Prudential Financial, Inc. — Q3 2014 Form 10-Q
Business context and reporting period. Prudential provides insurance, annuity, retirement, asset-management and related financial services in the U.S. and internationally. This unaudited filing covers the quarter and nine months ended September 30, 2014; comparisons are with the corresponding 2013 periods unless stated otherwise. Results combine the Financial Services Businesses and the separately managed Closed Block Business. Certain Gibraltar Life results and balances are included through August 31, 2014.
Financial performance and position
Amounts are in millions of dollars except per-share data, percentages and where noted.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $12,380 | $11,310 | $38,380 | $31,522 |
| Income (loss) before tax and joint-venture earnings | $284 | $1,526 | $3,509 | $(802) |
| Net income (loss) attributable to Prudential | $512 | $1,027 | $2,840 | $(207) |
| Diluted EPS, Common Stock | $0.99 | $2.04 | $5.80 | $(0.61) |
| Net investment income | $3,841 | $3,650 | $11,433 | $10,999 |
| Net realized investment gains (losses) | $75 | $(2,110) | $892 | $(3,857) |
- Revenue rose about 9% in Q3 and 22% year to date. Q3 attributable net income fell about 50%; the nine-month period moved from a loss to a profit. Reported results were heavily affected by derivatives, foreign-exchange movements, variable-annuity guarantee valuations, taxes and annual assumption updates.
- Q3 consolidated pretax income was about 2.3% of revenue, versus 13.5% in Q3 2013; the comparable nine-month ratios were about 9.1% and negative 2.5%. These simple ratios reflect substantial market-driven and accounting volatility and are not operating-margin measures.
- Financial Services Businesses adjusted operating income before tax, Prudential’s non-GAAP segment measure, was $1,353 in Q3 versus $1,913 and $4,547 for nine months versus $4,908. International Insurance and Asset Management improved, while Individual Annuities, Individual Life and Group Insurance declined. Retirement increased.
- Q3 Financial Services continuing-operations income was $476 versus $971; nine-month income was $2,776 versus a $222 loss. The Q3 comparison included large adverse FX and Capital Protection Framework effects, partly offset by favorable variable-annuity hedge-accounting and tax effects. Closed Block income before tax was $100 in Q3 and $169 for nine months, up from $85 and $108.
- Cash from operations for nine months was $11,422 versus $5,483; investing cash outflow was $9,677 versus $12,276; financing cash inflow was $4,118 versus $2,152. Cash and cash equivalents ended the period at $17,222, up from $11,439 at December 31, 2013.
- At September 30, total assets were $764.1 billion, total liabilities $721.8 billion, and total equity $42.4 billion, including $41.8 billion attributable to Prudential. Equity increased from $35.9 billion at year-end, principally alongside higher accumulated other comprehensive income.
- Short-term debt was $4.4 billion and long-term debt $22.6 billion, totaling about $27.0 billion, versus $26.2 billion at year-end. Prudential reported $3.75 billion of committed credit facilities, with no amounts drawn. Cash and short-term investments at the parent, excluding intercompany liquidity-account borrowings, were $4.2 billion.
- Available-for-sale fixed maturities had a fair value of $301.1 billion, up from $286.9 billion at year-end. Commercial mortgage and other loans were $44.8 billion versus $41.0 billion. Separate-account assets of $292.6 billion were matched by equal separate-account liabilities.
- Assets under management were $917.5 billion, up from $848.1 billion a year earlier, reflecting market appreciation and net flows. Common Stock dividends declared were $0.53 per share each quarter; $750 million of shares were repurchased in the first nine months.
Material changes and notable items
- Market-sensitive results: Q3 total realized investment gains were $75, compared with losses of $2,110 in Q3 2013. For nine months, gains were $892 versus losses of $3,857. Financial Services derivative results remained a major source of volatility; the filing attributes much of the year-over-year swing to interest rates, currency and variable-annuity guarantees.
