Prudential Financial, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; balance-sheet comparisons are with December 31, 2013. Figures are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. The filing is unaudited.
Business context
Prudential provides insurance, annuity, retirement, asset-management and related financial services in the U.S. and internationally. Its reporting separates the Financial Services Businesses—which include U.S. retirement and investment management, U.S. life and group insurance, and International Insurance—from the legacy Closed Block Business. Common Stock reflects Financial Services performance; privately placed Class B Stock reflects the Closed Block.
Financial performance and position
| Metric | Q1 2014 / March 31, 2014 | Comparable period / prior year-end |
|---|---|---|
| Total revenue | $12,854 | $10,171 in Q1 2013 |
| Net income attributable to Prudential Financial | $1,238 | $(720) in Q1 2013 |
| Diluted Common Stock EPS | $2.59 | $(1.58) in Q1 2013 |
| Financial Services adjusted operating income before tax | $1,571 | $1,478 in Q1 2013 |
| Operating cash flow | $1,979 | $187 in Q1 2013 |
| Total assets | $746,735 | $731,781 at Dec. 31, 2013 |
| Total equity | $38,864 | $35,881 at Dec. 31, 2013 |
| Cash and cash equivalents | $12,472 | $11,439 at Dec. 31, 2013 |
| Short- and long-term debt | $26,584 | $26,222 at Dec. 31, 2013 |
Revenue included premiums of $5,868 (down from $7,084), net investment income of $3,838 (up from $3,638), and net realized investment gains of $208 versus losses of $723 in Q1 2013. Benefits and expenses totaled $11,136, compared with $11,730. The tax provision was $473, versus a tax benefit of $827 in the prior-year quarter.
Cash flows were $1,979 provided by operations, $2,969 used in investing, and $1,997 provided by financing. Cash increased by $1,033 during the quarter. Reported debt excludes $4,101 of notes issued by consolidated variable-interest entities; those notes are separately reported and generally have recourse only to the assets of the respective entities.
Financial Services adjusted operating income before tax rose to $1,571 from $1,478. Segment amounts were: Individual Annuities $388 (prior year $372), Retirement $364 ($228), Asset Management $193 ($169), Individual Life $125 ($137), Group Insurance $6 ($9), International Insurance $837 ($877), and Corporate and Other $(342) ($(314)). These are non-GAAP segment measures and are not equivalent to consolidated net income.
Material changes versus Q1 2013 and year-end
- The shift from a consolidated net loss to profit was driven substantially by lower realized investment losses and foreign-currency-related accounting effects. Management reported a $2,618 favorable pre-tax year-over-year effect from currency movements on certain economically matched, non-yen assets and liabilities in Japanese operations; related effects are substantially reflected in other comprehensive income, so GAAP earnings can be volatile.
- Net realized investment results improved by $931, from a $723 loss to a $208 gain. Derivative losses were $145 versus $870 in Q1 2013, according to the investment note.
- Financial Services adjusted operating income increased 6%. Retirement benefited from investment spreads and fees; Asset Management from higher assets and positive net flows. International Insurance declined, including currency and reserve-refinement effects; Individual Life results declined on less favorable mortality and reserve updates.
- Individual Annuity sales fell, with net flows of $(283) versus positive $2,026 in Q1 2013. Individual Life annualized new business premiums fell to $122 from $216, and International annualized new business premiums were $772 on a constant-currency basis versus $841.
- Available-for-sale fixed maturities increased in fair value to $295,321 from $286,866, while total investments rose to $408,468 from $398,173. Accumulated other comprehensive income increased to $10,798 from $8,681, reflecting investment gains and other changes.
- Q1 included $250 of common-stock repurchases. The Board declared a $0.53 common dividend per share, up from $0.40 in Q1 2013.
Outlook, commentary, risks and unusual items
- Interest rates: Management said low rates depress reinvestment yields and expected portfolio yields to continue declining, although a sustained rise in rates could mitigate the effect. Domestic general-account fixed maturities and commercial mortgage loans had an approximately 4.5% average yield; scheduled payments and prepayments were expected to be about 10% of those portfolios annually through 2015. In a specified low-rate scenario, management estimated an unfavorable pre-tax adjusted-operating-income impact of about $11 in 2014 and $47 in 2015 for the contracts analyzed. These estimates are scenario-dependent, not company-wide earnings guidance.
- Capital and liquidity: Management said available sources were sufficient for current needs and reasonably foreseeable stress scenarios. Financial Services capital was $36.8 billion under the company’s stated measure. Domestic insurer RBC ratios cited were 456% for Prudential Insurance and 502% for Prudential Annuities Life Assurance Corporation as of Dec. 31, 2013; these are not March 2014 figures. The holding company had $3.75 billion of committed credit facilities with no borrowings outstanding at quarter-end.
- Regulation: Prudential is designated a systemically important financial company and was identified as a global systemically important insurer. The New York Department of Financial Services disputed the company’s statutory reserve and reinsurance-credit calculations for certain variable annuities; additional reserves or collateral, if required, could constrain capital deployment. Regulators were also reviewing captive reinsurance practices; the effects of potential changes were not yet estimable.
- Contingencies: The filing discusses unclaimed-property and death-benefit matters, retained-asset-account litigation, shareholder and securities actions, wage-and-hour claims, and the company’s RMBS lawsuits. Management estimated aggregate reasonably possible losses above established accruals at less than $250, where estimable, and said the ultimate outcome was not likely to materially affect financial position; it cautioned that outcomes could affect results or cash flow in a particular period.
- Other notable items: Prudential completed its UniAsia Life Assurance acquisition through a Malaysian joint venture on January 2, 2014. The Q1 financial statements include Gibraltar Life results through February 28, 2014. Variable-annuity guarantee valuation is sensitive to market and policyholder assumptions; the fair-value liability for optional living benefits increased materially from year-end. Management also noted that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- How much of the earnings turnaround reflects recurring segment performance versus foreign-currency, derivative, and other market-sensitive GAAP effects; reconcile reported earnings with adjusted operating income.
- Whether the low-interest-rate assumptions, reinvestment outlook, and variable-annuity guarantee and hedging assumptions remain appropriate as markets and policyholder behavior change.
- The outcome and potential capital or collateral impact of the NYDFS reserve dispute, captive-reinsurance proposals, and other regulatory developments.
- Developments in material litigation and unclaimed-property matters, including whether estimated losses or accruals change.
- Capital, liquidity, debt maturities and refinancing needs, insurer statutory capital measures, and the use of repurchases and dividends.