Our interest rate sensitive life products include traditional and universal life products. Since most of our traditional life insurance is participating, we can mitigate gross margin compression by adjusting the applicable dividend scale. For our universal life products, we manage interest rate risk through a combination of product design features and ALM strategies, including the use of interest rate derivatives. Although we are able mitigate gross margin compression by lowering interest crediting rates on certain in-force universal life policies, these actions may be partially offset by increased liabilities for policies with secondary guarantees.
Our DAC and VOBA balance is also impacted by unrealized investment gains (losses) and the amount of amortization which would have been recognized if such gains and losses had been realized. The increase in unrealized investment gains (losses) decreased the DAC and VOBA balance by $1.5 billion in 2019. The decrease in unrealized investment gains (losses) increased the DAC and VOBA balance by $521 million in 2018. See Notes 5 and 8 of the Notes to the Consolidated Financial Statements for information regarding the DAC and VOBA offset to unrealized investment gains (losses).
In the third quarter of 2019, we tested the MetLife Holdings life insurance reporting unit for impairment using the actuarial based embedded value fair valuation approach. The estimated fair value of the reporting unit exceeded the carrying value by approximately 43% and, therefore, the reporting unit was not impaired. If we had assumed that the discount rate was 100 basis points higher than the discount rate used, the estimated fair value of the MetLife Holdings life insurance reporting unit would have been higher than the carrying value by approximately 22%. This reporting unit consists of operations relating to products and businesses we no longer actively market. As of December 31, 2019, the amount of goodwill allocated to this reporting unit was $887 million.
The unfavorable change in net derivative gains (losses) on VA program derivatives was $475 million ($375 million, net of income tax). This was due to an unfavorable change of $249 million ($197 million, net of income tax) in the nonperformance risk adjustment on embedded derivatives and an unfavorable change of $235 million ($186 million, net of income tax) in freestanding derivatives hedging market risks in embedded derivatives, net of market risks in embedded derivatives, partially offset by a favorable change of $9 million, ($7 million, net of income tax) in other risks in embedded derivatives. Other risks relate primarily to the impact of policyholder behavior and other non-market risks that generally cannot be hedged.
Expenses and Taxes. Adjusted earnings decreased by $6 million, primarily driven by higher expenses in Europe due to transformation costs and regulatory fees, partially offset by lower costs associated with enterprise-wide initiatives. Adjusted earnings increased by $6 million due to reduced tax charges as a result of recently issued tax regulations related to U.S. Tax Reform and the filing of the Company’s 2018 U.S. tax return, partially offset by the prior period release of provisions arising from the finalization of historical corporate tax filings and changes in business mix among tax jurisdictions.
Other. Adjusted earnings increased $30 million, primarily as a result of lower interest expenses on certain tax positions, lower legal expenses and declines in various other expenses, partially offset by a loss related to the sale of a run-off business that was previously reinsured, as well as increases in certain corporate-related expenses.
As a global insurance company, we continue to be impacted by the changing global financial and economic environment, as well as the monetary policy of central banks around the world. See “- Industry Trends - Financial and Economic Environment.” Measures taken by central banks, including with respect to the level of interest rates, may have an impact on the pricing levels of risk-bearing investments and may adversely impact our business operations, investment portfolio and derivatives. The current environment continues to impact our net investment income, net investment gains (losses), net derivative gains (losses), level of unrealized gains (losses) within the various asset classes in our investment portfolio, and our level of investment in lower yielding cash equivalents, short-term investments and government securities. See “Risk Factors - Economic Environment and Capital Markets Risks - Difficult Economic Conditions May Harm Our Businesses, Results of Operations or Financial Condition.”
Selected Sector: Our exposure to energy sector fixed maturity securities AFS was $10.0 billion, of which 89% were investment grade, with unrealized gains of $849 million at December 31, 2019. We maintain a diversified energy sector fixed maturities securities portfolio across sub-sectors and issuers. This portfolio comprised less than 3% of total investments at December 31, 2019.
The tables above reflect NRSRO ratings including Moody’s, S&P, Fitch and Morningstar. CMBS designated NAIC 1 were 97.1% and 98.3% of total CMBS at December 31, 2019 and 2018, respectively.
In terms of total account value, GMIBs are our most significant living benefit guarantee. Our primary risk management strategy for our GMIB products is our derivatives hedging program as discussed below. Additionally, we have engaged in certain reinsurance agreements covering some of our GMIB business. As part of our overall risk management approach for living benefit guarantees, we continually monitor the reinsurance markets for the right opportunity to purchase additional coverage for our GMIB business. We stopped selling GMIBs in February 2016.
