Prudential Financial, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Unaudited U.S. GAAP consolidated results; dollar amounts are in millions unless noted. Prudential provides insurance, annuity, retirement, investment management and related financial services. Its principal divisions span U.S. workplace and individual solutions, PGIM, international insurance and the Closed Block.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenues | $15,388 | $14,655 | $30,479 | $28,412 |
| Income before tax and equity in operating joint ventures | $876 | $250 | $2,016 | $1,943 |
| Net income attributable to Prudential | $708 | $197 | $1,640 | $1,560 |
| Diluted earnings per share | $1.71 | $0.46 | $3.93 | $3.62 |
| Net investment income | $4,390 | $4,096 | $8,606 | $8,094 |
| Realized investment gains (losses), net | $(336) | $685 | $(1,102) | $1,110 |
- Cash flow: First-half operating cash flow was $8,324, versus $6,675 in 2018; investing cash flow was $(8,037), financing cash flow $(239). Cash, cash equivalents and restricted cash ended the period at $15,570, compared with $15,060 at year-end 2018.
- Balance sheet: Total assets were $873,825 and total equity $62,153 at June 30, compared with $815,078 and $49,031 at December 31, 2018. Separate-account assets and liabilities were each $303,580; these segregated customer assets should not be treated as general corporate liquidity.
- Investments: Total investments were $512,012. Available-for-sale fixed maturities had a fair value of $383,390. Net unrealized gains on investments in AOCI rose to $43,820 from $22,720 at year-end, mainly reflecting lower interest rates and tighter credit spreads.
- Debt and liquidity: Consolidated short- and long-term borrowings were $20,500, up $671 from year-end; balance-sheet short-term and long-term debt were $2,659 and $17,841. Prudential Financial, the parent, reported $5,664 of highly liquid assets ($4,867 excluding its intercompany liquidity account). No amounts were drawn on its syndicated committed credit facilities; PGIM’s separate $300 secured, limited-recourse facility was fully drawn. The company reported compliance with debt covenants.
- Capital: Management reported $51,274 of capital. Most recent reported domestic insurance RBC ratios were as of December 31, 2018: PICA 385%, PALAC 511%, and composite major U.S. subsidiaries 417%. Japanese subsidiary solvency ratios, as of March 31, 2019, were 806% for Prudential of Japan and 884% for Gibraltar Life.
Material changes and segment results
- Q2 revenue increased about 5% year over year and first-half revenue about 7%; attributable net income rose substantially in Q2 from a comparatively low prior-year quarter, while first-half net income increased about 5%.
- Management attributed a $1,624 favorable pre-tax year-over-year variance in Q2 and the first half to annual assumption reviews and other refinements, excluding the variable-annuity hedge program. A major comparison driver was Long-Term Care in Divested and Run-off Businesses: the prior-year period included a $1,458 charge from assumption updates, versus a $9 charge in Q2 2019. This makes the reported earnings comparison unusually sensitive to assumption-review items.
- Q2 adjusted operating income before tax was $1,653, versus $1,661 a year earlier; first-half adjusted operating income was $3,258, versus $3,382. This is a company-defined non-GAAP segment measure and is not equivalent to GAAP income.
- Q2 segment adjusted operating income improved in Retirement ($467 vs. $277), PGIM ($264 vs. $254) and International Insurance ($849 vs. $784); Individual Annuities declined ($462 vs. $507), Individual Life moved to a loss ($(135) vs. $43), and Corporate and Other losses widened ($(335) vs. $(286)). Management cited favorable assumption-review comparisons in Retirement and unfavorable mortality assumption updates in Individual Life.
- Variable-annuity embedded derivatives and associated hedges were a significant source of volatility: the reported net charge after non-performance risk, DAC and other costs was $532 in Q2 and $1,169 for the first half. Management cited declining interest rates in Q2 and tighter credit spreads together with falling rates for the first half. Reported realized investment losses were also materially affected by derivatives.
- PGIM assets under management reached $1.260 trillion, up from $1.161 trillion at year-end 2018; total Prudential AUM was $1.497 trillion. Market appreciation was a major contributor, while institutional and retail net flows were mixed.
Outlook, risks and unusual items
- Outlook: The filing provides no numerical earnings or revenue guidance. Management said a hypothetical U.S. low-rate scenario through year-end 2020 would not have a significant estimated impact on pre-tax adjusted operating income for that period. For Japanese operations, a hypothetical 25-basis-point lower new-money yield was estimated to reduce adjusted operating income by about $15 over the next 12 months; management cautioned that this scenario excludes several factors.
- Strategy and costs: Prudential began a multiyear acceleration of its U.S. Financial Wellness strategy, expecting significant technology, systems, severance and reskilling costs, with anticipated expense efficiencies and potential longer-term revenue growth. The filing does not quantify the total program cost or savings.
- Interest rates and markets: Low rates may pressure reinvestment yields, margins, guarantees, reserves, customer behavior and product economics. Equity, credit-spread and currency movements can affect earnings, AOCI, hedging and collateral needs. Prudential stated that its economic market-risk exposure had not materially changed from year-end.
- Regulatory and accounting: Japan issued corporate-insurance tax rules in July 2019; affected product sales had been suspended earlier in the year and Prudential was evaluating the impact. SEC best-interest requirements were scheduled to take effect June 30, 2020, with expected compliance costs. The pending long-duration insurance accounting standard was expected to have a significant financial-statement impact; Prudential was still assessing the amount.
- Legal and contingencies: Estimated reasonably possible litigation and regulatory losses in excess of established accruals were less than $250. Prudential was discussing a possible SEC settlement concerning securities-lending and foreign-tax-reclaim matters; the outcome could not be predicted. Management did not expect pending matters, after reserves and indemnification, to materially adversely affect financial position, but acknowledged unfavorable outcomes could affect results or cash flow.
- Capital returns and subsequent event: Prudential repurchased about $1.0 billion of shares in the first half under a $2.0 billion 2019 authorization and declared $2.00 per share in dividends for the first half. In August 2019, holders exchanged $500 million of surplus notes for approximately 6.2 million shares, satisfying the note obligations.
Important facts for investors to verify
- How much of the earnings improvement reflects recurring operating performance versus the prior-year Long-Term Care assumption-review charge and other reserve/DAC changes.
- The sensitivity of variable-annuity guarantees, derivative hedges and collateral liquidity to further interest-rate, equity-market and credit-spread movements.
- Current and expected statutory capital and liquidity at the regulated insurance subsidiaries, including restrictions on transfers to the parent.
- The status, potential financial remedies and timing of the SEC securities-lending and foreign-tax-reclaim matters, and any changes to the estimated litigation-loss range.
- The cost, implementation progress and measurable savings or growth outcomes of the Financial Wellness transformation, as well as the eventual impact of new regulation and insurance-accounting standards.