Prudential Financial, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; balance-sheet comparisons are with December 31, 2018. Amounts are in U.S. dollars. Interim results are unaudited and may not indicate full-year performance.
Business context
Prudential provides insurance, annuities, retirement services and investment management in the U.S. and internationally. It reported approximately $1.456 trillion in assets under management at quarter-end. Its operations span PGIM, U.S. Workplace Solutions, U.S. Individual Solutions, International Insurance, the Closed Block and Corporate and Other.
Key financial results
| Metric | Q1 2019 | Q1 2018 or prior date |
|---|---|---|
| Total revenue | $15.091 billion | $13.757 billion |
| Benefits and expenses | $13.951 billion | $12.064 billion |
| Income before tax and joint-venture earnings | $1.140 billion | $1.693 billion |
| Net income attributable to Prudential | $932 million | $1.363 billion |
| Diluted earnings per share | $2.22 | $3.14 |
| Net cash from operating activities | $3.085 billion | $2.301 billion |
| Cash and cash equivalents | $14.699 billion | $15.353 billion at Dec. 31, 2018 |
| Total assets | $849.324 billion | $815.078 billion at Dec. 31, 2018 |
| Total equity | $55.450 billion | $49.031 billion at Dec. 31, 2018 |
| Short- and long-term debt | $20.858 billion | $19.829 billion at Dec. 31, 2018 |
Net investment income was $4.216 billion, up from $3.998 billion. Net realized investment losses were $766 million, compared with gains of $425 million a year earlier. The filing attributes the year-over-year decline in net income principally to a $935 million unfavorable pre-tax change in embedded derivatives and related variable-annuity hedges, and a $47 million unfavorable variance in other realized investment results (excluding that hedge program). Net unrealized investment gains lifted other comprehensive income after tax to $6.304 billion; comprehensive income attributable to Prudential was $7.237 billion.
Cash flow from investing activities was a $5.299 billion outflow, while financing activities provided $1.566 billion. The company declared $415 million of common dividends and repurchased $500 million of shares during the quarter. It issued $1.0 billion of senior notes, including notes maturing in 2050 at a 4.350% rate. Debt covenants were met, and no amounts were drawn on committed credit facilities.
Segment performance and changes
- Adjusted operating income before tax: $1.605 billion, down from $1.721 billion. This is management’s non-GAAP segment measure, not consolidated GAAP net income.
- International Insurance: $922 million, up from $856 million, reflecting business growth and improved underwriting, with a favorable currency contribution.
- U.S. Individual Solutions: $577 million, up from $555 million; Individual Life improved, while Individual Annuities declined.
- U.S. Workplace Solutions: $304 million, down from $372 million, mainly due to lower Retirement investment spreads and higher expenses.
- PGIM: $214 million, down from $232 million; higher fees were more than offset by compensation and other expenses. PGIM AUM rose to $1.221 trillion from $1.161 trillion at year-end, aided by market appreciation.
- Corporate and Other: loss of $412 million, versus $294 million, reflecting higher corporate costs and capital-debt interest expense.
Revenue growth was partly driven by higher premiums, investment income and other income. Expenses rose materially, including interest credited to policyholders, policyholder benefits, dividends and general and administrative costs. Individual Annuities recorded a $738 million pre-tax loss, versus $991 million of income a year earlier, largely reflecting market-sensitive derivative and hedge results. The net charge from changes in variable-annuity embedded derivatives and hedges, after related DAC and other costs, was $637 million in Q1 2019, compared with a $298 million benefit in Q1 2018.
Outlook, risks and unusual items
- No general earnings guidance was provided in the supplied filing text. Management’s illustrative U.S. rate scenario—10-year Treasury averaging 2.50% through 2020 with unchanged credit spreads—estimated no significant impact on pre-tax adjusted operating income from reinvestment versus current portfolio yields. A separate Japan scenario with new-money yields 25 basis points lower estimated a roughly $15 million adverse 2019 adjusted operating income impact, subject to stated exclusions and assumptions.
- Management identified interest rates, equity markets, credit quality, foreign exchange, policyholder behavior and derivative collateral requirements as important earnings, valuation and liquidity risks. It reported no material change in economic market-risk exposure from year-end.
- Japan’s tax authority proposed limiting deductions on certain corporate insurance premiums. Prudential and other insurers suspended sales of affected products pending further rulemaking, expected later in 2019; final rules may affect sales.
- Litigation and regulatory outcomes remain uncertain. The company estimated reasonably possible losses in excess of established accruals at less than $250 million for matters where an estimate could be made. It was discussing a possible SEC settlement concerning securities-lending and foreign-tax-reclaim matters; outcome and any financial remedies were uncertain. Management did not expect pending matters, after reserves and indemnification, to materially affect financial position, while acknowledging an unfavorable resolution could affect results or cash flows.
- Adoption of lease accounting brought approximately $600 million of operating-lease right-of-use assets and liabilities onto the balance sheet at January 1, 2019. The company expected the forthcoming long-duration insurance accounting standard to significantly affect statements and disclosures; its impact was still being assessed.
- Management stated available liquidity was sufficient under reasonably foreseeable stress scenarios. Holding-company highly liquid assets were $6.411 billion, above its $1.3 billion minimum target. Major U.S. and Japanese insurance-subsidiary regulatory capital ratios cited were for December 31, 2018, not March 31, 2019; the company said subsidiary capital levels substantially exceeded regulatory minimums.
Important facts for investors to verify
- How much of the earnings decline reflects variable-annuity valuation and hedge volatility, and how might those effects develop under different market conditions?
- Whether the $637 million variable-annuity charge, realized investment losses and large OCI movement materially affect capital, statutory solvency or future earnings.
- Current statutory capital and solvency ratios, and the effect of regulatory changes, since the ratios disclosed were year-end figures.
- Progress and financial implications of Japan’s proposed corporate-product tax rules and the possible SEC settlement.
- Credit quality, liquidity and collateral exposure in the investment portfolio, including derivatives, commercial mortgages and below-investment-grade holdings.
- Whether share repurchases, dividends and debt growth remain consistent with capital needs and management’s ratings objectives.