Business context and reporting period
Prudential Financial, Inc. filed this Form 10-K for the fiscal year ended December 31, 2017. The company provides insurance, annuity, retirement, and investment-management products in the U.S. and internationally. Assets under management were approximately $1.394 trillion at year-end. In the fourth quarter, Prudential reorganized its U.S. businesses under new divisions; reporting segments and segment-profit measures were unchanged.
Financial and operating performance
| Metric | 2017 | 2016 |
|---|---|---|
| Total revenue | $59.689 billion | $58.779 billion |
| Income before tax and equity-method earnings | $6.487 billion | $5.705 billion |
| Net income attributable to Prudential | $7.863 billion | $4.368 billion |
| Diluted EPS | $17.86 | $9.71 |
| Adjusted operating income before tax | $6.244 billion | $5.399 billion |
| Net cash from operating activities | $13.445 billion | $14.815 billion |
| Total assets | $831.921 billion | $783.962 billion |
| Short- and long-term debt | $18.552 billion | $19.174 billion |
Revenue increased 1.5%; net income attributable to Prudential rose 80%, while adjusted operating income increased 15.7%. The reported net-income gain was substantially affected by tax reform: the company recorded a $2.880 billion tax benefit from the Tax Act, contributing to total income tax benefit of $1.438 billion versus tax expense of $1.335 billion in 2016. The 2017 effective tax rate was negative 22.2%, compared with 23.4%.
Operating cash flow declined about 9%. Cash and cash equivalents were $14.490 billion at year-end. Prudential reported $49.019 billion of capital under its management measure. Parent-company highly liquid assets were $4.376 billion excluding net borrowings from its intercompany liquidity account; the company targets at least $1.3 billion at the parent. The filing states that available sources are sufficient for current needs under reasonably foreseeable stress scenarios.
Segment adjusted operating income before tax
| Segment | 2017 | 2016 |
|---|---|---|
| Individual Annuities | $2.198 billion | $1.765 billion |
| Individual Life | $(191) million | $79 million |
| Retirement | $1.244 billion | $1.012 billion |
| Group Insurance | $253 million | $220 million |
| Investment Management | $979 million | $787 million |
| International Insurance | $3.198 billion | $3.117 billion |
| Corporate and Other | $(1.437) billion | $(1.581) billion |
Individual Annuities improved on higher fee income, lower amortization costs, and stronger investment spreads. Individual Life fell into a loss, chiefly due to assumption-review and modeling impacts, expenses, and mortality experience. Retirement and Group Insurance improved; Investment Management benefited from higher assets, fees, and incentive revenues. International Insurance grew modestly, with results also affected by currency and assumption changes.
Material changes versus the prior year
- Consolidated realized investment gains fell to $432 million from $2.194 billion. For Prudential excluding the Closed Block, realized investment results were a $102 million loss, compared with a $1.760 billion gain in 2016; derivative results were a significant driver.
- Individual Annuities account values rose to $168.626 billion, largely on market appreciation, but net flows were negative $5.800 billion. Sales fell to $5.894 billion from $8.054 billion amid industry pressure and DOL fiduciary-rule developments.
- Investment Management assets under management increased to $1.155 trillion from $1.040 trillion, supported by market appreciation and net inflows.
- Debt declined by $622 million. Prudential repurchased $1.25 billion of shares and declared $1.3 billion of common dividends in 2017.
- Common equity attributable to Prudential increased to $54.069 billion from $45.863 billion; total equity was $54.344 billion.
Outlook, risks, contingencies, and unusual items
Management expected 2018 results to benefit from diversified protection, retirement, and investment-management businesses, while identifying low interest rates, fee compression, and regulatory change as headwinds. It anticipated elevated strategic investment spending in technology, customer experience, and distribution. Individual Annuities near-term returns on assets were expected to remain above the long-term target but migrate toward it; management expected challenged industry sales and a slight account-value decline. Retirement pension risk-transfer opportunities were viewed favorably but episodic. Group Insurance cited improved disability claims management and pricing discipline.
- Interest rates: Management estimated that, under a specified U.S. Treasury-rate scenario, reinvestment at lower yields could reduce pre-tax adjusted operating income by $14 million in 2018 and $43 million in 2019 for certain U.S. contracts. A separate hypothetical 25-basis-point reduction in new-money yields in Japanese and Korean operations was estimated to reduce 2018 adjusted operating income by $10 million to $15 million. These are limited scenarios, not full forecasts.
- Tax reform: The 2017 tax accounting was provisional and subject to further analysis. The company expected the lower U.S. tax rate to reduce future effective taxes, but also expected an adverse effect on domestic insurers’ statutory capital and RBC. It expected major domestic insurance subsidiaries’ 2017 RBC ratios to exceed 400%, though figures were not yet filed.
- Variable annuities and markets: Guarantees, hedging effectiveness, policyholder behavior, interest rates, equity markets, credit spreads, and collateral demands may create earnings volatility or liquidity needs. The net loss from changes in variable-annuity embedded derivatives and hedges, after related DAC and other costs, was $719 million in 2017.
- Accounting and unusual items: Individual Life recorded a $237 million second-quarter charge from a change in estimated reinsurance cash flows and accounting method. Its 2017 annual assumption review and refinements included a $653 million net charge. The 2017 results also included a $1.5 billion favorable pre-tax variance from changes in how certain interest-rate risks were managed; this is not a simple measure of recurring earnings improvement.
- Regulation and legal matters: Prudential remained subject to enhanced Federal Reserve supervision as a designated financial company; its designation was under review. The DOL fiduciary rules had increased compliance costs and were associated with lower annuity sales; further rules or state standards could affect business. The company estimated reasonably possible litigation and regulatory losses beyond accruals at less than $250 million where estimable, but stated that outcomes remain uncertain. A securities-lending matter was under SEC review and settlement discussions; the company could not predict the outcome.
- Other risks: Material exposures include credit and counterparty losses, insurance claims and longevity/mortality experience, liquidity and collateral calls, cybersecurity and operational failures, ratings downgrades, foreign exchange, and regulatory or tax changes. Japan is a significant source of business and investment exposure.
Important facts for investors to verify
- How much of the 2017 earnings increase reflects the one-time Tax Act benefit, and what is the sustainable post-reform tax rate and statutory-capital effect?
- Whether adjusted operating income growth persists after separating market-sensitive hedging results, assumption updates, and other unusual items.
- Whether Individual Life can restore profitability following its substantial assumption-review charge, and whether annuity sales and net flows stabilize.
- Insurer statutory capital and RBC ratios after final tax and regulatory rules, including the availability and cost of reserve financing.
- How interest-rate, equity-market, foreign-exchange, and derivative-collateral stresses affect earnings, liquidity, and capital; review the filing’s scenario assumptions.
- Developments in the SEC securities-lending review, escheatment matters, ERISA litigation, and other disclosed legal proceedings.