Prudential Financial, Inc. — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010; unaudited. Prudential provides insurance, annuity, retirement, investment-management and related financial services. Its reporting separates the Financial Services Businesses from the legacy Closed Block Business. Unless noted, amounts below are in U.S. dollars.
Financial performance and condition
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total revenues | $9.962B | $8.543B | $30.308B | $23.947B |
| Income before tax and equity earnings of joint ventures | $1.740B | $848M | $4.284B | $841M |
| Net income attributable to Prudential Financial | $1.244B | $1.082B | $3.018B | $1.259B |
| Diluted EPS, Common Stock | $2.46 | $2.35 | $5.31 | $3.72 |
| Operating cash flow | Not separately presented for the quarter | Not separately presented for the quarter | $4.604B | $4.703B |
- For the first nine months, realized investment gains were $2.204B, versus losses of $2.577B in 2009. This swing materially contributed to higher reported income; it should not be read as equivalent growth in recurring operating earnings.
- Management’s non-GAAP adjusted operating income before tax for Financial Services Businesses was $1.377B for Q3 and $2.861B for the nine months, versus $1.072B and $2.506B, respectively. The measure excludes specified investment and other items; the company revised its definition in Q3 to exclude certain variable-annuity guarantee and hedge mark-to-market effects, and recast prior periods.
- Assets at September 30 were $526.924B, versus $480.203B at December 31, 2009; total equity was $34.068B, versus $25.729B. Accumulated other comprehensive income moved to $4.729B from a $443M loss, largely reflecting unrealized investment gains.
- Total investments were $287.395B, including $197.189B of available-for-sale fixed maturities. Cash and cash equivalents were $11.973B, down $1.191B from year-end. Nine-month investing cash outflow was $6.130B; financing cash flow was $258M.
- Short- and long-term debt totaled $24.909B, versus $24.159B at year-end. Committed unsecured credit lines totaled $3.906B, with no borrowings outstanding under those facilities at September 30. Parent-company cash and short-term investments were $5.426B.
- Fixed-maturity gross unrealized losses declined to $4.349B from $6.282B at year-end. Management attributed much of the improvement in unrealized values to lower risk-free rates; investment values and impairment judgments remain market-sensitive.
Changes, outlook and material items
- Business trends: Q3 adjusted operating income rose notably in Individual Annuities and Asset Management; International Insurance also improved. Individual Life and Group Insurance weakened on the nine-month comparison, with Group Insurance affected by less favorable claims and higher expenses. Individual annuity sales were lower year over year in Q3, while full-service retirement net additions improved.
- AIG Japan acquisition: On September 30, Prudential agreed to acquire four Japanese insurance-related entities for $4.8B, comprising about $4.2B cash and $0.6B assumed debt. Closing was expected in Q1 2011, subject to approvals and other conditions. The company planned to use about $2.2B of cash, issue approximately $1B each of equity and debt, and had a $3B bridge commitment. Management estimated about $500M of integration costs over five years and approximately $250M of annual savings after integration; these are expectations, not guarantees.
- Variable-annuity accounting and hedging: Q3 equity-market gains and assumption updates benefited reported results in some areas. Management changed the hedge target and the definition of adjusted operating income; it cautioned that the new approach may increase GAAP earnings volatility. Results remain sensitive to markets, interest rates, lapse behavior, and guarantee claims.
- Closed Block: Nine-month income before tax was $777M versus a $572M loss in 2009, chiefly reflecting the reversal from investment losses to gains and a prior-year $851M benefit from reducing the cumulative-earnings dividend obligation. A $3.149B obligation was recorded at September 30 for unrealized gains allocated to policyholders; actual cumulative earnings remained $64M below expected levels.
- Taxes and other unusual items: 2010 included a $94M first-quarter deferred-tax charge related to Medicare Part D subsidy changes and a $12M Q3 charge for compensation expected to be nondeductible. Q3 2009 benefited from a $156M reduction in unrecognized tax benefits and interest; the nine-month 2009 benefit was $307M.
- Risks and contingencies: The filing highlights market, low-interest-rate, credit, currency, variable-annuity guarantee, liquidity, capital, regulatory and litigation risks. Retained-asset-account practices were under investigation and subject to class-action claims. Management said ultimate outcomes of litigation and regulatory matters cannot be predicted, while stating that known matters were not likely to materially harm financial position after reserves and indemnification.
- No specific earnings guidance: The filing provides business expectations and acquisition estimates, but no clear consolidated earnings or revenue forecast. The company said it believed available liquidity sources were sufficient for current and reasonably foreseeable needs. The Dodd-Frank Act could lead to new capital, liquidity and other requirements.
Investor verification points
- Separate recurring segment performance from realized investment gains, market movements, actuarial assumption updates and other nonrecurring or excluded items; review the revised adjusted-operating-income definition and reconciliation.
- Track variable-annuity guarantee reserves, hedge effectiveness, policyholder behavior assumptions, statutory capital needs and the effect of low interest rates on spreads.
- Verify AIG transaction approvals, financing actually obtained, integration costs, savings realization and the effect on capital and liquidity.
- Review the quality and valuation of credit-sensitive assets, especially sub-prime asset-backed securities, commercial real estate exposures, aged unrealized losses and Level 3 estimates.
- Monitor subsidiary dividend capacity, regulatory restrictions, debt maturities, committed-credit availability and the status of significant litigation and regulatory investigations.