the benefits offered under Medicare Part D. FSP 106-2 is effective for interim periods beginning after June 15, 2004 and provides for either retroactive application to the date of enactment of the legislation or prospective application from the date of adoption of FSP 106-2. The Company is in the process of evaluating the alternatives, however, neither alternative is expected to have a significant impact on the Company's unaudited interim condensed consolidated financial statements. Effective October 1, 2003, the Company adopted Statement 133 Implementation Issue No. B36, Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments ("Issue B36"). Issue B36 concluded that (i) a company's funds withheld payable and/or receivable under certain reinsurance arrangements, and (ii) a debt instrument that incorporates credit risk exposures that are unrelated or only partially related to the creditworthiness of the obligor include an embedded derivative feature that is not clearly and closely related to the host contract. Therefore, the embedded derivative feature is measured at fair value on the balance sheet and changes in fair value are reported in income. As a result of the adoption of Issue B36, the Company recognized net income of $22 million and $13 million, net of amortization of DAC and income taxes, for the three months and six months ended June 30, 2004, respectively. Effective July 1, 2003, the Company adopted SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("SFAS 149"). SFAS 149 amended and clarified the accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Except for certain previously issued and effective guidance that was incorporated in SFAS 149, SFAS 149 is effective for contracts entered into or modified after June 30, 2003. The Company's adoption of SFAS 149 did not have a significant impact on its unaudited interim condensed consolidated financial statements. During 2003, the Company adopted FASB Interpretation No. 46, Consolidation of Variable Interest Entities -- An Interpretation of ARB No. 51 ("FIN 46"), and its December 2003 revision ("FIN 46(r)"). Certain of the Company's asset-backed securitizations, collateralized debt obligations, structured investment transactions, and investments in real estate joint ventures and other limited partnership interests meet the definition of a VIE and must be consolidated, in accordance with the transition rules and effective dates, because the Company is deemed to be the primary beneficiary. A VIE is defined as (i) any entity in which the equity investments at risk in such entity do not have the characteristics of a controlling financial interest, or (ii) any entity that does not have sufficient equity at risk to finance its activities without additional subordinated support from other parties. Effective February 1, 2003, the Company adopted FIN 46 for VIEs created or acquired on or after February 1, 2003 and, effective December 31, 2003, the Company adopted FIN 46(r) with respect to interests in entities formerly considered special purpose entities ("SPEs"), including interests in asset-backed securities and collateralized debt obligations. The adoption of FIN 46 as of February 1, 2003 did not have a significant impact on the Company's unaudited interim condensed consolidated financial statements. The adoption of the provisions of FIN 46(r) at December 31, 2003 did not require the Company to consolidate any additional VIEs that were not previously consolidated. In accordance with the provisions of FIN 46(r), the Company elected to defer until March 31, 2004 the consolidation of interests in VIEs for non SPEs acquired prior to February 1, 2003 for which it is the primary beneficiary. The transition effect recorded at March 31, 2004 as a result of such consolidations was insignificant. As of June 30, 2004, the Company consolidated assets and liabilities relating to real estate joint ventures of $16 million and $3 million, respectively, and assets and liabilities relating to other limited partnerships of $82 million and $15 million, respectively, for VIEs for which the Company was deemed to be the primary beneficiary. 10 2. INVESTMENTS NET INVESTMENT GAINS (LOSSES) Net investment gains (losses), including changes in valuation allowances, and related policyholder amounts were as follows: - ---------- THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, -------------- -------------- 2004 2003 2004 2003 ---- ---- ---- ---- (DOLLARS IN MILLIONS) Fixed maturities $ (3) $ (43) $ 31 $(192) Equity securities 89 (3) 97 (8) Mortgage loans on real estate -- (8) -- (22) Real estate and real estate joint ventures (1) 2 (6) 2 (4) Other limited partnership interests (2) 4 (10) (62) Sales of businesses -- -- 23 -- Derivatives (2) (29) 9 (38) (17) Other (10) 5 58 11 ----- ----- ----- ----- Total net investment gains (losses) $ 47 $ (42) $ 163 $(294) ===== ===== ===== ===== (1) The amounts presented exclude net investment gains related to sales of real estate held-for-sale presented as discontinued operations in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144") of $131 million and $152 million, respectively, for the three months and six months ended June 30, 2004 and $0 million and $90 million, respectively, for the three months and six months ended June 30, 2003. (2) The amounts presented include net investment gains related to scheduled periodic settlement payments on derivative instruments that do not qualify for hedge accounting under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") of $22 million and $36 million, respectively, for the three months and six months ended June 30, 2004 and $12 million and $20 million, respectively, for the three months and six months ended June 30, 2003. 11 The following tables show the estimated fair values and gross unrealized losses of the Company's fixed maturities in an unrealized loss position, aggregated by sector and length of time that the securities have been in a continuous unrealized loss position, at June 30, 2004 and December 31, 2003: JUNE 30, 2004 ------------------------------------------------------------------------------------------ LESS THAN 12 MONTHS EQUAL TO OR GREATER THAN 12 MONTHS TOTAL -------------------- ---------------------------------- ------------------------- ESTIMATED GROSS ESTIMATED GROSS ESTIMATED GROSS FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSS VALUE LOSS VALUE LOSS ----- ---- ----- ---- ----- ---- (DOLLARS IN MILLIONS) U.S. corporate securities $17,711 $ 509 $ 1,205 $ 91 $18,916 $ 600 Residential mortgage-backed securities 16,774 273 283 17 17,057 290 Foreign corporate securities 7,378 243 415 17 7,793 260 U.S. treasuries/agencies 7,773 160 74 6 7,847 166 Asset-backed securities 4,814 53 502 17 5,316 70 Commercial mortgage-backed securities 5,757 137 329 6 6,086 143 Foreign government securities 2,050 94 57 9 2,107 103 State and political subdivisions 1,149 36 69 6 1,218 42 Other fixed income assets 50 50 31 2 81 52 ------- ------- ------- ------- ------- ------- Total bonds 63,456 1,555 2,965 171 66,421 1,726 Redeemable preferred stocks 519 71 -- -- 519 71 ------- ------- ------- ------- ------- ------- Total fixed maturities $63,975 $ 1,626 $ 2,965 $ 171 $66,940 $ 1,797 ======= ======= ======= ======= ======= ======= DECEMBER 31, 2003 ------------------------------------------------------------------------------------- LESS THAN 12 MONTHS EQUAL TO OR GREATER THAN 12 MONTHS TOTAL ------------------- ---------------------------------- ----------------------- ESTIMATED GROSS ESTIMATED GROSS ESTIMATED GROSS VALUE UNREALIZED FAIR UNREALIZED FAIR UNREALIZED FAIR LOSS VALUE LOSS VALUE LOSS ---- ---- ----- ---- ----- ---- (DOLLARS IN MILLIONS) U.S. corporate securities $ 7,214 $ 152 $ 1,056 $ 100 $ 8,270 $ 252 Residential mortgage-backed securities 8,372 98 27 4 8,399 102 Foreign corporate securities 2,583 65 355 14 2,938 79 U.S. treasuries/agencies 3,697 26 -- -- 3,697 26 Asset-backed securities 2,555 34 861 26 3,416 60 Commercial mortgage-backed securities 2,449 20 282 2 2,731 22 Foreign government securities 331 28 2 -- 333 28 State and political subdivisions 389 12 38 3 427 15 Other fixed income assets 130 73 40 10 170 83 ------- ------- ------- ------- ------- ------- Total bonds 27,720 508 2,661 159 30,381 667 Redeemable preferred stocks 222 62 278 14 500 76 ------- ------- ------- ------- ------- ------- Total fixed maturities $27,942 $ 570 $ 2,939 $ 173 $30,881 $ 743 ======= ======= ======= ======= ======= ======= At June 30, 2004 and December 31, 2003, the Company had gross unrealized losses of $29 million and $6 million, respectively, from equity securities that had been in an unrealized loss position for less than twelve months. The amount of unrealized losses from equity securities that had been in an unrealized loss position for twelve months or greater is less than $1 million at both June 30, 2004 and December 31, 2003. The fair value of those equity securities that had been in an unrealized loss position for less than twelve months is $389 million and $53 million at June 30, 2004 and December 31, 2003, respectively. The fair value of those equity securities that had been in an unrealized loss position for twelve months or greater is $2 million and $22 million at June 30, 2004 and December 31, 2003, respectively. STRUCTURED INVESTMENT TRANSACTIONS The Company invests in structured notes and similar type instruments, which generally provide equity-based returns on debt securities. The carrying value of such investments was approximately $906 million and $880 million at June 30, 2004 and December 31, 2003, respectively. The related income recognized was $28 million and $21 million for the three months ended June 30, 2004 and 2003, respectively, and $33 million and $24 million for the six months ended June 30, 2004 and 2003, respectively. 12 VARIABLE INTEREST ENTITIES As discussed in Note 1, the Company has adopted the provisions of FIN 46(r). The adoption of FIN 46(r) required the Company to consolidate certain VIEs for which it is the primary beneficiary. The following table presents the total assets of and maximum exposure to loss relating to VIEs for which the Company has concluded that (i) it is the primary beneficiary and which are consolidated in the Company's unaudited interim condensed consolidated financial statements at June 30, 2004, and (ii) it holds significant variable interests but it is not the primary beneficiary and which have not been consolidated: JUNE 30, 2004 ----------------------------------------------- PRIMARY BENEFICIARY NOT PRIMARY BENEFICIARY ---------------------- ----------------------- MAXIMUM MAXIMUM TOTAL EXPOSURE TO TOTAL EXPOSURE TO ASSETS(1) LOSS(2) ASSETS(1) LOSS(2) --------- ----------- --------- ----------- (DOLLARS IN MILLIONS) Asset-backed securitizations and collateralized debt obligations $ -- $ -- $2,355 $ 16 Real estate joint ventures (3) 16 13 75 -- Other limited partnerships (4) 82 84 587 60 ------ ------ ------ ------ Total $ 98 $ 97 $3,017 $ 76 ====== ====== ====== ====== - ---------- (1) The assets of the asset-backed securitizations and collateralized debt obligations are reflected at fair value as of June 30, 2004. The assets of the real estate joint ventures and other limited partnerships are reflected at the carrying amounts at which such assets would have been reflected on the Company's balance sheet had the Company consolidated the VIE from the date of its initial investment in the entity. (2) The maximum exposure to loss of the asset-backed securitizations and collateralized debt obligations is equal to the carrying amounts of retained interests. In addition, the Company provides collateral management services for certain of these structures for which it collects a management fee. The maximum exposure to loss relating to real estate joint ventures and other limited partnerships is equal to the carrying amounts plus any unfunded commitments, reduced by amounts guaranteed by other partners. (3) Real estate joint ventures include partnerships and other ventures, which engage in the acquisition, development, management and disposal of real estate investments. (4) Other limited partnerships include partnerships established for the purpose of investing in real estate funds, public and private debt and equity securities, as well as limited partnerships established for the purpose of investing in low-income housing that qualifies for federal tax credits. 3. DERIVATIVE INSTRUMENTS The Company uses derivative instruments to manage risk through one of five principal strategies, the hedging of: (i) liabilities; (ii) invested assets; (iii) portfolios of assets or liabilities; (iv) net investments in certain foreign operations; and (v) firm commitments and forecasted transactions. Additionally, the Company enters into income generation and replication derivative transactions as permitted by its insurance subsidiaries' Derivatives Use Plans approved by the applicable state insurance departments. The Company's derivative hedging strategy employs a variety of instruments, including financial futures, financial forwards, interest rate swaps, caps and floors, credit default swaps and foreign currency swaps and foreign currency forwards and options. On the date the Company enters into a derivative contract for hedging purposes, management designates the derivative as a hedge of the identified exposure (fair value, cash flow or foreign currency). If a derivative does not qualify for hedge accounting, according to SFAS 133, the changes in its fair value and all scheduled periodic settlement receipts and payments are reported in net investment gains (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, 13 liability, firm commitment, foreign operation, or forecasted transaction that has been designated as a hedged item, states how the hedging instrument is expected to hedge the risks related to the hedged item, and sets forth the method that will be used to retrospectively and prospectively assess the hedging instrument's effectiveness and the method that will be used to measure hedge ineffectiveness. 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 de-designated 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 table below provides a summary of the notional amount and fair value of derivatives by type of hedge designation at: JUNE 30, 2004 DECEMBER 31, 2003 ---------------------------------------- ---------------------------------------- FAIR VALUE FAIR VALUE NOTIONAL ------------------------ NOTIONAL ------------------------ AMOUNT ASSETS LIABILITIES AMOUNT ASSETS LIABILITIES -------- ------ ----------- ------ ------ ----------- (DOLLARS IN MILLIONS) BY TYPE OF HEDGE Fair value $ 5,666 $ 77 $ 228 $ 4,027 $ 27 $ 297 Cash flow 14,472 136 403 13,173 59 449 Foreign operations 519 2 8 527 -- 10 Non qualifying 21,689 122 133 21,807 170 142 ------- ------- ------- ------- ------- ------- Total $42,346 $ 337 $ 772 $39,534 $ 256 $ 898 ======= ======= ======= ======= ======= ======= Non-qualifying derivatives are comprised of derivative instruments which do not meet the requirements for, or for which the Company does not seek, hedge accounting under SFAS 133. These include certain interest rate, foreign currency, credit default and total return swaps, interest rate caps, foreign currency forwards, purchased options and futures, embedded conversion options, and derivatives held in consolidated separate accounts. The non-qualifying notional amount at June 30, 2004 and December 31, 2003, includes $5,459 million and $5,177 million, respectively, related to synthetic guaranteed investment product contracts that meet the definition of a derivative, but are not considered to be accounting hedges. The market value of such contracts at June 30, 2004 and December 31, 2003 exceeds the contract value. During the three months and six months ended June 30, 2004, the Company recognized net investment expense of $38 million and $70 million, respectively, from the periodic settlement and amortization, and net investment losses of $13 million and $72 million, respectively, from disposals of interest rate caps, options, futures and interest rate, foreign currency and credit default swaps that qualify for hedge accounting. During the three and six months ended June 30, 2003 the Company recognized net investment expense of $10 million and $16 million, respectively, from the periodic settlement and amortization, and net investment gains of $24 million and $27 million, respectively, from disposals of interest rate caps and interest rate, foreign currency and credit default swaps that qualify for hedge accounting. The following table represents fair value hedges for the: THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, -------------- -------------- 2004 2003 2004 2003 ---- ---- ---- ---- (DOLLARS IN MILLIONS) Changes in the fair value of qualifying hedges $ 133 $ (83) $ 122 $ (92) Changes in the hedged items reclassified into net investment gains (losses) (130) 74 (99) 86 ----- ----- ----- ----- Net ineffectiveness gains (losses) from fair value hedging activities $ 3 $ (9) $ 23 $ (6) ===== ===== ===== ===== There were no discontinued fair value hedges during the three months and six months ended June 30, 2004 or 2003. 14 The following table represents cash flow hedges for the: THREE MONTHS SIX MONTHS YEAR THREE MONTHS SIX MONTHS ENDED ENDED ENDED ENDED ENDED JUNE 30, JUNE 30, DECEMBER 31, JUNE 30, JUNE 30, 2004 2004 2003 2003 2003 ------------ ---------- ------------ ------------ ---------- (DOLLARS IN MILLIONS) Changes in the fair value of qualifying hedges $ 115 $ 130 $(456) $(109) $(122) Less: Gains (losses) deferred in other comprehensive income on the effective portion of cash flow hedges 158 154 (387) (103) (116) ----- ----- ----- ----- ----- Net ineffectiveness recorded in net investment gains (losses) from cash flow hedging activities $ (43) $ (24) $ (69) $ (6) $ (6) ===== ===== ===== ===== ===== Other comprehensive income balance at the beginning of the period $(415) $(417) $ (24) $ (19) $ (24) Gains (losses) deferred in other comprehensive income on the effective portion of cash flow hedges 158 154 (387) (103) (116) Amounts reclassified to net investment income 1 1 2 1 1 Amounts reclassified to net investment gains (losses) (15) (5) -- (8) 12 Amortization of transition adjustment (2) (6) (8) (2) (4) ----- ----- ----- ----- ----- Other comprehensive income balance at the end of the period $(273) $(273) $(417) $(131) $(131) ===== ===== ===== ===== ===== The Company uses forward exchange contracts to provide a hedge on portions of its net investments in foreign operations against adverse movements in foreign currency exchange rates. For the three months and six months ended June 30, 2004, the Company experienced net unrealized gains of $0 million and $4 million, respectively, related to hedges of its investments in foreign operations. Unrealized losses of $6 million and $10 million were recorded as components of accumulated other comprehensive income at June 30, 2004 and December 31, 2003, respectively. There were no hedges of the net investment in foreign operations at June 30, 2003. For the three months and six months ended June 30, 2004, the Company recognized as net investment gains the scheduled periodic settlement payments of derivative instruments of $22 million and $36 million, respectively, and net investment gains (losses) of $2 million and $(1) million, respectively, from derivatives not qualifying as accounting hedges. For the three months and six months ended June 30, 2003, the Company recognized as net investment gains the scheduled periodic settlement payments of derivative instruments of $12 million and $20 million, respectively, and net investment losses of $12 million and $52 million, respectively, from derivatives not qualifying as accounting hedges. The use of these non-speculative derivatives is permitted by the applicable insurance departments. 4. INSURANCE CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS The Company issues variable annuity contracts which may include contractual guarantees to the contractholder for: (i) return of no less than total deposits made to the contract less any partial withdrawals ("return of net deposits") and (ii) the highest contract value on a specified anniversary date minus any withdrawals following the contract anniversary, or total deposits made to the contract less any partial withdrawals plus a minimum return ("anniversary contract value" or "minimum return"). The Company also issues annuity contracts that apply a lower rate of funds deposited if the contractholder elects to surrender the contract for cash and a higher rate if the contractholder elects to annuitize ("two tier annuities"). These guarantees include benefits that are payable in the event of death or at annuitization. The Company also issues universal and variable life contracts where the Company contractually guarantees to the contractholder a secondary guarantee or a guaranteed paid up benefit. The assets supporting the variable portion of contracts with guarantees are carried at fair value and reported in total separate account assets with an equivalent amount reported in separate account liabilities in the unaudited interim condensed consolidated balance sheets. Net investment income, net realized gains (losses) and net unrealized gains (losses) relating to such separate accounts accrue directly to the contractholders and, accordingly, are reflected net in the Company's unaudited interim condensed consolidated financial statements. Amounts assessed against the contractholders for mortality, administrative, and other services are included in universal life and investment-type policy fees. Liabilities for guarantees and changes in such liabilities are included in future policy benefits and policyholder benefits and claims in the unaudited interim condensed consolidated balance sheets and statements of income, respectively. 15 The Company had the following types of guarantees relating to annuity and universal and variable life contracts at: ANNUITY CONTRACTS JUNE 30, 2004 ------------------------------- IN THE AT EVENT OF DEATH ANNUITIZATION -------------- ------------- (DOLLARS IN MILLIONS) RETURN OF NET DEPOSITS Separate account value $ 5,557 N/A Net amount at risk $ 23 (1) N/A Average attained age of contractholders 60 years N/A ANNIVERSARY CONTRACT VALUE OR MINIMUM RETURN Separate account value $ 39,923 $ 11,571 Net amount at risk $ 1,267 (1) $ 92 (2) Average attained age of contractholders 61 years 59 years TWO TIER ANNUITIES General account value N/A $ 300 Net amount at risk N/A $ 36 (3) Average attained age of contractholders N/A 58 years UNIVERSAL AND VARIABLE LIFE CONTRACTS JUNE 30, 2004 ------------------------------ SECONDARY PAID UP GUARANTEES GUARANTEES ---------- ---------- (DOLLARS IN MILLIONS) Account value (general and separate account) $ 3,135 $ 4,886 Net amount at risk $ 66,489 (1) $ 43,805 (1) Average attained age of policyholders 44 years 52 years - ---------- (1) The net amount at risk for guarantees of amounts in the event of death is defined as the current guaranteed minimum death benefit in excess of the current account balance at the balance sheet date. (2) The net amount at risk for guarantees of amounts at annuitization is defined as the present value of the minimum guaranteed annuity payments available to the contractholder determined in accordance with the terms of the contract in excess of the current account balance. (3) The net amount at risk for two tier annuities is based on the excess of the upper tier, adjusted for a profit margin, less the lower tier. The net amount at risk is based on the direct amount at risk (excluding reinsurance). The Company's annuity and life contracts with guarantees may offer more than one type of guarantee in each contract. Therefore, the amounts listed above may not be mutually exclusive. 16 Liabilities for guarantees (excluding base policy liabilities) relating to annuity and universal and variable life contracts are as follows: ANNUITY CONTRACTS UNIVERSAL AND VARIABLE LIFE CONTRACTS ------------------------------- ------------------------------------- GUARANTEED GUARANTEED PAID DEATH ANNUITIZATION SECONDARY UP BENEFITS BENEFITS GUARANTEES GUARANTEES TOTAL ---------- ------------- ---------- ---------- ------ (DOLLARS IN MILLIONS) Balance at January 1, 2004 $ 9 $ 17 $ 13 $ 22 $ 61 Incurred guaranteed benefits 4 3 2 1 10 Paid guaranteed benefits (2) 0 (1) 0 (3) ---- ---- ---- ---- ---- Balance at March 31, 2004 11 20 14 23 68 ---- ---- ---- ---- ---- Incurred guaranteed benefits 2 3 6 1 12 Paid guaranteed benefits (2) 0 (1) 0 (3) ---- ---- ---- ---- ---- Balance at June 30, 2004 $ 11 $ 23 $ 19 $ 24 $ 77 ==== ==== ==== ==== ==== The guaranteed death benefit liabilities are determined by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised. The assumptions used in estimating the liability at June 30, 2004 are consistent with those used for amortizing DAC, including the mean reversion assumption. The assumptions of investment performance and volatility are consistent with historical S&P experience. The benefits used in calculating the liabilities are based on the average benefits payable over a range of scenarios. The guaranteed annuitization benefit liabilities are determined by estimating the expected value of the annuitization benefits in excess of the projected account balance at the date of annuitization and recognizing the excess ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised. The assumptions used for calculating such guaranteed annuitization benefit liabilities at June 30, 2004 are consistent with those used for calculating the guaranteed death benefit liabilities. In addition, the calculation of the guaranteed annuitization benefit liabilities incorporates a percentage of the potential annuitizations that may be elected by the contractholder. The liabilities for universal and variable life secondary guarantees and paid-up guarantees are determined by estimating the expected value of death benefits payable when the account balance is projected to be zero and recognizing those benefits ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balances, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised. The assumptions used in estimating the secondary and paid up guarantee liabilities at June 30, 2004 are consistent with those used for amortizing deferred acquisition costs. The assumptions of investment performance and volatility for variable products are consistent with historical S&P experience. The benefits used in calculating the liabilities are based on the average benefits payable over a range of scenarios. 17 SEPARATE ACCOUNTS Account balances of contracts with guarantees are invested in separate account asset classes as follows at: JUNE 30, 2004 JANUARY 1, 2004 ------------- --------------- (DOLLARS IN MILLIONS) Equity securities (including mutual funds) Equity $27,656 $23,784 Bond 3,934 3,531 Balanced 1,487 1,368 Money Market 511 501 Specialty 179 55 ------- ------- TOTAL $33,767 $29,239 ======= ======= At June 30, 2004, equity securities, fixed maturities and cash and cash equivalents include $77 million, $57 million and $4 million, respectively, of the Company's proportional interest in separate accounts. During the three months and six months ended June 30, 2004, there were no investment gains (losses) on transfers of assets from the general account to the separate account. SALES INDUCEMENTS The Company defers sales inducements and amortizes them over the life of the policy using the same methodology and assumptions used to amortize DAC. The Company has two different types of sales inducements: (i) a bonus whereby the policyholder's initial account balance is increased by an amount equal to a specified percentage of the customer's deposit and (ii) the policyholder receives a higher interest rate than the normal general account interest rate credited on money in the enhanced dollar cost averaging program. Changes in deferred sales inducements are as follows: SALES INDUCEMENTS ----------------- (DOLLARS IN MILLIONS) Balance at January 1, 2004 $ 196 Capitalization 40 Amortization (1) ----- Balance at March 31, 2004 235 ===== Capitalization 24 Amortization (3) ----- Balance at June 30, 2004 $ 256 ===== 5. CLOSED BLOCK On April 7, 2000, (the "date of demutualization"), 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 (the "Superintendent") approving Metropolitan Life's plan of reorganization, as amended (the "plan"). 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. 18 Liabilities and assets designated to the closed block are as follows: JUNE 30, DECEMBER 31, 2004 2003 -------- -------- (DOLLARS IN MILLIONS) CLOSED BLOCK LIABILITIES Future policy benefits $ 42,061 $ 41,928 Other policyholder funds 255 260 Policyholder dividends payable 728 682 Policyholder dividend obligation 1,330 2,130 Payables under securities loaned transactions 5,135 6,418 Other liabilities 156 180 -------- -------- Total closed block liabilities 49,665 51,598 -------- -------- ASSETS DESIGNATED TO THE CLOSED BLOCK Investments: Fixed maturities available-for-sale, at fair value (amortized cost: $29,243 and $30,381, respectively) 30,400 32,348 Equity securities, at fair value (cost: $323 and $217, respectively) 368 250 Mortgage loans on real estate 7,785 7,431 Policy loans 4,045 4,036 Short-term investments 62 123 Other invested assets 235 108 -------- -------- Total investments 42,895 44,296 Cash and cash equivalents 326 531 Accrued investment income 522 527 Deferred income taxes 946 1,043 Premiums and other receivables 93 164 -------- -------- Total assets designated to the closed block 44,782 46,561 -------- -------- Excess of closed block liabilities over assets designated to the closed block 4,883 5,037 -------- -------- Amounts included in accumulated other comprehensive loss: Net unrealized investment gains, net of deferred income tax of $443 and $730, respectively 787 1,270 Unrealized derivative gains (losses), net of deferred income tax benefit of ($23) and ($28), respectively (38) (48) Allocated from policyholder dividend obligation, net of deferred income tax benefit of ($464) and ($778), respectively (827) (1,352) -------- -------- (78) (130) -------- -------- Maximum future earnings to be recognized from closed block assets and liabilities $ 4,805 $ 4,907 ======== ======== Information regarding the policyholder dividend obligation is as follows: SIX MONTHS ENDED YEAR ENDED JUNE 30, 2004 DECEMBER 31, 2003 ------------- ----------------- (DOLLARS IN MILLIONS) Balance at beginning of period $ 2,130 $ 1,882 Impact on revenues, net of expenses and income taxes 40 -- Change in unrealized investment and derivative gains (losses) (840) 248 ------- ------- Balance at end of period $ 1,330 $ 2,130 ======= ======= 19 Closed block revenues and expenses are as follows: THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, -------------------------- ------------------------- 2004 2003 2004 2003 ------- ------- ------- ------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 776 $ 825 $ 1,524 $ 1,624 Net investment income and other revenues 631 623 1,263 1,265 Net investment gains (losses) 11 (19) (15) (52) ------- ------- ------- ------- Total revenues 1,418 1,429 2,772 2,837 ------- ------- ------- ------- EXPENSES Policyholder benefits and claims 877 911 1,703 1,764 Policyholder dividends 364 392 730 786 Change in policyholder dividend obligation 39 -- 40 -- Other expenses 69 76 140 152 ------- ------- ------- ------- Total expenses 1,349 1,379 2,613 2,702 ------- ------- ------- ------- Revenues net of expenses before income taxes 69 50 159 135 Income taxes 25 18 57 49 ------- ------- ------- ------- Revenues net of expenses and income taxes $ 44 $ 32 $ 102 $ 86 ======= ======= ======= ======= The change in maximum future earnings of the closed block is as follows: THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 2004 2003 2004 2003 ------- ------- ------- ------- (DOLLARS IN MILLIONS) Balance at end of period $ 4,805 $ 5,028 $ 4,805 $ 5,028 Balance at beginning of period 4,849 5,060 4,907 5,114 ------- ------- ------- ------- Change during period $ (44) $ (32) $ (102) $ (86) ======= ======= ======= ======= Metropolitan Life charges the closed block with federal income taxes, state and local premium taxes, and other additive state or local taxes, as well as investment management expenses relating to the closed block as provided in the plan of demutualization. Metropolitan Life also charges the closed block for expenses of maintaining the policies included in the closed block. Many of the derivative instrument strategies used by the Company are also used for the closed block. The table below provides a summary of the notional amount and fair value of derivatives by type of hedge designation at: JUNE 30, 2004 DECEMBER 31, 2003 -------------------------------- -------------------------------- FAIR VALUE FAIR VALUE NOTIONAL --------------------- NOTIONAL --------------------- AMOUNT ASSETS LIABILITIES AMOUNT ASSETS LIABILITIES ------ ------ ----------- -------- ------ ----------- (DOLLARS IN MILLIONS) BY TYPE OF HEDGE Fair value $ 31 $ 1 $ 2 $ 6 $ -- $ 1 Cash flow 661 2 75 473 -- 80 Non qualifying 115 -- 10 90 -- 12 ---- ---- ---- ---- ---- ---- Total $807 $ 3 $ 87 $569 $ -- $ 93 ==== ==== ==== ==== ==== ==== During both the three months and six months ended June 30, 2004, the closed block recognized net investment expense of $1 million, from periodic settlement and amortization, and net investment losses of $1 million, from disposals of interest rate, foreign currency and credit default swaps that qualify for hedge accounting. During both the three and six months ended June 30, 2003 the Company recognized net investment income of $2 million, from periodic settlement and amortization, and net investment gains of $5 million, from disposals of interest rate caps and interest rate, foreign currency and credit default swaps that qualify for hedge accounting. 20 During the three months and six months ended June 30, 2004 and 2003, net investment gains (losses) from ineffective fair value hedging activities were insignificant. There were no discontinued fair value hedges during the three months and six months ended June 30, 2004 and 2003. The following table represents cash flow hedges for the: THREE SIX THREE SIX MONTHS ENDED MONTHS ENDED YEAR ENDED MONTHS ENDED MONTHS ENDED JUNE 30, JUNE 30, DECEMBER 31, JUNE 30, JUNE 30, 2004 2004 2003 2003 2003 ------------ ------------ ------------ ------------ ------------ (DOLLARS IN MILLIONS) Changes in the qualifying hedges $ 2 $ 8 $(106) $(29) $(48) Less: Gains (losses) deferred in other comprehensive income on the effective portion of cash flow hedges 7 17 (93) (29) (48) ---- ---- ---- ---- ---- Net ineffectiveness recorded in net investment gains (losses) from cash flow hedging activities $ (5) $ (9) $(13) $ -- $ -- ==== ==== ==== ==== ==== Other comprehensive income balance at the beginning of the period $(67) $(76) $ 20 $ 1 $ 20 Gains (losses) deferred in other comprehensive income on the effective portion of cash flow hedges 7 17 (93) (29) (48) Amounts reclassified to net investment income -- Amounts reclassified to net investment gains (losses) -- Amortization of transition adjustment (1) (2) (3) (1) (1) ---- ---- ---- ---- ---- Other comprehensive income balance at the end of the period $(61) $(61) $(76) $(29) $(29) ==== ==== ==== ==== ==== For the three months and six months ended June 30, 2004, the closed block recognized no amounts as net investment gains from the scheduled periodic settlement payments of derivative instruments and net investment gains of $14 million and $9 million, respectively, from derivatives not qualifying as accounting hedges. For the three months and six months ended June 30, 2003, the Company recognized as net investment losses the scheduled periodic settlement payments of derivative instruments of $1 million and $1 million, respectively, and net investment losses of $20 million and $21 million, respectively, from derivatives not qualifying as accounting hedges. The use of these non-speculative derivatives is permitted by the applicable insurance department. 