Prudential Financial, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; balance-sheet comparisons are with December 31, 2014. Amounts are in U.S. dollars. The interim financial statements are unaudited.
Business context and comparability
Prudential provides insurance, annuity, retirement, investment-management and related financial services in the U.S. and internationally. On January 2, 2015, it repurchased and cancelled all Class B shares, ending the separate stock-based reporting of the former Financial Services and Closed Block businesses. Consequently, 2015 common-stock earnings reflect consolidated Prudential, while Q1 2014 common-stock EPS reflects only the former Financial Services Businesses. The reported year-over-year comparison is therefore not fully like-for-like.
Financial performance and position
| Metric | Q1 2015 | Comparable period / prior date |
|---|---|---|
| Total revenue | $15.552bn | $12.854bn in Q1 2014 |
| Net income attributable to Prudential | $2.036bn | $1.238bn in Q1 2014 |
| Diluted EPS | $4.37 | $2.59 in Q1 2014; comparison is affected by the reporting change |
| Adjusted operating income before tax | $1.745bn | $1.571bn in Q1 2014 |
| Net investment income | $3.769bn | $3.838bn in Q1 2014 |
| Operating cash flow | $5.528bn | $1.979bn in Q1 2014 |
| Total assets | $778.612bn | $766.655bn at Dec. 31, 2014 |
| Total equity | $45.574bn | $42.349bn at Dec. 31, 2014 |
| Cash and cash equivalents | $19.119bn | $14.918bn at Dec. 31, 2014 |
| Short- and long-term debt | $22.716bn | $23.670bn at Dec. 31, 2014 |
Revenue and earnings growth were strongly affected by realized investment gains: net realized gains were $2.361bn versus $208m a year earlier, including $1.545bn of derivative gains in PFI excluding the Closed Block division versus $169m of derivative losses in Q1 2014. Adjusted operating income, management’s non-GAAP segment measure, rose to $1.745bn from $1.571bn. These measures should not be conflated: adjusted operating income excludes many realized investment gains and related items.
Cash flows from investing activities were positive $1.648bn, compared with negative $2.969bn in Q1 2014; financing activities used $3.086bn, versus providing $1.997bn. Cash increased $4.201bn during the quarter. Prudential reported $41.227bn of capital under its management definition, which excludes AOCI and includes attributed equity and capital debt. The filing reports no consolidated profit-margin measure; GAAP earnings include substantial market-sensitive investment and derivative effects.
Material changes and segment results
- Individual Annuities: Adjusted operating income increased to $529m from $388m, with a $106m net benefit from changes in estimated profitability in Q1 2015 versus a $21m charge in Q1 2014. Account values reached $161.127bn; quarterly net flows were negative $457m.
- Retirement: Adjusted operating income declined to $284m from $364m, primarily due to lower investment spreads and reinvestment yields. Premiums rose substantially, largely reflecting pension risk-transfer business.
- Asset Management: Adjusted operating income increased to $205m from $193m. Assets under management were $961.7bn, up from $933.5bn at year-end 2014, supported by net additions and market appreciation.
- Individual Life: Adjusted operating income was $116m versus $125m, reflecting less favorable mortality experience.
- Group Insurance: Adjusted operating income improved to $30m from $6m, mainly on better disability underwriting and lower expenses; group-life underwriting was less favorable.
- International Insurance: Adjusted operating income was $834m, versus $837m. Management said results excluding currency effects improved, while reported results included unfavorable currency impacts. Constant-currency annualized new business premiums rose to $780m from $733m.
- Closed Block: Q1 2015 results are presented as a division following the Class B repurchase. Its GAAP loss before tax was $22m versus income of $13m in Q1 2014. A $275m policyholder-dividend-obligation expense was recorded in Q1 2015.
Liquidity, debt, outlook and risks
- Consolidated cash and cash equivalents rose to $19.119bn. Separately, Prudential Financial, the parent, reported $11.382bn of cash and short-term investments, including intercompany liquidity; excluding net intercompany borrowing, it had $3.825bn, down $491m from year-end.
- Short- and long-term debt totaled $22.716bn, down $954m from year-end. The company reported $3.75bn of committed credit facilities outstanding at March 31; on April 14, it entered a new $4.0bn five-year facility with no borrowings as of the filing date.
- Interest-rate outlook: Management expected continued low rates to reduce reinvestment yields and overall portfolio yields. Under a hypothetical 10-year Treasury rate of 2.00% through year-end 2016, with credit spreads unchanged, it estimated an unfavorable pretax adjusted-operating-income impact of approximately $27m in 2015 and $81m in 2016 for a specified group of contracts. This is a scenario estimate, not formal earnings guidance, and excludes several potential mitigants and other effects.
- Management said liquidity and capital resources were adequate under reasonably foreseeable stress scenarios. Domestic and international insurance subsidiaries’ reported capital ratios substantially exceeded regulatory minimums; the filing provides RBC and solvency-margin ratios as of December 31, 2014.
- Key sensitivities include prolonged low interest rates, market and currency movements, mortality and policyholder behavior, investment defaults, reserve and valuation assumptions, regulatory changes, and subsidiary dividend restrictions. Japan represented a significant investment exposure, including $60.9bn fair value of Japanese government and agency securities. Direct and indirect energy exposure was approximately $18bn at market value.
- Variable-annuity living-benefit guarantees are materially market-sensitive: the GAAP embedded-derivative liability was $9.4bn at March 31, while the company-defined hedge-target liability was $11.3bn. Management cautioned that hedge results may differ from GAAP liability movements.
- The company estimated reasonably possible litigation and regulatory losses in excess of established accruals, where estimable, at less than $250m. It said ultimate outcomes remain uncertain and could materially affect a particular period; management did not expect the matters, after reserves and indemnification, to materially harm financial position based on information then known.
- Other notable items: the Class B repurchase cost $651m, and former holders disputed the purchase-price calculation; Prudential repurchased $250m of common stock and declared a $0.58-per-share dividend in Q1. The proposed acquisition of an indirect interest in AFP Habitat was subject to approvals and expected to close in the second half of 2015.
Important facts for investors to verify
- How much of Q1 GAAP earnings growth reflects recurring operations versus derivative and other realized investment gains, and how the Class B reporting change affects comparisons.
- Whether low reinvestment yields, crediting-rate floors and competitive constraints affect future spreads beyond management’s illustrative scenario.
- The performance and assumptions underlying variable-annuity guarantees, hedging offsets, policyholder behavior and the $9.4bn GAAP embedded-derivative liability.
- Capital availability at the holding company versus regulated subsidiaries, including dividend permissions, the disputed Class B purchase price and the use of new financing facilities.
- Developments in litigation, regulatory supervision and proposed rules, and any resulting changes in reserves, capital requirements or business economics.