Prudential Financial, Inc. — Q1 2011 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2011, compared with the same period in 2010. Prudential provides insurance, annuity, retirement, investment-management and related services in the U.S. and internationally. It reports Financial Services Businesses separately from its legacy Closed Block Business. The February 1 acquisition of AIG’s Star and Edison Japanese insurance businesses is included for one month of results because those operations report on a one-month lag.
Financial performance and condition
- Revenue: $10.186 billion, up 10% from $9.247 billion. Premiums increased to $5.521 billion from $4.242 billion; net investment income rose to $3.118 billion from $2.872 billion.
- Earnings: Net income attributable to Prudential was $608 million, down from $697 million. Income from continuing operations before tax and equity in operating joint ventures was $704 million versus $1.009 billion. Diluted Common Stock EPS was $1.20 versus $1.15; continuing-operations EPS was $1.17 versus $1.15. Closed Block income fell to $19 million from $161 million.
- Segment measure: Financial Services adjusted operating income before tax increased to $1.154 billion from $921 million. This is a non-GAAP management measure and should not be treated as consolidated net income.
- Cash flow: Operating activities provided $2.231 billion, compared with $51 million used in Q1 2010. Investing activities used $3.932 billion, including $2.321 billion for acquisitions; financing activities used $171 million. Cash and equivalents ended at $10.995 billion, down from $12.915 billion at year-end.
- Balance sheet and debt: Total assets were $599.0 billion versus $539.9 billion at December 31, 2010; total equity was $33.2 billion versus $32.9 billion. Short- and long-term debt totaled $26.5 billion versus $25.6 billion. Including asset-based financing, reported borrowings and financing were $34.5 billion.
- Liquidity and capital: The parent had $3.365 billion of cash and short-term investments. The company reported $4.108 billion of unsecured committed credit facilities, with no borrowings outstanding. Prudential Insurance’s RBC ratio was 533% at December 31, 2010; management estimated domestic life subsidiaries remained above regulatory minimums at March 31, 2011.
- Investment and credit indicators: Net realized investment losses were $50 million versus gains of $389 million. Fixed-maturity other-than-temporary impairments recognized in earnings were $575 million, partly offset by $471 million of impairments recorded in OCI. The commercial mortgage and other loan loss allowance was $557 million at March 31, versus $575 million at year-end.
Material changes versus the prior period
- Reported revenue growth was substantially influenced by the Star and Edison acquisition and currency movements. The acquired businesses contributed $304 million revenue and a $17 million continuing-operations loss for February; acquisition-related transaction and integration costs were $55 million for the quarter.
- International Insurance adjusted operating income rose to $672 million from $491 million, including a $153 million pre-tax gain on a partial sale of China Pacific Insurance shares and acquisition-related effects. Individual Annuities increased to $292 million from $244 million; Asset Management rose to $154 million from $83 million. Group Insurance declined to $40 million from $53 million, primarily due to increased long-term disability claims.
- Closed Block pre-tax income declined to $27 million from $259 million, primarily because net realized investment gains fell to $30 million from $274 million.
- Accumulated other comprehensive income attributable to Prudential decreased to $2.564 billion from $2.978 billion, mainly reflecting a $550 million decline in net unrealized investment gains, partly offset by currency translation gains.
Outlook, commentary, risks and unusual items
- Management estimated a further approximately $55 million pre-tax charge in Q2 2011 for Japan earthquake and tsunami claims in Gibraltar Life, including Star and Edison; $19 million was recorded for Life Planner operations in Q1. Management said it did not expect a significant effect on Japanese investment values, business operations, capital or liquidity.
- For the Star and Edison integration, management expected approximately $500 million of pre-tax integration costs over five years, including about $400 million in 2011 and 2012, and approximately $250 million in annual cost savings after integration. These are estimates, not guarantees.
- On April 6, 2011, Prudential agreed to sell its Global Commodities Business to Jefferies for approximately book value, then about $430 million at December 31, 2010. Closing was expected in June, subject to approvals and other conditions. Prudential agreed to maintain certain guarantees for 18 months and may provide a temporary credit line of up to $1 billion after closing.
- An out-of-period adjustment reduced Q1 pre-tax continuing income by $95 million for amortization of losses on certain Gibraltar Life mortgage-backed securities. The filing says it did not affect adjusted operating income and was not material to previously reported periods.
- Key sensitivities include market and interest-rate movements, prolonged low rates, variable-annuity guarantee and hedging performance, investment impairments and counterparty risk, policyholder behavior, foreign exchange, regulatory and tax changes, acquisition integration, and subsidiary dividend restrictions. Litigation and regulatory matters include retained-asset-account class actions and other proceedings; management said outcomes are uncertain but did not expect the matters, after reserves and indemnification, to materially affect financial position.
- The filing gives no consolidated earnings guidance. It cautions that interim results are not necessarily indicative of full-year results. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Underlying earnings excluding the China Pacific gain, acquisition-related costs, realized investment effects and the $95 million adjustment; reconcile adjusted operating income to GAAP results.
- Star and Edison integration spending, realized synergies, purchase-price adjustments, assumed debt repayment and the effect of the reporting lag.
- Actual Q2 Japan catastrophe claims relative to the estimated $55 million charge, and any subsequent effects on capital, liquidity or investment values.
- Credit quality and valuation of mortgage-backed and other investments, realized and unrealized losses, and changes in commercial mortgage delinquencies and reserves.
- Variable-annuity guarantee exposure, hedge effectiveness and sensitivity to markets, interest rates, policyholder behavior and the company’s own credit spreads.
- Availability of subsidiary dividends, credit facilities and other liquidity sources, plus progress and remaining obligations in the Global Commodities sale.