6. COMMITMENTS, CONTINGENCIES AND GUARANTEES The Company is a defendant in a large number of litigation matters. In some of the matters, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Modern pleading practice in the United States permits considerable variation in the assertion of monetary damages or other relief. Jurisdictions may permit claimants to not specify the monetary damages sought or may permit claimants to state only that the amount sought is sufficient to invoke the jurisdiction of the trial court. In addition, jurisdictions may permit plaintiffs to allege monetary damages in amounts well exceeding reasonably possible verdicts in the jurisdiction for similar matters. This variability in pleadings, together with the actual experience of the Company in litigating or resolving through settlement numerous claims over an extended period of time, demonstrate to management that the monetary relief which may be specified in a lawsuit or claim bears little relevance to its merits or disposition value. Thus, unless stated below, the specific monetary relief sought is not noted. Due to the vagaries of litigation, the outcome of a litigation matter and the amount or range of potential loss at particular points in time may normally be inherently impossible to ascertain with any degree of certainty. Inherent uncertainties can include how fact finders will view individually and in their totality documentary evidence, the credibility and effectiveness of witnesses' testimony, and how trial and appellate courts will apply the law in the context of the pleadings or evidence presented, whether by motion practice, or at trial or on appeal. Disposition valuations are also subject to the uncertainty of how opposing parties and their counsel will themselves view the relevant evidence and applicable law. In this context, unless stated below, estimates of possible additional losses or ranges of loss for particular matters cannot in the ordinary course be made with a reasonable degree of certainty. Liabilities are established when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. SALES PRACTICES CLAIMS Over the past several years, Metropolitan Life, New England Mutual Life Insurance Company ("New England Mutual") and General American Life Insurance Company ("General American") have faced numerous claims, including class action lawsuits, alleging improper marketing and sales of individual life insurance policies or annuities. These lawsuits are generally referred to as "sales practices claims." 21 In December 1999, a federal court approved a settlement resolving sales practices claims on behalf of a class of 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. Similar sales practices class actions against New England Mutual, with which Metropolitan Life merged in 1996, and General American, which was acquired in 2000, have been settled. In October 2000, a federal court approved a settlement resolving sales practices claims on behalf of a class of owners of permanent life insurance policies issued by New England Mutual between January 1, 1983 through August 31, 1996. The class includes owners of approximately 600,000 in-force or terminated policies. A federal court has approved a settlement resolving sales practices claims on behalf of a class of owners of permanent life insurance policies issued by General American between January 1, 1982 through December 31, 1996. An appellate court has affirmed the order approving the settlement. The class includes owners of approximately 250,000 in-force or terminated policies. Certain class members have opted out of the class action settlements noted above and have brought or continued non-class action sales practices lawsuits. In addition, other sales practices lawsuits have been brought. As of June 30, 2004, there are approximately 331 sales practices lawsuits pending against Metropolitan Life; approximately 40 sales practices lawsuits pending against New England Mutual, New England Life Insurance Company, and New England Securities Corporation (collectively, "New England"); and approximately 51 sales practices lawsuits pending against General American. Metropolitan Life, New England and General American continue to defend themselves vigorously against these lawsuits. 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 Metropolitan Life class action settlement did not resolve two putative class actions involving sales practices claims filed against Metropolitan Life in Canada, and these actions remain pending. The Company believes adequate provision has been made in its unaudited interim condensed consolidated financial statements for all probable and reasonably estimable losses for sales practices claims against Metropolitan Life, New England and General American. Regulatory authorities in a small number of states have had investigations or inquiries relating to Metropolitan Life's, New England'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. ASBESTOS-RELATED CLAIMS Metropolitan Life is also a defendant in thousands of 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 nor has Metropolitan Life issued liability or workers' compensation insurance to companies in the business of manufacturing, producing, distributing or selling asbestos or asbestos-containing products. Rather, these lawsuits 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 have alleged 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. Metropolitan Life believes that it should not have legal liability in such cases. Legal theories asserted against Metropolitan Life have included negligence, intentional tort claims and conspiracy claims concerning the health risks associated with asbestos. Although Metropolitan Life believes it has meritorious defenses to these claims, and has not suffered any adverse monetary judgments in respect of these claims, due to the risks and expenses of litigation, almost all past cases have been resolved by settlements. Metropolitan Life's defenses (beyond denial of certain factual allegations) to plaintiffs' claims include that: (i) Metropolitan Life owed no duty to the plaintiffs -- it had no special relationship with the plaintiffs and did not manufacture, produce, distribute or sell the asbestos products that allegedly injured plaintiffs; (ii) plaintiffs cannot demonstrate justifiable detrimental reliance; and (iii) plaintiffs cannot demonstrate proximate causation. In defending asbestos cases, Metropolitan Life selects various strategies depending upon the jurisdictions in which such cases are brought and other factors which, in 22 Metropolitan Life's judgment, best protect Metropolitan Life's interests. Strategies include seeking to settle or compromise claims, motions challenging the legal or factual basis for such claims or defending on the merits at trial. In 2002, 2003 and 2004, trial courts in California, Utah, Texas and Georgia granted motions dismissing claims against Metropolitan Life on some or all of the above grounds. Other courts have denied motions brought by Metropolitan Life to dismiss cases without the necessity of trial. There can be no assurance that Metropolitan Life will receive favorable decisions on motions in the future. 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. See Note 12 of Notes to Consolidated Financial Statements for the year ended December 31, 2003 included in the MetLife, Inc. Annual Report on Form 10-K for information regarding historical asbestos claims information and the increase of its recorded liability at December 31, 2002. Metropolitan Life continues to study its claims experience, review external literature regarding asbestos claims experience in the United States and consider numerous variables that can affect its asbestos liability exposure, including bankruptcies of other companies involved in asbestos litigation and legislative and judicial developments, to identify trends and to assess their impact on the recorded asbestos liability. Recent bankruptcies of other companies involved in asbestos litigation, as well as advertising by plaintiffs' asbestos lawyers, may result in an increase in the number of claims and the cost of resolving claims, as well as the number of trials and possible adverse 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. In addition, publicity regarding legislative reform efforts may result in an increase in the number of claims. As reported in MetLife, Inc.'s Annual Report on Form 10-K, Metropolitan Life received approximately 60,300 asbestos-related claims in 2003. During the first six months of 2004 and 2003, Metropolitan Life received approximately 13,560 and 48,000 asbestos-related claims, respectively. The Company believes adequate provision has been made in its unaudited interim condensed consolidated financial statements for all probable and reasonably estimable losses for asbestos-related claims. The ability of Metropolitan Life to estimate its ultimate asbestos exposure is subject to considerable uncertainty due to numerous factors. The availability of data is limited and it is difficult to predict with any certainty numerous variables that can affect liability estimates, including the number of future claims, the cost to resolve claims, the disease mix and severity of disease, the jurisdiction of claims filed, tort reform efforts and the impact of any possible future adverse verdicts and their amounts. The number of asbestos cases that may be brought or the aggregate amount of any liability that Metropolitan Life may ultimately incur is uncertain. Accordingly, 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 unaudited interim condensed 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 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. During 1998, Metropolitan Life paid $878 million in premiums for excess insurance policies for asbestos-related claims. The excess insurance policies for asbestos-related claims provide for recovery of losses up to $1,500 million, which is in excess of a $400 million self-insured retention. The asbestos-related policies are also subject to annual and per-claim sublimits. Amounts are recoverable under the policies annually with respect to claims paid during the prior calendar year. Although amounts paid by Metropolitan Life in any given year that may be recoverable in the next calendar year under the policies will be reflected as a reduction in the Company's operating cash flows for the year in which they are paid, management believes that the payments will not have a material adverse effect on the Company's liquidity. Each asbestos-related policy contains an experience fund and a reference fund that provides for payments to Metropolitan Life at the commutation date if the reference fund is greater than zero at commutation or pro rata reductions from time to time in the loss reimbursements to Metropolitan Life if the cumulative return on the reference fund is less than the return specified in the experience fund. The return in the reference fund is tied to performance of the Standard & Poor's 500 Index and the Lehman Brothers Aggregate Bond Index. A claim was made under the excess insurance policies in 2003 and 2004 for the amounts paid with respect to asbestos litigation in excess of the retention. As the performance of the indices impact the return in the reference fund, it is possible that loss reimbursements to the Company and the recoverable with respect to later periods may be less than the amount of the recorded losses. Such foregone loss reimbursements may be recovered upon commutation depending upon future performance of the reference fund. If at some point in the future, the Company believes the liability for probable and reasonably estimable losses for asbestos-related claims should be increased, an expense would be recorded and the insurance recoverable would be adjusted subject to the terms, conditions 23 and limits of the excess insurance policies. Portions of the change in the insurance recoverable would be recorded as a deferred gain and amortized into income over the estimated remaining settlement period of the insurance policies. Metropolitan Life also has been named as a defendant in a small number of silicosis, welding and mixed dust cases. The cases are pending in Mississippi, Texas, Ohio, Pennsylvania, West Virginia, Louisiana, Kentucky, Georgia, Alabama, Illinois, Colorado, Indiana and Arkansas. The Company intends to defend itself vigorously against these cases. PROPERTY AND CASUALTY ACTIONS A purported class action has been filed against Metropolitan Property and Casualty Insurance Company's subsidiary, Metropolitan Casualty Insurance Company, in Florida alleging 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. During the first quarter of 2004, a purported class action was filed against Metropolitan Property and Casualty Insurance Company in Florida on behalf of medical practitioners who provide MRI services. The suit claims breach of contract and unjust enrichment arising out of the alleged failure to include a consumer price index adjustment when paying MRI provider fees. Metropolitan Property and Casualty Insurance Company is vigorously defending itself against this lawsuit. Two purported nationwide class actions have been filed against Metropolitan Property and Casualty Insurance Company in Illinois. One suit claims breach of contract and fraud due to the alleged underpayment of medical claims arising from the use of a purportedly biased provider fee pricing system. A motion for class certification has been filed and discovery is ongoing. The second suit claims breach of contract and fraud arising from the alleged use of preferred provider organizations to reduce medical provider fees covered by the medical claims portion of the insurance policy. A motion to dismiss has been filed. A purported class action has been filed against Metropolitan Property and Casualty Insurance Company in Montana. This suit alleges breach of contract and bad faith for not aggregating medical payment and uninsured coverages provided in connection with the several vehicles identified in insureds' motor vehicle policies. Metropolitan Property and Casualty Insurance Company is vigorously defending itself against this lawsuit. Certain plaintiffs' lawyers have alleged that the use of certain automated databases to provide total loss vehicle valuation methods was improper. Metropolitan Property and Casualty Insurance Company, along with a number of other insurers, has tentatively agreed in January 2004 to resolve this issue in a class action format. The amount to be paid in resolution of this matter will not be material to Metropolitan Property and Casualty Insurance Company. DEMUTUALIZATION ACTIONS Several lawsuits were brought in 2000 challenging the fairness of Metropolitan Life's plan of reorganization, as amended (the "plan") and the adequacy and accuracy of Metropolitan Life's disclosure to policyholders regarding the plan. These actions named as defendants some or all of Metropolitan Life, the Holding Company, the individual directors, the New York Superintendent of Insurance (the "Superintendent") 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 New York State court in New York County were consolidated within the commercial part of the New York State court. In addition, there remained a separate purported class action in New York State court in New York County. On February 21, 2003, the defendants' motions to dismiss both the consolidated action and separate action were granted; leave to replead as a proceeding under Article 78 of New York's Civil Practice Law and Rules has been granted in the separate action. On April 27, 2004, the appellate court modified the trial court's order by reinstating certain claims against Metropolitan Life, the Holding Company and the individual directors. 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 Superintendent who 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. 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 in connection with the plan. 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 in 2001. On February 4, 2003, plaintiffs filed a consolidated amended complaint adding a fraud claim under the Securities Exchange Act of 1934. Plaintiffs served a second consolidated amended complaint on April 2, 2004, and continue to assert violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. On June 22, 2004, the court denied the defendants' motion to dismiss the claim of violation of the Securities Exchange Act of 1934. 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. 24 In 2001, a lawsuit was filed in the Superior Court of Justice, Ontario, Canada 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 plaintiffs' claims in this matter. On April 30, 2004, a lawsuit was filed in New York state court in New York County against the Holding Company and Metropolitan Life on behalf of a proposed class comprised of the settlement class in the Metropolitan Life sales practices class action settlement approved in December 1999 by the United States District Court for the Western District of Pennsylvania. The complaint challenges the treatment of the cost of the sales practices settlement in the demutualization of Metropolitan Life and asserts claims of breach of fiduciary duty, common law fraud, and unjust enrichment. Plaintiffs seek compensatory and punitive damages, as well as attorneys' fees and costs. On May 24, 2004, the Holding Company and Metropolitan Life served a motion to dismiss the complaint. In October 2003, the United States District Court for the Western District of Pennsylvania dismissed plaintiffs' similar complaint alleging that the demutualization breached the terms of the 1999 settlement agreement and unjustly enriched the Holding Company and Metropolitan Life. In January 2004, plaintiffs' appeal of that decision to the United States Court of Appeals for the Third Circuit was dismissed. The Holding Company and Metropolitan Life intend to contest this matter vigorously. RACE-CONSCIOUS UNDERWRITING CLAIMS Insurance departments in a number of states initiated inquiries in 2000 about possible race-conscious 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 affiliates. The New York Insurance Department concluded its examination of Metropolitan Life concerning possible past race-conscious underwriting practices. Four purported class action lawsuits filed against Metropolitan Life in 2000 and 2001 alleging racial discrimination in the marketing, sale, and administration of life insurance policies were consolidated in the United States District Court for the Southern District of New York. On April 28, 2003, the United States District Court approved a class action settlement of the consolidated actions. Several persons filed notices of appeal from the order approving the settlement, but subsequently the appeals were dismissed. Metropolitan Life also entered into settlement agreements to resolve the regulatory examination. Twenty lawsuits involving approximately 140 plaintiffs were filed in federal and state court in Alabama, Mississippi and Tennessee alleging federal and/or state law claims of racial discrimination in connection with the sale, formation, administration or servicing of life insurance policies. Metropolitan Life resolved the claims of some of these plaintiffs through settlement, and some additional plaintiffs have voluntarily dismissed their claims. Metropolitan Life resolved claims of some additional persons who opted out of the settlement class referenced in the preceding paragraph but who had not filed suit. The actions filed in Alabama and Tennessee have been dismissed; two actions filed in Mississippi remain pending. Metropolitan Life is contesting plaintiffs' claims vigorously. The Company believes that adequate provision has been made to cover the costs associated with the resolution of these matters. OTHER In 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 were seeking unspecified compensatory damages, punitive damages, a declaration that the alleged practices were 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. In August 2003, the court granted preliminary approval to a settlement of the lawsuit. At the fairness hearing held on November 6, 2003, the court approved the settlement of the lawsuit. Implementation of the settlement commenced in 2004. A putative class action lawsuit is pending in the United States District Court for the District of Columbia, in which plaintiffs allege that they were denied certain ad hoc pension increases awarded to retirees under the Metropolitan Life retirement plan. The ad hoc pension increases were awarded only to retirees (i.e., individuals who were entitled to an immediate retirement benefit upon their termination of employment) and not available to individuals like these plaintiffs whose employment, or whose spouses' employment, had terminated before they became eligible for an immediate retirement benefit. The plaintiffs seek to represent a class consisting of former Metropolitan Life employees, or their surviving spouses, who are receiving deferred vested annuity payments under the 25 retirement plan and who were allegedly eligible to receive the ad hoc pension increases awarded in 1977, 1980, 1989, 1992, 1996 and 2001, as well as increases awarded in earlier years. Metropolitan Life is vigorously defending itself against these allegations. As previously reported, the SEC is conducting a formal investigation of New England Securities Corporation ("NES"), a subsidiary of New England Life Insurance Company ("NELICO"), in response to NES informing the SEC that certain systems and controls relating to one NES advisory program were not operating effectively. NES is cooperating fully with the SEC. Prior to filing the Company's June 30, 2003 Form 10-Q, MetLife announced a $31 million after-tax charge resulting from certain improperly deferred expenses at an affiliate, New England Financial. MetLife notified the SEC about the nature of this charge prior to its announcement. The SEC is pursuing a formal investigation of the matter and MetLife is fully cooperating with the investigation. The American Dental Association and two individual providers have sued MetLife, Mutual of Omaha and Cigna in a purported class action lawsuit brought in a Florida federal district court. The plaintiffs purport to represent a nationwide class of in-network providers who allege that their claims are being wrongfully reduced by downcoding, bundling, and the improper use and programming of software. The complaint alleges federal racketeering and various state law theories of liability. MetLife is vigorously defending the case and a motion to dismiss has been filed and argued. A purported class action in which two policyholders seek to represent a class of owners of participating life insurance policies is pending in state court in New York. Plaintiffs assert that Metropolitan Life breached their policies in the manner in which it allocated investment income across lines of business during a period ending with the 2000 demutualization. In August 2003, an appellate court affirmed the dismissal of fraud claims in this action. Plaintiffs have served their motion to certify a litigation class. MetLife is vigorously defending the case. Regulatory bodies have contacted the Company and have requested information relating to market timing and late trading of mutual funds and variable insurance products and, generally, the marketing of products. The Company believes that many of these inquiries are similar to those made to many financial services companies as part of industry-wide investigations by various regulatory agencies. State Street Research Investment Services, one of the Company's indirect broker/dealer subsidiaries, has entered into a settlement with the NASD resolving all outstanding issues relating to its investigation. The SEC has commenced an investigation with respect to market timing and late trading in a limited number of privately-placed variable insurance contracts that were sold through General American. As previously reported, in May 2004, General American received a so-called "Wells Notice" stating that the SEC staff is considering recommending that the SEC bring a civil action alleging violations of the U.S. securities laws against General American. Under the SEC procedures, General American can avail itself of the opportunity to respond to the SEC staff before it makes a formal recommendation regarding whether any action alleging violations of the U.S. securities laws should be considered. General American has responded to the Wells Notice. The Company is fully cooperating with regard to these information requests and investigations. The Company at the present time is not aware of any systemic problems with respect to such matters that may have a material adverse effect on the Company's consolidated financial position. As previously reported, the Company has received from the Office of the Attorney General of the State of New York a subpoena seeking information regarding certain compensation agreements between insurance brokers and the Company. The Company is fully cooperating with the inquiry. 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. SUMMARY 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, except as noted above in connection with specific matters. 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 26 certain matters could, from time to time, have a material adverse effect on the Company's consolidated net income or cash flows in particular quarterly or annual periods. COMMITMENTS TO FUND PARTNERSHIP INVESTMENTS The Company makes commitments to fund partnership investments in the normal course of business. The amounts of these unfunded commitments were approximately $1.4 billion at both June 30, 2004 and December 31, 2003, respectively. The Company anticipates that these amounts will be invested in the partnerships over the next three to five years. GUARANTEES In the course of its business, the Company has provided certain indemnities, guarantees and commitments to third parties pursuant to which it may be required to make payments now or in the future. In the context of acquisition, disposition, investment and other transactions, the Company has provided indemnities and guarantees, including those related to tax, environmental and other specific liabilities, and other indemnities and guarantees that are triggered by, among other things, breaches of representations, warranties or covenants provided by the Company. In addition, in the normal course of business, the Company provides indemnifications to counterparties in contracts with triggers similar to the foregoing, as well as for certain other liabilities, such as third party lawsuits. These obligations are often subject to time limitations that vary in duration, including contractual limitations and those that arise by operation of law, such as applicable statutes of limitation. In some cases, the maximum potential obligation under the indemnities and guarantees is subject to a contractual limitation ranging from less than $1 million to $800 million, while in other cases such limitations are not specified or applicable. Since certain of these obligations are not subject to limitations, the Company does not believe that it is possible to determine the maximum potential amount due under these guarantees in the future. In addition, the Company indemnifies its directors and officers as provided in its charters and by-laws. Also, the Company indemnifies other of its agents for liabilities incurred as a result of their representation of the Company's interests. Since these indemnities are generally not subject to limitation with respect to duration or amount, the Company does not believe that it is possible to determine the maximum potential amount due under these indemnities in the future. For the six months ended June 30, 2004, the Company recorded liabilities of $10 million with respect to indemnities provided in certain dispositions. The approximate term for these liabilities is 12 to 18 months. The maximum potential amount of future payments that MetLife could be required to pay for these liabilities is $73 million. Due to the uncertainty in assessing changes to the liabilities over the term, the liability on the balance sheet will remain until either expiration or settlement of the guarantee unless evidence clearly indicates that the estimates should be revised. The fair value of the remaining indemnities, guarantees and commitments entered into was insignificant and thus, no liabilities were recorded. The Company's recorded liability at June 30, 2004 and December 31, 2003 for indemnities, guarantees and commitments provided to third parties, excluding amounts recorded during the first six months of 2004, is insignificant. The Company writes credit default swap obligations requiring payment of principal due in exchange for the reference credit obligation, depending on the nature or occurrence of specified credit events for the referenced entities. In the event of a specified credit event, the Company's maximum amount at risk, assuming the value of the referenced credits become worthless, is $1.3 billion at June 30, 2004. The credit default swaps expire at various times during the next ten years. 7. EMPLOYEE BENEFIT PLANS PENSION BENEFIT AND OTHER BENEFIT PLANS The Company is both the sponsor and administrator of defined benefit pension plans covering eligible employees and sales representatives of the Company. Retirement benefits are based upon years of credited service and final average or career average earnings history. The Company also provides certain postemployment benefits and certain postretirement health care and life insurance benefits for retired employees through insurance contracts. Substantially all of the Company's employees may, in accordance with the plans applicable to the postretirement benefits, become eligible for these benefits if they attain retirement age, with sufficient service, while working for the Company. 27 The Company uses December 31 as the measurement date for all of its pension and postretirement benefit plans. The components of net periodic benefit cost were as follows: PENSION BENEFITS PENSION BENEFITS OTHER BENEFITS OTHER BENEFITS ---------------- ---------------- ---------------- --------------- FOR THE THREE FOR THE SIX FOR THE THREE FOR THE SIX MONTHS ENDED MONTHS ENDED MONTHS ENDED MONTHS ENDED JUNE 30, JUNE 30, JUNE 30, JUNE 30, ---------------- ---------------- ---------------- --------------- 2004 2003 2004 2003 2004 2003 2004 2003 ----- ----- ----- ----- ----- ----- ----- ----- (DOLLARS IN MILLIONS) Service cost $ 32 $ 31 $ 65 $ 62 $ 9 $ 10 $ 18 $ 20 Interest cost 78 79 156 158 31 31 62 62 Expected return on plan assets (108) (84) (215) (168) (19) (18) (38) (36) Amortization of prior actuarial gains (losses) 30 26 58 52 (1) (3) (2) (6) Curtailment (credit) cost -- 3 -- 6 -- 1 -- 2 ----- ----- ----- ----- ----- ----- ----- ----- Net periodic benefit (credit) cost $ 32 $ 55 $ 64 $ 110 $ 20 $ 21 $ 40 $ 42 ===== ===== ===== ===== ===== ===== ===== ===== EMPLOYER CONTRIBUTIONS As of June 30, 2004, contributions of $485 million have been made to the pension plans and the Company presently anticipates contributing an additional $33 million to fund its pension plans in 2004 for a total of $518 million. Contributions to the postretirement benefit plans are expected to be $89 million. 8. STOCK COMPENSATION PLANS Under the MetLife, Inc. 2000 Stock Incentive Plan, as amended, (the "Stock Incentive Plan"), awards granted may be in the form of non-qualified or incentive stock options qualifying under Section 422A of the Internal Revenue Code. Under the MetLife, Inc. 2000 Directors Stock Plan, as amended (the "Directors Stock Plan"), awards granted may be in the form of stock awards, non-qualified stock options, or a combination of the foregoing to outside Directors of the Company. The aggregate number of options to purchase shares of stock that may be awarded under the Stock Incentive Plan and the Directors Stock Plan is subject to a maximum limit of 37,823,333, of which no more than 378,233 may be awarded under the Directors Stock Plan. The Directors Stock Plan has a maximum limit of 500,000 stock awards. All options granted have an exercise price equal to the fair market value price of the Company's common stock on the date of grant, and an option's maximum term is ten years. Certain options under the Stock Incentive Plan become exercisable over a three year period commencing with the date of grant, while other options become exercisable three years after the date of grant. Options issued under the Directors Stock Plan are exercisable immediately. 28 The Company has elected to apply the fair value method of accounting for stock options granted by the Company subsequent to December 31, 2002. Options granted prior to January 1, 2003 continue to be accounted for under the intrinsic value method. Had compensation costs for grants prior to January 1, 2003 been determined based on fair value at the date of grant, the Company's earnings and earnings per share amounts would have been reduced to the following pro forma amounts for the: THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ----------------------- ----------------------- 2004 2003 2004 2003 ------- ------- ------- ------- (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) Net Income $ 947 $ 580 $ 1,470 $ 942 Charge for conversion of company-obligated mandatorily redeemable securities of a subsidiary trust (1) -- -- -- (21) ------- ------- ------- ------- Net income available to common shareholders 947 580 1,470 921 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects 7 3 13 6 Deduct: Total Stock-based employee compensation determined under fair value based method for all awards, net of related tax effects (11) (9) (24) (21) ------- ------- ------- ------- Pro forma net income available to common shareholders (2) (3) $ 943 $ 574 $ 1,459 $ 906 ======= ======= ======= ======= BASIC EARNINGS PER SHARE As reported $ 1.26 $ 0.79 $ 1.95 $ 1.29 ======= ======= ======= ======= Pro forma (2)(3) $ 1.25 $ 0.78 $ 1.93 $ 1.27 ======= ======= ======= ======= DILUTED EARNINGS PER SHARE As reported $ 1.25 $ 0.79 $ 1.94 $ 1.29 ======= ======= ======= ======= Pro forma (2)(3) $ 1.24 $ 0.78 $ 1.92 $ 1.27 ======= ======= ======= ======= - ---------- (1) MetLife Capital Trust I ("Trust") was dissolved on February 5, 2003, and $1,006 million aggregate principal amount of 8.00% debentures of the Holding Company (the "MetLife debentures"), the sole assets of the Trust, were distributed to the owners of the Trust's capital securities in exchange for their capital securities. The MetLife debentures were remarketed on behalf of the debenture owners on February 12, 2003 and the interest rate on the MetLife debentures was reset as of February 15, 2003 to 3.911% per annum for a yield to maturity of 2.876%. As a result of the remarketing, the debenture owners received $21 million ($0.03 per diluted common share) in excess of the carrying value of the capital securities. This excess was recorded by the Company as a charge to additional paid-in capital and, for the purpose of calculating earnings per share, is subtracted from net income to arrive at net income available to common shareholders. (2) The pro forma earnings disclosures are not necessarily representative of the effects on net income and earnings per share in future years. (3) Includes the Company's ownership share of stock compensation costs related to the Reinsurance Group of America, Incorporated ("RGA"), incentive stock plan and the stock compensation costs related to the incentive stock plans at SSRM Holdings, Inc. ("State Street Research"), determined in accordance with the fair value method. 