Prudential Financial, Inc. — Q1 2018 Form 10-Q
Business context and period: The filing reports unaudited results for the three months ended March 31, 2018, and financial position at March 31, 2018. Prudential provides insurance, annuity, retirement, and investment-management products in the U.S. and internationally. Amounts below are in U.S. dollars; financial figures are generally in millions unless stated otherwise.
Financial performance and position
- Revenue and earnings: Revenue was $13,757, up 0.6% from $13,670 a year earlier. Income before tax and equity earnings of operating joint ventures declined to $1,693 from $1,742. Net income attributable to Prudential was $1,363 versus $1,369; diluted EPS was $3.14 versus $3.09. Dividends declared per share rose to $0.90 from $0.75.
- Revenue and expense mix: Premiums increased to $7,311 from $6,481; asset-management and service fees rose to $1,026 from $951. Net investment income fell to $3,998 from $4,061. Other income (loss) was $(507), compared with income of $217. Benefits and expenses increased to $12,064 from $11,928.
- Cash flow: Operating cash flow was $2,301, versus $1,648; investing cash outflow was $2,273, versus $3,019; financing cash inflow was $889, versus $430. Cash, cash equivalents and restricted cash ended the quarter at $15,757, up from $14,536 at year-end 2017.
- Balance sheet and debt: Total assets were $829,677, down from $832,136 at December 31, 2017. Total liabilities were $777,502; total equity was $52,175, down from $54,511. Investments totaled $471,491. Short- and long-term debt totaled $19,526, up from $18,552 at year-end; the company reported compliance with debt covenants.
- Liquidity and capital: Prudential Financial reported $5,864 of highly liquid assets at the parent level, excluding the intercompany liquidity account balance of $741. Its targeted minimum parent-company highly liquid asset balance is $1.3 billion. Reported capital was $49.5 billion. The latest reported RBC ratios, as of December 31, 2017, were 410% for Prudential Insurance and 529% for the composite major U.S. insurance subsidiaries; these are not March 31 figures.
- Margins and segment measure: GAAP pretax income as a share of revenue was approximately 12.3%, compared with 12.7% a year earlier. Segment adjusted operating income before tax, a non-GAAP management measure, rose to $1,721 from $1,660.
Material changes versus the prior comparable period
- Reported attributable net income was nearly flat, while pretax income decreased. Management cited a $268 unfavorable pretax comparison from divested businesses and a $205 unfavorable variance in realized investment gains and losses (excluding the variable-annuity hedging program). These were partly offset by a $360 favorable variance from variable-annuity embedded derivatives and related hedges, and by higher segment operating results and lower tax expense.
- Adjusted operating income improved in Individual Annuities ($519 versus $468), Group Insurance ($55 versus $34), Investment Management ($232 versus $196), and International Insurance ($856 versus $799). It declined in Individual Life ($36 versus $118) and Retirement ($317 versus $397). Corporate and Other losses narrowed to $294 from $352.
- International Insurance’s reported improvement included a shift in earnings seasonality after Gibraltar Life eliminated its one-month reporting lag. The company says the change aligned reporting periods and had no material impact on the periods presented; prior equity was restated.
- Other comprehensive income was a loss of $3,106, compared with income of $3. Net unrealized investment losses and other market movements contributed to the decline in equity; the filing attributes increased fixed-maturity unrealized losses mainly to higher interest rates and wider credit spreads.
- Operating cash flow increased year over year. Q1 included $1.0 billion of medium-term note issuance, $375 million of share repurchases, and $387 million of common-stock dividends declared.
Outlook, commentary, risks, and unusual items
- Interest rates: Management said U.S. reinvestment yields remained below portfolio yields and expected portfolio yields to continue declining as assets mature or prepay. Under a hypothetical U.S. scenario with a 2.90% average 10-year Treasury rate through 2019 and unchanged credit spreads, estimated unfavorable pretax adjusted operating income effects were about $7 million in 2018 and $31 million in 2019. A separate hypothetical 25-basis-point reduction in 2018 new-money yields in Japanese and Korean operations was estimated to reduce 2018 adjusted operating income by $10–$15 million. These are scenario estimates, not company guidance.
- Accounting and reporting changes: Prudential adopted ASU 2016-01, moving fair-value changes on equity securities into earnings, and early-adopted ASU 2018-02, reclassifying $1,653 million of tax effects from accumulated other comprehensive income to retained earnings. It also adopted the revenue-recognition standard with no material adoption-date impact. Comparability of some line items is affected by these changes.
- Market and insurance risks: Risks include interest-rate, equity-market and currency movements; credit deterioration or counterparty default; variable-annuity guarantees and hedging; policyholder behavior; and liquidity needs, including derivative collateral. The filing notes that collateral requirements and asset-liability mismatches can create significant liquidity demands.
- Legal and regulatory matters: Management estimated the aggregate range of reasonably possible litigation and regulatory losses above established accruals at less than $250 million where estimable; this is not a forecast or maximum exposure. Management said ultimate resolution is not likely to materially adversely affect financial position, while acknowledging that outcomes are uncertain and could affect results or, in some cases, financial position. The filing also discusses pending fiduciary-rule developments and proposed SEC standards.
- Other notable items: The company established a $1.6 billion captive financing facility for Guideline XXX reserves; $100 million was outstanding at quarter-end. It repurchased 3.3 million shares for $375 million under a $1.5 billion 2018 authorization. No formal earnings guidance is provided in the supplied filing text.
Important facts for investors to verify
- Whether the large unfavorable swing in “Other income” and the effects of market marks and accounting changes are recurring, and how these items reconcile to reported earnings.
- The durability of segment adjusted operating income, especially declines in Individual Life and Retirement, and the contribution of Gibraltar Life’s reporting-period change to International Insurance growth.
- Exposure of investment spreads and policy guarantees to lower reinvestment yields, higher rates, credit-spread changes, and variable-annuity market movements.
- Capital and liquidity at the relevant insurance subsidiaries, including updated statutory RBC and solvency measures when available; quarter-end parent liquidity is not a substitute for subsidiary-level resources.
- Developments in litigation, regulatory requirements, tax accounting estimates, and the company’s ability to continue planned buybacks and dividends while meeting capital needs.