PRUDENTIAL FINANCIAL INC quarterly report, Q2 FY2013

Prudential Financial, Inc. — Q2 2013 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2013; unaudited. Amounts are U.S. dollars. Prudential operates insurance, retirement and investment-management businesses in the U.S. and internationally, alongside its separately reported Closed Block Business.

Financial results

MetricQ2 2013Q2 2012Six months 2013Six months 2012
Total revenue$10.044bn$16.136bn$20.229bn$25.759bn
Income (loss) attributable to Prudential$(521)m$2.224bn$(1.227)bn$1.285bn
Common Stock diluted EPS$(1.13)$4.69$(2.68)$2.69
Adjusted operating income before tax, Financial Services Businesses$1.513bn$853m$3.001bn$1.904bn

GAAP results were heavily affected by market-sensitive items and foreign exchange accounting. Q2 realized investment losses were $1.024bn versus gains of $1.763bn a year earlier; first-half losses were $1.747bn versus gains of $379m. The company reported a $273m tax benefit in Q2 and a $1.104bn tax benefit for the first half. No consolidated operating margin is presented as a key performance measure; reported results should be considered alongside the company’s non-GAAP segment measure, adjusted operating income.

  • Balance sheet at June 30: Assets $705.6bn, liabilities $669.7bn, total equity $35.9bn and Prudential-attributable equity $35.1bn. Total assets were $709.3bn and total equity $39.3bn at December 31, 2012.
  • Investments and AOCI: Total investments were $393.0bn, down from $405.6bn at year-end; available-for-sale fixed maturities were $286.1bn at fair value. AOCI fell to $8.4bn from $10.2bn, reflecting substantial market-related changes, including a $5.430bn pre-tax Q2 decline in unrealized investment gains.
  • Cash flow, first half: Operating cash flow was $2.386bn versus $6.036bn; investing cash flow was $(7.853)bn versus $(5.509)bn; financing cash flow was $1.265bn versus $(494)m. Cash and equivalents declined $5.055bn to $13.045bn.
  • Debt and liquidity: Short- and long-term debt totaled $26.3bn, down from $27.2bn at year-end. The company had $3.75bn of committed credit facilities with no borrowings outstanding; commercial paper outstanding was $993m. Management reported compliance with debt covenants.

Material changes and management commentary

  • Financial Services adjusted operating income before tax rose to $1.513bn in Q2 and $3.001bn for the first half. Gains were broad-based, notably in Individual Annuities, Retirement, Asset Management and International Insurance. Corporate and Other losses increased.
  • Despite improved segment operating results, Financial Services GAAP results were sharply lower. Management attributed much of the deterioration to yen depreciation and accounting mismatches on economically matched non-yen assets and liabilities, variable-annuity embedded derivatives and hedges, and derivative losses as interest rates rose. These items are volatile and are largely excluded from adjusted operating income.
  • Prudential completed the Hartford individual-life acquisition on January 2, 2013, paying $615m for reinsurance of about 700,000 policies. The filing cites approximately $90m of expected annual cost savings by 2015, with integration costs of about $125m over two to three years; $19m had been incurred in the first half.
  • The wealth-management-solutions sale to Envestnet closed July 1, after quarter-end. The Board authorized up to $1bn of Common Stock repurchases for July 2013–June 2014. Q2 Common Stock dividend declared was $0.40 per share.

Outlook, risks and contingencies

  • Interest rates: Management expects low rates to continue pressuring reinvestment yields and net interest margins. Under a hypothetical 10-year Treasury rate of 2.50% through 2014, with credit spreads unchanged, it estimated an unfavorable pre-tax adjusted-operating-income impact of about $8m in H2 2013 and $60m in 2014 on a specified $48bn block of contracts. This scenario excludes potential mitigants and is not company-wide earnings guidance.
  • Regulatory designation: The Financial Stability Oversight Council had proposed subjecting Prudential to Federal Reserve supervision and stricter prudential standards; the company contested the proposal, with a final determination expected within 60 days after the July 30 hearing. Separately, the Financial Stability Board identified Prudential as a global systemically important insurer. Effects remained uncertain.
  • Litigation and guarantees: Management estimated reasonably possible losses in excess of accruals for estimable litigation and regulatory matters at $0–approximately $175m, while noting this is not an expected-loss estimate or maximum exposure. Matters include unclaimed life-insurance proceeds and retained-asset-account litigation. Certain guarantees and commitments could expose the company to further payments.
  • Other sensitivities: Risks include variable-annuity guarantees and hedging effectiveness, reserve and policyholder-behavior assumptions, investment credit losses, currency movements, ratings changes, regulatory restrictions on subsidiary dividends, and reliance on subsidiaries for holding-company liquidity. Management cautions that interim results are not necessarily indicative of full-year results.

Investor verification priorities

  1. Reconcile GAAP losses to adjusted operating income, especially yen-related accounting effects, variable-annuity hedge/NPR impacts, and realized derivative results.
  2. Review the sustainability of operating gains by segment, acquisition integration costs and savings, and sales trends in annuities and life insurance.
  3. Assess sensitivity to rates, equity markets and foreign exchange, including the assumptions and scope of management’s interest-rate scenario.
  4. Check capital and liquidity at the holding company and regulated subsidiaries, dividend-transfer restrictions, and implications of potential Federal Reserve and G-SII requirements.
  5. Track litigation exposures, reserve adequacy, and the status of unclaimed-property and retained-asset-account matters.