PRUDENTIAL FINANCIAL INC quarterly report, Q3 FY2019

Prudential Financial, Inc. — Q3 2019 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2019. Amounts are in U.S. dollars; financial statement amounts are generally in millions. Prudential provides insurance, retirement, investment management and related financial services across the U.S. and international markets.

Key financial results

Metric	Q3 2019	Q3 2018	9M 2019	9M 2018
Total revenue	$15.105B	$16.148B	$45.584B	$44.560B
Income before tax and joint venture earnings	$1.725B	$1.838B	$3.741B	$3.781B
Net income attributable to Prudential	$1.418B	$1.672B	$3.058B	$3.232B
Diluted EPS	$3.44	$3.90	$7.35	$7.51
Adjusted operating income before tax	$1.652B	$1.668B	$4.910B	$5.050B

Approximate GAAP net margin, calculated as net income attributable to Prudential divided by revenue, was 9.4% in Q3 2019 versus 10.4% in Q3 2018, and 6.7% for the first nine months versus 7.3% in 2018.

Q3 revenue declined 6%, mainly reflecting lower pension risk transfer premiums in Retirement; those premiums also generally affect related policy benefits. Nine-month revenue increased 2%.
Q3 net income fell $254M and nine-month net income fell $174M year over year. Major pressures included variable-annuity embedded derivative and hedge movements, market experience updates, and higher tax expense versus the prior-year period.
Net investment income rose to $4.438B in Q3 from $4.046B, and to $13.044B for nine months from $12.140B. Realized investment results were a $853M gain in Q3, versus $151M, but a $249M loss for nine months, versus a $1.261B gain.

Financial position, cash flow and capital

At September 30, total assets were $885.6B, up from $815.1B at December 31, 2018; total equity was $66.3B, up from $49.0B. Accumulated other comprehensive income rose to $27.6B from $10.9B, substantially reflecting investment-related unrealized gains; this is not equivalent to realized earnings.
Cash and cash equivalents were $18.3B; cash, cash equivalents and restricted cash totaled $18.4B. Nine-month operating cash flow was $15.640B, investing cash outflow $13.116B, and financing cash inflow $358M.
Short- and long-term debt totaled $20.6B, versus $19.8B at year-end. Long-term debt was $19.2B. Prudential reported compliance with debt covenants and no draw on its syndicated unsecured committed credit facilities; PGIM’s separate $300M limited-recourse facility was fully drawn.
Management reported $52.8B of capital, defined in the filing using equity excluding AOCI, junior subordinated debt and other capital debt. Parent-company highly liquid assets were $6.974B, including the intercompany liquidity account. Management stated resources were sufficient under reasonably foreseeable stress scenarios.
For the nine months, Prudential repurchased $1.940B of shares and paid $1.237B in common dividends. The annual repurchase authorization was increased to $2.5B; $500M remained available at September 30. The quarterly dividend declared was $1.00 per share.

Material changes and segment performance

Adjusted operating income increased in Retirement ($302M vs. $239M) and Group Insurance ($90M vs. $59M) in Q3; International Insurance declined ($791M vs. $890M), while Individual Life declined ($59M vs. $170M). PGIM was broadly stable at $232M versus $230M.
For nine months, adjusted operating income increased in Retirement ($1.020B vs. $833M) and Group Insurance ($224M vs. $196M), but declined in Individual Annuities ($1.393B vs. $1.480B), Individual Life ($29M vs. $249M), and PGIM ($710M vs. $716M). International Insurance increased to $2.562B from $2.530B. Corporate and Other losses widened to $1.028B from $954M.
Management began excluding immediate impacts of current market changes on estimates of profitability from adjusted operating income in Q2 2019; comparisons with earlier periods may therefore be affected by presentation changes.
Variable-annuity account values were $164.7B at September 30. The nine-month GAAP impact from changes in embedded derivatives and related hedges, after related DAC and other costs, was a $1.415B charge, compared with a $378M benefit in 2018. Management attributed the 2019 charge chiefly to falling interest rates, partly offset by favorable equity markets.

Outlook, risks and unusual items

Outlook: No formal company-wide earnings guidance is stated in the provided filing text. Under specified interest-rate scenarios through December 2020, Prudential estimated an unfavorable $50M–$100M net investment income impact from reinvesting scheduled maturities and estimated prepayments for each of its U.S. operations and Japanese operations.
Strategy and costs: The multi-year Financial Wellness initiative is expected to require significant technology, systems, severance and related spending, with anticipated expense efficiencies over time. A voluntary separation program announced in October was expected to generate Q4 2019 charges and reduce expenses beginning in 2020; costs and savings depend on participation and approvals.
Assurance acquisition: Completed in October 2019, after quarter-end. Consideration included approximately $1.8B cash net of transaction expenses, about $0.5B in restricted stock and awards, and up to approximately $1.15B contingent consideration payable in 2023 based on performance. Management expected modest EPS and return-on-equity accretion beginning in 2020; purchase accounting was incomplete. Integration, execution, personnel-retention and contingent-payment risks are disclosed.
Interest-rate, market and insurance risks: Low rates may pressure reinvestment yields and margins; equity, interest-rate, currency and credit changes can affect investments, guarantees, hedge collateral and policyholder behavior. Management also identifies mortality, morbidity, lapse and other assumption risks. Variable-annuity guarantees rely on models with significant unobservable assumptions.
Investments: Fixed-maturity unrealized losses were $1.542B at September 30, down from $6.391B at year-end. Management attributed losses mainly to credit-spread widening, interest rates and currency movements, and said it did not intend to sell the securities and was not more likely than not to be required to sell before recovery. Japanese government and agency securities represented a significant single-country exposure.
Legal and regulatory: The estimated aggregate reasonably possible losses above established accruals for estimable litigation and regulatory matters were less than $250M; this is not a maximum exposure or expected-loss estimate. In September, Prudential settled SEC matters involving securities lending and foreign tax reclaims, agreeing to a $5M fine and $27.6M disgorgement without admitting or denying the findings.
Other notable items: The $500M exchangeable surplus notes were converted into approximately 6.2M common shares in August, satisfying the obligation. The filing also cites pending accounting changes, notably long-duration insurance contract accounting, expected to have a significant impact; the effective date was deferred to January 1, 2022.

Most important facts for investors to verify

Whether recurring segment earnings and cash generation remain resilient after separating market-driven realized gains and losses, assumption updates and variable-annuity hedging effects.
How lower rates, guarantee liabilities, policyholder behavior and collateral requirements affect statutory capital, earnings and liquidity; statutory capital ratios disclosed are based on the latest available reporting dates, not September 30, 2019.
Assurance’s realized performance, integration costs and progress toward the targets governing contingent consideration, as well as the impact of the Financial Wellness initiative and separation program.
The quality and concentration of investment exposures, including commercial real estate, Japan-related holdings and assets with Level 3 valuation inputs.
Developments in litigation, regulatory matters and accounting changes, including potential effects not captured by current accruals or estimates.