29 9. COMPREHENSIVE INCOME (LOSS) The components of comprehensive income (loss) are as follows: FOR THE THREE MONTHS FOR THE SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, -------------------- -------------------- 2004 2003 2004 2003 ------- ------- ------- ------- (DOLLARS IN MILLIONS) Net income $ 947 $ 580 $ 1,470 $ 942 Other comprehensive income (loss): Unrealized gains (losses) on derivative instruments, net of income taxes 81 (71) 85 (69) Unrealized investment gains (losses), net of related offsets, reclassification adjustments and income taxes (1,737) 936 (1,155) 1,234 Cumulative effect of a change in accounting, net of income taxes 90 -- Foreign currency translation adjustments (71) 129 (95) 143 Minimum pension liability adjustment -- -- -- (9) ------- ------- ------- ------- Other comprehensive income (loss): (1,727) 994 (1,075) 1,299 ------- ------- ------- ------- Comprehensive income (loss) $ (780) $ 1,574 $ 395 $ 2,241 ======= ======= ======= ======= 30 10. EARNINGS PER SHARE The following table presents the weighted average shares used in calculating basic earnings per share and those used in calculating diluted earnings per share for each income category presented below: THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ------------- ------------- ------------- ------------- 2004 2003 2004 2003 ------------- ------------- ------------- ------------- (DOLLARS IN MILLIONS, EXCEPT SHARE AND PER SHARE DATA) Weighted average common stock outstanding for basic earnings per share 753,331,966 731,242,226 754,915,747 715,866,466 Incremental shares from assumed: Exercise of stock options 3,455,800 14,228 3,284,270 -- Issuance under deferred stock compensation 1,183,084 -- 935,759 -- ------------- ------------- ------------- ------------- Weighted average common stock outstanding for diluted earnings per share 757,970,850 731,256,454 759,135,776 715,866,466 ============= ============= ============= ============= INCOME FROM CONTINUING OPERATIONS $ 852 $ 572 $ 1,510 $ 866 Charge for conversion of company-obligated mandatorily redeemable securities of a subsidiary trust (1) -- -- -- (21) INCOME FROM CONTINUING OPERATIONS AVAILABLE ------------- ------------- ------------- ------------- TO COMMON SHAREHOLDERS $ 852 $ 572 $ 1,510 $ 845 ============= ============= ============= ============= Basic earnings per share $ 1.13 $ 0.78 $ 2.00 $ 1.18 ============= ============= ============= ============= Diluted earnings per share $ 1.12 $ 0.78 $ 1.99 $ 1.18 ============= ============= ============= ============= INCOME FROM DISCONTINUED OPERATIONS AVAILABLE TO COMMON SHAREHOLDERS $ 95 $ 8 $ 118 $ 76 ============= ============= ============= ============= Basic earnings per share $ 0.13 $ 0.01 $ 0.16 $ 0.11 ============= ============= ============= ============= Diluted earnings per share $ 0.13 $ 0.01 $ 0.16 $ 0.11 ============= ============= ============= ============= CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING, NET OF INCOME TAXES $ -- $ -- $ (158) $ -- ============= ============= ============= ============= Basic earnings per share $ -- $ -- $ (0.21) $ -- ============= ============= ============= ============= Diluted earnings per share $ -- $ -- $ (0.21) $ -- ============= ============= ============= ============= NET INCOME $ 947 $ 580 $ 1,470 $ 942 Charge for conversion of company-obligated mandatorily redeemable securities of a subsidiary trust (1) -- -- -- (21) ============= ============= ============= ============= NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 947 $ 580 $ 1,470 $ 921 ============= ============= ============= ============= Basic earnings per share $ 1.26 $ 0.79 $ 1.95 $ 1.29 ============= ============= ============= ============= Diluted earnings per share $ 1.25 $ 0.79 $ 1.94 $ 1.29 ============= ============= ============= ============= - ---------- (1) See Note 8 for a discussion of this charge included in the calculation of net income available to common shareholders. On February 19, 2002, the Holding Company's Board of Directors authorized a $1 billion common stock repurchase program. Under this authorization, the Holding Company may purchase common stock from the MetLife Policyholder Trust, in the open market and in privately negotiated transactions. The Holding Company acquired 7,935,381 shares of common stock for approximately $275 million during the six months ended June 30, 2004. The Holding Company did not acquire any shares of common stock during the six months ended June 30, 2003. The Holding Company issued 805,262 shares of common stock from treasury stock for $25 million during the six months ended June 30, 2004. During the six months ended June 30, 2003, 59,865,424 shares of common stock were issued from treasury stock, 59,771,221 of which were issued in connection with the settlement of common stock purchase contracts 31 for approximately $1,006 million. At June 30, 2004, the Holding Company had approximately $434 million remaining on its existing share repurchase program. 11. BUSINESS SEGMENT INFORMATION The Company provides insurance and financial services to customers in the United States, Canada, Central America, South America, South Africa, and Asia. The Company's business is divided into six segments: Institutional, Individual, Auto & Home, International, Reinsurance and Asset Management. These segments are managed separately because they either provide different products and services, require different strategies or have different technology requirements. Institutional offers a broad range of group insurance and retirement and savings products and services, including group life insurance, non-medical health insurance, such as short and long-term disability, long-term care, and dental insurance, and other insurance products and services. Individual offers a wide variety of individual insurance and investment products, including life insurance, annuities and mutual funds. Auto & Home provides insurance coverages, including private passenger automobile, homeowners and personal excess liability insurance. International provides life insurance, accident and health insurance, annuities and retirement and savings products to both individuals and groups, and auto and homeowners coverage to individuals. Reinsurance provides primarily reinsurance of life and annuity policies in North America and various international markets. Additionally, reinsurance of critical illness policies is provided in select international markets. Asset Management provides a broad variety of asset management products and services to individuals and institutions. 32 Set forth in the tables below is certain financial information with respect to the Company's operating segments for the three months and six months ended June 30, 2004 and 2003. The accounting policies of the segments are the same as those of the Company, except for the method of capital allocation and the accounting for gains (losses) from intercompany sales, which are eliminated in consolidation. The Company allocates capital to each segment based upon an internal capital allocation system that allows the Company to more effectively manage its capital. The Company evaluates the performance of each operating segment based upon net income excluding certain net investment gains (losses), net of income taxes, and the impact from the cumulative effect of changes in accounting, net of income taxes. Scheduled periodic settlement payments on derivative instruments not qualifying for hedge accounting are included in net investment gains (losses). The Company allocates certain non-recurring items, such as expenses associated with certain legal proceedings, to Corporate & Other. FOR THE THREE MONTHS ENDED AUTO & ASSET CORPORATE & JUNE 30, 2004 INSTITUTIONAL INDIVIDUAL HOME INTERNATIONAL REINSURANCE MANAGEMENT OTHER TOTAL - --------------------------- ------------- ---------- ------ ------------- ----------- ---------- ----- ----- (DOLLARS IN MILLIONS) Premiums $2,382 $1,007 $ 734 $ 405 $ 807 $ -- $ (4) $5,331 Universal life and investment- type product policy fees 187 455 -- 86 -- -- -- 728 Net investment income 1,121 1,543 44 137 136 18 118 3,117 Other revenues 155 106 6 8 15 73 (7) 356 Net investment gains (losses) 32 35 (5) (3) 31 -- (43) 47 Income (loss) from continuing operations before provision for income taxes 576 341 91 101 46 26 (75) 1,106 FOR THE THREE MONTHS ENDED AUTO & ASSET CORPORATE & JUNE 30, 2003 INSTITUTIONAL INDIVIDUAL HOME INTERNATIONAL REINSURANCE MANAGEMENT OTHER TOTAL - -------------------------- ------------- ---------- ------ ------------- ----------- ---------- ----- ----- (DOLLARS IN MILLIONS) Premiums $ 2,334 $ 1,055 $ 721 $ 390 $ 588 $ -- $ (5) $ 5,083 Universal life and investment- type product policy fees 154 378 -- 71 -- -- -- 603 Net investment income 997 1,532 41 131 121 16 26 2,864 Other revenues 152 109 4 26 12 37 15 355 Net investment gains (losses) 1 (22) (2) (1) 5 -- (23) (42) Income (loss) from continuing operations before provision for income taxes 394 215 51 92 33 9 (10) 784 FOR THE SIX MONTHS ENDED AUTO & ASSET CORPORATE & JUNE 30, 2004 INSTITUTIONAL INDIVIDUAL HOME INTERNATIONAL REINSURANCE MANAGEMENT OTHER TOTAL - ------------------------ ------------- ---------- ------ ------------- ----------- ---------- ----- ----- (DOLLARS IN MILLIONS) Premiums $ 4,807 $ 1,985 $ 1,471 $ 817 $ 1,623 $ -- $ (5) $10,698 Universal life and investment- type product policy fees 358 877 -- 169 -- -- -- 1,404 Net investment income 2,208 3,058 90 260 266 36 174 6,092 Other revenues 319 223 15 12 27 113 -- 709 Net investment gains (losses) 142 12 (5) 23 52 -- (61) 163 Income (loss) from continuing operations before provision for income taxes 1,134 621 149 195 82 35 (149) 2,067 FOR THE SIX MONTHS ENDED AUTO & ASSET CORPORATE & JUNE 30, 2003 INSTITUTIONAL INDIVIDUAL HOME INTERNATIONAL REINSURANCE MANAGEMENT OTHER TOTAL - ------------------------ ------------- ---------- ------ ------------- ----------- ---------- ----- ----- (DOLLARS IN MILLIONS) Premiums $ 4,470 $ 2,096 $ 1,433 $ 785 $ 1,140 $ -- $ (9) $ 9,915 Universal life and investment- type product policy fees 315 738 -- 122 -- -- -- 1,175 Net investment income 1,972 3,087 80 254 231 32 81 5,737 Other revenues 294 195 13 34 24 66 27 653 Net investment gains (losses) (108) (123) (6) (1) 1 8 (65) (294) Income (loss) from continuing operations before provision for income taxes 621 391 74 134 63 19 (109) 1,193 33 The following amounts are reported as discontinued operations in accordance with SFAS 144: THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- (DOLLARS IN MILLIONS) Net investment income Institutional $ 1 $ 1 $ 3 $ 4 Individual 1 -- 1 3 Corporate & Other 23 11 39 23 ---- ---- ---- ---- Total net investment income $ 25 $ 12 $ 43 $ 30 ==== ==== ==== ==== Net investment gains (losses) Institutional $ -- $ (1) $ 2 $ 40 Individual 2 7 3 47 Corporate & Other 129 (6) 147 3 ---- ---- ---- ---- Total net investment gains (losses) $131 $ -- $152 $ 90 ==== ==== ==== ==== The following table presents assets with respect to the Company's operating segments at: JUNE 30, DECEMBER 31, 2004 2003 -------- ------------ (DOLLARS IN MILLIONS) Assets Institutional $119,565 $113,743 Individual 170,616 165,774 Auto & Home 5,008 4,698 International 9,175 9,935 Reinsurance 13,234 12,833 Asset Management 263 302 Corporate & Other 20,368 19,556 -------- -------- Total $338,229 $326,841 ======== ======== Corporate & Other includes various start-up and run-off entities, as well as the elimination of all intersegment amounts. The elimination of intersegment amounts relates to intersegment loans, which bear interest rates commensurate with related borrowings, as well as intersegment reinsurance transactions. Net investment income and net investment gains (losses) are based upon the actual results of each segment's specifically identifiable asset portfolio adjusted for allocated capital. Other costs are allocated to each of the segments based upon: (i) a review of the nature of such costs; (ii) time studies analyzing the amount of employee compensation costs incurred by each segment; and (iii) cost estimates included in the Company's product pricing. Revenues derived from any customer did not exceed 10% of consolidated revenues. Revenues from U.S. operations were $8,645 million and $8,019 million for the three months ended June 30, 2004 and 2003, respectively, which represented 90% and 90%, respectively, of consolidated revenues. Revenues from U.S. operations were $17,181 million and $15,567 million for the six months ended June 30, 2004 and 2003, respectively, which represented 90% and 91%, respectively, of consolidated revenues. 34 12. DISCONTINUED OPERATIONS The Company actively manages its real estate portfolio with the objective to maximize earnings through selective acquisitions and dispositions. Income related to real estate classified as held-for-sale is presented as discontinued operations. These assets are carried at the lower of cost or market. The following table presents the components of income from discontinued operations: THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------ ---------------- 2004 2003 2004 2003 ----- ----- ----- ----- (DOLLARS IN MILLIONS) Investment income $ 32 $ 32 $ 65 $ 71 Investment expense (7) (20) (22) (41) Net investment gains (losses) 131 -- 152 90 ----- ----- ----- ----- Total revenues 156 12 195 120 Interest expense 11 -- 13 -- Provision for income taxes 50 4 64 44 ----- ----- ----- ----- Income from discontinued operations $ 95 $ 8 $ 118 $ 76 ===== ===== ===== ===== The carrying value of real estate related to discontinued operations was $44 million and $832 million at June 30, 2004 and December 31, 2003, respectively. In February of 2004, MetLife entered into a marketing agreement to sell one of its real estate investments, Sears Tower, and reclassified the property from Real Estate -- Held-for-Investments to Real Estate -- Held-for-Sale. The sale, which occurred in April 2004, resulted in an after-tax gain of $85 million. 35 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" refers to MetLife, Inc., a Delaware corporation (the "Holding Company"), and its subsidiaries, including Metropolitan Life Insurance Company ("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. SUMMARY OF CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the unaudited interim condensed consolidated financial statements. The critical accounting policies, estimates and related judgments underlying the Company's unaudited interim condensed consolidated financial statements are summarized below. In applying these policies, management makes subjective and complex judgments that frequently require estimates about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company's businesses and operations. INVESTMENTS The Company's principal investments are in fixed maturities, mortgage loans and real estate, all of which are exposed to three primary sources of investment risk: credit, interest rate and market valuation. The financial statement risks are those associated with the recognition of impairments and income, as well as the determination of fair values. The assessment of whether impairments have occurred is based on management's case-by-case evaluation of the underlying reasons for the decline in fair value. Management considers a wide range of factors about the security issuer and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used by the Company in the impairment evaluation process include, but are not limited to: (i) the length of time and the extent to which the market value has been below amortized cost; (ii) the potential for impairments of securities when the issuer is experiencing significant financial difficulties; (iii) the potential for impairments in an entire industry sector or sub-sector; (iv) the potential for impairments in certain economically depressed geographic locations; (v) the potential for impairments of securities where the issuer, series of issuers or industry has suffered a catastrophic type of loss or has exhausted natural resources; (vi) the Company's ability and intent to hold the security for a period of time sufficient to allow for the recovery of its value to an amount equal to or greater than amortized cost; (vii) unfavorable changes in forecasted cash flows on asset-backed securities; and (viii) other subjective factors, including concentrations and information obtained from regulators and rating agencies. In addition, the earnings on certain investments are dependent upon market conditions, which could result in prepayments and changes in amounts to be earned due to changing interest rates or equity markets. The determination of fair values in the absence of quoted market values is based on: (i) valuation methodologies; (ii) securities the Company deems to be comparable; and (iii) assumptions deemed appropriate given the circumstances. The use of different methodologies and assumptions may have a material effect on the estimated fair value amounts. In addition, the Company enters into certain structured investment transactions, real estate joint ventures and limited partnerships for which the Company may be deemed to be the primary beneficiary and, therefore, may be required to consolidate such investments. The accounting rules for the determination of the primary beneficiary are complex and require evaluation of the contractual rights and obligations associated with each party involved in the entity, an estimate of the entity's expected losses and expected residual returns and the allocation of such estimates to each party. DERIVATIVES The Company enters into freestanding derivative transactions primarily to manage the risk associated with variability in cash flows or changes in fair values related to the Company's financial assets and liabilities or to changing fair values. The Company also uses derivative instruments to hedge its currency exposure associated with net investments in certain foreign operations. The Company also purchases investment securities, issues certain insurance policies and engages in certain reinsurance contracts that embed derivatives. The associated financial statement risk is the volatility in net income which can result from (i) changes in fair value of derivatives not qualifying as accounting hedges; (ii) ineffectiveness of designated hedges; and (iii) counterparty default. In addition, there is a risk that embedded derivatives requiring bifurcation are not identified and reported at fair value in the unaudited interim condensed consolidated financial statements. Accounting for derivatives is complex, as evidenced by significant authoritative interpretations of the primary accounting standards which continue to evolve, as well as the significant judgments and estimates involved in determining 36 fair value in the absence of quoted market values. These estimates are based on valuation methodologies and assumptions deemed appropriate in the circumstances. Such assumptions include estimated volatility and interest rates used in the determination of fair value where quoted market values are not available. The use of different assumptions may have a material effect on the estimated fair value amounts. DEFERRED POLICY ACQUISITION COSTS The Company incurs significant costs in connection with acquiring new and renewal insurance business. These costs, which vary with and are primarily related to the production of that business, are deferred. The recovery of such costs is dependent upon the future profitability of the related business. The amount of future profit is dependent principally on investment returns in excess of the amounts credited to policyholders, mortality, morbidity, persistency, interest crediting rates, expenses to administer the business, creditworthiness of reinsurance counterparties and certain economic variables, such as inflation. Of these factors, the Company anticipates that investment returns are most likely to impact the rate of amortization of such costs. The aforementioned factors enter into management's estimates of gross margins and profits, which generally are used to amortize such costs. Revisions to estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in the impairment of the asset and a charge to income if estimated future gross margins and profits are less than amounts deferred. In addition, the Company utilizes the reversion to the mean assumption, a standard industry practice, in its determination of the capitalization and amortization of deferred policy acquisition costs ("DAC"), including value of business acquired ("VOBA"). This practice assumes that the expectation for long-term appreciation in equity markets is not changed by minor short-term market fluctuations, but that it does change when large interim deviations have occurred. FUTURE POLICY BENEFITS The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance, annuities and disability insurance. Generally, amounts are payable over an extended period of time and liabilities are established based on methods and underlying assumptions in accordance with GAAP and applicable actuarial standards. Principal assumptions used in the establishment of liabilities for future policy benefits are mortality, morbidity, expenses, persistency, investment returns and inflation. The Company also establishes liabilities for unpaid claims and claims expenses for property and casualty insurance. Liabilities for property and casualty insurance are dependent on estimates of amounts payable for claims reported but not settled and claims incurred but not reported. These estimates are influenced by historical experience and actuarial assumptions with respect to current developments, anticipated trends and risk management strategies. Differences between the actual experience and assumptions used in pricing these policies and in the establishment of liabilities result in variances in profit and could result in losses. REINSURANCE The Company enters into reinsurance transactions as both a provider and a purchaser of reinsurance. Accounting for reinsurance requires extensive use of assumptions and estimates, particularly related to the future performance of the underlying business and the potential impact of counterparty credit risks. The Company periodically reviews actual and anticipated experience compared to the aforementioned assumptions used to establish assets and liabilities relating to ceded and assumed reinsurance and evaluates the financial strength of counterparties to its reinsurance agreements using criteria similar to that evaluated in the security impairment process discussed previously. Additionally, for each of its reinsurance contracts, the Company must determine if the contract provides indemnification against loss or liability relating to insurance risk, in accordance with applicable accounting standards. The Company must review all contractual features, particularly those that may limit the amount of insurance risk to which the reinsurer is subject or features that delay the timely reimbursement of claims. If the Company determines that a reinsurance contract does not expose the reinsurer to a reasonable possibility of a significant loss from insurance risk, the Company records the contract using the deposit method of accounting. LITIGATION The Company is a party to a number of legal actions and regulatory investigations. Given the inherent unpredictability of these matters, it is difficult to estimate the impact on the Company's consolidated financial position. Liabilities are established when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Liabilities related to certain lawsuits, including the Company's asbestos-related liability, are especially difficult to estimate due to the limitation of available data and 37 uncertainty regarding numerous variables used to determine amounts recorded. The data and variables that impact the assumption used to estimate the Company's asbestos-related liability include the number of future claims, the cost to resolve claims, the disease mix and severity of disease, the jurisdiction of claims filed, tort reform efforts and the impact of any possible future adverse verdicts and their amounts. It is possible that an adverse outcome in certain of the Company's litigation and regulatory investigations, including asbestos-related cases, or the use of different assumptions in the determination of amounts recorded could have a material effect upon the Company's consolidated net income or cash flows in particular quarterly or annual periods. EMPLOYEE BENEFIT PLANS The Company sponsors pension and other retirement plans in various forms covering employees who meet specified eligibility requirements. The reported expense and liability associated with these plans requires an extensive use of assumptions which include the discount rate, expected return on plan assets and rate of future compensation increases as determined by the Company. Management determines these assumptions based upon currently available market and industry data, historical performance of the plan and its assets, and consultation with an independent consulting actuarial firm to aid it in selecting appropriate assumptions and valuing its related liabilities. The expected return on plan assets includes an expectation of long-term market appreciation in equity markets which is not changed by short-term market fluctuations. These assumptions used by the Company may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of the participants. These differences may have a significant effect on the Company's unaudited interim condensed consolidated financial statements and liquidity. RESULTS OF OPERATIONS EXECUTIVE SUMMARY MetLife, Inc., through its subsidiaries and affiliates, is a leading provider of insurance and other financial services to individual and institutional customers. The MetLife companies serve individuals in approximately 13 million households in the U.S. and provide benefits to 37 million employees and family members through their plan sponsors. Outside the U.S., the MetLife companies serve approximately 8 million customers through direct insurance operations in Argentina, Brazil, Chile, China, Hong Kong, India, Indonesia, Mexico, South Korea, Taiwan and Uruguay. MetLife is organized into six business segments: Institutional, Individual, Auto & Home, International, Reinsurance and Asset Management. THREE MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2003 The Company reported $947 million in net income and diluted earnings per share of $1.25 for the three months ended June 30, 2004 compared to $580 million in net income and diluted earnings per share of $0.79 for the three months ended June 30, 2003. Continued top-line revenue growth across all of the Company's business segments, strong investment spreads, favorable claim experience and an improvement in net investment gains (losses) and the impact of certain transactions or events that result in net income not being indicative of future earnings are the leading contributors to the 63% increase in net income in the second quarter of 2004 over the comparable 2003 period. Total premiums and fees increased to $6.1 billion, up 7%, from the second quarter of 2003, which primarily stems from continued sales growth across most of the Company's business segments, as well as the positive impact of the U.S. financial markets on policy fees. Continued improvement in investment spreads is largely due to higher net investment income from corporate joint ventures, bond prepayments fees and commercial mortgage prepayments. In addition an improvement in net investment gains (losses), net of income taxes, of $57 million is primarily attributable to lower credit-related losses and the recognition of equity gains, reflecting the improved market conditions. SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2003 The Company reported $1,470 million in net income and diluted earnings per share of $1.94 for the six months ended June 30, 2004 compared to $942 million in net income and diluted earnings per share of $1.29 for the six months ended June 30, 2003. Continued top-line revenue growth across all of the Company's business segments, strong investment spreads, favorable claim experience and an improvement in net investment gains (losses), and the impact of certain transactions or events that result in net income not being indicative of future earnings are the leading contributors to the 56% increase in net income in the first six months of 2004 over the comparable 2003 period. Total premiums and fees increased to $12.1 billion, up 9%, from the first six months of 2003, which primarily stems from continued sales growth across most of the Company's business segments as well as the positive impact of the U.S. financial markets on policy fees. Continued improvement in investment spreads was primarily attributable to higher net investment income from corporate joint ventures, bond prepayments fees and commercial mortgage prepayments. In addition an 38 improvement in net investment gains (losses), net of income taxes, of $290 million is primarily attributable to lower credit-related losses and the recognition of equity gains, reflecting the improved market conditions. These increases are partially offset by a $158 million cumulative effect of a change in accounting in accordance with Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts ("SOP 03-1"). INDUSTRY TRENDS The Company's segments continue to be influenced by a variety of industry trends and the Company believes that each of its businesses is well positioned to capitalize on those trends. In general, the Company sees more employers, both large and small, outsourcing their benefits functions. Further, companies are offering broader arrays of voluntary benefits to help retain employees while adding little to their overall benefits costs. These trends will likely continue and in fact expand across companies of all sizes. Employers are also demanding substantial online access for their employees for various self-service functions. This functionality requires substantial information technology investment that smaller companies will find difficult to absorb. This will put pressure on those smaller and mid-size companies to gain scale quickly or exit the business. Additionally, the Company is seeing a trend of employers moving to defined contribution plans over defined benefit plans. In addition, alternative benefit structures, such as simple fixed benefit products, are becoming more popular as the cost of traditional medical indemnity products has continued to increase rapidly. These low cost fixed benefit products can provide effective catastrophic protection for high cost illnesses to supplement the basic health coverage provided by medical indemnity insurance. From a demographics standpoint, the bulk of the U.S. population is moving from an asset accumulation phase to an asset distribution phase. People within ten years of retirement hold significant assets. With continually lengthening lifespans and unstructured asset distribution, the Company believes many of these people may outlive their retirement savings and/or require long-term care. As a result, the Company expects that the demand for retirement payout solutions with guarantees will increase dramatically over the next decade. In each of these demographic scenarios, the quality of the guarantee will be a key driver of growth. The Company believes that these guarantees will be evaluated through balance sheet strength, the claims paying ability and financial strength ratings of the guarantor, as well as the reputation of the Company. The Company believes that in each of these comparisons, it will be at a distinct advantage versus the industry on average. The combination of these trends will continue to favor those with scale, breadth of distribution and product, ability to provide advice and financial strength to support long-term guarantees. 