Prudential Financial, Inc. — 2016 Form 10-K
Business context and reporting period
For the fiscal year ended December 31, 2016. Prudential is a global insurer and financial-services company operating in the U.S., Asia, Europe and Latin America. Its businesses span retirement and investment management, individual life and group insurance, international insurance, and a run-off Closed Block. The company reported approximately $1.264 trillion of assets under management at year-end; PGIM’s separately reported segment AUM was $1.040 trillion.
Comparisons with 2015 reflect consolidated Prudential results. The Closed Block has been reported separately as a divested business since the 2015 repurchase and cancellation of the Class B stock.
Financial and operating metrics
| Metric | 2016 | 2015 | Change / context |
|---|---|---|---|
| Total revenue | $58.779 billion | $57.119 billion | Up 2.9% |
| Income from continuing operations before tax and equity in joint ventures | $5.705 billion | $7.769 billion | Down 26.6%; equivalent pretax margins were approximately 9.7% and 13.6% |
| Net income attributable to Prudential | $4.368 billion | $5.642 billion | Down 22.6% |
| Diluted EPS | $9.71 | $12.17 | Down 20.2% |
| Adjusted operating income before tax | $5.399 billion | $6.231 billion | Down 13.3%; non-GAAP segment measure |
| Cash flow from operations | $14.778 billion | $13.895 billion | Up $883 million |
| Cash and cash equivalents | $14.127 billion | $17.612 billion | Down $3.485 billion |
| Total assets / total equity | $783.962 billion / $46.088 billion | $757.255 billion / $41.923 billion | Both increased |
| Short- and long-term debt | $19.174 billion | $20.810 billion | Down $1.636 billion |
| Net investment income | $15.520 billion | $14.829 billion | Up $691 million; portfolio yields remained under pressure |
| Dividends declared per share | $2.80 | $2.44 | Up; $2.0 billion of shares repurchased in 2016 |
Cash flow from operations was more than offset by investing outflows of $21.551 billion; financing activities provided $3.238 billion. Cash and cash equivalents therefore declined. These cash-flow totals reflect insurance and investment activity and should not be interpreted as conventional industrial-company free cash flow.
Segment adjusted operating income: Individual Annuities $1.765 billion (2015: $1.797 billion); Retirement $1.012 billion ($931 million); Asset Management $787 million ($779 million); Individual Life $79 million ($635 million); Group Insurance $220 million ($176 million); International Insurance $3.117 billion ($3.226 billion); and Corporate and Other loss of $1.581 billion ($1.313 billion).
Prudential reported 2015 RBC ratios of 484% for Prudential Insurance and 550% for PALAC; it expected both and the composite major U.S. insurance subsidiary ratio to exceed 400% at December 31, 2016. Japan and Gibraltar Life solvency margin ratios were 858% and 975% at September 30, 2016; the company expected each to exceed 700% at year-end. The 2016 year-end figures were not yet filed in the text provided.
Material changes versus the prior year
- Net income and adjusted operating income declined despite higher revenue. Management cited a $980 million unfavorable pretax comparative impact from DAC, other-cost and reserve updates; a $972 million unfavorable impact associated with the Capital Protection Framework; and $479 million lower net realized gains for PFI excluding the Closed Block and specified variable-annuity hedge effects. Partly offsetting items included $660 million from changes in embedded derivatives and related hedges and $737 million lower tax expense.
- Individual Life adjusted operating income fell to $79 million. The 2016 results included a $420 million net charge from assumption reviews and refinements, principally including a $444 million Profits Followed by Losses liability charge, and an out-of-period adjustment. Company-wide out-of-period adjustments reduced 2016 pretax income by $134 million; management said they were not material to the current or previously reported financial statements.
- International Insurance adjusted operating income declined $109 million, with foreign-exchange movements and assumption updates weighing on results. On a constant-exchange-rate basis, annualized new business premiums increased to $3.026 billion from $2.800 billion.
