Business context and reporting period
Prudential Financial, Inc. filed this Form 10-K for the fiscal year ended December 31, 2014. It is a diversified insurer and financial-services company operating in the U.S. and internationally, with approximately $1.176 trillion of assets under management and a $409.0 billion general account investment portfolio at year-end.
The 2014 filing presents the Financial Services Businesses and Closed Block Business separately, reflecting the structure in place through year-end. In January 2015, Prudential repurchased and cancelled all Class B shares, ending that reporting distinction for subsequent periods. The Closed Block policies and policyholder protections continue.
Financial results and key metrics
Amounts below are U.S. dollars; financial-statement amounts are in millions unless noted.
| Metric | 2014 | 2013 |
|---|---|---|
| Total revenue | $54,105 | $41,461 |
| Income (loss) from continuing operations before tax | $1,759 | $(1,684) |
| Net income (loss) attributable to Prudential Financial | $1,381 | $(667) |
| Diluted EPS, Common Stock | $3.23 | $(1.55) |
| Net investment income | $15,256 | $14,729 |
| Operating cash flow | $19,396 | $8,445 |
| Total assets | $766,655 | $731,781 |
| Total equity | $42,349 | $35,881 |
| Short-term and long-term debt | $23,670 | $26,222 |
- Cash and cash equivalents were $14.918 billion at year-end. Prudential Financial, the holding company, reported $11.064 billion of cash and short-term investments including intercompany liquidity balances; excluding net intercompany borrowings, it had $4.316 billion.
- Investments totaled $419.986 billion, including $296.435 billion of separate-account assets, which are generally matched by separate-account liabilities.
- Adjusted operating income before tax for the Financial Services Businesses, a non-GAAP segment measure, was $5.892 billion versus $6.369 billion. The filing does not present a single consolidated operating margin as a key performance measure.
- Segment adjusted operating income before tax: Individual Annuities $1.467 billion (2013: $2.085 billion); Retirement $1.215 billion ($1.039 billion); Asset Management $785 million ($723 million); Individual Life $498 million ($583 million); Group Insurance $23 million ($157 million); International Insurance $3.252 billion ($3.152 billion). Corporate and Other loss was $1.348 billion ($1.370 billion).
Material changes versus the prior comparable period
- GAAP net income rebounded from a 2013 loss, substantially reflecting investment and derivative valuation volatility: consolidated realized investment results were a $1.636 billion gain in 2014 versus a $5.206 billion loss in 2013. Prudential noted that declines in interest rates and changes in variable-annuity embedded derivatives and hedges contributed materially to year-over-year movements.
- Underlying segment performance was mixed. Higher Retirement and Asset Management results and modest International Insurance growth were outweighed by lower Individual Annuities, Individual Life and Group Insurance results; total Financial Services Businesses adjusted operating income declined.
- Revenue rose, while reported premiums were affected by large pension risk-transfer transactions: 2012 included approximately $32 billion of premiums from two transactions, and 2014 included significant pension risk-transfer activity. These transactions generally bring corresponding benefit and reserve costs.
- Assets and equity increased year over year. Debt declined, including because of the redemption of the IHC Debt; the Company also issued $1.8 billion of medium-term notes during 2014.
- The fourth quarter reported a $1.451 billion loss from continuing operations and a $2.69 diluted loss per Common share. Annual results therefore obscure substantial quarterly volatility.
Outlook, risks, contingencies and unusual items
- Outlook: Management’s 2015 commentary emphasizes retirement-income needs, high-quality U.S. insurance growth, strengthening distribution, and expansion in existing international markets. It did not provide a specific consolidated earnings or revenue forecast. In a stated domestic reinvestment scenario with the 10-year Treasury averaging 2.15% through 2016 and credit spreads unchanged, Prudential estimated an unfavorable net-interest-margin impact of about $17 million in 2015 and $50 million in 2016 for a specified subset of contracts; this is a scenario, not full-company guidance.
- Interest rates and guarantees: Management warned that prolonged low rates could pressure investment yields, spreads, reserves and statutory capital. Variable-annuity guarantees remain sensitive to equity markets, interest rates, volatility, policyholder behavior and hedge effectiveness. The fair value of variable-annuity living-benefit embedded derivatives was a net liability of $8.2 billion at year-end, up from $0.4 billion in 2013.
- Capital and regulation: Prudential was designated a U.S. systemically important non-bank financial company and a global systemically important insurer. Additional Federal Reserve and international capital, liquidity, stress-testing and resolution requirements could affect costs, capital deployment and shareholder distributions. The company reported domestic insurer RBC ratios above 400% and Japanese solvency margin ratios above 700% at the dates stated; the Japanese figures were as of September 30, 2014.
- Reserving and financing: Prudential reached agreement with New York regulators on reserve methodologies that require additional New York statutory reserves for certain products, while stating that subsidiaries had sufficient New York statutory surplus at year-end. New NAIC captive-reinsurance guidance became effective January 1, 2015; its impact on future reserve financing had not been quantified.
- Unusual transactions: The $2.1 billion IHC Debt redemption included a $487 million charge for the make-whole provision, swap termination and related debt-cost effects. The $650.8 million Class B share repurchase price remained subject to a potential dispute and arbitration. The transactions did not change Closed Block guarantees, premiums or dividend methodology.
- Other notable items: The filing reports $193 million of net unfavorable 2014 out-of-period pretax adjustments, which management said were not material to current or previously reported periods. The Company also identified litigation, unclaimed-property matters, cybersecurity, reinsurance counterparty, foreign-exchange and investment-credit risks. Management reported effective internal control over financial reporting; the independent auditor issued an unqualified opinion.
Important facts for investors to verify
- How much of the 2014 GAAP earnings recovery reflects recurring business performance versus interest-rate, currency, derivative and embedded-derivative valuation movements; compare GAAP results with adjusted operating income.
- The assumptions, sensitivities, hedge effectiveness and collateral or liquidity needs associated with variable-annuity guarantees, especially after the sharp increase in the reported embedded-derivative liability.
- The development of statutory reserves and capital under the New York agreement, AG 48 and forthcoming Federal Reserve and global insurer requirements.
- The final Class B repurchase price after the dispute period, and the effects of the IHC Debt redemption and Closed Block reinsurance changes on post-2014 reporting and capital.
- Whether low reinvestment yields, policyholder behavior, Japan currency exposure and pension risk-transfer economics continue to support the reported segment trends and shareholder distributions.