Prudential Financial, Inc. — Q2 2012 Form 10-Q
Business context and period. Unaudited results cover the quarter and six months ended June 30, 2012, compared with the corresponding 2011 periods. Prudential provides insurance, annuity, retirement, and investment-management services. Its reporting separates the Financial Services Businesses from the legacy Closed Block Business. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $16,136 | $12,244 | $25,759 | $22,414 |
| Income before tax and joint-venture earnings | $2,932 | $1,084 | $2,133 | $1,712 |
| Net income attributable to Prudential Financial | $2,198 | $789 | $1,231 | $1,350 |
| Diluted Common Stock EPS | $4.64 | $1.58 | $2.58 | $2.68 |
| Financial Services adjusted operating income, pretax | $829 | $1,052 | $1,844 | $2,148 |
- Quarterly net income rose sharply, but the comparison was substantially affected by market and currency-related gains. Q2 realized investment gains were $1,763 million versus $468 million; derivative gains were $1,874 million. Adjusted operating income, management’s non-GAAP segment measure, declined.
- For the six months, attributable net income fell despite higher revenue. International Insurance adjusted operating income improved, while the U.S. Retirement Solutions and Investment Management and U.S. Individual Life and Group Insurance divisions declined.
- At June 30, total assets were $647.5 billion, up from $620.2 billion at year-end 2011; total equity was $38.6 billion, up from $34.8 billion. AOCI increased to $8.3 billion from $5.4 billion, largely reflecting unrealized investment gains.
- Six-month operating cash flow was $6.0 billion versus $5.2 billion; investing activities used $5.5 billion versus $6.3 billion. Financing activities used $0.5 billion, compared with $2.0 billion provided in 2011. Period-end cash and cash equivalents were $14.2 billion, essentially unchanged from year-end.
- Consolidated short- and long-term debt totaled $27.5 billion, versus $27.0 billion at year-end; short-term debt was $3.2 billion and long-term debt $24.3 billion. Including asset-based financing, total borrowings and financing were $38.8 billion. The company reported $3.75 billion of committed credit facilities with no outstanding borrowings.
Material changes, outlook, and risks
- Underlying results and market effects: Q2 adjusted operating income fell $223 million year over year. Management cited weaker Individual Annuities and Asset Management results, lower retirement spreads, and unfavorable mortality in Individual Life. International Insurance improved, supported by growth, integration synergies, and the absence of prior-year Japan earthquake costs. Investment yields were pressured by lower reinvestment rates.
- Unusual adjustments: Two out-of-period adjustments reduced pretax income by $122 million in Q2: a $75 million real-estate-related investment impairment, including $61 million attributable to prior years, and a $61 million increase in estimated death-benefit reserves using revised Social Security Death File matching criteria. The adjustments reduced current-quarter adjusted operating income by $106 million in the Financial Services Businesses and $16 million in the Closed Block. Management said they were not material to previously reported periods.
- Accounting change: Retrospective adoption of revised insurance acquisition-cost guidance reduced December 2011 deferred acquisition costs by approximately $4.3 billion and equity by approximately $3.0 billion. The change affects the timing of earnings, not total acquisition costs over time or cash flows; management expects lower earnings initially in certain segments.
- Business outlook: No consolidated earnings guidance is provided in the supplied filing text. A General Motors pension risk-transfer agreement signed in June was expected to close by year-end 2012 and would expand payout annuity operations. Prudential reduced expected Star and Edison integration costs by $50 million to about $450 million; $269 million had been incurred, and management continued to expect about $250 million of annual savings, with two-thirds expected by year-end 2012. Variable-annuity product changes were expected to take effect in Q3, with a temporary sales increase anticipated ahead of implementation. Group long-term-care sales were to be discontinued effective August 1, 2012, or later where required by state law.
- Principal risks: Management identifies low interest rates, market volatility, variable-annuity guarantees and hedging effectiveness, reserve and policyholder-behavior assumptions, investment credit losses, foreign-exchange movements, regulatory changes, and access to financing as material risks. The company reported $12.0 billion of instruments hedging Japanese insurance earnings and equity exposure, while noting potential liquidity needs from yen appreciation and other adverse movements.
- Contingencies: Litigation and regulatory matters include investigations and claims concerning unclaimed life benefits and use of the Social Security Death File, retained-asset death-benefit accounts, and RMBS investments. In the State Street matter, the court found an ERISA fiduciary breach and awarded $28.1 million in additional damages; other counterclaims and requests remained unresolved. Management said outcomes are uncertain and an adverse resolution could affect a particular period, while it did not expect the matters, in aggregate and after reserves and indemnification, to materially harm financial position.
Important facts for investors to verify
- How much of the Q2 earnings increase came from derivative, foreign-currency, and other nonrecurring market effects versus recurring operating performance.
- The assumptions and sensitivity of variable-annuity guarantee liabilities, hedges, and the decision to hedge below the stated target; the filing reports a $1.7 billion cumulative increase in the hedge-target liability associated with that decision through June 30, 2012.
- Whether the revised death-file matching procedures and unclaimed-property settlements will lead to additional claims, reserves, or regulatory costs.
- Performance of the Japanese businesses, including currency exposure, acquisition integration costs, and delivery of expected savings.
- Investment-portfolio credit quality and impairment exposure, particularly sub-prime asset-backed securities, and the effect of low rates on investment spreads and liquidity.
- Debt maturities, short-term funding and collateral needs, subsidiary dividend capacity, and the timing and financial impact of the GM pension transaction and announced share-repurchase authorization.