39 DISCUSSION OF RESULTS The following table presents consolidated financial information for the Company for the periods indicated: THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 2004 2003 2004 2003 ---------- -------- -------- --------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 5,331 $ 5,083 $ 10,698 $ 9,915 Universal life and investment-type product policy fees 728 603 1,404 1,175 Net investment income 3,117 2,864 6,092 5,737 Other revenues 356 355 709 653 Net investment gains (losses) 47 (42) 163 (294) -------- -------- -------- -------- Total revenues 9,579 8,863 19,066 17,186 -------- -------- -------- -------- EXPENSES Policyholder benefits and claims 5,335 4,970 10,795 9,895 Interest credited to policyholder account balances 751 761 1,494 1,508 Policyholder dividends 471 507 913 1,010 Other expenses 1,916 1,841 3,797 3,580 -------- -------- -------- -------- Total expenses 8,473 8,079 16,999 15,993 -------- -------- -------- -------- Income from continuing operations before provision for income taxes 1,106 784 2,067 1,193 Provision for income taxes 254 212 557 327 -------- -------- -------- -------- Income from continuing operations 852 572 1,510 866 Income from discontinued operations, net of income taxes 95 8 118 76 -------- -------- -------- -------- Income before cumulative effect of a change in accounting 947 580 1,628 942 Cumulative effect of a change in accounting, net of income taxes -- -- (158) -- -------- -------- -------- -------- Net income $ 947 $ 580 $ 1,470 $ 942 ======== ======== ======== ======== THREE MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2003 -- THE COMPANY Income from continuing operations increased by $280 million, or 49%, to $852 million for the three months ended June 30, 2004 from $572 million in the comparable 2003 period. Income from continuing operations for the three months ended June 30, 2004 and 2003 includes the impact of certain transactions or events that result in net income not being indicative of future earnings, which are described in the applicable segment's results of operations discussions. These items contributed an after-tax benefit of $104 million for the three months ended June 30, 2004 and an after-tax benefit of $95 million in the comparable 2003 period. Excluding the impact of these items, income from continuing operations increased by $271 million for the three months ended June 30, 2004 compared to the prior 2003 period. An improvement in net investment gains (losses), net of income taxes, account for $57 million of this increase. The remainder is primarily attributable to higher net investment income along with favorable results in the Auto & Home, Institutional and Individual segments. The results for these segments were primarily attributable to an improvement in the combined loss ratio; business growth and favorable underwriting results; and wider interest spreads and higher fee income, respectively. Premiums, fees and other revenues increased by $374 million, or 6%, to $6,415 million for the three months ended June 30, 2004 from $6,041 million for the comparable 2003 period. This increase primarily results from the Reinsurance, Institutional and Asset Management segments. The Reinsurance segment represents approximately 59% of the contribution to the Company's period over period increase. This growth is primarily attributable to this segment's coinsurance agreement with Allianz Life Insurance Company of North America ("Allianz Life"). The Institutional segment contributed 22% to the year over year increase. This increase stems primarily from sales growth as well as the acquisitions of new businesses in the group life and the non-medical health and other businesses. Additionally, the Asset Management segment contributed 10% to the overall increase primarily due to higher performance fees, as well as an increase in fees earned on average assets under management. Investment spreads, which generally represent the margin between net investment income and interest credited to policyholder account balances, continued to strengthen during the three months ended June 30, 2004 and were considerably higher, compared to the prior 40 year period. The improvement in the investment spreads is primarily the result of higher net investment income, which stems in part, from corporate joint ventures, bond prepayment fees and commercial mortgage prepayments. Underwriting results in 2004 were largely favorable compared to the second quarter of 2003. The Individual life mortality incurred ratio, which represents actual life claims as a percentage of assumed claims incurred used in the determination of future policy benefits, was favorable at 78.1%, compared with 99.4% in the prior year period. This reflects an overall improvement in mortality, on direct business, in both traditional and variable and universal life products. In addition, the prior year period includes the impact of a single large claim in the variable and universal product line. Group disability's morbidity incurred loss ratio, which represents actual disability claims as a percentage of assumed claims incurred used in the determination of future policy benefits, decreased to 92.7%, from 95.1% in the comparable 2003 period. This improvement is predominately due to lower long-term disability incidence, partially offset by lower net claim closures within the quarter. The group term life mortality incurred ratio, which represents incurred claims as a percentage of premiums earned, increased to 93.3%, from 92.0% in the prior year period, reflecting a modest increase in mortality, however this is still below management's expected range. The Auto & Home combined ratio, which is a measure of both the loss and loss adjustment expense ratio, as well as the other expense ratio, declined to 88.1% excluding catastrophes, from 95.6% in the prior year period. This result is largely due to continued improvement in both auto and homeowner claim frequencies, as well as an increase in average earned premiums. Other expenses increased by $75 million, or 4%, to $1,916 million for the three months ended June 30, 2004 from $1,841 million for the comparable 2003 period. The 2003 quarter includes the impact of $100 million reduction of a previously established liability related to the Company's race-conscious underwriting settlement. In addition, the 2003 period includes a $48 million charge related to certain improperly deferred expenses and a $45 million charge related to a change in reserve methodology in the Company's International segment. The current period quarter reflects a $49 million reduction of a premium tax liability and a reduction of a liability of $22 million of interest associated with the resolution of all issues relating to the Internal Revenue Service's audit of Metropolitan Life's and its subsidiaries' tax returns for the years 1997-1999. These decreases were partially offset by a $50 million contribution to MetLife Foundation. Excluding the impact of these transactions, other expenses increased by $89 million, or 5%, from the comparable 2003 period. The transaction with Allianz Life, mentioned above, is mostly offset by the sale of the Spanish operations. The remaining variance is primarily attributable to an increase in non-deferrable volume related expenses associated with general business growth. Net investment gains (losses) improved by $89 million, or 212%, to $47 million for the three months ended June 30, 2004 from ($42) million for the comparable 2003 period. This improvement is primarily due to lower credit-related losses and the recognition of equity gains, reflecting the improved market conditions. Income tax expense for the three months ended June 30, 2004 was $254 million, or 23% of income from continuing operations before provision for income taxes, compared with $212 million, or 27%, for the comparable 2003 period. The 2004 effective tax rate differs from the corporate tax rate of 35% primarily due to the impact of non-taxable investment income, tax credits for investments in low income housing, decreasing the deferred tax valuation allowance to recognize the effect of foreign net operating loss carryforward in Korea, and the contribution of appreciated stock to the MetLife Foundation. In addition, the 2004 effective tax rate reflects an adjustment for the resolution of all issues relating to the Internal Revenue Service's audit of Metropolitan Life's and its subsidiaries' tax returns for the years 1997-1999. The 2003 effective tax rate differs from the corporate tax rate of 35% primarily due to the impact of non-taxable investment income, tax credits for investments in low income housing, and decreasing the deferred tax valuation allowance to recognize the effect of certain foreign net operating loss carryforwards. Income from discontinued operations, net of income taxes, increased $87 million, or 1,088%, to $95 million for the three months ended June 30, 2004 from $8 million for the comparable 2003 period. The increase is primarily due to the $85 million gain on the sale of Sears Tower in April 2004. The income from discontinued operations is comprised of net investment income and net investment gains related to properties that the Company has classified as available-for-sale. For the three months ended June 30, 2004 and 2003, the Company recognized $131 million and $0 million of net investment gains, respectively, from discontinued operations related to real estate properties sold or held-for-sale. SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2003 - -- THE COMPANY Income from continuing operations increased by $644 million, or 74%, to $1,510 million for the six months ended June 30, 2004 from $866 million in the comparable 2003 period. Income from continuing operations for the six months ended June 30, 2004 and 2003 includes the impact of certain transactions or events that result in net income not being indicative of future earnings, which are described in the applicable segment's results of operations discussions. These items contributed an after-tax benefit of $104 million for the six months ended June 30, 2004 and an after-tax benefit of $95 million in the comparable 2003 period. Excluding the impact of these items, income from continuing operations increased by $635 million for the six months ended June 30, 2004 compared to the 41 prior 2003 period. An improvement in net investment gains (losses), net of income taxes, account for $290 million of this increase. The remainder of the variance is attributable to the Institutional, Individual, and Auto & Home segments and Corporate & Other. This increase was primarily attributable to higher net investment income along with favorable results in the Institutional, Individual and Auto & Home segments. The results for these segments were primarily attributable to business growth and favorable underwriting results, wider interest spreads and higher fee income, and an improvement in the combined loss ratio, respectively. Premiums, fees and other revenues increased by $1,068 million, or 9%, to $12,811 million for the six months ended June 30, 2004 from $11,743 million from the comparable 2003 period. This increase primarily results from the Reinsurance, Institutional, Individual and International segments. The Reinsurance segment represents approximately 46% of the contribution to the Company's period over period increase. This growth is primarily attributable to this segment's coinsurance agreement with Allianz Life. The Institutional segment contributed 38% to the period over period increase. This increase stems primarily from sales growth as well as the acquisitions of new businesses in the group life and the non-medical health and other businesses. In addition, the Individual segment's growth accounted for 5% of the period over period increase. This stems in part from fee income earned on $6.3 billion of annuity deposits in 2004, which increased 14% from the prior year period. In addition, the annuity separate account balance is $33.0 billion at June 30, 2004, up 49% versus the prior year quarter end. Partially offsetting this increase is a decline in traditional life premiums, which is largely attributable to the run off in the Company's closed block of business. The International segment represents 5% of the Company's growth period over period. This increase is primarily due to higher sales in South Korea, Mexico, Chile and Taiwan. Investment spreads, which generally represent the margin between net investment income and interest credited to policyholder account balances, continued to strengthen during the six months ended June 30, 2004 and were considerably higher, compared to the prior year period. The improvement in the investment spreads were primarily the result of higher net investment income, which stems in part, from corporate joint ventures, bond prepayment fees and commercial mortgage prepayments. Underwriting results in 2004 were largely favorable compared to the 2003 period. Group disability's morbidity incurred loss ratio, which represents actual disability claims as a percentage of premiums earned used in the determination of future policy benefits, decreased to 93.0%, from 95.8% in the comparable 2003 period. This improvement is predominately due to lower long-term disability incidence, partially offset by lower net claim closures within the period. The group term life mortality incurred ratio, which represents actual life claims as a percentage of premiums earned used in the determination of future policy benefits, increased to 94.5%, from 92.6% in the prior year period, reflecting a modest increase in mortality; however, this is still below management's expected range. The Individual life mortality incurred ratio, which represents actual life claims as a percentage of assumed claims incurred, was favorable at 81.8%, compared with 93.3% in the prior year period. This reflects an overall improvement in mortality, on direct business, in both traditional and variable and universal life products. In addition, the prior year period includes the impact of a single large claim in the variable and universal product line. The Auto & Home combined ratio, which is a measure of both the loss and loss adjustment expense ratio, as well as the other expense ratio, declined to 92.4% excluding catastrophes, from 98.4% in the prior year period. This result is largely due to continued improvement in both auto and homeowner claim frequencies, as well as an increase in average earned premiums. Other expenses increased by $217 million, or 6%, to $3,797 million for the six months ended June 30, 2004 from $3,580 million for the comparable 2003 period. The 2003 quarter includes the impact of $100 million reduction of a previously established liability related to the Company's race-conscious underwriting settlement. In addition, the 2003 period includes a $48 million charge related to certain improperly deferred expenses and a $45 million charge related to a change in reserve methodology in the Company's International segment. The current period quarter reflects a $49 million reduction of a premium tax liability and a reduction of a liability of $22 million of interest associated with the resolution of all issues relating to the Internal Revenue Service's audit of Metropolitan Life's and its subsidiaries' tax returns for the years 1997-1999. These decreases were partially offset by a $50 million contribution to MetLife Foundation. Excluding the impact of these transactions, other expenses increased by $231 million, or 6%, from the comparable 2003 period. The transaction with Allianz Life mentioned above is mostly offset by the sale of the Spanish operations. The remaining variance is primarily attributable to an increase in non-deferrable volume related expenses associated with general business growth. In addition, other expenses include cost associated with office consolidations and related fixed assets write-offs in the first half of 2004. Net investment gains (losses) improved by $457 million, or 155%, to $163 million for the six months ended June 30, 2004 from ($294) million for the comparable 2003 period. This improvement is primarily due to lower credit-related losses and the recognition of equity gains, reflecting the improved market conditions. Income tax expense for the six months ended June 30, 2004 was $557 million, or 27% of income from continuing operations before provision for income taxes, compared with $327 million, or 27%, for the comparable 2003 period. The 2004 effective tax rate differs from the corporate tax rate of 35% primarily due to the impact of non-taxable investment income, tax credits for investments in low income housing, decreasing the deferred tax valuation allowance to 42 recognize the effect of certain foreign net operating loss carryforward in Korea, and the contribution of appreciated stock to the MetLife Foundation. In addition, the 2004 effective tax rate reflects an adjustment for the resolution of all issues relating to the Internal Revenue Service's audit of Metropolitan Life's and its subsidiaries' tax returns for the years 1997-1999. The 2003 effective tax rate differs from the corporate tax rate of 35% primarily due to the impact of non-taxable investment income, tax credits for investments in low income housing, tax adjustment for a recovery of prior year tax overpayments on tax-exempt bonds, and decreasing the deferred tax valuation allowance to recognize the effect of certain foreign net operating loss carryforwards. Income from discontinued operations, net of income taxes, increased $42 million, or 55%, to $118 million for the six months ended June 30, 2004 from $76 million for the comparable 2003 period. The increase is primarily due to the gain of $85 million on the sale of Sears Tower in April 2004, partially offset by lower recognized net investment gains from real estate properties sold in the six months ended June 30, 2004 as compared to the prior 2003 period. The income from discontinued operations is comprised of net investment income and net investment gains related to properties that the Company has classified as available-for-sale. For the six months ended June 30, 2004 and 2003, the Company recognized $152 million and $90 million of net investment gains, respectively, from discontinued operations related to real estate properties sold or held-for-sale. During the six months ended June 30, 2004, the Company recorded a $158 million charge for a cumulative effect of a change in accounting in accordance with SOP 03-1, which provides guidance on (i) the classification and valuation of long-duration contract liabilities; (ii) the accounting for sales inducements; and (iii) separate account presentation and valuation. INSTITUTIONAL The following table presents consolidated financial information for the Institutional segment for the periods indicated: THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 2004 2003 2004 2003 ------ ------ ------ ------ (DOLLARS IN MILLIONS) REVENUES Premiums $ 2,382 $ 2,334 $ 4,807 $ 4,470 Universal life and investment-type product policy fees 187 154 358 315 Net investment income 1,121 997 2,208 1,972 Other revenues 155 152 319 294 Net investment gains (losses) 32 1 142 (108) ------- ------- ------- ------- Total revenues 3,877 3,638 7,834 6,943 ------- ------- ------- ------- EXPENSES Policyholder benefits and claims 2,583 2,506 5,292 4,885 Interest credited to policyholder account balances 240 228 472 452 Policyholder dividends 38 54 45 93 Other expenses 440 456 891 892 ------- ------- ------- ------- Total expenses 3,301 3,244 6,700 6,322 ------- ------- ------- ------- Income from continuing operations before provision for income taxes 576 394 1,134 621 Provision for income taxes 200 140 390 220 ------- ------- ------- ------- Income from continuing operations 376 254 744 401 Income from discontinued operations, net of income taxes 1 -- 3 28 ------- ------- ------- ------- Income before cumulative effect of a change in accounting 377 254 747 429 Cumulative effect of a change in accounting, net of income taxes -- -- (60) -- ------- ------- ------- ------- Net income $ 377 $ 254 $ 687 $ 429 ======= ======= ======= ======= THREE MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2003 -- INSTITUTIONAL The Company's Institutional segment offers a broad range of group insurance and retirement and savings products and services to corporations and other institutions. Group insurance products are offered as either an employer-contributed benefit, or as a voluntary benefit with premiums paid by the employee. Retirement and savings products and services include an array of annuity and investment products, as well as bundled administrative and investment services sold to sponsors of small- and mid-sized 401(k) and other defined contribution plans. 43 Income from continuing operations increased by $122 million, or 48%, to $376 million for the three months ended June 30, 2004 from $254 million for the comparable 2003 period. Favorable interest spreads are estimated to contribute $70 million after-tax compared to the prior year period. In addition, the application of SOP 03-1 in the current period contributed $53 million after-tax to the decrease in policyholder liabilities as a result of the decline in the fair value of the assets associated with these contracts. A reduction in a premium tax liability of $31 million after-tax and an improvement of $20 million after-tax in net investment gains (losses) also contributed to the increase. These increases were partially offset by an estimated $41 million after-tax decrease in earnings, which management attributes to lower underwriting results in several products in the retirement and savings and the non-medical health and other businesses. Total revenues, excluding net investment gains (losses), increased by $208 million, or 6%, to $3,845 million for the three months ended June 30, 2004 from $3,637 million for the comparable 2003 period. This increase is due in part to a $124 million increase in net investment income, which is primarily due to higher income from growth in the asset base, corporate joint ventures and mortgage prepayments, partially offset by lower yields. This increase was a component of the favorable interest spreads discussed above. In addition, growth of $84 million in premiums, fees, and other revenues contributed to the revenue increase. Group life insurance business' premiums, fees and other revenues increased by $102 million, which management primarily attributes to continued strong sales and favorable persistency, as well as the late 2003 acquisition of the John Hancock group life insurance business, which contributed $26 million to the increase. A $105 million increase in premiums, fees and other revenue in the non-medical health and other business is primarily attributable to continued growth in dental of $39 million and disability of $18 million. In addition, long-term care grew $35 million compared to the prior year period, $9 million of which is related to the 2003 acquisition of TIAA/CREF's long-term care business. These increases in premiums, fees and other revenues were partially offset by a decline in the retirement and savings business of $123 million. This decrease is primarily attributable to an unusually high amount of structured settlement deposits in 2003. Premiums, fees and other revenues from retirement and savings products are significantly influenced by large transactions and as a result can fluctuate from period to period. Total expenses increased by $57 million, or 2%, to $3,301 million for the three months ended June 30, 2004 from $3,244 million for the comparable 2003 period. Policyholder related expenses increased $73 million. An increase of $48 million is commensurate with the aforementioned revenue growth. Less favorable mortality and morbidity results in several products in the retirement and savings and non-medical health and other business contributed an estimated $64 million compared to the prior year period. In addition, the acquisition of certain businesses from John Hancock and TIAA/CREF contributed $32 million and $11 million, respectively. These increases are partially offset by the aforementioned $82 million pre-tax decrease in policyholder liabilities resulting from the change in reserve valuation from the application of SOP 03-1. Other operating expenses decreased $16 million, which is primarily due to a reduction of a premium tax liability of $49 million, partially offset by a $33 million increase due primarily to growth in the business. SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2003 - -- INSTITUTIONAL Income from continuing operations increased by $343 million, or 86%, to $744 million for the six months ended June 30, 2004 from $401 million for the comparable 2003 period. Net investment gains increased by $159 million after-tax compared to the prior year period. Favorable interest spreads are estimated to contribute $140 million after-tax compared to the prior year period. In addition, the application of SOP 03-1 in the current period contributed $42 million after-tax to the decrease in policyholder liabilities as a result of the decline in the fair value of the assets associated with these contracts. A reduction in a premium tax liability of $31 million after-tax also contributed to the increase compared to the prior year period. These increases were partially offset by lower underwriting results in the group life insurance and non-medical health and other segments, which management estimates decreased approximately $34 million after-tax compared to the prior year period. Total revenues, excluding net investment gains (losses), increased by $641 million, or 9%, to $7,692 million for the six months ended June 30, 2004 from $7,051 million for the comparable 2003 period. This increase is due in part to a $236 million increase in net investment income, which is primarily due to higher income from growth in the asset base, corporate joint ventures and mortgage prepayments, partially offset by lower yields. This increase was a component of the favorable interest spreads discussed above. In addition, growth of $405 million in premiums, fees and other revenues contributed to the increase. Group life insurance business' premiums, fees and other revenues increased by $234 million, which management primarily attributes to continued strong sales and favorable persistency, as well as the late 2003 acquisition of the John Hancock group life insurance business, which contributed $50 million to the increase. A $191 million increase in premiums, fees and other revenue in the non-medical health and other business is primarily attributable to continued growth in dental of $80 million and disability of $28 million. In addition, long-term care grew $56 million compared to the prior year period, $9 million of which is related to the acquisition of TIAA/CREF's long-term care business. These increases in premiums, fees and other revenues were partially offset by a decline in the retirement and savings business of $20 million. Premiums, fees and other revenues 44 from retirement and savings products are significantly influenced by large transactions and as a result can fluctuate from period to period Total expenses increased by $378 million, or 6%, to $6,700 million for the six months ended June 30, 2004 from $6,322 million for the comparable 2003 period. Policyholder related expenses increased $379 million. An increase of $330 million is commensurate with the aforementioned revenue growth. Less favorable mortality and morbidity results primarily in the group life insurance and non-medical health and other business contributed an estimated $54 million compared to the prior year period. In addition, the acquisition of certain businesses from John Hancock and TIAA/CREF contributed $49 million and $11 million, respectively. These increases are partially offset by the aforementioned $65 million pre-tax reserve valuations resulting from the application of SOP 03-1. Other operating expenses decreased $1 million, primarily due to 2004 including a reduction in a premium tax related liability of $49 million pre-tax. This decrease is offset by growth in operating expenses related to the direct business support expenses primarily related to business growth. INDIVIDUAL The following table presents consolidated financial information for the Individual segment for the periods indicated: THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------- -------------------- 2004 2003 2004 2003 -------- -------- -------- -------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 1,007 $ 1,055 $ 1,985 $ 2,096 Universal life and investment-type product policy fees 455 378 877 738 Net investment income 1,543 1,532 3,058 3,087 Other revenues 106 109 223 195 Net investment gains (losses) 35 (22) 12 (123) ------- ------- ------- ------- Total revenues 3,146 3,052 6,155 5,993 ------- ------- ------- ------- EXPENSES Policyholder benefits and claims 1,261 1,191 2,447 2,415 Interest credited to policyholder account balances 427 452 850 895 Policyholder dividends 413 439 831 879 Other expenses 704 755 1,406 1,413 ------- ------- ------- ------- Total expenses 2,805 2,837 5,534 5,602 ------- ------- ------- ------- Income from continuing operations before provision for income taxes 341 215 621 391 Provision for income taxes 104 76 199 138 ------- ------- ------- ------- Income from continuing operations 237 139 422 253 Income from discontinued operations, net of income taxes 2 5 3 32 ------- ------- ------- ------- Income before cumulative effect of a change in accounting 239 144 425 285 Cumulative effect of a change in accounting, net of income taxes -- -- (70) -- ------- ------- ------- ------- Net income $ 239 $ 144 $ 355 $ 285 ======= ======= ======= ======= THREE MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2003 -- INDIVIDUAL MetLife's Individual segment offers a wide variety of protection and asset accumulation products aimed at serving the financial needs of its customers throughout their entire life cycle. Products offered by Individual include insurance products, such as traditional, universal and variable life insurance and variable and fixed annuities. In addition, Individual sales representatives distribute disability insurance and long-term care insurance products offered through the Institutional segment, investment products, such as mutual funds, and other products offered by the Company's other businesses. Income from continuing operations increased by $98 million, or 71%, to $237 million for the three months ended June 30, 2004 from $139 million for the comparable 2003 period. This increase period over period is largely attributable to increased fee income of $50 million. Higher net investment income of $7 million and lower interest credited of $16 million to policyholder account balances, resulted in higher spreads. In addition, lower operating expenses contributed $33 million to the year over year increase, which is primarily driven by charges recorded in the prior year period and a decline in the policyholder dividend expense of $17 million compared to the prior year period. Partially offsetting the increase to income from continuing operations, were higher policyholder benefits of $45 million which management primarily attributes to an increase in the closed block related policyholder dividend obligation and favorable mortality in the prior year. 45 Total revenues, excluding net investment gains (losses), increased by $37 million, or 1%, to $3,111 million for the three months ended June 30, 2004 from $3,074 million for the comparable 2003 period. Higher fee income of $77 million is largely attributable to a $67 million increase in fees from separate accounts. Management attributes the increase in separate account asset balances to higher sales of variable annuities and overall positive market performance. Net investment income increased $11 million primarily due to higher income from corporate joint ventures, mortgage prepayments and growth in the asset base offset by lower yields. This increase was a component of the favorable interest spreads discussed above. Partially offsetting the increase in revenues are lower premiums associated with the Company's closed block of business of $49 million, which continues to run off at management's expected range of 3% to 6% per year. Total expenses decreased by $32 million, or 1%, to $2,805 million for the three months ended June 30, 2004 from $2,837 million for the comparable 2003 period. The decrease is primarily attributable to a $25 million decline in interest credited to policyholder account balances primarily due to lower crediting rates and a $26 million decline in policyholder dividends, which is largely due to the reductions in the dividend scale in late 2003. In addition, the prior period includes a charge related to certain improperly deferred expenses at New England Financial of $48 million and expenses associated with office consolidations and fixed asset write-offs of $18 million. Partially offsetting the decreases in expenses are higher policyholder benefits of $70 million, which includes a $39 million increase in the closed block related policyholder dividend obligation and an increase of $31 million, which management attributes to better than expected mortality in the prior year period. SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2003 - -- INDIVIDUAL Income from continuing operations increased by $169 million, or 67%, to $422 million for the six months ended June 31, 2004 from $253 million for the comparable 2003 period. This increase period over period is largely attributable to increased fee income of $90 million. Lower interest credited of $29 million to policyholder account balances partially offset by lower net investment income of $19 million resulted in higher spreads. In addition, a decline in the policyholder dividend expense of $31 million and lower operating expenses contributed $5 million to the year over year increase, which is primarily driven by charges recorded in the prior year period. Partially offsetting the increase to income from continuing operations were higher policyholder benefits of $21 million which management attributes primarily to favorable mortality in the prior year. Total revenues, excluding net investment gains (losses), increased by $27 million, or 1%, to $6,143 million for the six months ended June 30, 2004 from $6,116 million for the comparable 2003 period. Higher fee income of $139 million is largely attributable to a $138 million increase in fees earned on separate accounts. Management attributes the increase in separate account asset balances to higher sales of variable annuities and overall positive market performance. Partially offsetting the increase in revenues are lower premiums associated with the Company's closed block of business of $100 million, which continues to run off at the expected range of 3% to 6% per year. In addition, net investment income decreased by $29 million due to lower yields partially offset by growth in the asset base and higher income from corporate joint ventures, and mortgage prepayments. Total expenses decreased by $68 million, or 1%, to $5,534 million for the six months ended June 30, 2004 from $5,602 million for the comparable 2003 period. This decrease is primarily attributed to a $45 million decline in interest credited to policyholder account balances largely due to lower crediting rates and a $48 million decline in policyholder dividends, which is primarily due to the reductions in the dividend scale in late 2003. In addition, the prior period included a charge related to certain improperly deferred expenses at New England Financial of $48 million. Partially offsetting the decrease in expenses is a $40 million increase in the closed block related policyholder dividend obligation. In addition, expenses increased $21 million over the prior year period as a result of an acceleration of DAC amortization associated with an increase in net investment gains (losses). 