Prudential Financial, Inc. — Q1 2012 Form 10-Q
Business context and reporting period. The unaudited quarter ended March 31, 2012. Prudential provides insurance, retirement, investment-management and related financial services in the U.S. and internationally. Reporting separates the Financial Services Businesses from the legacy Closed Block Business; the publicly traded Common Stock reflects the former, while Class B Stock reflects the latter. Gibraltar Life’s reported quarter ended February 29, 2012.
Key financial results
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Total revenue | $9.623 billion | $10.170 billion |
| Net income (loss) attributable to Prudential | $(967) million | $561 million |
| Common Stock diluted EPS | $(2.09) | $1.10 |
| Financial Services adjusted operating income, pre-tax | $1.015 billion | $1.096 billion |
| Operating cash flow | $767 million | $2.231 billion |
- Premiums rose to $6.773 billion from $5.510 billion, and net investment income increased to $3.320 billion from $3.118 billion. These gains were outweighed by a $1.384 billion net realized investment loss (versus a $50 million loss in 2011), including $1.319 billion of derivative losses; asset management fees and other income was $(135) million versus $644 million.
- Total benefits and expenses increased to $10.422 billion from $9.542 billion. The company reported a $799 million pre-tax loss from continuing operations before income taxes and joint-venture earnings, compared with $628 million of income.
- Financial Services adjusted operating income declined about 7% to $1.015 billion. Individual Annuities rose to $421 million from $274 million; Retirement fell to $156 million from $172 million; Asset Management fell to $121 million from $154 million; Individual Life increased to $112 million from $98 million; Group Insurance shifted to a $38 million loss from $39 million of income; and International Insurance declined to $606 million from $628 million. These are non-GAAP segment measures.
- Cash and cash equivalents were $14.201 billion at March 31, versus $14.251 billion at year-end; total assets were $637.737 billion versus $620.244 billion, and total equity was $35.538 billion versus $34.841 billion. Cash declined $50 million during the quarter. Investing activities used $2.224 billion and financing activities provided $1.519 billion.
- Short-term debt was $3.655 billion and long-term debt $24.379 billion, totaling $28.034 billion. Including $10.155 billion of asset-based financing, reported borrowings and asset-based financing totaled $38.189 billion. The parent holding company had $4.135 billion in cash and short-term investments; $3.75 billion of committed credit facilities was undrawn.
Material changes and unusual items
- The GAAP loss was driven substantially by market-sensitive, non-cash accounting effects, notably currency remeasurement of economically hedged Japanese operations and variable-annuity embedded derivatives and hedge positions. Management said currency-driven changes were largely offset in accumulated other comprehensive income, not net income. Q1 2012 also included a $339 million U.S. tax expense related to utilization of acquired Japanese deferred tax assets.
- Investment markets lifted other comprehensive income: net-of-tax OCI was $1.804 billion, and Prudential-attributable comprehensive income was $841 million despite the net loss. General-account fixed-maturity unrealized gains increased from $10.493 billion at year-end to $12.960 billion for Financial Services, while Closed Block unrealized gains decreased from $3.876 billion to $3.607 billion.
- Effective January 1, 2012, Prudential retrospectively adopted revised insurance acquisition-cost guidance. The change reduced December 2011 deferred acquisition costs by about $4.3 billion and total equity by about $3.0 billion, with no cash-flow impact. Management expects initially lower earnings, particularly in International Insurance and Individual Annuities; comparative 2011 results were revised.
- Individual Annuity adjusted operating income included a $196 million benefit from quarterly reserve and acquisition-cost adjustments, versus $58 million in Q1 2011, reflecting actual variable-annuity returns above assumptions. The filing describes substantial earnings sensitivity to markets and assumptions, and a decision to hedge variable-annuity risks below the defined hedge target.
- Management gave no numerical consolidated earnings guidance. It said available cash sources were sufficient for current liquidity needs under reasonably foreseeable stress scenarios. Outlook remains exposed to markets, low interest rates, currency movements, claims and persistency experience, investment credit losses, and regulation.
Liquidity, contingencies and risks
- Prudential Insurance had $924 million of FHLB New York advances and $1.5 billion of collateralized funding agreements, supported by $2.9 billion of pledged assets. The filing notes that access to financing may depend on ratings, eligible collateral and lender discretion.
- Commercial mortgage and other loans totaled $35.623 billion net, with a $351 million allowance for credit losses. Nonaccrual loans were $609 million, down from $711 million at year-end. The loan portfolio and commercial real estate conditions remain relevant credit risks.
- Reported commitments include $1.658 billion of commercial mortgage loan commitments and $3.813 billion of investment commitments expected to be funded outside separate accounts. Guarantees and indemnities include $1.090 billion maximum exposure on serviced mortgage loans, with a $20 million accrued liability, and $23 million of guarantees related to the former global commodities business, with no accrued liability.
- Legal and regulatory matters include disputes and inquiries concerning unclaimed life-insurance benefits and retained-asset accounts, among other proceedings. Management said ultimate outcomes cannot be predicted, but did not expect pending matters, after reserves and indemnification, to materially adversely affect financial position.
- Other risks include the holding company’s reliance on subsidiary distributions, regulatory restrictions on insurer dividends, potential ratings downgrades, derivative collateral requirements, variable-annuity guarantees, and possible stricter prudential standards under Dodd-Frank. The filing states there were no material changes in market-risk exposures from year-end.
Most important facts for investors to verify
- How much of the GAAP loss reflects volatile mark-to-market and currency effects versus underlying segment performance, and how those effects may reverse or recur.
- The assumptions, hedge effectiveness and capital implications for variable-annuity guarantees, including the below-target hedging decision and the effect of non-performance-risk adjustments.
- The sustainability of segment results and sales, especially Group Insurance claims, Individual Annuity sales, and International Insurance growth and integration savings.
- The acquired Japanese businesses’ tax impact, integration costs, and future earnings contribution, alongside the expected earnings effect of the acquisition-cost accounting change.
- Insurer statutory capital and dividend capacity, holding-company liquidity, debt maturities, refinancing needs, and reliance on collateralized or market-based funding.
- Investment credit quality and unrealized-loss recovery assumptions, including sub-prime asset-backed exposures and commercial mortgage loan performance; also monitor material legal and regulatory developments.