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PRU > SEC Filings for PRU > Form 10-Q on 8-May-2014All Recent SEC Filings

Show all filings for PRUDENTIAL FINANCIAL INC

Form 10-Q for PRUDENTIAL FINANCIAL INC


8-May-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") addresses the consolidated financial condition of Prudential Financial as of March 31, 2014, compared with December 31, 2013, and its consolidated results of operations for the three months ended March 31, 2014 and 2013. You should read the following analysis of our consolidated financial condition and results of operations in conjunction with the MD&A, the "Risk Factors" section, and the audited Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013, as well as the statements under "Forward-Looking Statements" and the Unaudited Interim Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q.

Overview

Prudential Financial has two classes of common stock outstanding. The Common Stock, which is publicly traded (NYSE:PRU), reflects the performance of the Financial Services Businesses, while the Class B Stock, which was issued through a private placement and does not trade on any exchange, reflects the performance of the Closed Block Business. The Financial Services Businesses and the Closed Block Business are discussed below.

Financial Services Businesses

Our Financial Services Businesses consist of three operating divisions, which together encompass six segments, and our Corporate and Other operations. The U.S. Retirement Solutions and Investment Management division consists of our Individual Annuities, Retirement and Asset Management segments. The U.S. Individual Life and Group Insurance division consists of our Individual Life and Group Insurance segments. The International Insurance division consists of our International Insurance segment. Our Corporate and Other operations include corporate items and initiatives that are not allocated to business segments, as well as businesses that have been or will be divested.

We attribute financing costs to each segment based on the amount of financing used by each segment, excluding financing costs associated with corporate debt which are reflected in Corporate and Other operations. The net investment income of each segment includes earnings on the amount of capital that management believes is necessary to support the risks of that segment.

We seek growth internally and through acquisitions, joint ventures or other forms of business combinations or investments. Our principal acquisition focus is in our current business lines, both domestic and international.

Closed Block Business

In connection with the demutualization, we ceased offering domestic participating products. The liabilities for our traditional domestic in force participating products were segregated, together with assets, in a regulatory mechanism referred to as the "Closed Block." The Closed Block is designed generally to provide for the reasonable expectations for future policy dividends after demutualization of holders of participating individual life insurance policies and annuities included in the Closed Block by allocating assets that will be used exclusively for payment of benefits, including policyholder dividends, expenses and taxes with respect to these products. See Note 6 to the Unaudited Interim Consolidated Financial Statements and "Business-Demutualization and Separation of Businesses" in our 2013 Annual Report on Form 10-K for more information on the Closed Block.


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Executive Summary

Prudential Financial, a financial services leader with approximately $1.131 trillion of assets under management as of March 31, 2014, has operations in the United States, Asia, Europe and Latin America. Through our subsidiaries and affiliates, we offer a wide array of financial products and services, including life insurance, annuities, retirement-related services, mutual funds, and investment management. We offer these products and services to individual and institutional customers through one of the largest distribution networks in the financial services industry.

On February 11, 2014, Prudential Financial's Board of Directors declared a cash dividend of $0.53 per share of Common Stock.

On January 2, 2014, we completed the acquisition of UniAsia Life Assurance Berhad, an established life insurance company in Malaysia, through the formation of a joint venture with Bank Simpanan Nasional ("BSN"), a bank owned by the Malaysian government. The joint venture paid cash consideration of $158 million, 70% of which was provided by Prudential Insurance and 30% of which was provided by BSN.

During the first quarter of 2014, we purchased 2.9 million shares of our Common Stock at a total cost of $250 million, under the $1.0 billion share repurchase authorization from our Board of Directors covering the period from July 1, 2013 through June 30, 2014. We also purchased 6.1 million shares in 2013 under this authorization at a total cost of $500 million. The timing and amount of any share repurchases will be determined by management based upon market conditions and other considerations, and such repurchases may be effected in the open market, through derivative, accelerated repurchase and negotiated transactions and through prearranged trading plans designed to comply with Rule 10b5-1(c) under the Securities Exchange Act of 1934, as amended.

Regulatory Developments

Prudential Financial is a "Designated Financial Company" under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). As a "Designated Financial Company," Prudential Financial is subject to supervision and examination by the Federal Reserve Bank of Boston and to prudential regulatory standards under the Dodd-Frank Act. The Financial Stability Board (the "FSB"), consisting of representatives of national financial authorities of the G20 nations, has also identified Prudential Financial as a global systemically important insurer that is to be subject to enhanced regulation.

At the direction of the FSB, the International Association of Insurance Supervisors (the "IAIS") is currently developing a model framework ("ComFrame") for the supervision of internationally active insurance groups ("IAIGs") that contemplates "group wide supervision" across national boundaries. Prudential Financial qualifies as an IAIG. In March 2014, we began participating in field testing to assist the IAIS in its development of ComFrame. Initial field testing will focus on gathering data to inform the development of the first step of ComFrame's risk-based global insurance capital standard, known as the "Basic Capital Requirement".