46 AUTO & HOME The following table presents consolidated financial information for the Auto & Home segment for the periods indicated: THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------ ------------------------ 2004 2003 2004 2003 ------- ------- ------- ------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 734 $ 721 $ 1,471 $ 1,433 Net investment income 44 41 90 80 Other revenues 6 4 15 13 Net investment gains (losses) (5) (2) (5) (6) ------- ------- ------- ------- Total revenues 779 764 1,571 1,520 ------- ------- ------- ------- EXPENSES Policyholder benefits and claims 495 527 1,031 1,061 Policyholder dividends -- -- -- -- Other expenses 193 186 391 385 ------- ------- ------- ------- Total expenses 688 713 1,422 1,446 ------- ------- ------- ------- Income before provision (benefit) for income taxes 91 51 149 74 Provision (benefit) for income taxes 23 10 35 6 ------- ------- ------- ------- Net income $ 68 $ 41 $ 114 $ 68 ======= ======= ======= ======= THREE MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2003 -- AUTO & HOME Auto & Home, operating through Metropolitan Property and Casualty Insurance Company, and its subsidiaries, offers personal lines property and casualty insurance directly to employees at the workplace, as well as through a variety of retail distribution channels. Auto & Home primarily sells auto insurance and homeowners insurance. Net income increased by $27 million, or 66%, to $68 million for the three months ended June 30, 2004 from $41 million for the comparable 2003 period. This increase is primarily attributable to a $26 million after-tax contribution from a lower combined ratio, which was driven by improved automobile and homeowners claim frequencies and $7 million after-tax from less adverse claim development related to prior years, partially offset by $9 million after-tax from increased catastrophes. Total revenues, excluding net investment gains (losses), increased by $18 million, or 2%, to $784 million for the three months ended June 30, 2004 from $766 million for the comparable 2003 period. This variance is primarily due to a $13 million increase in premiums, which are primarily attributable to an increase in the average earned premium from continued rate increases. In addition, a $3 million increase in net investment income is largely due to growth in the underlying asset base. Total expenses decreased by $25 million, or 4%, to $688 million for the three months ended June 30, 2004 from $713 million for the comparable 2003 period. This decrease is largely the result of a decline in policyholder benefits and claims resulting from improved automobile and homeowners claim frequencies and less adverse claims development related to prior accident years. Together, these items contributed $50 million to the decline in expenses. These decreases are partially offset by increases in catastrophes of $13 million and an increase in other expenses due to higher agent and employee related expenses of $3 million and $4 million, respectively. The combined ratio excluding catastrophes declined to 88.1% for the three months ended June 30, 2004 versus 95.6 % for the comparable 2003 period. SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2003 - -- AUTO & HOME Net income increased by $46 million, or 68%, to $114 million for the six months ended June 30, 2004 from $68 million for the comparable 2003 period. This increase is primarily attributable to less adverse claim development related to prior accident years of $31 million, after-tax. In addition, a $20 million after-tax contribution resulted from a lower combined ratio, which was driven by improved automobile and homeowner claim frequencies, and higher investment income. Total revenues, excluding net investment gains (losses), increased by $50 million, or 3%, to $1,576 million for the six months ended June 30, 2004 from $1,526 million for the comparable 2003 period. This variance is primarily due to a $38 million increase in 47 premiums, which are largely attributable to an increase in the average earned premium from continued rate increases. In addition, a $10 million increase in net investment income is largely due to growth in the underlying asset base. Total expenses decreased by $24 million, or 2%, to $1,422 for the six months ended June 30, 2004 from $1,446 million for the comparable 2003 period. This decrease is the result of an improvement in policyholder benefits and claims due to a $48 million improvement in adverse prior year claim development, as well as an improved combined ratio primarily due to lower non-catastrophe automobile and homeowners claim frequencies of $31 million. This is partially offset by an increase due to growth in the business of $37 million and higher catastrophes of $18 million. The combined ratio excluding catastrophes declined to 92.4% for the six months ended June 30, 2004 from 98.4 % for the comparable 2003 period. INTERNATIONAL The following table presents consolidated financial information for the International segment for the periods indicated: THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------- ------------------------ 2004 2003 2004 2003 ------- ------- ------- -------- (DOLLARS IN MILLIONS) REVENUES Premiums $ 405 $ 390 $ 817 $ 785 Universal life and investment-type product policy fees 86 71 169 122 Net investment income 137 131 260 254 Other revenues 8 26 12 34 Net investment gains (losses) (3) (1) 23 (1) ------- ------- ------- ------- Total revenues 633 617 1,281 1,194 ------- ------- ------- ------- EXPENSES Policyholder benefits and claims 348 286 721 644 Interest credited to policyholder account balances 32 36 69 73 Policyholder dividends 15 8 27 27 Other expenses 137 195 269 316 ------- ------- ------- ------- Total expenses 532 525 1,086 1,060 ------- ------- ------- ------- Income from continuing operations before provision for income taxes 101 92 195 134 Provision for income taxes 31 (6) 59 8 ------- ------- ------- ------- Income from continuing operations 70 98 136 126 Cumulative effect of a change in accounting, net of income taxes -- -- (30) -- ------- ------- ------- ------- Net income $ 70 $ 98 $ 106 $ 126 ======= ======= ======= ======= THREE MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2003 -- INTERNATIONAL International provides life insurance, accident and health insurance, annuities and savings and retirement products to both individuals and groups. The Company focuses on emerging markets in the Latin America and Asia/Pacific regions. Income from continuing operations decreased by $28 million, or 29%, to $70 million for the three months ended June 30, 2004 from $98 million for the comparable 2003 period. The prior year period includes a $62 million after-tax benefit from both the merger of the Mexican operations and a reduction in policyholder liabilities resulting from a change in reserve methodology. Excluding these items, net income increased by $34 million. The most significant component of this increase is attributable to the application of SOP 03-1 in the current period, which resulted in a $32 million after-tax decrease in policyholder liabilities in Mexico as a result of the decline in the fair value of the assets associated with these contracts. In addition, South Korea's results include approximately $8 million of certain tax-related benefits. Total revenues, excluding net investment gains (losses), increased by $18 million, or 3%, to $636 million for the three months ended June 30, 2004 from $618 million for the comparable 2003 period. The sale of the Spanish operation reduced revenues by $52 million over the year ago period. Excluding this event, revenues increased by $70 million, or 12%, of which $9 million, or 13%, was due to foreign currency exchange rates. South Korea's, Mexico's and Chile's revenues increased by $27 million, $16 million and $14 million, respectively, primarily due to growth in the business as well higher net investment income. 48 Total expenses increased by $7 million, or 1%, to $532 million for the three months ended June 30, 2004 from $525 million for the comparable 2003 period. The sale of the Spanish operation reduced expenses by $47 million over the year ago period. Excluding this event, expenses increased by $54 million, or 11%, of which $5 million, or 8%, was due to foreign currency exchange rates. The prior 2003 period includes a $79 million reduction in Mexico's policyholder liabilities resulting from a change in reserve methodology, partially offset by a related increase of $45 million in amortization of value of business acquired. Other than this reduction, Mexico's expenses increased by $10 million in line with the revenue growth outlined above. Chile's expenses also increased by $16 million primarily in line with the revenue growth outlined above. South Korea's expenses increased by $24 million, net of a partial offset of a $6 million reduction to a tax-related liability. The remainder of the increase in total expenses is primarily related to the ongoing investment in International's infrastructure. Partially offsetting these increases is the aforementioned $50 million decrease in policyholder liabilities resulting from the application of SOP 03-1. SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2003 - -- INTERNATIONAL Income from continuing operations increased by $10 million, or 8%, to $136 million for the six months ended June 30, 2004 from $126 million for the comparable 2003 period. The prior year period includes a $62 million after-tax benefit from both the merger of the Mexican operations and a reduction in policyholder liabilities resulting from a change in reserve methodology. Excluding these items, income from continuing operations increased by $72 million. The most significant component of this increase is attributable to the application of SOP 03-1 in the current period, which resulted in a $34 million after-tax decrease in policyholder liabilities in Mexico as a result of the decline in the fair value of the assets associated with these contracts. The increase of $24 million in net investment gains (losses) is primarily due to the gain on the sale of the Spanish operations. In addition, South Korea's results include approximately $8 million of certain tax-related benefits. Total revenues, excluding net investment gains (losses), increased by $63 million, or 5%, to $1,258 million for the six months ended June 30, 2004 from $1,195 million for the comparable 2003 period. The sale of the Spanish operation reduced revenues by $103 million over the year ago period. Excluding this, revenues increased by $166 million, or 15% of which $7 million, or 4%, was due to foreign currency exchange rates. South Korea's, Mexico's, Chile's and Taiwan's revenues increased by $49 million, $47 million, $33 million, and $16 million, respectively, primarily due to planned growth in the business, as well as better investment earnings. Total expenses increased by $26 million, or 2%, to $1,086 million for the six months ended June 30, 2004 from $1,060 million for the comparable 2003 period. The sale of the Spanish operation reduced expenses by $97 million over the year ago period. Excluding this, expenses increased by $123 million, or 13%, of which $9 million, or 7%, was due to foreign currency exchange rates. The prior 2003 period includes a $79 million reduction in Mexico's policyholder liabilities resulting from a change in reserve methodology, partially offset by a related increase of $45 million in amortization of value of business acquired. Other than this reduction, Mexico's expenses increased by $22 million in line with the revenue growth outlined above. Chile and Taiwan's expenses increased by $35 million and $17 million, respectively, primarily in line with the revenue growth outlined above. South Korea's expenses increased by $43 million, net of a partial offset of a $6 million reduction to a tax-related liability. The remainder of the increase in total expenses is primarily related to the ongoing investment in International's infrastructure. Partially offsetting these increases is the aforementioned $53 million decrease in policyholder liabilities resulting from the application of SOP 03-1. 49 REINSURANCE The following table presents consolidated financial information for the Reinsurance segment for the periods indicated: THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ------------------- ------------------- 2004 2003 2004 2003 ------ ------ ------ ------ (DOLLARS IN MILLIONS) REVENUES Premiums $ 807 $ 588 $1,623 $1,140 Net investment income 136 121 266 231 Other revenues 15 12 27 24 Net investment gains (losses) 31 5 52 1 ------ ------ ------ ------ Total revenues 989 726 1,968 1,396 ------ ------ ------ ------ EXPENSES Policyholder benefits and claims 646 460 1,300 888 Interest credited to policyholder account balances 52 45 103 88 Policyholder dividends 5 6 10 11 Other expenses 240 182 473 346 ------ ------ ------ ------ Total expenses 943 693 1,886 1,333 ------ ------ ------ ------ Income before provision for income taxes 46 33 82 63 Provision for income taxes 16 11 28 21 ------ ------ ------ ------ Income from continuing operations 30 22 54 42 Cumulative effect of a change in accounting, net of income taxes -- -- 3 -- ------ ------ ------ ------ Net income $ 30 $ 22 $ 57 $ 42 ====== ====== ====== ====== THREE MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2003 -- REINSURANCE MetLife's Reinsurance segment is comprised of the life reinsurance business of Reinsurance Group of America, Incorporated ("RGA"), a publicly traded company, and MetLife's ancillary life reinsurance business. RGA has operations in North America and has subsidiary companies, branch offices, or representative offices in Australia, Barbados, Hong Kong, India, Ireland, Japan, Mexico, South Africa, South Korea, Spain, Taiwan and the United Kingdom. Income from continuing operations increased by $8 million, or 36%, to $30 million for the three months ended June 30, 2004 from $22 million for the comparable 2003 period. This increase is primarily attributable to a $17 million after-tax increase in net investment gains, offset in part by a $13 million after-tax increase in other expenses on the related change in deferred acquisition and minority interest costs. Operations from RGA provided an additional $10 million in net income, but are almost entirely offset by an increase in minority interest expense as MetLife's ownership in RGA fell from 59% to 52% in the comparable periods. Operations from MetLife's ancillary life reinsurance business provided an additional $3 million in net income. Total revenues, excluding net investment gains (losses), increased by $237 million, or 33%, to $958 million for the three months ended June 30, 2004 from $721 million for the comparable 2003 period. Approximately $129 million of the increase during the second quarter of 2004 was a result of RGA's coinsurance agreement with Allianz Life under which RGA assumed 100% of Allianz Life's U.S. traditional life reinsurance business. This transaction closed during the fourth quarter of 2003 and was effective retroactive to July 1, 2003. The balance of the increase in total revenues relates to new premiums from facultative and automatic treaties and renewal premiums on existing blocks of business in the U.S. and certain international operations. Premium levels are significantly influenced by large transactions, such as the Allianz Life transaction, and reporting practices of ceding companies and, as a result, can fluctuate from period to period. Total expenses increased by $250 million, or 36%, to $943 million for the three months ended June 30, 2004 from $693 million for the comparable 2003 period. This increase is primarily attributable to an increase of $186 million in policyholder benefits and claims associated with RGA's growth in insurance in force, including the Allianz Life transaction. Additionally, other expenses increased primarily due to higher allowances paid on assumed reinsurance of $27 million associated with RGA's growth in insurance in force and the aforementioned increase in minority interest expense of $22 million. In addition, expenses increased $13 million over the prior year period as a result of an acceleration of DAC amortization associated with an increase in net investment gains (losses). 50 SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2003 - - REINSURANCE Income from continuing operations increased $12 million, or 29%, to $54 million for the six months ended June 30, 2004 from $42 million for the comparable 2003 period. This increase was primarily attributable to a $32 million increase in after-tax net investment gains, offset in part by a $23 million after-tax increase in other expenses on the related change in deferred acquisition and minority interest costs. Additionally, operations from RGA provided an increase of $21 million in net income, but were offset by $18 million after-tax in higher minority interest expense as MetLife's ownership in RGA fell from 59% to 52% in the comparable periods. Operations from MetLife's ancillary life reinsurance business decreased net income by $1 million in the comparable periods. Total revenues, excluding net investment gains (losses), increased by $521 million, or 37%, to $1,916 million for the six months ended June 30, 2004 from $1,395 million for the comparable 2003 period. Approximately $258 million of the increase during the six months ended June 30, 2004 was the result of the coinsurance agreement with Allianz Life. The balance of the increase in total revenues relates to new premiums from facultative and automatic treaties and renewal premiums on existing blocks of business in the U.S. and certain international operations. Premium levels are significantly influenced by large transactions, such as the Allianz Life transaction, and reporting practices of ceding companies and, as a result, can fluctuate from period to period. Total expenses increased by $553 million, or 41%, to $1,886 million for the six months ended June 30, 2004 from $1,333 million for the comparable 2003 period. This increase was primarily attributable to an increase of $412 million in policyholder benefits and claims associated with RGA's growth in insurance in force, including the Allianz Life transaction. Additionally, other expenses increased primarily due to higher allowances paid on assumed reinsurance of $60 million associated with RGA's growth in insurance in force and the aforementioned increase in pre-tax minority interest expense of $46 million. In addition, expenses increased $17 million over the prior year period as a result of an acceleration of DAC amortization associated with an increase in net investment gains (losses). ASSET MANAGEMENT The following table presents consolidated financial information for the Asset Management segment for the periods indicated: THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ---------------- ---------------- 2004 2003 2004 2003 ---- ---- ---- ---- (DOLLARS IN MILLIONS) REVENUES Net investment income $ 18 $ 16 $ 36 $ 32 Other revenues 73 37 113 66 Net investment gains (losses) -- -- -- 8 ---- ---- ---- ---- Total revenues 91 53 149 106 ---- ---- ---- ---- OTHER EXPENSES 65 44 114 87 ---- ---- ---- ---- Income before provision for income taxes 26 9 35 19 Provision for income taxes 10 4 14 8 ---- ---- ---- ---- Net income $ 16 $ 5 $ 21 $ 11 ==== ==== ==== ==== THREE MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2003 -- ASSET MANAGEMENT Asset Management, through SSRM Holdings, Inc. ("State Street Research"), provides a broad variety of asset management products and services to MetLife, third-party institutions and individuals. State Street Research offers investment management services in all major investment disciplines through multiple channels of distribution in both the retail and institutional marketplaces. Net income increased by $11 million, or 220%, to $16 million for the three months ended June 30, 2004 from $5 million for the comparable 2003 period. This increase is primarily due to higher performance fees earned, as well as revenue earned on higher average assets under management. This was partially offset by expense increases resulting from compensation related to the performance fees and higher average assets under management. Total revenues, excluding net investment gains (losses), increased by $38 million, or 72%, to $91 million for the three months ended June 30, 2004 from $53 million for the comparable 2003 period. The increase is primarily the result of $25 million in higher performance fees earned on certain hedge products and real estate investments. Excluding the performance fees, total revenue increased $13 million as a result of higher fees earned on higher average assets under management. Assets under management 51 increased 12% to $51.7 billion as of June 30, 2004, from $46.1 billion as of June 30, 2003, and is primarily attributable to positive net sales and market appreciation from strong equity market performance. Other expenses increased by $21 million, or 48%, to $65 million for the three months ended June 30, 2004 from $44 million for the comparable 2003 period. Compensation and benefits increased $17 million, of which $10 million are commensurate with the revenue earned from the performance fees and the remaining $7 million variance being primarily attributable to higher salaries and compensation-related expenses. Higher average mutual fund assets under management resulted in an increase of approximately $5 million in promoting and servicing expenses. SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2003 - -- ASSET MANAGEMENT Net income increased $10 million, or 91%, to $21 million for the six months ended June 30, 2004 from $11 million for the comparable 2003 period. This increase is primarily due to higher revenue earned on higher average assets under management, as well as higher performance fees earned in the second quarter of 2004. These increases are partially offset by a regulatory settlement and associated legal costs, in addition to expense increases resulting from higher average assets under management. Total revenues, excluding net investment gains (losses), increased by $51 million, or 52%, to $149 million for the six months ended June 30, 2004 from $98 million for the comparable 2003 period. This increase is primarily the result of $25 million in higher performance fees earned on certain hedge products and real estate investments in the second quarter. Excluding performance fees, total revenues increased $26 million as a result of an increase in fees earned on higher average assets under management. Other expenses increased by $27 million, or 31%, to $114 million for the six months ended June 30, 2004 from $87 million for the comparable 2003 period. The increase is primarily attributable to an increase in compensation related expenses of approximately $17 million of which approximately $10 million related to the performance fees and the remainder of the variance is primarily attributable to a $7 million increase in salaries and compensation-related expenses. Higher average assets under management also contributed to higher promoting and servicing expenses of approximately $8 million. The increase is also attributable to a regulatory settlement and associated legal costs incurred in the first quarter of 2004 of approximately $4 million. 52 CORPORATE & OTHER The following table presents consolidated financial information for Corporate & Other for the periods indicated: THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ------------------ ---------------- 2004 2003 2004 2003 ----- ----- ----- ----- (DOLLARS IN MILLIONS) REVENUES Premiums $ (4) $ (5) $ (5) $ (9) Net investment income 118 26 174 81 Other revenues (7) 15 -- 27 Net investment gains (losses) (43) (23) (61) (65) ----- ----- ----- ----- Total revenues 64 13 108 34 ----- ----- ----- ----- EXPENSES Policyholder benefits and claims 2 -- 4 2 Other expenses 137 23 253 141 ----- ----- ----- ----- Total expenses 139 23 257 143 ----- ----- ----- ----- Income (loss) from continuing operations before income tax benefit (75) (10) (149) (109) Income tax benefit (130) (23) (168) (74) ----- ----- ----- ----- Income (loss) from continuing operations 55 13 19 (35) Income from discontinued operations, net of income taxes 92 3 112 16 ----- ----- ----- ----- Income (loss) before cumulative effect of change in accounting 147 16 131 (19) Cumulative effect of a change in accounting, net of income taxes -- -- (1) -- ----- ----- ----- ----- Net income (loss) $ 147 $ 16 $ 130 $ (19) ===== ===== ===== ===== THREE MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2003 -- CORPORATE & OTHER Corporate & Other contains the excess capital not allocated to the business segments, as well as expenses associated with the resolution of certain legal proceedings, and interest expense related to the majority of the Company's outstanding debt. Income from continuing operations improved by $42 million, or 323%, to $55 million for the three months ended June 30, 2004 from $13 million for the comparable 2003 period. The 2004 period includes a $105 million benefit, net of income tax, associated with the resolution of all issues relating to the Internal Revenue Service's audit of Metropolitan Life's and its subsidiaries' tax returns for the years 1997-1999. Also included in the 2004 period is a $32 million after-tax contribution to the MetLife Foundation. The 2003 period includes a $64 million after-tax benefit from a reduction of a previously established liability related to the Company's race-conscious underwriting settlement. Excluding the impact of these items, income from continuing operations increased by $33 million. The increase in earnings over the prior year period is mainly due to $58 million of higher after-tax investment income, partially offset by $13 million of after-tax net investment gains (losses). Total revenues, excluding net investment gains (losses), increased by $71 million, or 197%, to $107 million for the three months ended June 30, 2004 from $36 million for the comparable 2003 period. This variance is mainly due to $107 million of higher investment income resulting from increases in income from long-term bonds, and real estate and corporate joint ventures. This increase is partially offset by an increase of $15 million in interest paid on allocated capital and a decrease of $15 million in the elimination of underlying affiliated activity. Total expenses increased by $116 million, or 504%, to $139 million for the three months ended June 30, 2004 from $23 million for the comparable 2003 period. The 2004 period includes a $50 million contribution to the MetLife Foundation, partially offset by a reduction of a liability of $22 million of interest associated with the resolution of all issues relating to the Internal Revenue Service's audit of Metropolitan Life's and its subsidiaries' tax returns for the years 1997-1999. The 2003 period includes a $100 million benefit from a reduction of a previously established liability associated with the Company's race-conscious underwriting settlement. This is partially offset by a decrease of $15 million in the elimination of underlying affiliated activity. 53 SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2003 - -- CORPORATE & OTHER Income (loss) from continuing operations improved by $54 million, or 154%, to $19 million for the six months ended June 30, 2004 from ($35) million for the comparable 2003 period. The 2004 period includes a $105 million benefit, net of income tax, associated with the resolution of all issues relating to the Internal Revenue Service's audit of Metropolitan Life's and its subsidiaries' tax returns for the years 1997-1999. Also included in the 2004 period is a $32 million after-tax contribution to the MetLife Foundation. The 2003 period includes a $64 million after-tax benefit from a reduction of a previously established liability related to the Company's race-conscious underwriting settlement. Excluding the impact of these items, income from continuing operations increased by $45 million. The increase in earnings over the prior period is mainly due to $59 million of higher after-tax investment income. Total revenues, excluding net investment gains (losses), increased by $70 million, or 71%, to $169 million for the six months ended June 30, 2004 from $99 million for the comparable 2003 period. This variance is mainly due to $123 million of higher investment income resulting from increases in income from long-term bonds, and real estate and corporate joint ventures. This increase is partially offset by an increase of $30 million in interest paid on allocated capital and a decrease of $22 million in the elimination of underlying affiliated activity. Total expenses increased by $114 million, or 80%, to $257 million for the six months ended June 30, 2004 from $143 million for the comparable 2003 period. The 2004 period includes a $50 million contribution to the MetLife Foundation, partially offset by a reduction of a liability of $22 million of interest associated with the resolution of all issues relating to the Internal Revenue Service's audit of Metropolitan Life's and its subsidiaries' tax returns for the years 1997-1999. The 2003 period includes a $100 million benefit from a reduction of a previously established liability associated with the Company's race-conscious underwriting settlement. This is partially offset by a decrease of $22 million in the elimination of underlying affiliated activity. LIQUIDITY AND CAPITAL RESOURCES THE HOLDING COMPANY CAPITAL Restrictions and Limitations on Bank Holding Companies and Financial Holding Companies -- Capital. MetLife, Inc. and its insured depository institution subsidiary, MetLife Bank, N.A. ("MetLife Bank"), a national bank, are subject to risk-based and leverage capital 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 June 30, 2004, MetLife, Inc. and MetLife Bank were in compliance with the aforementioned guidelines. LIQUIDITY Liquidity refers to a company's ability to generate adequate amounts of cash to meet its needs. It is managed to preserve stable, reliable and cost-effective sources of cash to meet all current and future financial obligations and is provided by a variety of sources, including a portfolio of liquid assets, a diversified mix of short and long-term funding sources from the wholesale financial markets and the ability to borrow through committed credit facilities. The Holding Company is an active participant in the global financial markets through which it obtains a significant amount of funding. These markets, which serve as cost-effective sources of funds, are critical components of the Holding Company's liquidity management. Decisions to access these markets are based upon relative costs, prospective views of balance sheet growth and a targeted liquidity profile. A disruption in the financial markets could limit the Holding Company's access to liquidity. The Holding Company's ability to maintain regular access to competitively priced wholesale funds is fostered by its current debt ratings from the major credit rating agencies. Management views its capital ratios, credit quality, stable and diverse earnings streams, diversity of liquidity sources and its liquidity monitoring procedures as critical to retaining high credit ratings. Liquidity is monitored through the use of internal liquidity risk metrics, including the composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, access to the financial markets for capital and debt transactions and exposure to contingent draws on the Holding Company's liquidity. 54 LIQUIDITY SOURCES Dividends. The primary source of the Holding Company's liquidity is dividends it receives from Metropolitan Life. Under the New York Insurance Law, Metropolitan Life is permitted, without prior insurance regulatory clearance, to pay a cash 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 statutory surplus 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 cash 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 (the "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 Holding 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. In addition, the Holding Company receives dividends from its other subsidiaries. The Holding Company's other insurance subsidiaries are also subject to similar restrictions on the payment of dividends to their respective parent companies. The dividend limitation is based on statutory financial results. Statutory accounting practices, as prescribed by insurance regulators of various states in which the Company conducts business, differ in certain respects from accounting principles used in financial statements prepared in conformity with GAAP. The significant differences relate to the treatment of DAC, certain deferred income taxes, required investment reserves, reserve calculation assumptions, goodwill and surplus notes. Liquid Assets. An integral part of the Holding Company's liquidity management is the amount of liquid assets that it holds. Liquid assets include cash, cash equivalents, short-term investments and marketable fixed maturity and equity securities. Liquid assets exclude assets relating to securities lending and dollar roll activities. At June 30, 2004 and December 31, 2003, the Holding Company had $1,376 million and $1,320 million in liquid assets, respectively. Global Funding Sources. Liquidity is also provided by a variety of both short and long-term instruments, including repurchase agreements, commercial paper, medium and long-term debt, capital securities and stockholders' equity. The diversification of the Holding Company's funding sources enhances funding flexibility and limits dependence on any one source of funds, and generally lowers the cost of funds. At June 30, 2004, the Holding Company had no short-term debt outstanding as compared to $106 million at December 31, 2003. At June 30, 2004 and December 31, 2003, the Holding Company had $4.5 billion and $4.0 billion in long-term debt outstanding, respectively. As of July 23, 2004, the Holding Company has issued an aggregate principal amount of senior debt of $1.1 billion under the $5.0 billion shelf registration statement filed with the U.S. Securities and Exchange Commission ("SEC") during the first quarter of 2004. The shelf registration will permit the registration and issuance of a wide range of debt and equity securities. Approximately $44 million of registered but unissued securities remaining from the Company's 2001 $4.0 billion shelf registration statement was carried over to this shelf registration. The Holding Company issued and remarketed senior debt in the aggregate principal amount of $3.96 billion under the 2001 $4.0 billion shelf registration statement. Under this shelf registration statement, the Holding Company remarketed $1,006 million aggregate principal amount of debentures previously issued in connection with the issuance of equity security units in February of 2003. 