Prudential Financial, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; comparisons are primarily with FY 2017. Prudential is a diversified insurer and asset manager operating in the U.S. and internationally. It reported approximately $1.377 trillion in assets under management at year-end.
Financial performance and position
| Metric | FY 2018 / year-end | FY 2017 / year-end |
|---|---|---|
| Total revenue | $62.992 billion | $59.689 billion |
| Income before tax and equity earnings | $4.834 billion | $6.487 billion |
| Net income attributable to Prudential | $4.074 billion; diluted EPS $9.50 | $7.863 billion; diluted EPS $17.86 |
| Operating cash flow | $21.664 billion | $13.460 billion |
| Total assets | $815.078 billion | $832.136 billion |
| Total equity | $49.031 billion | $54.511 billion |
| Short- and long-term debt | $19.829 billion | $18.552 billion |
| Common dividends declared per share | $3.60 | $3.00 |
Revenue rose about 5.5%, while net income attributable to Prudential fell about 48.2%. Operating cash flow increased; investing cash flow was negative $21.628 billion and financing cash flow was positive $781 million. Consolidated cash and cash equivalents were $15.353 billion at year-end. Parent-company highly liquid assets were $5.548 billion excluding net intercompany liquidity-account borrowings; the company targets at least $1.3 billion at the parent to cover fixed expenses in a stress scenario.
Net investment income was $16.176 billion versus $16.435 billion. General account investment income after expenses yielded 3.68% in 2018 versus 3.53% in 2017. The company reported a 17.0% effective tax rate, compared with a tax benefit and negative effective rate of 22.2% in 2017. The filing does not present a single consolidated operating-margin measure; segment adjusted operating income is a non-GAAP management measure.
Segment adjusted operating income before tax was $6.368 billion, up from $6.244 billion. International Insurance contributed $3.266 billion, Individual Annuities $1.925 billion, Retirement $1.049 billion, PGIM $959 million, Group Insurance $229 million, and Individual Life $223 million; Corporate and Other was a loss of $1.283 billion. These figures exclude items reconciled to GAAP results.
Material changes versus the prior year
- The $3.789 billion decline in net income attributable to Prudential was driven principally by a $3.693 billion unfavorable tax comparison: 2017 included a substantial Tax Act benefit, while 2018 had tax expense. Also cited were $1.427 billion of unfavorable pre-tax assumption and estimate updates and a $221 million unfavorable comparison in divested and run-off businesses. Favorable offsets included investment gains and changes in variable-annuity embedded derivatives and related hedges.
- Long-Term Care, a closed-to-new-business run-off operation, recorded a $1.458 billion charge in 2018, mainly after management removed its assumption of future morbidity improvement following experience that was worse than expected.
- Total assets fell $17.1 billion and equity fell $5.5 billion. Other comprehensive income was a loss of $6.969 billion, with unrealized investment losses a major factor. Separate account assets declined to $279.136 billion from $306.617 billion; associated liabilities declined by the same amount.
- Consolidated debt increased $1.277 billion. Prudential repurchased $1.5 billion of common stock and declared $1.525 billion of common dividends during 2018. The board authorized up to $2.0 billion of repurchases for 2019.
- PGIM assets under management increased to $1.161 trillion from $1.155 trillion, while total company AUM declined to $1.377 trillion from $1.394 trillion, reflecting market depreciation and asset flows across businesses. Individual Annuities account values fell to $151.1 billion from $168.6 billion, primarily due to market declines.
Outlook, risks, contingencies and unusual items
Management expected 2019 to benefit from Prudential’s diversified protection, retirement and investment-management businesses, while identifying low interest rates, fee compression and market conditions as headwinds. It gave no specific consolidated earnings or revenue guidance. Management anticipated continued pension risk-transfer opportunities, but noted that large transactions are episodic; expected ongoing spread and fee pressure in full-service retirement; and projected Individual Annuities returns on assets to move toward long-term targets as the existing block matures and newer products carry lower fees. Strategic investments in product development, distribution and technology may increase near-term expenses.
- Interest rates and markets: Low reinvestment yields may pressure spreads, particularly in Japan and on long-duration guarantees. Under a stated hypothetical, 25 basis points lower new-money yields in Japanese and Korean operations would reduce 2019 adjusted operating income by about $10–$15 million, subject to significant exclusions and assumptions. Equity declines, interest-rate moves and volatility can affect variable-annuity guarantees, hedges, fees and reported earnings.
- Insurance and investment exposures: Actual mortality, morbidity, longevity, lapses, withdrawals and benefit utilization may differ from pricing and reserve assumptions. Credit deterioration, illiquid assets, counterparty defaults and derivative collateral demands could affect earnings, capital or liquidity.
- Capital and regulation: Prudential reported strong regulatory capital, but 2018 RBC ratios were not yet filed; management expected them to remain above its financial-strength targets. The Financial Stability Oversight Council rescinded Prudential’s non-bank designation in October 2018, ending Federal Reserve supervision and related fees, previously about $24 million annually. Future regulatory, reserving and capital-rule changes remain uncertain.
- Tax and accounting: Tax Act implementation affected year-to-year comparisons, and potential BEAT and GILTI effects remain under assessment. The company expects the long-duration insurance accounting standard (ASU 2018-12), effective in 2021, to significantly affect financial statements and earnings patterns; the impact was not yet quantified.
- Legal and contingent matters: The company estimated reasonably possible litigation and regulatory losses in excess of accruals at less than $250 million for matters where an estimate could be made; this is not an estimate of maximum exposure. It disclosed ongoing RMBS trustee and LIBOR litigation, among other proceedings, and SEC discussions regarding securities-lending practices and foreign-tax-reclaim processing. Management said ultimate outcomes could affect results or cash flow and, in some cases, financial position.
- Other notable changes: Prudential sold its Pramerica of Poland subsidiary in 2018; its agreement to sell Pramerica of Italy was terminated in February 2019. It exited PGIM Brazil operations in 2018. Gibraltar Life’s reporting period was aligned with the parent’s year-end; prior-period retained earnings were restated by about $167 million, while operating-statement effects were not material.
Most important facts for investors to verify
- Reconcile the decline in GAAP net income to the tax comparison, Long-Term Care reserve charge, assumption updates, realized investment results and variable-annuity hedge effects; compare with adjusted operating income.
- Track Long-Term Care claims experience, future premium-rate approvals, reserve adequacy and statutory-capital demands after the removal of expected morbidity improvement.
- Review statutory RBC and Japan solvency results when filed, and assess capital fungibility, dividend restrictions and the sustainability of buybacks and dividends.
- Monitor investment portfolio credit quality, unrealized losses, mortgage exposures, derivative collateral needs and sensitivity of guarantees to markets and policyholder behavior.
- Follow material litigation and regulatory developments, including SEC remediation discussions, and assess potential cash, capital and reputational consequences.
- Assess the eventual adoption impact of ASU 2018-12 and changes in tax rules, including BEAT and GILTI; neither future effect is clearly quantified in the filing.