- PGIM AUM rose to $1.040 trillion from $963.1 billion, supported by market appreciation and fixed-income inflows. Individual Annuities account values increased to $156.8 billion, but net flows remained negative at $1.6 billion.
- The Variable Annuities Recapture moved certain living-benefit and retirement risks from a captive to statutory insurance entities. It released approximately $1.0 billion of highly liquid assets to Prudential Financial. The company also changed its annuity asset-liability management strategy in 2016.
- Prudential completed a $532 million investment for an indirect 40% interest in Chile’s AFP Habitat. It also deconsolidated certain collateralized loan obligations following an accounting-standard change, reducing reported assets and liabilities.
Outlook, management commentary and risks
- Management expected 2017 results to benefit from the company’s mix of protection, retirement and asset-management businesses, while acknowledging low interest rates, near-term strategic investment spending and regulatory uncertainty. It provided qualitative expectations, not a consolidated earnings or revenue forecast in the supplied filing text.
- For a hypothetical U.S. 10-year Treasury rate of 2.45% through 2018 with unchanged credit spreads, management estimated an unfavorable adjusted-operating-income effect of $9 million in 2017 and $26 million in 2018 from reinvestment on certain adjustable-crediting-rate contracts. A separate hypothetical 25-basis-point reduction in 2017 new-money yields in Japan and Korea was estimated to reduce 2017 adjusted operating income by $10 million to $15 million. These scenarios exclude multiple possible offsets and other factors.
- Persistent low rates may compress investment spreads, increase guarantee and reserve costs, and require reinvestment at yields below existing portfolio yields. The company said approximately 10% of specified U.S. fixed-maturity and commercial-mortgage assets were expected to mature or prepay annually through 2018.
- Key exposures include variable-annuity guarantees and hedge effectiveness; mortality, morbidity, persistency and benefit utilization assumptions; investment defaults and counterparty performance; yen and other currency movements; and concentrations in international insurance, particularly Japan. The company’s $8.2 billion net Level 3 variable-annuity living-benefit liability uses significant unobservable assumptions.
- Regulatory risks include Federal Reserve supervision as a designated financial company, potential group capital and liquidity standards, NAIC reserving and capital changes, and the DOL fiduciary rule. The rule’s implementation and final form were uncertain at the filing date; management anticipated possible compliance costs, product or distribution changes, and legal exposure.
- Prudential self-reported a securities-lending administration issue to the SEC and other regulators; remediation was substantially implemented but remained subject to regulatory review. It also suspended MyTerm sales through Wells Fargo in December 2016 pending a sales-practices review, and reported regulatory inquiries and related litigation.
- The company estimated reasonably possible litigation and regulatory losses above recorded accruals, where estimable, at less than $250 million as of year-end. It cautioned that outcomes remain uncertain and an unfavorable resolution could materially affect a particular period or, in some cases, financial position.
- Liquidity and capital distributions depend in part on regulated subsidiaries’ ability to pay dividends to the holding company. Prudential reported $4.553 billion of parent highly liquid assets excluding intercompany liquidity-account borrowings, against a $1.3 billion targeted minimum. It declared a $0.75 per-share dividend in February 2017 and authorized up to $1.25 billion of 2017 repurchases.
Most important facts for an investor to verify
- Reconcile GAAP earnings with adjusted operating income, including the reserve and DAC assumption changes, the Profits Followed by Losses charge, and variable-annuity hedge and Capital Protection Framework effects.
- Check actual 2016 year-end statutory RBC and international solvency ratios against management’s expectations, and review the capital and liquidity consequences of regulatory changes.
- Assess the sensitivity of annuity and life reserves to interest rates, equity markets, policyholder behavior, and mortality assumptions; verify external reinsurance coverage and counterparty exposure.
- Review parent-company liquidity, subsidiary dividend restrictions, debt maturities, reserve-financing arrangements, and the sustainability of dividends and repurchases.
- Track the Wells Fargo MyTerm review, securities-lending remediation, unclaimed-property matters, ERISA class actions, and the status of litigation and regulatory reserves.