55 The following table summarizes the Holding Company's senior debt issuances: ISSUE DATE PRINCIPAL INTEREST RATE MATURITY ---------- --------- ------------- -------- (DOLLARS IN MILLIONS) June 2004 (1) $350 5.50% 2014 June 2004 (1) $750 6.38% 2034 November 2003 $500 5.00% 2013 November 2003 $200 5.88% 2033 December 2002 $400 5.38% 2012 December 2002 $600 6.50% 2032 November 2001 $500 5.25% 2006 November 2001 $750 6.13% 2011 - ---------- (1) On July 23, 2004, the Holding Company reopened its June 3, 2004 senior notes offering and increased the principal outstanding on the 5.50% notes due June 2014, from $200 million to $350 million and on the 6.38% notes due June 2034, from $400 million to $750 million. Other sources of the Holding Company's liquidity include programs for short and long-term borrowing, as needed, arranged through Metropolitan Life. Credit Facilities. The Holding Company maintains committed and unsecured credit facilities aggregating $2.5 billion ($1 billion expiring in 2005 and $1.5 billion expiring in 2009) which it shares with Metropolitan Life and MetLife Funding, Inc. ("MetLife Funding"). Drawdowns under these facilities bear interest at varying rates stated in the agreements. These facilities are primarily used for general corporate purposes and as back-up lines of credit for the borrowers' commercial paper programs. At June 30, 2004, neither the Holding Company, Metropolitan Life nor MetLife Funding had drawn against these credit facilities. LIQUIDITY USES The primary uses of liquidity of the Holding Company include cash dividends on common stock, service on debt, capital contributions to subsidiaries, payment of general operating expenses and the repurchase of the Holding Company's common stock. Dividends. On October 21, 2003, the Holding Company's Board of Directors approved an annual dividend for 2003 of $0.23 per share. The dividend was paid on December 15, 2003 to shareholders of record on November 7, 2003. The 2003 dividend represents an increase of $0.02 per share from the 2002 annual dividend of $0.21 per share. Future dividend decisions will be determined by the Holding Company's Board of Directors after taking into consideration factors such as the Holding Company's current earnings, expected medium and long-term earnings, financial condition, regulatory capital position, and applicable governmental regulations and policies. Capital Contributions to Subsidiaries. During the six months ended June 30, 2004 and 2003, the Holding Company contributed an aggregate of $271 million and $42 million to various subsidiaries, respectively. Share Repurchase. On February 19, 2002, the Holding Company's Board of Directors authorized a $1 billion common stock repurchase program. Under this authorization, the Holding Company may purchase its common stock from the MetLife Policyholder Trust, in the open market and in privately negotiated transactions. The following table summarizes the Company's repurchase activity: SIX MONTHS ENDED JUNE 30, -------------- 2004 2003 ---- ---- (DOLLARS IN MILLIONS) Shares Repurchased 7,935,381 -- Cost $ 275 -- 56 At June 30, 2004, the Holding Company had approximately $434 million remaining on its existing share repurchase program. See Part II, Item 2, "Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities." In the fourth quarter of 2003, RGA offered to the public 12,075,000 shares of its common stock at $36.65 per share. MetLife and its affiliates purchased 3,000,000 shares of the common stock offered by RGA. As a result of this offering, MetLife's ownership percentage of outstanding shares of RGA common stock was reduced from approximately 59% at December 31, 2002 to approximately 52% at December 31, 2003. Support Agreements. In 2002, the Holding Company entered into a net worth maintenance agreement with three of its insurance subsidiaries, MetLife Investors Insurance Company, First MetLife Investors Insurance Company and MetLife Investors Insurance Company of California. Under the agreements, the Holding Company agreed, without limitation as to the amount, to cause each of these subsidiaries to have a minimum capital and surplus of $10 million (or, with respect to MetLife Investors Insurance Company of California, $5 million), total adjusted capital at a level not less than 150% of the company action level RBC, as defined by state insurance statutes, and liquidity necessary to enable it to meet its current obligations on a timely basis. At June 30, 2004, the capital and surplus of each of these subsidiaries is in excess of the minimum capital and surplus amounts referenced above, and their total adjusted capital was in excess of the most recent referenced RBC-based amount calculated at December 31, 2003. Based on management's analysis and comparison of its current and future cash inflows from the dividends it receives from subsidiaries, including Metropolitan Life, that are permitted to be paid without prior insurance regulatory approval and its portfolio of liquid assets and other anticipated cash flows, management believes there will be sufficient liquidity to enable the Holding Company to make payments on debt, make cash dividend payments on its common stock, contribute capital to its subsidiaries, pay all operating expenses, and meet its cash needs. THE COMPANY 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; similar rules apply to each of the Company's domestic insurance subsidiaries. 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 to take various actions against, insurers whose total adjusted capital does not exceed certain RBC levels. At December 31, 2003, Metropolitan Life's and each of the Holding Company's domestic 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") adopted Codification of Statutory Accounting Principles ("Codification"), which is intended to standardize regulatory accounting and reporting to state insurance departments and became effective January 1, 2001. However, statutory accounting principles continue to be established by individual state laws and permitted practices. The Department required adoption of Codification with certain modifications for the preparation of statutory financial statements of insurance companies domiciled in New York effective January 1, 2001. Effective December 31, 2002, the Department adopted a modification to its regulations to be consistent with Codification with respect to the admissibility of deferred income taxes by New York insurers, subject to certain limitations. The adoption of Codification, as modified by the Department, did not adversely affect Metropolitan Life's statutory capital and surplus. Further modifications by state insurance departments may impact the effect of Codification on the statutory capital and surplus of Metropolitan Life and the Holding Company's other insurance subsidiaries. ASSET/LIABILITY MANAGEMENT The Company actively manages its assets using an approach that balances quality, diversification, asset/liability matching, liquidity and investment return. The goals of the investment process are to optimize after-tax, risk-adjusted investment income and after-tax, risk-adjusted total return while ensuring that the assets and liabilities are managed on a cash flow and duration basis. The Company establishes target asset portfolios for each major insurance product, which represent the investment strategies used to profitably fund its liabilities within acceptable levels of risk. These strategies include objectives for effective duration, yield curve sensitivity, convexity, liquidity, asset sector concentration and credit quality. 57 The Company's liquidity position (cash and cash equivalents and short-term investments) was $6.5 billion and $5.6 billion at June 30, 2004 and December 31, 2003, respectively. Liquidity needs are determined from a rolling 12-month forecast by portfolio and are monitored daily. Asset mix and maturities are adjusted based on forecast. Cash flow testing and stress testing provide additional perspectives on liquidity. LIQUIDITY The Company believes that it has sufficient liquidity to fund its cash needs under various scenarios that include the potential risk of early contractholder and policyholder withdrawal. The Company includes 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 funds liabilities) sold to employee benefit plan sponsors. In the event of significant unanticipated cash requirements beyond normal liquidity, the Company has multiple liquidity alternatives available based on market conditions and the amount and timing of the liquidity need. These options include cash flow from operations (insurance premiums, annuity considerations and deposit funds), borrowings under committed credit facilities, secured borrowings, the ability to issue commercial paper, long-term debt, capital securities, common equity and, if necessary, the sale of liquid long-term assets. The Company's ability to sell investment assets could be limited by accounting rules including rules relating to the intent and ability to hold impaired securities until the market value of those securities recovers. In extreme circumstances, all general account assets within a statutory legal entity are available to fund any obligation of the general account. LIQUIDITY SOURCES Cash Flow from Operations. The Company's principal cash inflows from its insurance activities come from 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 includes 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 come 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 risk of default by debtors and market volatilities. The Company closely monitors and manages these risks through its credit risk management process. Liquid Assets. An integral part of the Company's liquidity management is the amount of liquid assets it holds. Liquid assets include cash, cash equivalents, short-term investments and marketable fixed maturity and equity securities. Liquid assets exclude assets relating to securities lending and dollar roll activities. At June 30, 2004 and December 31, 2003, the Company had $128 billion and $125 billion in liquid assets, respectively. Global Funding Sources. Liquidity is also provided by a variety of both short and long-term instruments, including repurchase agreements, commercial paper, medium and long-term debt, capital securities and stockholders' equity. The diversification of the Company's funding sources enhances funding flexibility, limits dependence on any one source of funds and generally lowers the cost of funds. At June 30, 2004 and December 31, 2003, the Company had $3.2 billion and $3.6 billion in short-term debt outstanding and $6.2 billion and $5.7 billion in long-term debt outstanding, respectively. On November 1, 2003, the Company redeemed the $300 million of 7.45% Surplus Notes outstanding scheduled to mature on November 1, 2023 at a redemption price of $311 million. 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 June 30, 2004 and December 31, 2003, MetLife Funding had a tangible net worth of $10.9 million and $10.8 million, respectively. MetLife Funding raises funds from various funding 58 sources and uses the proceeds to extend loans, through MetLife Credit Corp., a subsidiary of Metropolitan Life, 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 and other affiliated companies. At June 30, 2004 and December 31, 2003, MetLife Funding had total outstanding liabilities, including accrued interest payable, of $846 million and $1,042 million, respectively, consisting primarily of commercial paper. Credit Facilities. The Company maintains committed and unsecured credit facilities aggregating $2.7 billion ($1 billion expiring in 2005, $175 million expiring in 2006 and $1.5 billion expiring in 2009). If these facilities were drawn upon, they would bear interest at varying rates in accordance with the respective agreements. The facilities can be used for general corporate purposes and also as back-up lines of credit for the Company's commercial paper programs. At June 30, 2004, the Company had drawn approximately $52 million under the facilities expiring in 2005 at interest rates ranging from 5.32% to 6.18% and approximately $50 million under a facility expiring in 2006 at an interest rate of 1.94%. LIQUIDITY USES Insurance Liabilities. The Company's principal cash outflows primarily relate to the liabilities associated with its various life insurance, property and casualty, annuity and group pension products, operating expenses and 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 aforementioned products, as well as payments for policy surrenders, withdrawals and loans. Investment and Other. Additional cash outflows include those related to obligations of securities lending and dollar roll activities, investments in real estate, limited partnerships and joint ventures, as well as litigation-related liabilities. The following table summarizes the Company's major contractual obligations as of June 30, 2004: LESS THAN THREE THREE TO FIVE MORE THAN FIVE CONTRACTUAL OBLIGATIONS TOTAL YEARS YEARS YEARS - ----------------------- ----- --------------- ------------- -------------- (DOLLARS IN MILLIONS) Other long-term liabilities (1) $ 89,798 $ 12,421 $ 6,852 $ 70,525 Long-term debt (2) 6,180 2,126 60 3,994 Partnership investments (3) 1,443 1,443 -- -- Operating leases 1,273 468 252 553 Mortgage commitments 1,580 1,580 -- -- Shares subject to mandatory redemption (2) 350 -- -- 350 Capital leases 70 27 23 20 -------- -------- -------- -------- Total $100,694 $ 18,065 $ 7,187 $ 75,442 ======== ======== ======== ======== - ------------ (1) Other long-term liabilities include various investment-type products with contractually scheduled maturities including guaranteed interest contracts, structured settlements, pension closeouts and certain annuity policies. This line item also includes claim reserves for which the amount of the claim payment is generally known, including life insurance and property and casualty insurance incurred and reported claims. Where the claim payment timing is not known, the Company uses historical experience to estimate the payout pattern. (2) Amounts differ from the balances presented on the consolidated balance sheets. The amounts above do not include related premiums and discounts or capital leases which are presented separately. (3) The Company anticipates that these amounts could be invested in these partnerships any time over the next five years, but are presented in the current period, as the timing of the fulfillment of the obligation cannot be predicted. A significant portion of the Company's insurance liabilities, including most future policy benefits, are excluded from the contractual obligations table because such amounts and/or their timing are inherently subjective. As of June 30, 2004, and relative to its liquidity program, the Company had no material (individually or in the aggregate) purchase obligations or material (individually or in the aggregate) unfunded pension or other postretirement benefit obligations due within one year. On April 11, 2003, an affiliate of the Company elected not to make future payments required by the terms of a non-recourse loan obligation. The book value of this loan was approximately $16 million at June 30, 2004. The Company's exposure under the terms of the applicable loan agreement is limited solely to its investment in certain securities held by an affiliate. 59 Letters of Credit. At June 30, 2004 and December 31, 2003, the Company had outstanding approximately $742 million and $828 million, respectively, in letters of credit from various banks, all of which expire within one year. Since commitments associated with letters of credit and financing arrangements may expire unused, these amounts do not necessarily reflect the actual future cash funding requirements. Support Agreements. In addition to the support agreements described above, Metropolitan Life entered into a net worth maintenance agreement with New England Life Insurance Company ("NELICO") at the time Metropolitan Life merged with New England Mutual Life Insurance Company. Under the agreement, Metropolitan Life agreed, without limitation as to the amount, to cause NELICO to have a minimum capital and surplus of $10 million, total adjusted capital at a level not less than the company action level RBC, as defined by state insurance statutes, and liquidity necessary to enable it to meet its current obligations on a timely basis. At June 30, 2004, the capital and surplus of NELICO was in excess of the minimum capital and surplus amount referenced above, and its total adjusted capital was in excess of the most recent referenced RBC-based amount calculated at December 31, 2003. In connection with the Company's acquisition of GenAmerica Financial Corporation ("GenAmerica"), Metropolitan Life entered into a net worth maintenance agreement with General American Life Insurance Company ("General American"). Under the agreement, Metropolitan Life agreed, without limitation as to amount, to cause General American to have a minimum capital and surplus of $10 million, total adjusted capital at a level not less than 180% of the company action level RBC, as defined by state insurance statutes, and liquidity necessary to enable it to meet its current obligations on a timely basis. The agreement was subsequently amended to provide that, for the five year period from 2003 through 2007, total adjusted capital must be maintained at a level not less than 200% of the company action level RBC, as defined by state insurance statutes. At June 30, 2004, the capital and surplus of General American was in excess of the minimum capital and surplus amount referenced above, and its total adjusted capital was in excess of the most recent referenced RBC-based amount calculated at December 31, 2003. Metropolitan Life has also entered into arrangements for the benefit of some of its other subsidiaries and affiliates to assist such subsidiaries and affiliates in meeting various jurisdictions' regulatory requirements regarding capital and surplus and security deposits. In addition, Metropolitan Life has entered into a support arrangement with respect to a subsidiary under which Metropolitan Life may become responsible, in the event that the subsidiary becomes the subject of insolvency proceedings, for the payment of certain reinsurance recoverables due from the subsidiary to one or more of its cedents in accordance with the terms and conditions of the applicable reinsurance agreements. General American has agreed to guarantee the contractual obligations of its subsidiary, Paragon Life Insurance Company, and certain contractual obligations of its former subsidiaries, MetLife Investors Insurance Company ("MetLife Investors"), First MetLife Investors Insurance Company and MetLife Investors Insurance Company of California. In addition, General American has entered into a contingent reinsurance agreement with MetLife Investors. Under this agreement, in the event that MetLife Investors' statutory capital and surplus is less than $10 million or total adjusted capital falls below 150% of the company action level RBC, as defined by state insurance statutes, General American would assume as assumption reinsurance, subject to regulatory approvals and required consents, all of MetLife Investors' life insurance policies and annuity contract liabilities. At June 30, 2004, the capital and surplus of MetLife Investors was in excess of the minimum capital and surplus amount referenced above, and its total adjusted capital was in excess of the most recent referenced RBC-based amount calculated at December 31, 2003. Management does not anticipate that these arrangements will place any significant demands upon the Company's liquidity resources. 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 except with respect to certain matters. In some of the matters, 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 consolidated net income or cash flows in particular quarterly or annual periods. 60 Based on management's analysis of its expected cash inflows from operating activities, the dividends it receives from subsidiaries, including Metropolitan Life, that are permitted to be paid without prior insurance regulatory approval and its portfolio of liquid assets and other anticipated cash flows, management believes there will be sufficient liquidity to enable the Company to make payments on debt, make cash dividend payments on its common stock, pay all operating expenses, and meet its cash needs. The nature of the Company's diverse product portfolio and customer base lessens the likelihood that normal operations will result in any significant strain on liquidity. Consolidated cash flows. Net cash provided by operating activities was $3,380 million and $3,201 million for the six months ended June 30, 2004 and 2003, respectively. The $179 million increase in operating cash flows in 2004 over the comparable 2003 period is primarily attributable to continued growth in the group life, disability and long-term care businesses. The late 2003 acquisition of John Hancock's group life business and the acquisition of TIAA-CREF's long-term care business also contributed to growth in the 2004 period. In addition, increase in MetLife Bank's customer deposits, particularly in personal and business savings accounts, contributed to the increase in operating cash flows. Net cash used in investing activities was $6,304 million and $8,049 million for the six months ended June 30, 2004 and 2003, respectively. The $1,745 million decrease in net cash used in investing activities in 2004 over the comparable 2003 period is primarily due to a decrease in the purchase of fixed maturities, additional proceeds from sales of fixed maturities, and a decrease in cash used for the purpose of short-term investments. In addition, the 2004 period includes proceeds associated with the sale of Sears Tower in April 2004. These items were partially offset by an increase in mortgage loans funded and a reduction of net payables under securities loaned in 2004 over the comparable 2003 period. Net cash provided by financing activities was $3,650 million and $8,239 million for the six months ended June 30, 2004 and 2003, respectively. The $4,589 million decrease in net cash provided by financing activities in 2004 over the comparable 2003 period is primarily attributable to the repayment of short-term debt related to dollar roll activity. In addition, the 2004 period includes the purchase of treasury stock under the authorization of the Company's common stock repurchase program. The 2003 period included cash received from the settlement of common stock purchase contracts. These items were somewhat offset by an increase in long-term debt issued in connection with the Holding Company's shelf registration. 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. APPLICATION OF RECENT ACCOUNTING PRONOUNCEMENTS In March 2004, the Emerging Issues Task Force ("EITF") reached further consensus on Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, ("EITF 03-1"). EITF 03-1 provides accounting guidance regarding the determination of when an impairment of debt and marketable equity securities and investments accounted for under the cost method should be considered other-than-temporary and recognized in income. An EITF 03-1 consensus reached in November 2003 also requires certain quantitative and qualitative disclosures for debt and marketable equity securities classified as available-for-sale or held-to-maturity under Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities, that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The disclosure requirements of EITF 03-1 were effective December 31, 2003. The accounting guidance of EITF 03-1 will be effective in the third quarter of 2004 and is not expected to have a material impact on the Company's unaudited interim condensed consolidated financial statements. In March 2004, the EITF reached consensuses on Issue No. 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128 ("EITF 03-6"). EITF 03-6 provides guidance in determining whether a security should be considered a participating security for purposes of computing earnings per share and how earnings should be allocated to the participating security. EITF 03-6, which was effective for the Company in the second quarter of 2004, did not have an impact on the Company's earnings per share calculations. In March 2004, the EITF reached consensus on Issue No. 03-16, Accounting for Investments in Limited Liability Companies ("EITF 03-16"). EITF 03-16 provides guidance regarding whether a limited liability company should be viewed as similar to a corporation or similar to a partnership for purposes of determining whether a noncontrolling investment should be accounted for using 61 the cost method or the equity method of accounting. EITF 03-16, which will be effective in the third quarter of 2004, is not expected to have a material impact on the Company's unaudited interim condensed consolidated financial statements. Effective January 1, 2004, the Company adopted Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts ("SOP 03-1"). SOP 03-1 provides guidance on (i) the classification and valuation of long-duration contract liabilities; (ii) the accounting for sales inducements; and (iii) separate account presentation and valuation. At adoption, the Company increased future policyholder benefits for changes in the methodology relating to various guaranteed death and annuitization benefits and for determining reserves for certain universal life insurance contracts by approximately $68 million, which has been reported as a cumulative effect of a change in accounting. This amount is net of corresponding changes in DAC and unearned revenue liability ("offsets") under certain variable annuity and life contracts and income taxes. In June 2004, the Financial Accounting Standards Board ("FASB") released Staff Position paper No. 97-1, Situations in Which Paragraphs 17(b) and 20 of FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, Permit or Require Accrual of an Unearned Revenue Liability ("FSP 97-1") which included clarification that unearned revenue liabilities should be considered in determining the necessary insurance benefit liability required under SOP 03-1. FSP 97-1 is effective July 1, 2004. However, additional industry guidance related to SOP 03-1 continues to evolve. Although currently evaluating FSP 97-1 and the possible additional accounting guidance, the Company anticipates a reduction of the initial liability established under SOP 03-1 in subsequent accounting periods. Certain other contracts sold by the Company provide for a return through periodic crediting rates, surrender adjustments or termination adjustments based on the total return of a contractually referenced pool of assets owned by the Company. To the extent that such contracts are not accounted for under the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") and not already credited to the contract account balance, under SOP 03-1 the change relating to the fair value of the referenced pool of assets is recorded as a liability through policyholder benefits and claims. Prior to the adoption of SOP 03-1, the Company recorded the change in such liability as other comprehensive income. At adoption, this change decreased net income and increased other comprehensive income by $63 million, net of income taxes, which were recorded as cumulative effects of a change in accounting. Effective with the adoption of SOP 03-1, costs associated with enhanced or bonus crediting rates to contractholders must be deferred and amortized over the life of the related contract using assumptions consistent with the amortization of DAC. Since the Company followed a similar approach prior to adoption of SOP 03-1, the provisions of SOP 03-1 relating to sales inducements had no significant impact on the Company's unaudited interim condensed consolidated financial statements. At adoption, the Company reclassified $155 million of ownership in its own separate accounts from other assets to fixed maturities, equity securities and cash and cash equivalents. This reclassification had no significant impact on net income or other comprehensive income at adoption. In accordance with SOP 03-1's guidance for the reporting of certain separate accounts, at adoption, the Company also reclassified $1.7 billion of separate account assets to general account investments and $1.7 billion of separate account liabilities to future policy benefits and policyholder account balances. This reclassification decreased net income and increased other comprehensive income by $27 million, net of income taxes, which were reported as cumulative effects of a change in accounting. For the three months and six months ended June 30, 2004, the impact of SOP 03-1 increased the Company's net income by $78 million and $64 million, respectively. In December 2003, FASB revised SFAS No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits -- an Amendment of FASB Statements No. 87, 88 and 106 ("SFAS 132(r)"). SFAS 132(r) retains most of the disclosure requirements of SFAS 132 and requires additional disclosure about assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined postretirement plans. SFAS 132(r) was primarily effective for fiscal years ending after December 15, 2003; however, certain disclosures about foreign plans and estimated future benefit payments are effective for fiscal years ending after June 15, 2004. The Company's adoption of SFAS 132(r) on December 31, 2003 did not have a significant impact on its consolidated financial statements since it only revised disclosure requirements. In May 2004, the FASB issued FASB Staff Position ("FSP") No. 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("FSP 106-2"), which provides accounting guidance to a sponsor of a postretirement health care plan that provides prescription drug benefits. The Company expects to receive subsidies on prescription drug benefits beginning in 2006 under the Medicare Prescription Drug, Improvement and Modernization Act of 2003 based on the Company's determination that the prescription drug benefits offered under certain postretirement plans are actuarially equivalent to the benefits offered under Medicare Part D. FSP 106-2 is effective for interim periods beginning after June 15, 2004 and provides for either retroactive application to the date of enactment of the legislation or prospective application from the date of adoption of FSP 106-2. The Company is in the process of evaluating the alternatives, however, neither alternative is expected to have a significant impact on the Company's unaudited interim condensed consolidated financial statements. Effective October 1, 2003, the Company adopted Statement 133 Implementation Issue No. B36, Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments ("Issue B36"). Issue B36 concluded that (i) a company's funds withheld payable and/or receivable under certain reinsurance arrangements, and (ii) a debt instrument that incorporates credit risk exposures that are unrelated or only partially related to the creditworthiness of the obligor include an embedded derivative feature that is not clearly and closely related to the host contract. Therefore, the embedded derivative feature is measured at fair value on the balance sheet and changes in fair value are reported in income. As a result of the adoption of Issue B36, the Company recognized net income of $22 million and $13 million, net of amortization of DAC and income taxes, for the three months and six months ended June 30, 2004, respectively. 62 Effective July 1, 2003, the Company adopted SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("SFAS 149"). SFAS 149 amended and clarified the accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Except for certain previously issued and effective guidance that was incorporated in SFAS 149, SFAS 149 is effective for contracts entered into or modified after June 30, 2003. The Company's adoption of SFAS 149 did not have a significant impact on its unaudited interim condensed consolidated financial statements. During 2003, the Company adopted FASB Interpretation No. 46, Consolidation of Variable Interest Entities -- An Interpretation of ARB No. 51 ("FIN 46"), and its December 2003 revision ("FIN 46(r)"). Certain of the Company's asset-backed securitizations, collateralized debt obligations, structured investment transactions, and investments in real estate joint ventures and other limited partnership interests meet the definition of a variable interest entities ("VIEs") and must be consolidated, in accordance with the transition rules and effective dates, because the Company is deemed to be the primary beneficiary. A VIE is defined as (i) any entity in which the equity investments at risk in such entity do not have the characteristics of a controlling financial interest, or (ii) any entity that does not have sufficient equity at risk to finance its activities without additional subordinated support from other parties. Effective February 1, 2003, the Company adopted FIN 46 for VIEs created or acquired on or after February 1, 2003 and, effective December 31, 2003, the Company adopted FIN 46(r) with respect to interests in entities formerly considered special purpose entities ("SPEs"), including interests in asset-backed securities and collateralized debt obligations. The adoption of FIN 46 as of February 1, 2003 did not have a significant impact on the Company's unaudited interim condensed consolidated financial statements. The adoption of the provisions of FIN 46(r) at December 31, 2003 did not require the Company to consolidate any additional VIEs that were not previously consolidated. In accordance with the provisions of FIN 46(r), the Company elected to defer until March 31, 2004 the consolidation of interests in VIEs for non SPEs acquired prior to February 1, 2003 for which it is the primary beneficiary. The transition effect recorded at March 31, 2004 as a result of such consolidations was insignificant. As of June 30, 2004, the Company consolidated assets and liabilities relating to real estate joint ventures of $16 million and $3 million, respectively, and assets and liabilities relating to other limited partnerships of $82 million and $15 million, respectively, for VIEs for which the Company was deemed to be the primary beneficiary. 63 INVESTMENTS The Company had total cash and invested assets at June 30, 2004 and December 31, 2003 of $227.4 billion and $221.8 billion, respectively. In addition, the Company had $79.7 billion and $75.8 billion held in its separate accounts, for which the Company generally does not bear investment risk, as of June 30, 2004 and December 31, 2003, respectively. The following table summarizes the Company's cash and invested assets at: JUNE 30, 2004 DECEMBER 31, 2003 ------------- ----------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL ----- ----- ----- ----- (DOLLARS IN MILLIONS) Fixed maturities available-for-sale, at fair value $170,192 74.7% $167,752 75.6% Mortgage loans on real estate 28,118 12.4 26,249 11.8 Real estate and real estate joint ventures held-for-investment 4,110 1.8 3,848 1.8 Real estate held-for-sale 44 0.0 832 0.4 Policy loans 8,766 3.9 8,749 3.9 Equity securities, at fair value and other limited partnership interests 4,549 2.0 4,198 1.9 Cash and cash equivalents 4,459 2.0 3,733 1.7 Short-term investments 2,089 0.9 1,826 0.8 Other invested assets 5,119 2.3 4,645 2.1 -------- ----- -------- ----- Total cash and invested assets $227,446 100.0% $221,832 100.0% ======== ===== ======== ===== INVESTMENT RESULTS Net investment income, including net investment income from discontinued operations and scheduled periodic settlement payments on derivative instruments that do not qualify for hedge accounting under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended ("SFAS 133"), on general account cash and invested assets totaled $3,165 million and $2,889 million for the three months ended June 30, 2004 and 2003, respectively, and $6,171 million and $5,788 million for the six months ended June 30, 2004 and 2003, respectively. The annualized yields on general account cash and invested assets, including net investment income from discontinued operations and scheduled periodic settlement payments on derivative instruments that do not qualify for hedge accounting under SFAS 133, and excluding all net investment gains (losses), were 6.60% and 6.68% for the three months ended June 30, 2004 and 2003, respectively, and 6.52% and 6.79% for the six months ended June 30, 2004 and 2003, respectively. The decline in annualized yields is due primarily to the decline in interest rates during these periods. 