Prudential Financial, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014; balance-sheet comparisons are to December 31, 2013. Amounts are in millions of dollars unless stated otherwise. Prudential provides insurance, annuity, retirement, investment-management and related financial services. Its reporting distinguishes the Financial Services Businesses from the Closed Block Business.
Key financial results
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $13,146 | $10,041 | $26,000 | $20,212 |
| Income (loss) from continuing operations before tax and joint-venture earnings | $1,507 | $(769) | $3,225 | $(2,328) |
| Net income (loss) attributable to Prudential Financial | $1,090 | $(514) | $2,328 | $(1,234) |
| Common Stock diluted EPS | $2.22 | $(1.12) | $4.81 | $(2.69) |
| Financial Services adjusted operating income before tax | $1,623 | $1,517 | $3,194 | $2,995 |
- For Q2, net investment income was $3,754, up from $3,711; net realized investment gains were $609, compared with losses of $1,024 in Q2 2013. For the first half, net investment income was $7,592 versus $7,349, and realized gains were $817 versus losses of $1,747.
- Q2 Financial Services adjusted operating income increased modestly year over year, while GAAP results swung to profit. Management attributed much of the GAAP improvement to derivative valuation changes, foreign-currency effects and variable-annuity embedded-derivative and hedge movements—not solely to recurring operating performance.
- The filing does not provide a single consolidated operating-margin measure; Prudential uses adjusted operating income to evaluate its Financial Services segments. That measure is non-GAAP and differs from consolidated GAAP income.
Balance sheet, cash flow and liquidity
- At June 30, 2014, total assets were $765,537, total liabilities $723,730 and total equity $41,807, compared with $731,781, $695,900 and $35,881, respectively, at year-end 2013. Separate account assets and liabilities were each $296,801.
- Total investments were $419,319, including $304,472 of available-for-sale fixed maturities; cash and cash equivalents were $12,160. Available-for-sale fixed maturities had $28,305 of gross unrealized gains and $1,589 of gross unrealized losses.
- For the first six months, operating cash flow was $5,555 (prior year $2,386), investing cash flow was $(7,525) (prior year $(7,853)), and financing cash flow was $2,617 (prior year $1,265). Cash increased $721 to $12,160.
- Short-term debt was $3,804 and long-term debt $23,488 at June 30; consolidated borrowings including certain debt classifications totaled $27,292, up from $26,222 at year-end. The company had $3,750 of committed credit facilities, with no borrowings outstanding, and reported $5,981 of parent-company cash and short-term investments.
- Financial Services Businesses capital, as defined by management and excluding AOCI from attributed equity, was $37,612. Reported statutory capital ratios are dated earlier: domestic RBC ratios at December 31, 2013 were 456% for Prudential Insurance and 502% for PALAC; Japanese solvency-margin ratios at March 31, 2014 were 777% for Prudential of Japan and 955% for Gibraltar Life consolidated.
Material changes and business performance
- GAAP revenue rose sharply, but comparisons were affected by volatile investment and foreign-exchange items. Q2 2013 included large derivative losses and unfavorable yen-related remeasurement effects; Q2 2014 included gains in several investment and derivative categories. Premiums fell to $6,068 from $6,922 in Q2 and to $11,936 from $14,006 for the first half, including lower international premiums following discontinued bank-channel sales of certain Japanese products and pricing actions.
- First-half Financial Services adjusted operating income rose to $3,194 from $2,995. Retirement, Asset Management, Individual Life and Group Insurance improved; International Insurance was broadly flat for the half, and Corporate and Other losses widened. Management cited market appreciation and positive asset-management flows, business growth, underwriting experience, expenses and foreign exchange as key drivers.
- Assets under management reached $921.5 billion at June 30, up from $869.9 billion at year-end 2013, reflecting market appreciation and net flows. Individual Annuity account values rose to $159.5 billion from $141.5 billion a year earlier, but first-half net flows were negative $321 million versus positive $2.1 billion in 2013.
- Shareholders’ equity increased, with AOCI rising to $13,077 from $8,681, largely reflecting higher unrealized investment gains. The company repurchased $500 million of common stock in the first half and declared common dividends of $0.53 per share in each of Q1 and Q2.
Outlook, risks and unusual items
- Low interest rates: Management expected reinvestment yields to remain below current portfolio yields and said overall portfolio yields were expected to continue declining through the remainder of 2014. In a specified hypothetical scenario—10-year U.S. Treasury rates at 2.50% through year-end 2015 and unchanged credit spreads—the estimated unfavorable effect on pre-tax adjusted operating income from reinvestment was about $6 million in 2014 and $50 million in 2015. This scenario covers only specified contracts and excludes potential mitigants and other effects; it is not full-company earnings guidance.
- Variable annuities and market exposure: The fair-value liability for certain living-benefit embedded derivatives was $3.4 billion at June 30, versus $0.5 billion at year-end, while the hedge-target liability/(contra-liability) was $2.1 billion versus a $(1.2) billion contra-liability. Results depend on interest rates, equity markets, volatility, policyholder behavior and hedge effectiveness; accounting and hedge-target assumptions differ.
- Regulatory uncertainty: The New York Department of Financial Services disputed Prudential’s statutory reserve and reinsurance-credit calculations for certain variable annuities. Additional reserves or collateral could constrain capital deployment. NAIC initiatives concerning captive reinsurance could also affect reserve financing; the company said the eventual effects could not yet be estimated.
- Litigation and contingencies: The company estimated aggregate reasonably possible losses beyond established accruals for matters that could be estimated at less than $250 million, while noting outcomes remain uncertain. Matters include unclaimed-property and retained-asset-account disputes, shareholder and securities litigation, and RMBS-related claims. Management stated the ultimate outcome was not expected to materially adversely affect financial position, but adverse resolutions could affect results or cash flow.
- Other notable items: The company acquired UniAsia Life Assurance in Malaysia through a joint venture on January 2, 2014. It also expanded financing capacity for Guideline AXXX captive reserves; financing needs for Regulation XXX reserves remain dependent on executing additional solutions. The filing cautions that interim results are not necessarily indicative of full-year results.
Most important facts for investors to verify
- How much of the GAAP earnings rebound came from market-sensitive derivatives and foreign-currency accounting effects versus recurring segment operations.
- Whether variable-annuity guarantee liabilities, hedge performance, collateral needs and statutory reserves remain manageable under adverse market conditions.
- The effects of low reinvestment yields on spreads, crediting rates and future earnings, compared with management’s limited hypothetical sensitivity estimate.
- Changes in captive-reinsurance rules and the availability, cost and terms of financing for Regulation XXX and Guideline AXXX reserves.
- Developments in the NYDFS reserve dispute, litigation and other contingencies, including any changes to accruals or the estimated loss range.
- Capital and liquidity after dividends, share repurchases, debt maturities and insurance-subsidiary dividend restrictions; verify statutory capital ratios when updated figures become available.