Why Brighthouse Financial's Discount to Book Value Persists

Brighthouse Financial shares have gained about 9% over the past year. That return lags most life insurers. The annuity writer, spun off from MetLife in 2017, trades at a discount to book value that has shown little sign of narrowing since the separation.

The discount reflects uncertainty around Brighthouse's core business: fixed and variable annuities. The company reported a net loss in one quarter last year, partly because of hedging costs tied to the variable annuity book. Operating earnings have been volatile. Steady cash flow from the fixed annuity block supports the franchise. Variable annuity hedging costs and regulatory overhang weigh on valuation.

The variable annuity business exposes Brighthouse to interest rate and equity market risk. The guarantees embedded in those contracts require the company to hold reserves that rise when rates fall or markets decline. A rising-rate environment should normally compress a discount to book value for an insurer. Brighthouse has not delivered the earnings acceleration to justify that compression. The stock's 9% gain over the past year reflects the market's wait-and-see stance.

Brighthouse is the largest standalone annuity issuer in the U.S. That scale gives it a cost advantage in administering its block of policies. Concentration in annuities also means the company has no cushion from life insurance or retirement plan businesses that could offset volatility in the variable annuity line. Peers like MetLife and Prudential Financial trade at or above book value. Brighthouse's discount to book value has persisted because the market prices in the risk of a negative shock to reserves.

The second-quarter earnings call, expected in late July, is the next event that could shift sentiment. Analysts will focus on two metrics: fee-based earnings from the annuity book, and the pace of share buybacks. Brighthouse bought back $150 million of stock last year. Management has indicated that pace could accelerate if regulatory changes to reserve requirements go through. State insurance regulators are reviewing reserve methodologies for variable annuities. Any easing would free up capital for buybacks.

The discount could widen rather than narrow. An earnings miss would be the most direct trigger. A Federal Reserve rate cut would increase the present value of guaranteed annuity benefits, forcing higher reserve charges. That dynamic has kept some institutional investors on the sidelines. A downgrade from A.M. Best would also hurt. The company currently holds an A- rating. A downgrade would raise collateral costs for its hedging program and could force it to post additional margin. A loss in the lawsuit over variable annuity sales practices, now in early discovery, could add to the regulatory reserve burden. The company has not set aside a material amount.

The third-party asset management platform launched two years ago has generated modest fee income so far. Until that unit scales and diversifies revenue, the valuation discount will likely persist. Brighthouse remains largely a bet on its annuity block and the regulatory environment.

The next test comes with the second-quarter earnings call. The gap between book value and market price has no single trigger for convergence. The operating trajectory and management's buyback plans will determine whether the discount shrinks or expands.