Prudential Financial, Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013; unaudited. Amounts are U.S. dollars. Prudential operates insurance, retirement and investment-management businesses in the U.S. and internationally, alongside its separately reported Closed Block Business.
Financial results
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue | $10.044bn | $16.136bn | $20.229bn | $25.759bn |
| Income (loss) attributable to Prudential | $(521)m | $2.224bn | $(1.227)bn | $1.285bn |
| Common Stock diluted EPS | $(1.13) | $4.69 | $(2.68) | $2.69 |
| Adjusted operating income before tax, Financial Services Businesses | $1.513bn | $853m | $3.001bn | $1.904bn |
GAAP results were heavily affected by market-sensitive items and foreign exchange accounting. Q2 realized investment losses were $1.024bn versus gains of $1.763bn a year earlier; first-half losses were $1.747bn versus gains of $379m. The company reported a $273m tax benefit in Q2 and a $1.104bn tax benefit for the first half. No consolidated operating margin is presented as a key performance measure; reported results should be considered alongside the company’s non-GAAP segment measure, adjusted operating income.
- Balance sheet at June 30: Assets $705.6bn, liabilities $669.7bn, total equity $35.9bn and Prudential-attributable equity $35.1bn. Total assets were $709.3bn and total equity $39.3bn at December 31, 2012.
- Investments and AOCI: Total investments were $393.0bn, down from $405.6bn at year-end; available-for-sale fixed maturities were $286.1bn at fair value. AOCI fell to $8.4bn from $10.2bn, reflecting substantial market-related changes, including a $5.430bn pre-tax Q2 decline in unrealized investment gains.
- Cash flow, first half: Operating cash flow was $2.386bn versus $6.036bn; investing cash flow was $(7.853)bn versus $(5.509)bn; financing cash flow was $1.265bn versus $(494)m. Cash and equivalents declined $5.055bn to $13.045bn.
- Debt and liquidity: Short- and long-term debt totaled $26.3bn, down from $27.2bn at year-end. The company had $3.75bn of committed credit facilities with no borrowings outstanding; commercial paper outstanding was $993m. Management reported compliance with debt covenants.
Material changes and management commentary
- Financial Services adjusted operating income before tax rose to $1.513bn in Q2 and $3.001bn for the first half. Gains were broad-based, notably in Individual Annuities, Retirement, Asset Management and International Insurance. Corporate and Other losses increased.
- Despite improved segment operating results, Financial Services GAAP results were sharply lower. Management attributed much of the deterioration to yen depreciation and accounting mismatches on economically matched non-yen assets and liabilities, variable-annuity embedded derivatives and hedges, and derivative losses as interest rates rose. These items are volatile and are largely excluded from adjusted operating income.
- Prudential completed the Hartford individual-life acquisition on January 2, 2013, paying $615m for reinsurance of about 700,000 policies. The filing cites approximately $90m of expected annual cost savings by 2015, with integration costs of about $125m over two to three years; $19m had been incurred in the first half.
- The wealth-management-solutions sale to Envestnet closed July 1, after quarter-end. The Board authorized up to $1bn of Common Stock repurchases for July 2013–June 2014. Q2 Common Stock dividend declared was $0.40 per share.
Outlook, risks and contingencies
- Interest rates: Management expects low rates to continue pressuring reinvestment yields and net interest margins. Under a hypothetical 10-year Treasury rate of 2.50% through 2014, with credit spreads unchanged, it estimated an unfavorable pre-tax adjusted-operating-income impact of about $8m in H2 2013 and $60m in 2014 on a specified $48bn block of contracts. This scenario excludes potential mitigants and is not company-wide earnings guidance.
- Regulatory designation: The Financial Stability Oversight Council had proposed subjecting Prudential to Federal Reserve supervision and stricter prudential standards; the company contested the proposal, with a final determination expected within 60 days after the July 30 hearing. Separately, the Financial Stability Board identified Prudential as a global systemically important insurer. Effects remained uncertain.
- Litigation and guarantees: Management estimated reasonably possible losses in excess of accruals for estimable litigation and regulatory matters at $0–approximately $175m, while noting this is not an expected-loss estimate or maximum exposure. Matters include unclaimed life-insurance proceeds and retained-asset-account litigation. Certain guarantees and commitments could expose the company to further payments.
- Other sensitivities: Risks include variable-annuity guarantees and hedging effectiveness, reserve and policyholder-behavior assumptions, investment credit losses, currency movements, ratings changes, regulatory restrictions on subsidiary dividends, and reliance on subsidiaries for holding-company liquidity. Management cautions that interim results are not necessarily indicative of full-year results.
Investor verification priorities
- Reconcile GAAP losses to adjusted operating income, especially yen-related accounting effects, variable-annuity hedge/NPR impacts, and realized derivative results.
- Review the sustainability of operating gains by segment, acquisition integration costs and savings, and sales trends in annuities and life insurance.
- Assess sensitivity to rates, equity markets and foreign exchange, including the assumptions and scope of management’s interest-rate scenario.
- Check capital and liquidity at the holding company and regulated subsidiaries, dividend-transfer restrictions, and implications of potential Federal Reserve and G-SII requirements.
- Track litigation exposures, reserve adequacy, and the status of unclaimed-property and retained-asset-account matters.