64 The following table illustrates the net investment income and annualized yields on average assets for each of the components of the Company's investment portfolio for the three months and six months ended June 30, 2004 and 2003: AT OR FOR THE THREE MONTHS ENDED JUNE 30, AT OR FOR THE SIX MONTHS ENDED JUNE 30, ----------------------------------------- --------------------------------------- 2004 2003 2004 2003 ------------------ ----------------- ------------------ ------------------ YIELD(1) AMOUNT YIELD(1) AMOUNT YIELD(1) AMOUNT YIELD(1) AMOUNT -------- ------ -------- ------ -------- ------ -------- ------ (DOLLARS IN MILLIONS) FIXED MATURITIES: (2) Investment income 6.64% $ 2,291 6.87% $ 2,073 6.64% $ 4,523 6.91% $ 4,117 Net investment gains (losses) (3) (43) 31 (192) -------- -------- -------- -------- Total $ 2,288 $ 2,030 $ 4,554 $ 3,925 -------- -------- -------- -------- Ending assets $170,192 $158,822 $170,192 $158,822 -------- -------- -------- -------- MORTGAGE LOANS ON REAL ESTATE: (3) Investment income 6.83% $ 468 7.50% $ 472 6.80% $ 917 7.50% $ 942 Net investment gains (losses) -- (8) -- (22) -------- -------- -------- -------- Total $ 468 $ 464 $ 917 $ 920 -------- -------- -------- -------- Ending assets $ 28,118 $ 25,289 $ 28,118 $ 25,289 -------- -------- -------- -------- REAL ESTATE AND REAL ESTATE JOINT VENTURES HELD-FOR-INVESTMENT: (4) Investment income, net of expenses 13.36% $ 148 11.20% $ 125 12.71% $ 287 11.14% $ 252 Net investment gains (losses) 133 (6) 154 86 -------- -------- -------- -------- Total $ 281 $ 119 $ 441 $ 338 -------- -------- -------- -------- Ending assets $ 4,154 $ 4,491 $ 4,154 $ 4,491 -------- -------- -------- -------- POLICY LOANS: Investment income 6.13% $ 134 6.46% $ 139 6.12% $ 268 6.47% $ 278 -------- -------- -------- -------- Ending assets $ 8,766 $ 8,627 $ 8,766 $ 8,627 -------- -------- -------- -------- EQUITY SECURITIES AND OTHER LIMITED PARTNERSHIP INTERESTS: Investment income 10.27% $ 100 3.62% $ 32 6.70% $ 129 4.80% $ 86 Net investment gains (losses) 87 1 87 (70) -------- -------- -------- -------- Total $ 187 $ 33 $ 216 $ 16 -------- -------- -------- -------- Ending assets $ 4,549 $ 4,117 $ 4,549 $ 4,117 -------- -------- -------- -------- CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS: Investment income 2.37% $ 30 2.23% $ 42 2.45% $ 60 3.40% $ 106 Net investment gains (losses) -- -- -- (4) -------- -------- -------- -------- Total $ 30 $ 42 $ 60 $ 102 -------- -------- -------- -------- Ending assets $ 6,548 $ 8,354 $ 6,548 $ 8,354 -------- -------- -------- -------- OTHER INVESTED ASSETS: (5) Investment income 5.10% $ 55 8.47% $ 69 5.39% $ 112 8.43% $ 132 Net investment gains (losses), (6) (60) 2 8 (22) -------- -------- -------- -------- Total $ (5) $ 71 $ 120 $ 110 -------- -------- -------- -------- Ending assets $ 5,119 $ 4,261 $ 5,119 $ 4,261 -------- -------- -------- -------- TOTAL INVESTMENTS: Investment income before expenses and fees 6.73% $ 3,226 6.82% $ 2,952 6.65% $ 6,296 6.94% $ 5,913 Investment expenses and fees (0.13%) (61) (0.14%) (63) (0.13%) (125) (0.15%) (125) ------ -------- ------ -------- ------ -------- ------ -------- Net investment income 6.60% $ 3,165 6.68% $ 2,889 6.52% $ 6,171 6.79% $ 5,788 Net investment gains (losses) 157 (54) 280 (224) -------- -------- -------- -------- Total $ 3,322 $ 2,835 $ 6,451 $ 5,564 ======== ======== ======== ======== - ------ ---- (1) Yields are based on quarterly average asset carrying values, excluding recognized and unrealized gains (losses), and for yield calculation purposes, average assets exclude collateral associated with the Company's securities lending program. (2) Included in fixed maturities are equity-linked notes of $906 million and $887 million at June 30, 2004 and 2003, respectively, which include an equity-like component as part of the notes' return. Investment income for fixed maturities includes prepayment fees and income from the securities lending program. Fixed maturity investment income has been reduced by rebates paid under the securities lending program. (3) Investment income from mortgage loans on real estate includes prepayment fees. (4) Real estate and real estate joint venture income is shown net of depreciation of $42 million and $43 million for the three months 65 ended June 30, 2004 and 2003, respectively, and $86 million and $88 million for the six months ended June 30, 2004 and 2003, respectively. Real estate and real estate joint venture income includes amounts classified as discontinued operations of $25 million and $12 million for the three months ended June 30, 2004 and 2003, respectively, and $43 million and $30 million for the six months ended June 30, 2004 and 2003, respectively. These amounts are net of depreciation of $1 million and $5 million for the three months ended June 30, 2004 and 2003, respectively, and $3 million and $11 million for the six months ended June 30, 2004 and 2003, respectively. Net investment gains (losses) include $131 million and $0 million of gains classified as discontinued operations for the three months ended June 30, 2004 and 2003, respectively, and $152 million and $90 million of gains classified as discontinued operations for the six months ended June 30, 2004 and 2003, respectively. (5) Investment income from other invested assets includes scheduled periodic settlement payments on derivative instruments that do not qualify for hedge accounting under SFAS 133 of $22 million and $12 million for the three months ended June 30, 2004 and 2003, respectively, and $36 million and $20 million for the six months ended June 30, 2004 and 2003, respectively. These amounts are excluded from net investment gains (losses). (6) Included in net investment gains (losses) for the six months ended June 30, 2004 is a $23 million gain from the sale of a subsidiary. FIXED MATURITIES Fixed maturities consist principally of publicly traded and privately placed debt securities, and represented 74.7% and 75.6% of total cash and invested assets at June 30, 2004 and December 31, 2003, respectively. Based on estimated fair value, public fixed maturities represented $149,949 million, or 88.1% and $147,489 million, or 87.9%, of total fixed maturities at June 30, 2004 and December 31, 2003, respectively. Based on estimated fair value, private fixed maturities represented $20,243 million, or 11.9% and $20,263 million, or 12.1%, of total fixed maturities at June 30, 2004 and December 31, 2003, respectively. In cases where quoted market prices are not available, fair values are estimated using present value or valuation techniques. The fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counter-party. Factors considered in estimating fair value include: coupon rate, maturity, estimated duration, call provisions, sinking fund requirements, credit rating, industry sector of the issuer and quoted market prices of comparable securities. The Securities Valuation Office of the NAIC evaluates the fixed maturity investments of insurers for regulatory reporting purposes and assigns securities to one of six investment categories called "NAIC designations." The NAIC ratings are similar to the rating agency designations of the Nationally Recognized Statistical Rating Organizations for marketable bonds. NAIC ratings 1 and 2 include bonds generally considered investment grade (rated "Baa3" or higher by Moody's Investors Services ("Moody's"), or rated "BBB-" or higher by Standard & Poor's ("S&P")) by such rating organizations. NAIC ratings 3 through 6 include bonds generally considered below investment grade (rated "Ba1" or lower by Moody's, or rated "BB+" or lower by S&P). 66 The following table presents the Company's total fixed maturities by Nationally Recognized Statistical Rating Organizations designation and the equivalent ratings of the NAIC, as well as the percentage, based on estimated fair value, that each designation is comprised of at: JUNE 30, 2004 DECEMBER 31, 2003 -------------------------------- ----------------------------------- ESTIMATED ESTIMATED NAIC RATING AGENCY AMORTIZED FAIR % OF AMORTIZED FAIR % OF RATING DESIGNATION (1) COST VALUE TOTAL COST VALUE TOTAL ------ --------------- --------- --------- ----- --------- --------- ----- (DOLLARS IN MILLIONS) 1 Aaa/Aa/A $110,622 $113,607 66.8% $106,779 $112,333 67.0% 2 Baa 42,035 43,829 25.8 39,006 42,057 25.0 3 Ba 6,923 7,334 4.3 7,388 8,011 4.8 4 B 3,963 4,086 2.4 3,578 3,814 2.3 5 Caa and lower 562 583 0.3 630 629 0.4 6 In or near default 184 211 0.1 341 371 0.2 -------- -------- ----- -------- -------- ----- Subtotal 164,289 169,650 99.7 157,722 167,215 99.7 Redeemable preferred stock 613 542 0.3 611 537 0.3 -------- -------- ----- -------- -------- ----- Total fixed maturities $164,902 $170,192 100.0% $158,333 $167,752 100.0% ======== ======== ===== ======== ======== ===== - ---------- (1) Amounts presented are based on rating agency designations. Comparisons between NAIC ratings and rating agency designations are published by the NAIC. The rating agency designations are based on availability and the lower of the applicable ratings between Moody's and S&P. The current period ratings are presented so that the consolidated rating is equal to the Moody's or S&P rating, whichever is more conservative. If no rating is available from a rating agency, then the MetLife rating will be used. 67 The fixed maturities portfolio is diversified across a broad range of asset sectors, and the sector mix did not change significantly in the second quarter of 2004. The following tables set forth the amortized cost, gross unrealized gain and loss, and estimated fair value of the Company's fixed maturities by sector, as well as the percentage of the total fixed maturities holdings that each sector represents at: JUNE 30, 2004 ---------------------------------------------------------------- GROSS UNREALIZED AMORTIZED ------------------ ESTIMATED % OF COST GAIN LOSS FAIR VALUE TOTAL --------- ---- ---- ---------- ----- (DOLLARS IN MILLIONS) U.S. treasuries/agencies $ 15,838 $ 992 $ 166 $ 16,664 9.8% State and political subdivisions 3,592 125 42 3,675 2.2 U.S. corporate securities 58,536 2,683 600 60,619 35.6 Foreign government securities 7,537 585 103 8,019 4.7 Foreign corporate securities 23,349 1,643 260 24,732 14.5 Residential mortgage-backed securities 30,464 524 290 30,698 18.0 Commercial mortgage-backed securities 11,801 361 143 12,019 7.1 Asset-backed securities 12,378 136 70 12,444 7.3 Other fixed income assets 794 38 52 780 0.5 -------- -------- -------- -------- ----- Total bonds 164,289 7,087 1,726 169,650 99.7 Redeemable preferred stocks 613 -- 71 542 0.3 -------- -------- -------- -------- ----- Total fixed maturities $164,902 $ 7,087 $ 1,797 $170,192 100.0% ======== ======== ======== ======== ===== DECEMBER 31, 2003 ---------------------------------------------------------------- GROSS UNREALIZED AMORTIZED ------------------ ESTIMATED % OF COST GAIN LOSS FAIR VALUE TOTAL ---------- ---- ---- ---------- ----- (DOLLARS IN MILLIONS) U.S. treasuries/agencies $ 14,707 $ 1,264 $ 26 $ 15,945 9.5% State and political subdivisions 3,155 209 15 3,349 2.0 U.S. corporate securities 56,757 3,886 252 60,391 36.0 Foreign government securities 7,789 1,003 28 8,764 5.2 Foreign corporate securities 21,727 2,194 79 23,842 14.2 Residential mortgage-backed securities 30,836 720 102 31,454 18.8 Commercial mortgage-backed securities 10,523 530 22 11,031 6.6 Asset-backed securities 11,736 187 60 11,863 7.1 Other fixed income assets 492 167 83 576 0.3 -------- -------- ---- -------- ----- Total bonds 157,722 10,160 667 167,215 99.7 Redeemable preferred stocks 611 2 76 537 0.3 -------- -------- ---- -------- ----- Total fixed maturities $158,333 $ 10,162 $743 $167,752 100.0% ======== ======== ==== ======== ===== Fixed Maturity Impairment. The Company classifies all of its fixed maturities as available-for-sale and marks them to market through other comprehensive income. All securities with gross unrealized losses at the consolidated balance sheet date are subjected to the Company's process for identifying other-than-temporary impairments. The Company writes down to fair value securities that it deems to be other-than-temporarily impaired in the period the securities are deemed to be so impaired. The assessment of whether such impairment has occurred is based on management's case-by-case evaluation of the underlying reasons for the decline in fair value. Management considers a wide range of factors, as described below, about the security issuer and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used by the Company in the impairment evaluation process include, but are not limited to, the following: - - length of time and the extent to which the market value has been below amortized cost; - - potential for impairments of securities when the issuer is experiencing significant financial difficulties, including a review of all securities of the issuer, including its known subsidiaries and affiliates, regardless of the form of the Company's ownership; 68 - - potential for impairments in an entire industry sector or sub-sector; - - potential for impairments in certain economically depressed geographic locations; - - potential for impairments of securities where the issuer, series of issuers or industry has suffered a catastrophic type of loss or has exhausted natural resources; - - the Company's ability and intent to hold the security for a period of time sufficient to allow for the recovery of its value to an amount equal to or greater than cost; - - unfavorable changes in forecasted cash flows on asset-backed securities; and - - other subjective factors, including concentrations and information obtained from regulators and rating agencies. The Company's review of its fixed maturities for impairments includes an analysis of the total gross unrealized losses by three categories of securities: (i) securities where the estimated fair value had declined and remained below amortized cost by less than 20%; (ii) securities where the estimated fair value had declined and remained below amortized cost by 20% or more for less than six months; and (iii) securities where the estimated fair value had declined and remained below amortized cost by 20% or more for six months or greater. While all of these securities are monitored for potential impairment, the Company's experience indicates that the first two categories do not present as great a risk of impairment, and often, fair values recover over time as the factors that caused the declines improve. The Company records writedowns 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. Writedowns of fixed maturities were $46 million and $63 million for the three months ended June 30, 2004 and 2003, respectively, and $52 million and $239 million for the six months ended June 30, 2004 and 2003, respectively. The Company's three largest writedowns totaled $32 million and $25 million for the three months ended June 30, 2004 and 2003, respectively, and $32 million and $101 million for the six months ended June 30, 2004 and 2003, respectively. The circumstances that gave rise to these impairments were either financial restructurings or bankruptcy filings. During the three months ended June 30, 2004 and 2003, the Company sold fixed maturities with a fair value of $5,920 million and $3,543 million, respectively, at a loss of $113 million and $55 million, respectively. During the six months ended June 30, 2004 and 2003, the Company sold fixed maturities with a fair value of $8,878 million and $7,752 million, respectively, at a loss of $178 million and $120 million, respectively. The following table presents the total gross unrealized losses for fixed maturities where the estimated fair value had declined and remained below amortized cost by: JUNE 30, 2004 ------------------------ GROSS UNREALIZED % OF LOSSES TOTAL ----------- ----- (DOLLARS IN MILLIONS) Less than 20% $1,735 96.6% 20% or more for less than six months 47 2.6 20% or more for six months or greater 15 0.8 ------ ------ Total $1,797 100.0% ====== ====== The gross unrealized loss related to the Company's fixed maturities at June 30, 2004 was $1,797 million. These fixed maturities mature as follows: 2% due in one year or less; 21% due in greater than one year to five years; 16% due in greater than five years to ten years; and 61% due in greater than ten years (calculated as a percentage of amortized cost). Additionally, such securities are concentrated by sector in U.S. corporates (33%); mortgage-backed (24%); and foreign corporates (14%); and are concentrated by industry in mortgage-backed (24%); utilities (12%); and finance (10%) (calculated as a percentage of gross unrealized loss). Non-investment grade securities represent 4% of the $66,940 million fair value and 8% of the $1,797 million gross unrealized loss. 69 The following table presents the amortized cost, gross unrealized losses and number of securities for fixed maturities where the estimated fair value had declined and remained below amortized cost by less than 20%, or 20% or more for: JUNE 30, 2004 -------------------------------------------------------------------------- AMORTIZED COST GROSS UNREALIZED LOSSES NUMBER OF SECURITIES -------------------- ----------------------- -------------------- LESS THAN 20% OR LESS THAN 20% OR LESS THAN 20% OR 20% MORE 20% MORE 20% MORE --------- ------ --------- ------ ---------- ------ (DOLLARS IN MILLIONS) Less than six months $62,568 $ 140 $ 1,445 $ 47 4,761 40 Six months or greater but less than nine months 979 31 30 11 102 2 Nine months or greater but less than twelve months 1,883 -- 93 -- 221 1 Twelve months or greater 3,132 4 167 4 511 8 ------- ------- ------- ------- ------- ------- Total $68,562 $ 175 $ 1,735 $ 62 5,595 51 ======= ======= ======= ======= ===== ======= The category of fixed maturity securities where the estimated fair value has declined and remained below amortized cost by less than 20% matures as follows: 2% due in one year or less; 21% due in greater than one year to five years; 16% due in greater than five years to ten years; and 61% due in greater than ten years (calculated as a percentage of amortized cost). Additionally, such securities are concentrated by sector in U.S. corporates (33%); mortgage-backed (25%); and foreign corporates (14%); and are concentrated by industry in mortgage-backed (25%); utilities (12%); and finance (10%) (calculated as a percentage of gross unrealized loss). Non-investment grade securities represent 3% of the $66,827 million fair value and 7% of the $1,735 million gross unrealized loss. The category of fixed maturity securities where the estimated fair value has declined and remained below amortized cost by 20% or more for less than six months matures as follows: 4% due in one year or less; 45% due in greater than five years to ten years; and 51% due in greater than ten years (calculated as a percentage of amortized cost). Additionally, such securities are concentrated by sector in U.S. corporates (40%); foreign corporates (19%); and asset-backed (16%); and are concentrated by industry in asset-backed (16%); services (15%); and finance (10%) (calculated as a percentage of gross unrealized loss). Non-investment grade securities represent 45% of the $93 million fair value and 42% of the $47 million gross unrealized loss. The category of fixed maturity securities where the estimated fair value has declined and remained below amortized cost by 20% or more for six months or greater matures as follows: 86% due in greater than five years to ten years; and 14% due in greater than ten years (calculated as a percentage of amortized cost). Additionally, such securities are concentrated by sector in foreign government (73%); and asset-backed (21%); and are concentrated by industry in government (73%); and finance (5%) (calculated as a percentage of gross unrealized loss). Non-investment grade securities represent 97% of the $20 million fair value and 78% of the $15 million gross unrealized loss. The Company held five fixed maturity securities each with a gross unrealized loss at June 30, 2004 greater than $10 million. One of these securities represents 73% of the gross unrealized loss on fixed maturities where the estimated fair value had declined and remained below amortized cost by 20% or more for six months or greater. 70 Corporate Fixed Maturities. The table below shows the major industry types that comprise the corporate bond holdings at: JUNE 30, 2004 DECEMBER 31, 2003 ---------------------- -------------------- ESTIMATED % OF ESTIMATED % OF FAIR VALUE TOTAL FAIR VALUE TOTAL ---------- ----- ---------- ----- (DOLLARS IN MILLIONS) Industrial $34,849 40.8% $34,474 40.9% Utility 10,493 12.3 9,955 11.8 Finance 14,665 17.2 14,287 17.0 Yankee/Foreign (1) 24,732 29.0 23,842 28.3 Other 612 0.7 1,675 2.0 ------- ----- ------- ----- Total $85,351 100.0% $84,233 100.0% ======= ===== ======= ===== - ---------- (1) Includes publicly traded, U.S. dollar-denominated debt obligations of foreign obligors, known as Yankee bonds, and other foreign investments. The Company maintains a diversified corporate bond portfolio across industries and issuers. The portfolio does not have exposure to any single issuer in excess of 1% of the total invested assets of the portfolio. At June 30, 2004, the Company's combined holdings in the ten issuers to which it had the greatest exposure totaled $4,663 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 held at June 30, 2004 was $632 million. The Company has hedged all of its material exposure to foreign currency risk in its invested assets. In the Company's international insurance operations, both its assets and liabilities are generally denominated in local currencies. Structured Securities. The following table shows the types of structured securities the Company held at: JUNE 30, 2004 DECEMBER 31, 2003 -------------------- -------------------- ESTIMATED % OF ESTIMATED % OF FAIR VALUE TOTAL FAIR VALUE TOTAL ---------- ----- ---------- ----- (DOLLARS IN MILLIONS) Residential mortgage-backed securities: Pass-through securities $14,085 25.5% $15,427 28.4% Collateralized mortgage obligations 16,613 30.1 16,027 29.5 ------- ----- ------- ----- Total residential mortgage-backed securities 30,698 55.6 31,454 57.9 Commercial mortgage-backed securities 12,019 21.8 11,031 20.3 Asset-backed securities 12,444 22.6 11,863 21.8 ------- ----- ------- ----- Total $55,161 100.0% $54,348 100.0% ======= ===== ======= ===== The majority of the residential mortgage-backed securities are guaranteed or otherwise supported by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation or the Government National Mortgage Association. At June 30, 2004 and December 31, 2003, $29,838 million and $31,210 million, respectively, or 97.2% and 99.2%, respectively, of the residential mortgage-backed securities were rated Aaa/AAA by Moody's or S&P. At June 30, 2004 and December 31, 2003, $8,387 million and $6,992 million, respectively, or 69.8% and 63.4%, respectively, of the commercial mortgage-backed securities were rated Aaa/AAA by Moody's or S&P. 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 maturity assets and to provide income. The Company's asset-backed securities are diversified both by sector and by issuer. Credit card and home equity loan securitizations, each accounting for about 29% and 27% of the total holdings, respectively, constitute the largest exposures in the Company's asset-backed securities portfolio. Asset-backed securities generally have limited sensitivity to changes in interest rates. Approximately $8,195 71 million and $7,528 million, or 65.9% and 63.5%, of total asset-backed securities were rated Aaa/AAA by Moody's or S&P at June 30, 2004 and December 31, 2003, respectively. Structured Investment Transactions. The Company participates in structured investment transactions, primarily asset securitizations and structured notes. These transactions enhance the Company's total return of the investment portfolio principally by generating management fee income on asset securitizations and by providing equity-based returns on debt securities through structured notes and similar instruments. The Company sponsors financial asset securitizations of high yield debt securities, investment grade bonds and structured finance securities and also is the collateral manager and a beneficial interest holder in such transactions. As the collateral manager, the Company earns management fees on the outstanding securitized asset balance, which are recorded in income as earned. When the Company transfers assets to a bankruptcy-remote SPE and surrenders control over the transferred assets, the transaction is accounted for as a sale. Gains or losses on securitizations are determined with reference to the carrying amount of the financial assets transferred, which is allocated to the assets sold and the beneficial interests retained based on relative fair values at the date of transfer. Beneficial interests in securitizations are carried at fair value in fixed maturities. Income on these beneficial interests is recognized using the prospective method in accordance with EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Certain Investments ("EITF 99-20"). The SPEs used to securitize assets are not consolidated by the Company because the Company has determined that it is not the primary beneficiary of these entities based on the framework provided in FIN 46 and the December 2003 revision FIN 46(r). Prior to the adoption of FIN 46(r), such SPEs were not consolidated because they did not meet the criteria for consolidation under previous accounting guidance. The Company purchases or receives beneficial interests in SPEs, which generally acquire financial assets, including corporate equities, debt securities and purchased options. The Company has not guaranteed the performance, liquidity or obligations of the SPEs and the Company's exposure to loss is limited to its carrying value of the beneficial interests in the SPEs. The Company uses the beneficial interests as part of its risk management strategy, including asset-liability management. These SPEs are not consolidated by the Company because the Company has determined that it is not the primary beneficiary of these entities based on the framework provided in FIN 46(r). Prior to the adoption of FIN 46(r), such SPEs were not consolidated because they did not meet the criteria for consolidation under previous accounting guidance. These beneficial interests are generally structured notes, as defined by EITF Issue No. 96-12, Recognition of Interest Income and Balance Sheet Classification of Structured Notes, which are included in fixed maturities, and their income is recognized using the retrospective interest method or the level yield method, as appropriate. Impairments of these beneficial interests are included in net investment gains (losses). MORTGAGE LOANS ON REAL ESTATE The Company's mortgage loans on real estate are collateralized by commercial, agricultural and residential properties. Mortgage loans on real estate comprised 12.4% and 11.8% of the Company's total cash and invested assets at June 30, 2004 and December 31, 2003, respectively. The carrying value of mortgage loans on real estate 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 on real estate by type at: JUNE 30, 2004 DECEMBER 31, 2003 --------------------- ----------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL -------- ----- -------- ----- (DOLLARS IN MILLIONS) Commercial $22,005 78.3% $20,300 77.3% Agricultural 5,377 19.1 5,327 20.3 Residential 736 2.6 622 2.4 ------- ----- ------- ----- Total $28,118 100.0% $26,249 100.0% ======= ===== ======= ===== 72 Commercial Mortgage Loans. The Company diversifies its commercial mortgage loans by both geographic region and property type. The following table presents the distribution across geographic regions and property types for commercial mortgage loans at: JUNE 30, 2004 DECEMBER 31, 2003 --------------------- -------------------- CARRYING % OF CARRYING % OF VALUE TOTAL VALUE TOTAL -------- ----- -------- ----- (DOLLARS IN MILLIONS) REGION South Atlantic $ 5,247 23.8% $ 4,978 24.5% Pacific 5,327 24.2 5,005 24.7 Middle Atlantic 3,513 16.0 3,455 17.0 East North Central 2,294 10.4 1,821 9.0 New England 1,302 5.9 1,278 6.3 West South Central 1,470 6.7 1,370 6.8 Mountain 785 3.6 740 3.6 West North Central 625 2.8 619 3.0 International 1,064 4.8 836 4.1 East South Central 278 1.3 198 1.0 Other 100 0.5 -- 0.0 ------- ----- ------- ----- Total $22,005 100.0% $20,300 100.0% ======= ===== ======= ===== PROPERTY TYPE Office $10,301 46.8% $ 9,170 45.2% Retail 5,221 23.7 5,006 24.7 Apartments 3,001 13.6 2,832 13.9 Industrial 1,951 8.9 1,911 9.4 Hotel 1,098 5.0 1,032 5.1 Other 433 2.0 349 1.7 ------- ----- ------- ----- Total $22,005 100.0% $20,300 100.0% ======= ===== ======= ===== Restructured, Delinquent or Under Foreclosure and Potentially Delinquent. The Company monitors its mortgage loan investments on an ongoing basis, including reviewing loans that are restructured, delinquent or under foreclosure and potentially delinquent. These loan classifications are consistent with those used in industry practice. The Company defines potentially delinquent loans as loans that, in management's opinion, have a high probability of becoming delinquent. 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 as loans in which foreclosure proceedings have formally commenced. The Company defines restructured mortgage loans 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. The Company reviews all mortgage loans on an ongoing 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 establishes valuation allowances for loans that it deems impaired. The Company's valuation allowance is established both on a loan specific basis for those loans where a property or market specific risk has been identified that could likely result in a future default, as well as for pools of loans with similar high risk characteristics where a property specific or market risk has not been identified. 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 (losses). 73 The following table presents the amortized cost and valuation allowance for commercial mortgage loans distributed by loan classification at: JUNE 30, 2004 DECEMBER 31, 2003 ------------------------------------------------ ---------------------------------------------- % OF % OF AMORTIZED % OF VALUATION AMORTIZED AMORTIZED % OF VALUATION AMORTIZED COST(1) TOTAL ALLOWANCE COST COST(1) TOTAL ALLOWANCE COST ------- ----- --------- ---- ------- ----- --------- ---- (DOLLARS IN MILLIONS) Performing $22,003 99.4% $ 91 0.4% $20,315 99.5% $ 95 0.5% Restructured 61 0.3 18 29.5% 77 0.4 23 29.9% Delinquent or under foreclosure 13 0.1 3 23.1% -- -- -- --% Potentially delinquent 47 0.2 7 14.9% 30 0.1 4 13.3% ------- ----- ---- ------- ----- ---- Total $22,124 100.0% $119 0.5% $20,422 100.0% $122 0.6% ======= ===== ==== ======= ===== ==== - ---------- (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: SIX MONTHS ENDED JUNE 30, 2004 --------------------- (DOLLARS IN MILLIONS) Balance, beginning of period $ 122 Additions -- Deductions (3) ----- Balance, end of period $ 119 ===== Agricultural Mortgage Loans. The Company diversifies its agricultural mortgage loans by both geographic region and product type. Approximately 68.4% of the $5,377 million of agricultural mortgage loans outstanding at June 30, 2004 were subject to rate resets prior to maturity. A substantial portion of these loans generally is 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: JUNE 30, 2004 DECEMBER 31, 2003 ----------------------------------------------- ------------------------------------------------ % OF % OF AMORTIZED % OF VALUATION AMORTIZED AMORTIZED % OF VALUATION AMORTIZED COST (1) TOTAL ALLOWANCE COST COST (1) TOTAL ALLOWANCE COST -------- ----- --------- -------- -------- ----- --------- -------- (DOLLARS IN MILLIONS) Performing $5,199 96.6% $ -- --% $5,162 96.7% $ -- --% Restructured 77 1.4 1 1.3% 111 2.1 1 0.9% Delinquent or under foreclosure 109 2.0 9 8.3% 36 0.7 2 5.6% Potentially delinquent 2 -- -- --% 24 0.5 3 12.5% ------ ----- ---- ------ ----- ---- Total $5,387 100.0% $ 10 0.2% $5,333 100.0% $ 6 0.1% ====== ===== ==== ====== ===== ==== - ---------- (1) Amortized cost is equal to carrying value before valuation allowances. 74 The following table presents the changes in valuation allowances for agricultural mortgage loans for the: SIX MONTHS ENDED JUNE 30, 2004 --------------------- (DOLLARS IN MILLIONS) Balance, beginning of period $ 6 Additions 4 Deductions - ----- Balance, end of period $ 10 ===== REAL ESTATE AND REAL ESTATE JOINT VENTURES The Company's real estate and real estate joint venture investments consist of commercial properties located primarily throughout the U.S. At June 30, 2004 and December 31, 2003, the carrying value of the Company's real estate, real estate joint ventures and real estate held-for-sale was $4,154 million and $4,680 million, respectively, or 1.8%, and 2.2% of total cash and invested assets, respectively. The carrying value of real estate is stated at depreciated cost net of impairments and valuation allowances. The carrying value of real estate joint ventures is stated at the Company's equity in the real estate joint ventures net of impairments and valuation allowances. The following table presents the carrying value of the Company's real estate, real estate joint ventures, real estate held-for-sale and real estate acquired upon foreclosure at: JUNE 30, 2004 DECEMBER 31, 2003 --------------------- --------------------- CARRYING CARRYING TYPE VALUE % OF TOTAL VALUE % OF TOTAL -------- ---------- -------- ---------- (DOLLARS IN MILLIONS) Real estate held-for-investment $3,779 91.0 % $3,531 75.4 % Real estate joint ventures held-for-investment 329 7.9 315 6.7 Foreclosed real estate held-for-investment 2 -- 2 0.1 ------ ----- ------ ----- 4,110 98.9 3,848 82.2 ------ ----- ------ ----- Real estate held-for-sale 44 1.1 831 17.8 Foreclosed real estate held-for-sale -- -- 1 -- ------ ----- ------ ----- 44 1.1 832 17.8 ------ ----- ------ ----- Total real estate, real estate joint ventures and real estate held-for-sale $4,154 100.0 % $4,680 100.0 % ====== ===== ====== ===== The Company's carrying value of real estate held-for-sale, including real estate acquired upon foreclosure of commercial and agricultural mortgage loans, in the amounts of $44 million and $832 million at June 30, 2004 and December 31, 2003, respectively, are net of valuation allowances of $0 million and $12 million, respectively. There were no impairments at June 30, 2004 and impairments of $2 million at December 31, 2003. 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. Certain of the Company's investments in real estate joint ventures meet the definition of a VIE under FIN 46(r). See "-- Variable Interest Entities." EQUITY SECURITIES AND OTHER LIMITED PARTNERSHIP INTERESTS The Company's carrying value of equity securities, which primarily consist of investments in common and preferred stocks and mutual fund interests, was $1,744 million and $1,598 million at June 30, 2004 and December 31, 2003, respectively. Equity securities include private equity securities with an estimated fair value of $537 million and $432 million at June 30, 2004 and December 31, 2003, respectively. 