- Variable annuities: The net fair-value liability for certain living-benefit embedded derivatives was $5.3 billion at September 30, compared with $0.4 billion at year-end. In Q3 the related embedded-derivative and hedge results, after associated DAC effects and NPR, produced a net $621 million loss; the comparable 2013 quarter showed a $1.939 billion loss. The hedge target and GAAP liability use different assumptions, so they may not offset period to period.
- Assumption updates and prior-period adjustments: Annual reviews and assumption changes affected multiple segments. Q3 included a $156 million aggregate pretax out-of-period adjustment, which management said was not material to the current or prior statements. Identified components included $48 million of higher group long-term-disability reserves and $45 million of higher variable-annuity reserves, net of related DAC effects.
- Closed Block: The policyholder dividend obligation was $5.829 billion, including $1.427 billion for cumulative earnings above expectations and $4.402 billion related to post-demutualization unrealized investment gains. Those amounts are attributable to policyholders, not available to shareholders, subject to future experience.
- Acquisitions and expansion: Prudential completed its Malaysian UniAsia Life joint venture acquisition in January 2014. After quarter-end, it announced a memorandum of understanding to acquire an indirect 34%–40% interest in Chile’s AFP Habitat for an estimated $530–$620 million; closing was expected in the first half of 2015, subject to conditions and approvals.
Outlook, risks and contingencies
- Low interest rates: Management said reinvestment yields were below portfolio yields and expected overall yields to continue declining. It estimated that, under a hypothetical 10-year Treasury rate of 2.50% through 2015 with credit spreads unchanged, reinvestment would reduce pretax adjusted operating income by about $1 million in 2014 and $32 million in 2015 for the specified domestic contracts. This scenario excludes several potential offsets and is not formal guidance.
- Capital and regulation: Prudential is subject to Federal Reserve supervision as a designated financial company and identified as a global systemically important insurer. Global capital standards and U.S. regulatory requirements remained under development. The New York DFS disputed Prudential’s statutory reserve calculation for certain variable annuities; additional reserves or collateral, if required, could constrain capital deployment. NAIC proposals on captive reinsurance may also affect financing and product economics; Prudential said the impact was not yet estimable.
- Capital resources: Financial Services Businesses capital was reported at $38.9 billion. The latest disclosed domestic RBC ratios were as of December 31, 2013: 456% for Prudential Insurance and 502% for PALAC. June 30, 2014 solvency-margin ratios were 835% for Prudential of Japan and 967% for Gibraltar Life consolidated. The filing said subsidiaries exceeded regulatory minimums; these dates are not quarter-end figures.
- Litigation and guarantees: The company reported that the aggregate range of reasonably possible losses above established accruals, where estimable, was less than $250 million at September 30. Management did not expect pending matters, after reserves and indemnification, to materially harm financial position, but noted that litigation outcomes are uncertain and could materially affect a particular period. Matters include unclaimed-property and retained-asset-account cases, shareholder and securities litigation, and RMBS- and LIBOR-related actions.
- Other risks: Key exposures include interest-rate and equity-market changes, mortality and policyholder behavior, reserve and DAC assumption changes, credit losses and counterparty performance, foreign exchange, regulation, ratings, liquidity, and the parent company’s reliance on subsidiary distributions. Management said available cash sources were sufficient for current needs under reasonably foreseeable stress scenarios. No formal earnings guidance was provided.
Important facts for investors to verify
- How much of earnings and equity reflects recurring underwriting, fee and investment-spread performance versus market-driven derivative, FX and AOCI movements.
- Whether variable-annuity guarantee liabilities, hedge effectiveness, capital needs and annual assumption updates develop in line with disclosed assumptions.
- Progress on resolving the New York statutory-reserve dispute and the eventual effects of NAIC captive-reinsurance rules and broader capital standards.
- Commercial mortgage portfolio credit quality, including watch-list, nonaccrual and loan-loss allowance trends, alongside continued low-rate reinvestment pressure.
- Actual cash availability at the parent and regulated subsidiaries, debt maturities and financing access; consolidated cash and separate-account assets are not interchangeable with parent liquidity.
- Final terms, approvals, funding and integration economics of the proposed AFP Habitat transaction, and the outcome of material litigation and regulatory matters.