Business context and reporting period
Prudential Financial, Inc. filed this unaudited Form 10-Q for the quarter ended September 30, 2012. The company provides insurance, annuity, retirement, investment-management and related financial services in the U.S. and internationally. Reporting separates the Financial Services Businesses from the legacy Closed Block Business; the company cautions that interim results are not necessarily indicative of full-year results.
Financial results and position
Amounts are in U.S. dollars; income-statement and cash-flow amounts are in millions unless stated otherwise.
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue | $13,144 | $14,931 | $38,903 | $37,345 |
| Realized investment gains (losses), net | $(1,445) | $2,528 | $(1,066) | $2,946 |
| Income (loss) from continuing operations before tax and joint-venture earnings | $(967) | $2,406 | $1,166 | $4,118 |
| Net income (loss) attributable to Prudential Financial | $(618) | $1,594 | $613 | $2,944 |
| Common-stock diluted EPS | $(1.41) | $3.18 | $1.21 | $5.85 |
| Financial Services Businesses adjusted operating income before tax | $982 | $509 | $2,808 | $2,642 |
- Q3 revenue fell year over year despite higher premiums and policy charges, principally because realized investment results swung to a loss. Derivative results were a $1,458 million loss in Q3 2012 versus a $2,557 million gain in Q3 2011; the filing describes substantial variable-annuity hedge and foreign-currency effects.
- Nine-month revenue increased, but attributable net income declined sharply. Results were affected by investment volatility, foreign-currency movements, reserve and acquisition-cost assumption changes, and the comparison with prior-year gains. No standard consolidated profit-margin measure is highlighted in the filing.
- For the nine months, operating cash flow was $11,749 versus $10,821; investing cash flow was $(11,412) versus $(10,984), and financing cash flow was $(669) versus $2,593. Cash and cash equivalents declined $345 to $13,906.
- At September 30, total assets were $671.7 billion and total equity was $39.4 billion. Total investments were $378.1 billion; separate-account assets and liabilities were each $247.5 billion.
- Balance-sheet short- and long-term debt were $3.0 billion and $23.8 billion. The company separately reported total consolidated borrowings of $26.9 billion and, including asset-based financing, $38.3 billion. It had $964 million of commercial paper outstanding and $3.75 billion of committed credit facilities with no borrowings outstanding.
- Financial Services Businesses assets under management were $670.2 billion at quarter-end, up from $599.4 billion a year earlier. General-account investment income yield after expenses was 3.72% for the nine months, versus 3.87% in 2011; management cited lower reinvestment rates and floating-rate resets.
Material changes versus comparable periods
- Financial Services Businesses attributable net income was a $661 million loss in Q3 2012, versus $1,562 million of income in Q3 2011; nine-month income was $554 million versus $2,880 million. Adjusted operating income before tax, a non-GAAP segment measure, rose in Q3 but increased only modestly for the nine months.
- Individual Annuities adjusted operating income improved to $207 million in Q3 from a $192 million loss, including favorable comparative effects from variable-annuity assumption and market adjustments. International Insurance adjusted operating income rose to $783 million from $660 million in Q3 and to $2,070 million from $1,788 million for the nine months. Group Insurance fell to $35 million from $45 million in Q3 and to $28 million from $121 million for the nine months.
- Two out-of-period adjustments recorded in Q2 reduced nine-month pretax income by $122 million and adjusted operating income by $106 million. They related to a real-estate-related investment impairment and increased reserves using revised Social Security death-file matching criteria; the company said they were not material to previously reported periods.
- Retrospective adoption of revised insurance acquisition-cost guidance reduced December 2011 deferred acquisition costs by about $4.3 billion and total equity by about $3.0 billion. The filing says the change affects timing of earnings, not total acquisition costs over time or cash flows; prior-period comparisons were adjusted.
Outlook, management commentary, risks and unusual items
- Management expects continued pressure on investment yields from low interest rates. It said roughly 10% of domestic Financial Services Businesses fixed maturities and commercial mortgage loans mature annually through 2014, and reinvestment yields are expected to decline. The Federal Reserve had indicated low rates through at least 2014.
- Prudential announced a $615 million reinsurance acquisition of The Hartford’s individual life business, covering about 700,000 policies and approximately $135 billion of net retained face amount; closing was expected in early 2013, subject to approvals. It also completed a General Motors pension risk-transfer transaction on November 1 and signed a Verizon transaction expected to close in December 2012.
- The company discontinued individual long-term-care sales in March and group long-term-care sales effective August 2012, citing challenging economics and low interest rates. It recorded a $693 million pretax adverse adjustment related to long-term-care reserves and acquisition costs, based on updated interest-rate and morbidity assumptions and expected future premium increases. Actual premium increases require state approval and may differ from assumptions.
- For Japan acquisitions, management reported $303 million of integration costs through September 2012, revised total expected costs to approximately $450 million, and continued to expect about $250 million in annual savings, with two-thirds targeted by year-end 2012.
- After quarter-end, the Financial Stability Oversight Council notified Prudential that it was under consideration for possible designation for enhanced Federal Reserve supervision under Dodd-Frank; this was not a proposed determination. The filing also disclosed unclaimed-life-benefit examinations and litigation. Estimated reasonably possible litigation and regulatory losses in excess of accruals were $0 to approximately $250 million, where estimable; this is not an expected-loss estimate.
- After quarter-end, the board declared a 2012 annual Common Stock dividend of $1.60 per share, about 10% above 2011, and announced a quarterly dividend schedule beginning in Q1 2013. The company had repurchased $150 million under a new $1.0 billion authorization by September 30.
- Other material exposures include variable-annuity guarantees and hedge effectiveness, interest-rate and market risk, foreign-currency movements, credit losses and counterparty performance, reserve assumptions, regulatory requirements, litigation, and dependence of the holding company on subsidiary distributions. The company reported disclosure controls as effective and no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- How much of Q3 and nine-month earnings volatility arose from variable-annuity derivatives, foreign-currency accounting, and hedge mismatches versus underlying operating performance.
- The assumptions, state approvals and subsequent reserve effects behind the $693 million long-term-care charge, including whether expected premium increases are achieved.
- Progress, closing conditions, financing and integration economics for the Hartford, GM and Verizon transactions, and delivery of the Japan integration savings.
- Liquidity and capital impacts of persistently low rates, regulatory capital needs, debt maturities, asset-based financing and any potential Dodd-Frank designation.
- Developments in unclaimed-benefit investigations, retained-asset-account litigation and other legal matters, including whether potential losses exceed recorded reserves.
- How to interpret reported book equity and earnings in light of the significant rise in accumulated other comprehensive income, retrospective acquisition-cost accounting changes and separate-account balances.