Our risk mitigating hedging strategy uses various OTC and exchange traded derivatives. The table below presents the gross notional amount, estimated fair value and primary underlying risk exposure of the derivatives hedging our variable annuity guarantees:
The amount of dividends that our insurance subsidiaries can pay to MetLife, Inc. or to other parent entities is constrained by the amount of surplus we hold to maintain our ratings and provides an additional margin for risk protection and investment in our businesses. We proactively take actions to maintain capital consistent with these ratings objectives, which may include adjusting dividend amounts and deploying financial resources from internal or external sources of capital. Certain of these activities may require regulatory approval. Furthermore, the payment of dividends and other distributions to MetLife, Inc. and other parent entities by their respective insurance subsidiaries is governed by insurance laws and regulations. See “Business - Regulation - Insurance Regulation,” “- MetLife, Inc. - Liquidity and Capital Sources - Dividends from Subsidiaries” and Note 16 of the Notes to the Consolidated Financial Statements.
Credit ratings indicate the rating agency’s opinion regarding a debt issuer’s ability to meet the terms of debt obligations in a timely manner. They are important factors in our overall funding profile and ability to access certain types of liquidity. The level and composition of regulatory capital at the subsidiary level and our equity capital are among the many factors considered in determining our insurer financial strength ratings and credit ratings. Each agency has its own capital adequacy evaluation methodology, and assessments are generally based on a combination of factors. In addition to heightening the level of scrutiny that they apply to insurance companies, rating agencies have increased and may continue to increase the frequency and scope of their credit reviews, may request additional information from the companies that they rate and may adjust upward the capital and other requirements employed in the rating agency models for maintenance of certain ratings levels.
For the years ended December 31, 2019 and 2018, we borrowed $3.0 billion and $3.1 billion, respectively, and repaid $3.0 billion and $2.6 billion, respectively, under advance agreements with the FHLB of Boston. At both December 31, 2019 and 2018, total obligations outstanding under these advance agreements were $800 million. See Note 8 of the Notes to the Consolidated Financial Statements.
Dividends are paid quarterly on the Series A preferred stock. Dividends are paid semi-annually on MetLife, Inc.’s 5.25% Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series C, until June 15, 2020 and, thereafter, will be paid quarterly. Dividends are paid semi-annually on the Series D preferred stock, in September and March until March 15, 2028 and, thereafter, will be paid quarterly. Dividends are paid quarterly on the Series E preferred stock.
At December 31, 2019 and 2018, MetLife, Inc. and other MetLife holding companies had $4.2 billion and $3.0 billion, respectively, in liquid assets. Of these amounts, $3.0 billion and $2.4 billion were held by MetLife, Inc. and $1.2 billion and $607 million were held by other MetLife holding companies at December 31, 2019 and 2018, respectively. Liquid assets include cash and cash equivalents, short-term investments and publicly-traded securities, excluding assets that are pledged or otherwise committed. Assets pledged or otherwise committed include amounts received in connection with derivatives and a collateral financing arrangement.
We proactively manage target and excess capital levels and dividend flows and forecast local capital positions as part of the financial planning cycle. The dividend capacity of certain U.S. and non-U.S. subsidiaries is also subject to business targets in excess of the minimum capital necessary to maintain the desired rating or level of financial strength in the relevant market. See “Risk Factors - Capital Risks - As a Holding Company, MetLife, Inc. Depends on the Ability of Its Subsidiaries to Pay Dividends, a Major Component of Holding Company Free Cash Flow” and Note 16 of the Notes to the Consolidated Financial Statements.
Any of these financial measures shown on a constant currency basis reflect the impact of changes in foreign currency exchange rates and are calculated using the average foreign currency exchange rates for the most recent period and applied to the comparable prior period (“constant currency basis”).
The critical audit matters communicated below are matters arising from the current-period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
evaluated the methods, models, and judgments applied by management in the determination of principal assumptions and the calculation of embedded derivative liabilities.
VOBA is an intangible asset resulting from a business combination that represents the excess of book value over the estimated fair value of acquired insurance, annuity, and investment-type contracts in-force at the acquisition date. The estimated fair value of the acquired liabilities is based on projections, by each block of business, of future policy and contract charges, premiums, mortality and morbidity, separate account performance, surrenders, operating expenses, investment returns, nonperformance risk adjustment and other factors. Actual experience with the purchased business may vary from these projections.
Annuities funding structured settlement claims represent annuities funding claims assumed by the Company in its capacity as a structured settlements assignment company. The annuities are stated at their contract value, which represents the present value of the future periodic claim payments to be provided. The net investment income recognized reflects the amortization of discount of the annuity at its implied effective interest rate.
Net investment in a foreign operation (“NIFO”) hedge - in OCI, consistent with the translation adjustment for the hedged net investment in the foreign operation.
ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as clarified and amended by ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, ASU 2019-05, Financial Instruments-Credit Losses (Topic 326): Targeted Transition Relief, and ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments-Credit Losses
The Company incurred pre-tax Separation-related transaction costs of $470 million for the year ended December 31, 2017, primarily related to fees for the terminations of financing arrangements and professional services. For the year ended December 31, 2017, the Company reported $333 million within discontinued operations for fees for the terminations of financing arrangements and costs required to complete the Separation. All other Separation-related transaction costs are recorded in other expenses and reported within continuing operations.
Separate account assets and liabilities include two categories of account types: pass-through separate accounts totaling $142.5 billion and $129.2 billion at December 31, 2019 and 2018, respectively, for which the policyholder assumes all investment risk, and separate accounts for which the Company contractually guarantees either a minimum return or account value to the policyholder which totaled $45.9 billion and $46.4 billion at December 31, 2019 and 2018, respectively. The latter category consisted primarily of guaranteed interest contracts (“GICs”). The average interest rate credited on these contracts was 2.92% and 2.60% at December 31, 2019 and 2018, respectively.
The following table presents the fixed maturity securities AFS by sector. U.S. corporate and foreign corporate sectors include redeemable preferred stock. RMBS includes agency, prime, alternative and sub-prime mortgage-backed securities. ABS includes securities collateralized by corporate loans and consumer loans. Municipals includes taxable and tax-exempt revenue bonds and, to a much lesser extent, general obligations of states, municipalities and political subdivisions. Commercial mortgage-backed securities (“CMBS”) primarily includes securities collateralized by multiple commercial mortgage loans. RMBS, ABS and CMBS are collectively, “Structured Products.”
The amortized cost of securities is adjusted for OTTI in the period in which the determination is made. The Company does not change the revised cost basis for subsequent recoveries in value.
Future contractual receipts under direct financing leases as of December 31, 2019 are $104 million in 2020, $98 million in 2021, $104 million in 2022, $108 million in 2023, $95 million in 2024, $1.4 billion thereafter, and in total $1.9 billion.
The Company’s PCI investments had an outstanding principal balance of $3.3 billion and $4.0 billion at December 31, 2019 and 2018, respectively, which represents the contractually required principal and accrued interest payments whether or not currently due and a carrying value (estimated fair value of the investments plus accrued interest) of $2.7 billion and $3.3 billion at December 31, 2019 and 2018, respectively. Accretion of accretable yield on PCI investments recognized in earnings in net investment income was $178 million and $275 million for the years ended December 31, 2019 and 2018, respectively. Purchases of PCI investments were insignificant in both of the years ended December 31, 2019 and 2018.
At December 31, 2019 and 2018, the balance in AOCI associated with cash flow hedges was $2.2 billion and $2.1 billion, respectively.
The receivable for the return of cash collateral provided by the Company is inclusive of initial margin on exchange-traded and OTC-cleared derivatives and is included in premiums, reinsurance and other receivables on the balance sheet. The amount of cash collateral offset in the table above is limited to the net estimated fair value of derivatives after application of netting agreements. At December 31, 2019 and 2018, the Company received excess cash collateral of $389 million and $135 million, respectively, and provided excess cash collateral of $266 million and $226 million, respectively, which is not included in the table above due to the foregoing limitation.
Total assets included in the fair value hierarchy exclude other limited partnership interests that are measured at estimated fair value using the net asset value (“NAV”) per share (or its equivalent) practical expedient. At December 31, 2019 and 2018, the estimated fair value of such investments was $95 million and $145 million, respectively.
Operating lease expense was $342 million and $374 million for the years ended December 31, 2018 and 2017, respectively. Non-cancelable sublease income was $72 million and $46 million for the years ended December 31, 2018 and 2017, respectively.
The declaration, record and payment dates, as well as per share and aggregate dividend amounts, for MetLife, Inc.’s common stock were as follows for the years ended December 31, 2019, 2018 and 2017:
MetLife granted cash-settled awards based in whole or in part on the price of Shares or changes in the price of Shares (“Phantom Stock-Based Awards”) under the MetLife, Inc. International Unit Option Incentive Plan, the MetLife International Performance Unit Incentive Plan, and the MetLife International Restricted Unit Incentive Plan prior to 2015, and under the 2015 Stock Plan in 2015 and later.
The decreases in 2019 and 2018 are primarily related to the tax audit settlement, of which $377 million and $284 million, respectively, was reclassified to the current income tax payable account.
MetLife, Inc. lends funds as necessary, through credit agreements or otherwise to its subsidiaries, some of which are regulated, to meet their capital requirements or to provide liquidity. Payments of interest and principal on surplus notes of regulated subsidiaries, which are subordinate to all other obligations of the issuing company, may be made only with the prior approval of the insurance department of the state of domicile.
The aggregate maturities of long-term debt at December 31, 2019 for the next five years and thereafter are $244 million in 2020, $997 million in 2021, $500 million in 2022, $1.3 billion in 2023, $1.5 billion in 2024 and $9.8 billion thereafter.