Prudential Financial, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; balance-sheet comparisons are with December 31, 2019. Prudential provides insurance, annuities, retirement services, and investment management. Results were heavily affected by COVID-19-related financial-market volatility. Interim results are not necessarily indicative of full-year results.
Key financial results
| Metric | Q1 2020 | Q1 2019 or prior date |
|---|---|---|
| Total revenue | $13.464 billion | $15.091 billion |
| Net income (loss) attributable to Prudential | $(271) million | $932 million |
| Diluted EPS | $(0.70) | $2.22 |
| Segment adjusted operating income before tax | $1.192 billion | $1.605 billion |
| Net cash from operating activities | $14.766 billion | $3.085 billion |
| Total assets | $873.712 billion | $896.552 billion |
| Total equity | $61.072 billion | $63.719 billion |
| Short- and long-term debt, consolidated | $22.688 billion | $20.579 billion |
Revenue decreased about 11% year over year. The company reported a pretax loss of $338 million, compared with pretax income of $1.140 billion. The filing does not provide a directly comparable consolidated operating margin; reported results combine insurance, investment, and market-sensitive items.
Operating cash flow rose substantially, but included a $15.388 billion net cash-flow contribution from derivatives in the reconciliation. It should not be treated as a straightforward measure of recurring cash generation. Cash and cash equivalents were $31.646 billion at quarter-end; cash, cash equivalents, and restricted cash totaled $31.797 billion.
At March 31, total investments were $524.676 billion. Fixed-maturity available-for-sale securities had a $389.714 billion fair value and $7.125 billion in gross unrealized losses. Net unrealized gains on fixed-maturity investments, excluding trading securities, were $40.552 billion, down from $44.891 billion at year-end. The company recorded a $158 million allowance for credit losses on available-for-sale securities and $240 million on commercial mortgage and other loans.
Prudential reported $5.293 billion of highly liquid assets at the parent holding company, excluding net intercompany borrowings. Significant insurance subsidiaries remained at capital levels consistent with management’s ratings targets. The company’s reported total capital measure was $52.429 billion, defined to exclude AOCI from equity and include capital debt.
Material changes and drivers
- The year-over-year net-income decline reflected market-related losses and assumption updates. Management cited unfavorable pretax variances of $1.383 billion from investment-related activity recorded in other income, $1.006 billion from market-experience updates, and $809 million from changes in variable-annuity embedded derivatives and related hedges. A $2.444 billion favorable pretax variance from realized investment gains and losses partially offset these items.
- Realized investment gains were $1.667 billion versus losses of $766 million a year earlier, largely reflecting derivative results. Conversely, other income was a loss of $2.591 billion versus income of $1.254 billion, including unfavorable changes in equity securities and assets supporting experience-rated contracts.
- Quarter-end assets fell by $22.840 billion from year-end, including a $39.614 billion decline in separate-account assets. Separate-account assets and liabilities are generally matched, with investment risks borne by customers except where guarantees apply.
- Unrealized investment losses reduced accumulated other comprehensive income; Prudential’s equity declined to $60.447 billion from $63.115 billion.
- Adjusted operating income before tax declined across PGIM ($164 million versus $214 million), U.S. Businesses ($619 million versus $881 million), and International Businesses ($751 million versus $922 million). Assurance IQ, acquired in October 2019, contributed a $23 million adjusted operating loss.
Outlook, risks, and notable items
- COVID-19: Management said ultimate effects could not be estimated. It expected approximately $200 million of adverse underwriting impact across businesses, with more than half in Q2, under assumptions including 100,000 U.S. deaths and 40,000 deaths in Japan. It also expected approximately $230 million of additional 2020 expenses, with more than half in Q2. These are estimates, not guarantees.
- Management anticipated near-term pressure on sales, investment-management fees, account values, and claims experience. Risks include credit deterioration and defaults, mortality and morbidity, policyholder behavior, low interest rates, market-sensitive guarantees, derivative collateral needs, and potential liquidity and capital pressure. Most employees had moved to remote work; the company reported no expected significant interruption to critical operations at filing.
- Under a specified low-rate scenario, Prudential estimated an unfavorable net-investment-income impact of $40 million–$80 million over the following 12 months for U.S. operations and a separate $40 million–$80 million for Japanese operations.
- To support liquidity and capital, Prudential issued $1.5 billion of senior notes and $800 million of surplus notes during Q1, added capital hedges, and suspended common-stock repurchases beginning April 1. It had repurchased $500 million of shares in Q1 and declared $1.10 per share in dividends. No amounts were drawn on its committed credit facilities at March 31.
- Korea sale: On April 10, 2020, Prudential agreed to sell its Korean insurance business for approximately $1.9 billion, subject to approvals and closing conditions. Management expected a $600 million after-tax charge in Q2 to adjust the business to the purchase price, and an approximately $100 million tax expense at closing, offset by an AOCI benefit. These amounts could change.
- Credit and legal matters: Management identified energy and consumer-cyclical exposures as vulnerable to pandemic-related stress. It estimated reasonably possible litigation and regulatory losses in excess of established accruals at less than $250 million where estimable, while noting outcomes remain uncertain. A shareholder demand and related securities litigation were ongoing.
- The company adopted the CECL credit-loss standard on January 1, 2020, reducing opening retained earnings by $99 million. It expects the long-duration insurance accounting standard to take effect January 1, 2022 and anticipates material financial-statement and earnings-pattern effects; the magnitude was still being assessed.
Most important facts for investors to verify
- How much of Q1’s reported loss and cash-flow increase reflects volatile derivative, market-value, and other nonrecurring effects, versus ongoing insurance and fee-based operations.
- Whether COVID-19 claims, expenses, credit losses, policyholder withdrawals, and sales trends exceed management’s estimates, and how those developments affect statutory capital and liquidity.
- The performance of variable-annuity guarantees and hedges, including the substantial quarter-over-quarter increase in the net embedded-derivative liability and related sensitivity to markets and assumptions.
- Whether the Korea sale closes on expected terms and timing, and the ultimate charge, tax, and hedge-settlement effects.
- How credit quality and collateral values evolve in energy, commercial real estate, and other exposed investments, as well as developments in litigation and regulatory matters.