Prudential Financial, Inc. — Q2 2017 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2017; unaudited results are presented under U.S. GAAP. Prudential provides insurance, annuity, retirement, asset-management and related financial services in the U.S. and internationally. The filing reports Q2 and first-half results against 2016; interim results are not necessarily indicative of full-year performance.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $13.441bn | $14.439bn | $27.111bn | $28.768bn |
| Net income attributable to Prudential | $491m | $921m | $1.860bn | $2.257bn |
| Diluted EPS | $1.12 | $2.04 | $4.21 | $4.97 |
| Adjusted operating income before tax (management measure) | $1.228bn | $1.057bn | $2.888bn | $2.382bn |
| Net investment income | $4.089bn | $3.789bn | $8.150bn | $7.459bn |
- Q2 revenue fell about 7% and attributable net income about 47%; first-half revenue fell about 6% and attributable net income about 18%. The sharp earnings decline primarily reflected adverse changes in variable-annuity embedded derivatives and related hedges, plus lower realized investment gains.
- Adjusted operating income before tax rose about 16% in Q2 and 21% for the first half. This non-GAAP segment measure excludes significant investment-related and other items and is not a substitute for GAAP earnings.
- Q2 realized investment losses were $1.092bn, versus gains of $1.433bn a year earlier; first-half losses were $665m, versus gains of $3.314bn. Derivative results were the principal driver of the reversal.
- First-half operating cash flow was $4.703bn, down from $13.524bn. Investing cash used was $2.787bn; financing provided $452m. Cash and cash equivalents ended the period at $16.605bn, versus $14.127bn at year-end 2016.
- At June 30, total assets were $812.590bn and total liabilities $763.950bn; total equity was $48.640bn. Investments totaled $458.401bn, including $335.254bn of available-for-sale fixed maturities. Separate-account assets and liabilities were each $297.433bn.
- Short- and long-term debt totaled about $19.405bn, compared with $19.174bn at year-end. The company reported compliance with debt covenants. Parent-company highly liquid assets were $4.449bn, or $3.651bn excluding net intercompany liquidity-account borrowings. No credit-facility amounts were drawn at June 30.
- Management-reported capital was $43.723bn, including $32.082bn of equity excluding AOCI, $5.820bn of junior subordinated debt and $5.821bn of other capital debt. The company reported domestic and international insurance capital ratios substantially above regulatory minimums; reported ratios are from the latest available statutory dates, not June 30.
- Common dividends declared were $0.75 per share for Q2; $625m of shares were repurchased in the first half under a $1.25bn 2017 authorization.
Material changes and segment results
- U.S. Retirement Solutions and Investment Management adjusted operating income before tax increased to $1.138bn in Q2 from $870m, and to $2.199bn for the first half from $1.582bn. Individual Annuities and Retirement improved, supported by fees, investment spreads and reserve experience.
- Individual Life recorded adjusted operating losses of $557m in Q2 and $439m for the first half, versus losses of $290m and $170m. The Q2 annual assumption review produced a $653m net charge, including a $237m charge from a change in reinsurance cash-flow estimates and accounting method, as well as model refinements and unfavorable lapse assumptions.
- International Insurance adjusted operating income increased to $823m in Q2 from $803m and to $1.622bn for the first half from $1.582bn. Business growth and mortality experience helped; currency effects, expenses and lower reinvestment yields were offsets.
- Group Insurance adjusted operating income increased to $136m in Q2 from $89m and to $170m for the first half from $115m, reflecting underwriting and investment-spread improvements.
- First-half Individual Annuities account-value net flows were negative $2.783bn, versus negative $353m a year earlier; management cited lower sales and higher surrenders and withdrawals. Retirement also reported net withdrawals in full-service accounts and institutional investment products in the first half.
Outlook, risks and unusual items
- Management expects low U.S. reinvestment yields to pressure portfolio yields as assets mature. Under a stated hypothetical scenario—average 10-year Treasury rate of 2.25% through 2018 with credit spreads unchanged—the estimated pre-tax adjusted-operating-income impact for specified U.S. contracts was unfavorable by about $6m in 2017 and $52m in 2018. This excludes potential mitigants and other business and market effects.
- For Japanese and Korean operations, a hypothetical 25-basis-point reduction in 2017 new-money yields was estimated to reduce 2017 adjusted operating income by about $10m–$15m, subject to stated exclusions.
- Management cites interest-rate, equity-market, foreign-exchange, credit, policyholder-behavior and reserve-estimation risks; derivative effectiveness and collateral demands may also affect earnings and liquidity. The filing says economic market-risk exposure had not materially changed from year-end 2016.
- Regulatory uncertainty includes the DOL fiduciary rules, potential Dodd-Frank changes and oversight of designated financial companies. A new U.S. organizational structure was announced for Q4 2017; management said it would not change reportable segments or the segment profitability measure.
- Litigation and regulatory outcomes are uncertain. The company estimated reasonably possible losses in excess of established accruals at less than $250m for matters where an estimate could be made, but said this is not an expected-loss or maximum-exposure estimate. Management did not expect ultimate outcomes, after reserves and indemnification, to materially harm financial position, while acknowledging an unfavorable resolution could affect results, cash flow or financial position.
- Other notable items include the $148m 2016 out-of-period reserve adjustment in Individual Life, which management said was not material to the then-current or previously reported statements; and $82m of first-quarter 2017 compensation expense recognized earlier because of a change in long-term incentive-plan timing.
- Subsequent to quarter-end, Prudential amended and extended its $4bn five-year credit facility to July 2022. A July 2017 Indonesian insurance joint venture was also announced.
Important facts for investors to verify
- How much of the GAAP earnings decline reflects variable-annuity embedded-derivative and hedge accounting volatility, and how much reflects underlying operating performance?
- Whether Individual Life assumption updates and the reinsurance-method change lead to further reserve, DAC or earnings adjustments.
- Trends in annuity surrenders, sales, account values and Retirement net flows, and their implications for future fee and spread income.
- Exposure to prolonged low rates, especially guaranteed-rate liabilities, and whether asset-liability management can preserve spreads and liquidity.
- Current statutory capital and solvency ratios, holding-company liquidity, subsidiary dividend capacity and effects of regulatory requirements on repurchases and dividends.
- Developments in litigation, regulatory matters and guarantees, including securities-lending indemnities and mortgage-servicing loss-sharing arrangements.