Prudential Financial, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Unaudited consolidated financial statements; dollar amounts below are in millions unless stated otherwise. Prudential provides insurance, annuity, retirement, investment-management and related financial services. Its reporting separates the Financial Services Businesses from the Closed Block Business.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenues | $11,343 | $13,144 | $31,572 | $38,903 |
| Income (loss) from continuing operations before tax and joint-venture earnings | $1,559 | $(930) | $(752) | $1,276 |
| Net income (loss) attributable to Prudential | $1,042 | $(584) | $(185) | $701 |
| Common Stock diluted EPS | $2.07 | $(1.34) | $(0.57) | $1.40 |
| Adjusted operating income before tax, Financial Services Businesses | $1,940 | $1,021 | $4,941 | $2,925 |
- Q3 net investment income was $3,650, up from $3,433; nine-month net investment income was $10,999, up from $10,111. Net realized investment losses were $2,110 in Q3 and $3,857 for the nine months, largely reflecting derivative results.
- Operating performance improved across several U.S. segments. Q3 adjusted operating income rose particularly in Individual Annuities ($821 vs. $207) and Retirement ($237 vs. $110). International Insurance was nearly flat in Q3 ($778 vs. $782), but higher for the nine months ($2,505 vs. $2,057).
- At September 30, total assets were $723,126, total liabilities $688,010, and total equity $35,116. Assets rose from $709,298 at year-end 2012, while Prudential-attributable equity declined from $38,575 to $34,358. AOCI fell to $6,899 from $10,214, including a $3,337 after-tax nine-month OCI loss.
- Cash and cash equivalents were $12,650, down from $18,100 at year-end. For the first nine months, operating cash flow was $5,483 (vs. $11,749), investing cash outflow was $12,276, financing cash inflow was $2,152, and cash declined $5,450.
- Short- and long-term debt totaled $26,760 at quarter-end, versus $27,213 at year-end. The company reported $3,118 of short-term debt and $23,642 of long-term debt; no borrowings were outstanding under its $3.75 billion committed credit facilities.
Changes, unusual items and management commentary
- Q3 returned to GAAP profitability from a year-earlier loss; nine-month attributable net income shifted to a loss. Management attributed the divergent comparisons to market-sensitive items, not a uniform change in underlying operations. In the nine-month comparison, variable-annuity embedded derivative and hedge movements were unfavorable by $2,811 pre-tax, and yen-related remeasurement effects were also unfavorable. These effects are volatile and may be partly offset in AOCI.
- Q3 Financial Services results included a $1,563 pre-tax favorable comparative effect from foreign-currency movements on economically matched Japanese assets and liabilities, and a $1,350 favorable variance from DAC, other-cost and reserve updates. These were partly offset by a $1,123 unfavorable variable-annuity guarantee and hedge impact. The filing’s adjusted operating income is a non-GAAP segment measure and excludes specified market-related items.
- The third-quarter DAC amortization line was a credit of $452, compared with expense of $182 a year earlier; for the nine months, it was a credit of $14, compared with expense of $1,194. Assumption reviews and variable-annuity market effects materially influenced these figures.
- Prudential acquired The Hartford’s individual life business in January for $615 cash, adding about 700,000 policies. It reported $43 of integration costs through September and expected about $125 total through 2015, with approximately $90 of annual savings by 2015; about 65% of that savings was achieved on a run-rate basis by quarter-end. The wealth-management solutions business was sold July 1. An agreed Malaysian life-insurance joint venture, with approximately $160 consideration, remained subject to approvals.
- Management said prolonged low rates are expected to reduce reinvestment yields. In a specified hypothetical scenario—a 2.50% average 10-year Treasury rate through 2014, with credit spreads unchanged—it estimated an approximately $30 pre-tax adjusted-operating-income impact in 2014 for the identified domestic contracts. This is a limited scenario estimate, not company-wide guidance.
- Regulatory oversight increased: Prudential accepted its designation as a Dodd-Frank “Covered Company” and was identified as a global systemically important insurer. The company said future capital, liquidity, stress-testing and other requirements remained uncertain. Regulators were also reviewing captive reinsurance practices.
- Legal and regulatory matters include unclaimed life-insurance proceeds, retained-asset-account litigation, shareholder suits and Prudential’s own RMBS lawsuits. The company estimated reasonably possible losses above established accruals at $0–approximately $175, but said this is not an expected-loss estimate or maximum exposure.
Liquidity, capital and risk indicators
- Financial Services Businesses capital was $37.2 billion at September 30, including $26.1 billion of attributed equity, $4.9 billion of junior subordinated debt and $6.2 billion of other capital debt. Management said this was consistent with its ratings targets.
- Domestic insurance liquidity assets totaled $174.2 billion and international insurance liquidity assets $135.8 billion. Prudential Financial parent cash and short-term investments, excluding net intercompany borrowings, were $4,669; its stated minimum target is $1.3 billion.
- Domestic statutory RBC ratios reported for year-end 2012 were 456% for Prudential Insurance and 421% for PALAC. The filing states insurance subsidiaries substantially exceeded regulatory minimum capital levels.
- Commercial mortgage and other loans totaled $39,497, up from $36,733 at year-end. More than 99% of Financial Services and Closed Block balances were current. The commercial/agricultural mortgage portfolios had weighted-average debt-service coverage ratios of 2.09x and 2.08x, respectively.
- Interest-rate, equity, currency and credit-market exposure, low reinvestment yields, reserve and policyholder-behavior assumptions, derivative counterparty risk, foreign-exchange movements, ratings changes, and the ability of subsidiaries to distribute funds to the holding company remain material risks.
Most important facts for investors to verify
- Reconcile the nine-month GAAP loss with adjusted operating income, particularly derivative, variable-annuity guarantee, currency and DAC/reserve effects.
- Review the assumptions and sensitivity of variable-annuity embedded guarantees, hedging effectiveness, and policyholder lapse and benefit-utilization behavior.
- Track reinvestment yields, crediting-rate flexibility and the effects of sustained low interest rates on spreads and reserves.
- Assess capital and liquidity implications of new Federal Reserve and global insurer requirements, captive-reinsurance reviews, and any restrictions on subsidiary dividends.
- Monitor developments in unclaimed-property, retained-asset-account and RMBS matters; the disclosed potential-loss range is uncertain and excludes matters for which a range cannot currently be estimated.