PRUDENTIAL FINANCIAL INC annual report, FY2010

Prudential Financial, Inc. — 2010 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2010. Prudential is a global insurer and financial services company with approximately $784 billion in assets under management. Its operations are reported as Financial Services Businesses and a Closed Block Business; these are reporting allocations, not legally separate entities. The filing was signed February 25, 2011.

Key financial results

Metric	2010	2009
Total revenue	$38.414 billion	$32.566 billion
Income from continuing operations before tax and equity in operating joint ventures	$4.422 billion	$1.552 billion
Net income attributable to Prudential Financial	$3.195 billion	$3.124 billion
Diluted continuing-operations EPS, Common Stock	$5.73	$7.72
Cash flow from operating activities	$6.542 billion	$5.840 billion
Cash flow from investing activities	$(8.522) billion	$2.429 billion
Cash flow from financing activities	$1.613 billion	$(10.421) billion
Total assets	$539.854 billion	$480.203 billion
Prudential Financial, Inc. equity	$32.415 billion	$25.195 billion

Reported total revenue includes premiums of $18.260 billion, net investment income of $11.875 billion, asset management fees and other income of $3.908 billion, and net realized investment gains of $1.050 billion. The comparable 2009 figure included net realized investment losses of $2.897 billion.
Financial Services Businesses adjusted operating income before tax, a non-GAAP segment measure, was $4.052 billion versus $3.274 billion. Results improved in Individual Annuities, Retirement, Asset Management and International Insurance; Group Insurance and Individual Life declined.
Financial Services Businesses net income attributable to Prudential was $2.714 billion, compared with $3.411 billion in 2009. The prior year included a $1.457 billion after-tax gain from the sale of the Wachovia Securities interest. Excluding that gain, 2010 Financial Services Businesses continuing income increased year over year.
The Closed Block Business reported net income of $481 million, versus a $287 million loss in 2009, principally reflecting the swing in realized investment results. Closed Block results accrue to the policyholder and Class B structure, subject to the filing’s allocation rules.
Cash and cash equivalents declined by $249 million to $12.915 billion. Prudential Financial, the parent, reported $6.672 billion of cash and short-term investments. The filing reports total short- and long-term debt of $25.635 billion and separate asset-based financing of $8.057 billion; these figures should not be treated as interchangeable measures.
At year-end, the Financial Services Businesses’ general account investment portfolio was $209.9 billion and the Closed Block portfolio was $65.6 billion. General account fixed maturity investments had net unrealized gains of $5.726 billion and $1.671 billion, respectively.

Material changes versus 2009

Revenue rose approximately 18%, while net income attributable to Prudential increased approximately 2%. The reported comparison is affected by the 2009 Wachovia Securities sale gain and a significant shift from investment losses in 2009 to gains in 2010.
Total assets rose about $59.7 billion; separate account assets increased from $174.1 billion to $207.8 billion. These assets are generally held for customers, with investment risk primarily borne by policyholders except for applicable guarantees.
Short-term debt decreased to $1.982 billion from $3.122 billion, while long-term debt rose to $23.653 billion from $21.037 billion. Parent debt increased in part due to 2010 note issuance and the equity offering.
Individual Annuities achieved record 2010 gross sales of $21.8 billion and net sales of $14.6 billion; total annuity account values reached $106.2 billion. Asset Management AUM reached $537.3 billion, up from $456.8 billion, with record institutional net flows of $28.6 billion.
Group Insurance adjusted operating income fell to $215 million from $331 million, reflecting less favorable claims experience and higher expenses. Its group disability benefits ratio deteriorated to 94.7% from 88.9%.

Outlook, commentary, risks and unusual items

Management’s 2011 commentary emphasizes retirement-income needs, high-quality U.S. insurance business, international growth and integration of the newly acquired Japanese businesses. It provides no general quantified earnings guidance.
Prudential completed the acquisition of AIG Star Life, AIG Edison Life and related Japanese entities on February 1, 2011, after year-end. The purchase price was approximately $4.8 billion ($4.2 billion cash and $0.6 billion assumed third-party debt). Management estimated approximately $500 million of pre-tax integration costs over five years, including about $400 million in 2011–2012, and expected annual cost savings of about $250 million after integration. These are expectations, not guarantees.
The acquisition was partly funded by a November 2010 offering of 18.35 million Common shares and $1.0 billion of medium-term notes, generating approximately $2.0 billion in aggregate proceeds; the remainder was funded with cash and short-term investments.
Management estimated 2011 statutory reserve growth under Regulation XXX and Guideline AXXX could reach $600 million and was evaluating internal and external funding solutions. Failure to secure funding could affect capital, pricing or sales of term and universal life products.
Variable annuity guarantees remain sensitive to equity markets, interest rates, volatility, policyholder behavior and hedge effectiveness. In the third quarter of 2010, Prudential changed its living-benefit hedge target; management cautioned that the strategy can cause differences between GAAP liability changes and hedge results, increasing earnings volatility.
Other significant risks include prolonged low interest rates, investment and counterparty losses, credit-rating downgrades, foreign exchange exposure, reserve assumptions, regulatory changes under Dodd-Frank, tax-law changes, litigation and distribution concentration. Prudential disclosed $4.108 billion of committed credit facilities with no borrowings at year-end; access is subject to covenants.
Fixed maturity other-than-temporary impairments recognized in earnings were $732 million in 2010, down from $1.694 billion in 2009. The company also reported a $94 million 2010 deferred-tax-asset charge associated with the Medicare Part D subsidy and a $29 million increase in valuation allowance.
The board declared a 2010 annual Common Stock dividend of $1.15 per share, up from $0.70 in 2009. Subsidiary dividend capacity is subject to insurance regulation and other restrictions.
Management and the independent auditor concluded internal control over financial reporting was effective at December 31, 2010; the auditor issued an unqualified opinion on the consolidated financial statements.

Most important facts for investors to verify

Reconcile reported earnings and EPS to adjusted operating income, especially the effects of realized investment gains and losses, hedging, and the 2009 Wachovia Securities gain.
Review the assumptions and exposure behind variable annuity guarantees, including net amounts at risk, reserve sensitivity, the revised hedge strategy and collateral needs under rating stress.
Assess the quality, valuation and liquidity of investments, including sub-prime asset-backed securities, commercial mortgage-backed securities, interim commercial mortgage loans and Level 3 assets.
Track the Star and Edison acquisition’s integration costs, funding, capital impact and realization of projected savings; reported 2010 results exclude post-acquisition operations.
Verify statutory capital and dividend capacity at insurance subsidiaries, parent liquidity, debt maturities and financing needs for Regulation XXX/AXXX reserves.
Monitor claims trends and underwriting profitability in Group Insurance, Individual Life and international operations, as well as material litigation and regulatory developments.