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 $2,805 million and $2,600 75 million at June 30, 2004 and December 31, 2003, 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 uses the equity method of accounting for investments in limited partnership interests in which it has more than a minor interest, has influence over the partnership's operating and financial policies and does not have a controlling interest. The Company uses the cost method for minor interest investments and when it has virtually no influence over the partnership's operating and financial policies. The Company's investments in equity securities excluding partnerships represented 0.8% and 0.7% of cash and invested assets at June 30, 2004 and December 31, 2003, respectively. Some of the Company's investments in other limited partnership interests meet the definition of a VIE under FIN 46(r). See " -- Variable Interest Entities." The following tables set forth the cost, gross unrealized gain or loss and estimated fair value of the Company's equity securities, as well as the percentage of the total equity securities at: JUNE 30, 2004 ---------------------------------------------------- GROSS UNREALIZED ---------------- ESTIMATED % OF COST GAIN LOSS FAIR VALUE TOTAL ------ ------ ------ ---------- ------ (DOLLARS IN MILLIONS) Equity Securities: Common stocks $ 848 $ 315 $ 20 $1,143 65.5 % Nonredeemable preferred stocks 589 21 9 601 34.5 ------ ------ ------ ------ ----- Total equity securities $1,437 $ 336 $ 29 $1,744 100.0 % ====== ====== ====== ====== ===== DECEMBER 31, 2003 ---------------------------------------------------- GROSS UNREALIZED ---------------- ESTIMATED % OF COST GAIN LOSS FAIR VALUE TOTAL ------ ------ ------ ---------- ------ (DOLLARS IN MILLIONS) Equity Securities: Common stocks $ 620 $ 334 $ 2 $ 952 59.6 % Nonredeemable preferred stocks 602 48 4 646 40.4 ------ ------ ------ ------ ----- Total equity securities $1,222 $ 382 $ 6 $1,598 100.0 % ====== ====== ====== ====== ===== Equity Security Impairment. The Company classifies all of its equity securities as available-for-sale and marks them to market through other comprehensive income. All securities with gross unrealized losses at the consolidated balance sheet date are subjected to the Company's process for identifying other-than-temporary impairments. The Company writes down to fair value securities that it deems to be other-than-temporarily impaired in the period the securities are deemed to be so impaired. The assessment of whether such impairment has occurred is based on management's case-by-case evaluation of the underlying reasons for the decline in fair value. Management considers a wide range of factors, as described below, about the security issuer and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used by the Company in the impairment evaluation process include, but are not limited to, the following: - length of time and the extent to which the market value has been below cost; - potential for impairments of securities when the issuer is experiencing significant financial difficulties, including a review of all securities of the issuer, including its known subsidiaries and affiliates, regardless of the form of the Company's ownership; - potential for impairments in an entire industry sector or sub-sector; - potential for impairments in certain economically depressed geographic locations; 76 - potential for impairments of securities where the issuer, series of issuers or industry has suffered a catastrophic type of loss or has exhausted natural resources; - the Company's ability and intent to hold the security for a period of time sufficient to allow for the recovery of its value to an amount equal to or greater than cost; and - other subjective factors, including concentrations and information obtained from regulators and rating agencies. Equity securities or other limited partnership interests which are deemed to be other-than-temporarily impaired are written down to fair value. The Company records writedowns as investment losses and adjusts the cost basis of the equity securities accordingly. The Company does not change the revised cost basis for subsequent recoveries in value. Writedowns of equity securities and other limited partnership interests were $4 million and $13 million for the three months ended June 30, 2004 and 2003, respectively, and $10 million and $90 million for the six months ended June 30, 2004 and 2003, respectively. During the three months ended June 30, 2004 and 2003, the Company sold equity securities with an estimated fair value of $5 million and $22 million, respectively, at a loss of $3 million and $1 million, respectively. During the six months ended June 30, 2004 and 2003, the Company sold equity securities with an estimated fair value of $88 million and $42 million, at a loss of $14 million and $6 million, respectively. The gross unrealized loss related to the Company's equity securities at June 30, 2004 was $29 million. Such securities are concentrated by security type in mutual funds (39%); and preferred stock (35%) and are concentrated by industry in domestic broad market mutual funds (39%); and financial (29%) (calculated as a percentage of gross unrealized loss). The following table presents the cost, gross unrealized losses and number of securities for equity securities where the estimated fair value had declined and remained below cost by less than 20%, or 20% or more for: JUNE 30, 2004 ------------------------------------------------------------------------------ COST GROSS UNREALIZED LOSSES NUMBER OF SECURITIES ---------------------- ----------------------- ---------------------- LESS THAN 20% OR LESS THAN 20% OR LESS THAN 20% OR 20% MORE 20% MORE 20% MORE --------- ------ --------- ------ --------- ------- (DOLLARS IN MILLIONS) Less than six months $ 375 $ 40 $ 13 $ 16 1,168 206 Six months or greater but less than nine months 2 -- -- -- 4 2 Nine months or greater but less than twelve months 1 -- -- -- 2 -- Twelve months or greater 2 -- -- -- 4 -- ----- ----- ----- ----- ----- --- Total $ 380 $ 40 $ 13 $ 16 1,178 208 ===== ===== ===== ===== ===== === The Company's review of its equity security exposure includes the analysis of total gross unrealized losses by three categories of securities: (i) securities where the estimated fair value had declined and remained below cost by less than 20%; (ii) securities where the estimated fair value had declined and remained below cost by 20% or more for less than six months; and (iii) securities where the estimated fair value had declined and remained below cost by 20% or more for six months or greater. While all of these securities are monitored for potential impairment, the Company's experience indicates that the first two categories do not present as great a risk of impairment, and often, fair values recover over time as the factors that caused the declines improve. The following table presents the total gross unrealized losses for equity securities at June 30, 2004 where the estimated fair value had declined and remained below cost by: JUNE 30, 2004 ------------------------ GROSS UNREALIZED % OF LOSSES TOTAL ---------- ------------ (DOLLARS IN MILLIONS) Less than 20% $ 13 44.8 % 20% or more for less than six months 16 55.2 20% or more for six months or greater -- -- ----- ------- Total $ 29 100.0 % ===== ======= 77 Equity securities where the estimated fair value has declined and remained below cost by less than 20% are concentrated by security type in preferred stock (77%); and mutual funds (12%); and concentrated by industry in financial (67%); and domestic broad market mutual funds (12%) (calculated as a percentage of gross unrealized loss). Equity securities where the estimated fair value has declined and remained below cost by 20% or more for less than six months are concentrated by security type in mutual funds (61%); and common stock (38%) and concentrated by industry in domestic broad market mutual funds (61%) (calculated as a percentage of gross unrealized loss). The significant factors considered at June 30, 2004 in the review of equity securities for other-than-temporary impairment were a result of generally difficult economic and market conditions. The Company did not hold any equity securities with a gross unrealized loss at June 30, 2004 greater than $5 million. OTHER INVESTED ASSETS The Company's other invested assets consist principally of leveraged leases and funds withheld at interest of $4.3 billion and $3.9 billion at June 30, 2004 and December 31, 2003, respectively. The leveraged leases are recorded net of non-recourse debt. The Company participates in lease transactions, which are diversified by industry, asset type and 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 agreements written on a coinsurance basis, assets supporting the reinsured policies equal to the net statutory reserves are withheld and continue to be legally owned by the ceding company. Other invested assets also include the fair value of embedded derivatives related to funds withheld and modified coinsurance contracts. Interest accrues to these funds withheld at rates defined by the treaty terms and may be contractually specified or directly related to the investment portfolio. The Company's other invested assets represented 2.3% and 2.1% of cash and invested assets at June 30, 2004 and December 31, 2003, respectively. DERIVATIVE FINANCIAL INSTRUMENTS The Company uses derivative instruments to manage risk through one of five principal strategies, the hedging of: (i) liabilities; (ii) invested assets; (iii) portfolios of assets or liabilities; (iv) net investments in certain foreign operations; and (v) firm commitments and forecasted transactions. Additionally, the Company enters into income generation and replication derivative transactions as permitted by its insurance subsidiaries' Derivatives Use Plans approved by the applicable state insurance departments. The Company's derivative hedging strategy employs a variety of instruments, including financial futures, financial forwards, interest rate swaps, caps and floors, credit default and foreign currency swaps and foreign currency forwards and options. The table below provides a summary of the notional amount and fair value of derivative financial instruments held at: JUNE 30, 2004 DECEMBER 31, 2003 ---------------------------------------- ------------------------------------- CURRENT MARKET CURRENT MARKET OR FAIR VALUE OR FAIR VALUE NOTIONAL ------------------------- NOTIONAL --------------------- AMOUNT ASSETS LIABILITIES AMOUNT ASSETS LIABILITIES -------- ------- ----------- -------- ------- ----------- (DOLLARS IN MILLIONS) Financial futures $ 806 $ 1 $ 9 $ 1,348 $ 8 $ 30 Interest rate swaps 13,235 264 79 9,944 189 36 Floors 325 1 -- 325 5 -- Caps 9,120 26 -- 9,345 29 -- Financial forwards 350 1 1 1,310 2 3 Foreign currency swaps 6,677 27 671 4,710 9 796 Options 3,731 4 -- 6,065 7 -- Foreign currency forwards 848 3 8 695 5 32 Credit default swaps 1,645 10 4 615 2 1 Synthetic GICs 5,459 -- -- 5,177 -- -- Other 150 -- -- -- -- -- ------- ------- ------- ------- ------- ------- Total contractual commitments $42,346 $ 337 $ 772 $39,534 $ 256 $ 898 ======= ======= ======= ======= ======= ======= 78 VARIABLE INTEREST ENTITIES The Company has adopted the provisions of FIN 46 and FIN 46(r). See "-- Application of Recent Accounting Pronouncements." The adoption of FIN 46(r) required the Company to consolidate certain VIEs for which it is the primary beneficiary. The following table presents the total assets of and maximum exposure to loss relating to VIEs for which the Company has concluded that (i) it is the primary beneficiary and which are consolidated in the Company's unaudited interim condensed consolidated financial statements at June 30, 2004, and (ii) it holds significant variable interests but it is not the primary beneficiary and which have not been consolidated: JUNE 30, 2004 ------------------------------------------------------ PRIMARY BENEFICIARY NOT PRIMARY BENEFICIARY ------------------------ ----------------------- MAXIMUM MAXIMUM TOTAL EXPOSURE TO TOTAL EXPOSURE TO ASSETS (1) LOSS (2) ASSETS (1) LOSS (2) ---------- ----------- ---------- ----------- (DOLLARS IN MILLIONS) Asset-backed securitizations and collateralized debt obligations $ -- $ -- $2,355 $ 16 Real estate joint ventures (3) 16 13 75 -- Other limited partnerships (4) 82 84 587 60 ------ ------ ------ ------ Total $ 98 $ 97 $3,017 $ 76 ====== ====== ====== ====== - -------- (1) The assets of the asset-backed securitizations and collateralized debt obligations are reflected at fair value as of June 30, 2004. The assets of the real estate joint ventures and other limited partnerships are reflected at the carrying amounts at which such assets would have been reflected on the Company's balance sheet had the Company consolidated the VIE from the date of its initial investment in the entity. (2) The maximum exposure to loss of the asset-backed securitizations and collateralized debt obligations is equal to the carrying amounts of retained interests. In addition, the Company provides collateral management services for certain of these structures for which it collects a management fee. The maximum exposure to loss relating to real estate joint ventures and other limited partnerships is equal to the carrying amounts plus any unfunded commitments, reduced by amounts guaranteed by other partners. (3) Real estate joint ventures include partnerships and other ventures, which engage in the acquisition, development, management and disposal of real estate investments. (4) Other limited partnerships include partnerships established for the purpose of investing in real estate funds, public and private debt and equity securities, as well as limited partnerships established for the purpose of investing in low-income housing that qualifies for federal tax credits. SECURITIES LENDING The Company participates in a securities lending program whereby blocks of securities, which are included in investments, are loaned to third parties, primarily major brokerage firms. The Company requires a minimum of 102% of the fair value of the loaned securities to be separately maintained as collateral for the loans. Securities with a cost or amortized cost of $26,842 million and $25,121 million and an estimated fair value of $27,484 million and $26,387 million were on loan under the program at June 30, 2004 and December 31, 2003, respectively. The Company was liable for cash collateral under its control of $28,132 million and $27,083 million at June 30, 2004 and December 31, 2003, respectively. Security collateral on deposit from customers may not be sold or repledged and is not reflected in the consolidated financial statements. SEPARATE ACCOUNTS 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 commingled basis in conformity with insurance laws. Effective with the adoption of SOP 03-1, the Company reports separately, as assets and liabilities, investments held in separate accounts and liabilities of the separate accounts if (i) such separate accounts are legally recognized; (ii) assets supporting the contract liabilities are legally insulated from the Company's general account liabilities; (iii) investments are 79 directed by the contractholder; and (iv) all investment performance, net of contract fees and assessments, is passed through to the contractholder. The Company reports separate account assets meeting such criteria at their fair value. Investment performance (including investment income, net investment gains (losses) and changes in unrealized gains (losses) and the corresponding amounts credited to contractholders are offset within the same line in the unaudited interim condensed consolidated statements of income. The Company's revenues reflect fees charged to the separate accounts, including mortality charges, risk charges, policy administration fees, investment management fees and surrender charges. Separate accounts not meeting the above criteria are combined on a line-by-line basis with the Company's general account assets, liabilities, revenues and expenses. Effective January 1, 2004, in accordance with the SOP 03-1 separate account reporting criteria, separate account assets with a fair value of $1.7 billion were reclassified to general account investments with a corresponding transfer of separate account liabilities to future policy benefits and policyholder account balances. See "--Application of Recent Accounting Pronouncements." 80 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company has material exposure to interest rate, equity market and foreign currency 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, including derivative instruments. The Company's market risk exposure at June 30, 2004 is relatively unchanged in amount from that reported on December 31, 2003, a description of which may be found in the 2003 Annual Report on Form 10-K. ITEM 4. CONTROLS AND PROCEDURES The Holding Company's management, with the participation of the Holding Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Holding Company's disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. There were no changes in the Holding Company's internal control over financial reporting as defined in Exchange Act Rule 13a-15(f) during the quarter ended June 30, 2004 that have materially affected, or are reasonably likely to materially affect, the Holding Company's internal control over financial reporting. 81 PART II - OTHER INFORMATION ITEM I. LEGAL PROCEEDINGS The following should be read in conjunction with Note 6 to the unaudited interim condensed consolidated financial statements in Part I of this Report. The Company is a defendant in a large number of litigation matters. In some of the matters, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Modern pleading practice in the United States permits considerable variation in the assertion of monetary damages or other relief. Jurisdictions may permit claimants to not specify the monetary damages sought or may permit claimants to state only that the amount sought is sufficient to invoke the jurisdiction of the trial court. In addition, jurisdictions may permit plaintiffs to allege monetary damages in amounts well exceeding reasonably possible verdicts in the jurisdiction for similar matters. This variability in pleadings, together with the actual experience of the Company in litigating or resolving through settlement numerous claims over an extended period of time, demonstrate to management that the monetary relief which may be specified in a lawsuit or claim bears little relevance to its merits or disposition value. Thus, unless stated below, the specific monetary relief sought is not noted. Due to the vagaries of litigation, the outcome of a litigation matter and the amount or range of potential loss at particular points in time may normally be inherently impossible to ascertain with any degree of certainty. Inherent uncertainties can include how fact finders will view individually and in their totality documentary evidence, the credibility and effectiveness of witnesses' testimony, and how trial and appellate courts will apply the law in the context of the pleadings or evidence presented, whether by motion practice, or at trial or on appeal. Disposition valuations are also subject to the uncertainty of how opposing parties and their counsel will themselves view the relevant evidence and applicable law. In this context, unless stated below, estimates of possible additional losses or ranges of loss for particular matters can not in the ordinary course be made with a reasonable degree of certainty. Liabilities are established when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. SALES PRACTICES CLAIMS As previously disclosed, over the past several years, Metropolitan Life, New England Mutual Life Insurance Company ("New England Mutual") and General American Life Insurance Company ("General American") have faced numerous claims, including class action lawsuits, alleging improper marketing and sales of individual life insurance policies or annuities. These lawsuits are generally referred to as "sales practices claims." Settlements have been reached in the sales practices class actions against Metropolitan Life, New England Mutual and General American. Certain class members have opted out of these class action settlements and have brought or continued non-class action sales practices lawsuits. In addition, other sales practices lawsuits have been brought. As of June 30, 2004, there are approximately 331 sales practices lawsuits pending against Metropolitan Life; approximately 40 sales practices lawsuits pending against New England Mutual, New England Life Insurance Company, and New England Securities Corporation (collectively, "New England"); and approximately 51 sales practices lawsuits pending against General American. The Company believes adequate provision has been made in its unaudited interim condensed consolidated financial statements for all probable and reasonably estimable losses for sales practices claims against Metropolitan Life, New England and General American. ASBESTOS-RELATED CLAIMS As previously reported, Metropolitan Life received approximately 60,300 asbestos-related claims in 2003. During the first six months of 2004 and 2003, Metropolitan Life received approximately 13,560 and 48,000 asbestos-related claims, respectively. Metropolitan Life also has been named as a defendant in a small number of silicosis, welding and mixed dust cases. The cases are pending in Mississippi, Texas, Ohio, Pennsylvania, West Virginia, Louisiana, Kentucky, Georgia, Alabama, Illinois, Colorado, Indiana and Arkansas. The Company intends to defend itself vigorously against these cases. Metropolitan Life continues to study its claims experience, review external literature regarding asbestos claims experience in the United States and consider numerous variables that can affect its asbestos liability exposure, including bankruptcies of other companies involved in asbestos litigation and legislative and judicial developments, to identify trends and to assess their impact on the recorded asbestos liability. 82 The Company believes adequate provision has been made in its unaudited interim condensed consolidated financial statements for all probable and reasonably estimable losses for asbestos-related claims. The ability of Metropolitan Life to estimate its ultimate asbestos exposure is subject to considerable uncertainty due to numerous factors. The availability of data is limited and it is difficult to predict with any certainty numerous variables that can affect liability estimates, including the number of future claims, the cost to resolve claims, the disease mix and severity of disease, the jurisdiction of claims filed, tort reform efforts and the impact of any possible future adverse verdicts and their amounts. The number of asbestos cases that may be brought or the aggregate amount of any liability that Metropolitan Life may ultimately incur is uncertain. Accordingly, 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 unaudited interim condensed 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 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. DEMUTUALIZATION ACTIONS Several lawsuits were brought in 2000 challenging the fairness of Metropolitan Life's plan of reorganization, as amended (the "plan") and the adequacy and accuracy of Metropolitan Life's disclosure to policyholders regarding the plan. These actions named as defendants some or all of Metropolitan Life, the Holding Company, the individual directors, the New York Superintendent of Insurance (the "Superintendent") 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 New York State court in New York County were consolidated within the commercial part of the New York State court. In addition, there remained a separate purported class action in New York State court in New York County. On February 21, 2003, the defendants' motions to dismiss both the consolidated action and separate action were granted; leave to replead as a proceeding under Article 78 of New York's Civil Practice Law and Rules has been granted in the separate action. On April 27, 2004, the appellate court modified the trial court's order by reinstating certain claims against Metropolitan Life, the Holding Company and the individual directors. 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 in connection with the plan. 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 in 2001. On February 4, 2003, plaintiffs filed a consolidated amended complaint adding a fraud claim under the Securities Exchange Act of 1934. Plaintiffs served a second consolidated amended complaint on April 2, 2004, and continue to assert violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. On June 22, 2004, the court denied the defendants' motion to dismiss the claim of violation of the Securities Exchange Act of 1934. 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. On April 30, 2004, a lawsuit was filed in New York state court in New York County against the Holding Company and Metropolitan Life on behalf of a proposed class comprised of the settlement class in the Metropolitan Life sales practices class action settlement approved in December 1999 by the United States District Court for the Western District of Pennsylvania. The complaint challenges the treatment of the cost of the sales practices settlement in the demutualization of Metropolitan Life and asserts claims of breach of fiduciary duty, common law fraud, and unjust enrichment. Plaintiffs seek compensatory and punitive damages, as well as attorneys' fees and costs. On May 24, 2004, the Holding Company and Metropolitan Life served a motion to dismiss the complaint. In October 2003, the United States District Court for the Western District of Pennsylvania dismissed plaintiffs' similar complaint alleging that the demutualization breached the terms of the 1999 settlement agreement and unjustly enriched the Holding Company and Metropolitan Life. In January 2004, plaintiffs' appeal of that decision to the United States Court of Appeals for the Third Circuit was dismissed. The Holding Company and Metropolitan Life intend to contest this matter vigorously. RACE-CONSCIOUS UNDERWRITING CLAIMS As previously reported, insurance departments in a number of states initiated inquiries in 2000 about possible race-conscious 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 affiliates. The New York Insurance Department concluded its examination of Metropolitan Life concerning possible past race-conscious underwriting practices. Four purported class action lawsuits filed against Metropolitan Life in 2000 and 2001 alleging racial discrimination in the marketing, sale, and administration of life insurance policies were consolidated in the United States District Court for the Southern District of New York. On April 28, 2003, the United States 83 District Court approved a class action settlement of the consolidated actions. Several persons filed notices of appeal from the order approving the settlement, but subsequently the appeals were dismissed. Metropolitan Life also entered into settlement agreements to resolve the regulatory examination. Twenty lawsuits involving approximately 140 plaintiffs were filed in federal and state court in Alabama, Mississippi and Tennessee alleging federal and/or state law claims of racial discrimination in connection with the sale, formation, administration or servicing of life insurance policies. Metropolitan Life resolved the claims of some of these plaintiffs through settlement, and some additional plaintiffs have voluntarily dismissed their claims. Metropolitan Life resolved claims of some additional persons who opted out of the settlement class referenced in the preceding paragraph but who had not filed suit. The actions filed in Alabama and Tennessee have been dismissed; two actions filed in Mississippi remain pending. Metropolitan Life is contesting plaintiffs' claims vigorously. The Company believes that adequate provision has been made to cover the costs associated with the resolution of these matters. OTHER A purported class action in which two policyholders seek to represent a class of owners of participating life insurance policies is pending in state court in New York. Plaintiffs assert that Metropolitan Life breached their policies in the manner in which it allocated investment income across lines of business during a period ending with the 2000 demutualization. In August 2003, an appellate court affirmed the dismissal of fraud claims in this action. Plaintiffs have served their motion to certify a litigation class. MetLife is vigorously defending the case. Regulatory bodies have contacted the Company and have requested information relating to market timing and late trading of mutual funds and variable insurance products and, generally, the marketing of products. The Company believes that many of these inquiries are similar to those made to many financial services companies as part of industry-wide investigations by various regulatory agencies. State Street Research Investment Services, one of the Company's indirect broker/dealer subsidiaries, has entered into a settlement with the NASD resolving all outstanding issues relating to its investigation. The SEC has commenced an investigation with respect to market timing and late trading in a limited number of privately-placed variable insurance contracts that were sold through General American. As previously reported, in May 2004, General American received a so-called "Wells Notice" stating that the SEC staff is considering recommending that the SEC bring a civil action alleging violations of the U.S. securities laws against General American. Under the SEC procedures, General American can avail itself of the opportunity to respond to the SEC staff before it makes a formal recommendation regarding whether any action alleging violations of the U.S. securities laws should be considered. General American has responded to the Wells Notice. The Company is fully cooperating with regard to these information requests and investigations. The Company at the present time is not aware of any systemic problems with respect to such matters that may have a material adverse effect on the Company's consolidated financial position. As previously reported, the Company has received from the Office of the Attorney General of the State of New York a subpoena seeking information regarding certain compensation agreements between insurance brokers and the Company. The Company is fully cooperating with the inquiry. 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. SUMMARY 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, except as noted above in connection with specific matters. 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 84 certain matters could, from time to time, have a material adverse effect on the Company's consolidated net income or cash flows in particular quarterly or annual periods. 85 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES Purchases of common stock made by or on behalf of the Holding Company during the three months ended June 30, 2004 are set forth below: ISSUER PURCHASES OF EQUITY SECURITIES (D) MAXIMUM NUMBER (OR APPROXIMATE DOLLAR (C) TOTAL NUMBER OF VALUE) OF SHARES THAT (B) AVERAGE PRICE SHARES PURCHASED AS PART MAY YET BE PURCHASED (A) TOTAL NUMBER OF PAID OF PUBLICLY ANNOUNCED UNDER THE PLANS OR SHARES PURCHASED(1) PER SHARE PLANS OR PROGRAMS(2) PROGRAMS PERIOD ------------------- ----------------- ------------------------ --------------------- - ------------------------ April 1 - April 30, 2004 - - - $ 644,406,343 May 1 - May 31, 2004 4,004,000 $ 33.89 4,004,000 $ 508,730,688 June 1 - June 30, 2004 2,081,881 $ 35.94 2,081,881 $ 433,901,324 Total 6,085,881 $ 34.59 6,085,881 $ 433,901,324 (1) During the periods reported above, there were no shares of Common Stock which were repurchased by the Holding Company other than through a publicly announced plan or program. (2) On February 19, 2002, the Holding Company's Board of Directors authorized a $1 billion common stock repurchase program. Under this authorization, the Holding Company may purchase its common stock from the MetLife Policyholder Trust, in the open market and in privately negotiated transactions. 86 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The information called for by this Item is incorporated herein by reference to Part II, Item 4. "Submission of Matters to a Vote of Security Holders" in MetLife, Inc.'s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004. 87 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.2 MetLife, Inc. Amended and Restated By-laws (effective July 27, 2004). 10.1 Five-Year Credit Agreement, dated as of April 23, 2004, among MetLife, Inc., Metropolitan Life Insurance Company, MetLife Funding, Inc. and the other parties signatory thereto. 10.2 364-Day Credit Agreement, dated as of April 23, 2004, among MetLife, Inc., Metropolitan Life Insurance Company, MetLife Funding, Inc. and the other parties signatory thereto. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K To date, the following current reports were filed on Form 8-K: 1. Form 8-K filed May 14, 2004 (dated May 14, 2004) attaching a press release announcing receipt by MetLife, Inc.'s subsidiary, General American Life Insurance Company, of a "Wells Notice" from the SEC. 2. Form 8-K filed June 3, 2004 (dated June 3, 2004) regarding offering of 5.50% senior notes and 6.375% senior notes and attaching relevant documentation. 3. Form 8-K filed June 14, 2004 (dated June 11, 2004) attaching a press release announcing receipt by MetLife, Inc. of a subpoena from the Office of the Attorney General of the State of New York. 4. Form 8-K filed June 22, 2004 (dated June 22, 2004) attaching a press release announcing certain organizational changes. 5. Form 8-K filed June 29, 2004 (dated June 29, 2004) attaching a press release announcing the resignation of John C. Danforth from the boards of directors of MetLife, Inc. and Metropolitan Life Insurance Company. 6. Form 8-K filed July 23, 2004 (dated July 23, 2004) regarding offering of additional 5.50% senior notes and additional 6.375% senior notes and attaching relevant documentation. 7. Form 8-K filed July 30, 2004 (dated July 29, 2004) regarding the issuance by the Internal Revenue Service of its audit report on Metropolitan Life Insurance Company and its subsidiaries for the years 1997-1999. 88 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/ Joseph J. Prochaska, Jr. -------------------------------- Name: Joseph J. Prochaska, Jr. Title: Senior Vice-President, Finance Operations and Chief Accounting Officer (Authorized Signatory and Chief Accounting Officer) Date: August 3, 2004 89 EXHIBIT INDEX EXHIBIT NUMBER EXHIBIT NAME ------- ------------ 3.2 MetLife, Inc. Amended and Restated By-laws (effective July 27, 2004). 10.1 Five-Year Credit Agreement, dated as of April 23, 2004, among MetLife, Inc., Metropolitan Life Insurance Company, MetLife Funding, Inc. and the other parties signatory thereto. 10.2 364-Day Credit Agreement, dated as of April 23, 2004, among MetLife, Inc., Metropolitan Life Insurance Company, MetLife Funding, Inc. and the other parties signatory thereto. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 90