In February 2014, the New York Department of Financial Services ("NY DFS") notified us that it does not agree with our calculation of statutory reserves (including the applicable credit for reinsurance) for New York purposes in respect of certain variable annuity products. We are continuing discussions with the NY DFS regarding the proper level of statutory reserves (including the applicable credit for reinsurance) for these and other products. If we are ultimately required to establish material additional reserves on a New York statutory accounting basis or post material amounts of additional collateral with respect to such variable annuity or other products, our ability to deploy capital held within our U.S. domestic insurance subsidiaries for other purposes could be affected. Most of our U.S. operating insurance companies are licensed in New York, but none are domiciled in New York.


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The National Association of Insurance Commissioners ("NAIC"), the NY DFS and other regulators continue to review life insurers' use of captive reinsurance companies. In February 2014, Rector & Associates, Inc., a consulting firm commissioned by the NAIC, issued a report to the NAIC that recommends placing limitations on the types of assets that may be used to finance reserves associated with certain term and universal life insurance policies and requiring captive reinsurers to collateralize their reinsurance obligations. In addition, in March 2014, a committee of the NAIC proposed changes to the NAIC accreditation standards that would regulate captive reinsurance companies that assume business directly written in more than one state as "multi-state reinsurers" and apply accreditation standards to those captives that historically were applicable only to traditional insurers. For information on our use of captive reinsurance companies and the potential effects of these proposals on us, see "-Liquidity and Capital Resources-Capital-Captive Reinsurance Companies" below.

For additional information on the potential impacts of regulation on the Company, including the topics described above, see "Business-Regulation" and "Risk Factors" included in our Annual Report on Form 10-K for the year ended December 31, 2013.

Impact of a Low Interest Rate Environment

Domestic Financial Services Businesses

As interest rates in the U.S. continue to remain lower than historical levels, our current reinvestment yields are consequently lower than the overall portfolio yield, primarily for our investments in fixed maturity securities and commercial mortgage loans. With the Federal Reserve Board's stated intention to keep interest rates low through at least 2014, our overall portfolio yields are expected to continue to decline throughout the coming year; however, the recent trend of increasing interest rates, if sustained, will mitigate the impact of new investment purchases on our overall portfolio yields.

For the domestic Financial Services Businesses' general account, we expect annual scheduled payments and prepayments to be approximately 10% of the fixed maturity security and commercial mortgage loan portfolios through 2015. The domestic Financial Services Businesses' general account has approximately $161 billion of such assets (based on net carrying value) as of March 31, 2014. As these assets mature, the current average portfolio yield for fixed maturities and commercial mortgage loans of approximately 4.5% is expected to decline due to reinvesting in a lower interest rate environment. Included in the $161 billion of fixed maturity securities and commercial mortgage loans are approximately $63 billion that are subject to call or redemption features at the issuer's option and have a weighted average interest rate of approximately 5%. As of March 31, 2014, approximately 80% of these assets contain prepayment penalties.

The reinvestment of scheduled payments and prepayments at rates below the current portfolio yield, including in some cases at rates below those guaranteed under our insurance contracts, will impact future operating results to the extent we do not, or are unable to, reduce crediting rates on in-force blocks of business, or effectively utilize other asset/liability management strategies described below, in order to maintain current net interest margins. As of March 31, 2014, our domestic Financial Services Businesses have approximately $152 billion of insurance liabilities and policyholder account balances. Of this amount, approximately $49 billion represents contracts with crediting rates that may be adjusted over the life of the contract, subject to guaranteed minimums. The following table sets forth the related account values by range of guaranteed minimum crediting rates and the related range of the difference, in basis points
(bps), between rates being credited to contractholders as of March 31, 2014, and the respective guaranteed minimums.


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                                                                 Account Values with Crediting Rates
                                                                                                            Greater than
                                                     1-49               50-99             100-150                150
                                  At              bps above           bps above          bps above            bps above
                              guaranteed          guaranteed         guaranteed          guaranteed          guaranteed
                                minimum            minimum             minimum            minimum              minimum           Total
                                                                            ($ billions)
Range of Guaranteed
Minimum Crediting Rates:
Less than 1.00%               $       0.5        $        0.0        $       0.0        $        0.0        $         0.0        $  0.5
1.00%-1.99%                           1.3                 1.8               10.9                 1.8                  0.2          16.0
2.00%-2.99%                           2.4                 0.0                0.1                 2.0                  0.2           4.7
3.00%-4.00%                          24.0                 0.4                2.0                 0.2                  0.0          26.6
Greater than 4.00%                    1.1                 0.0                0.0                 0.0                  0.0           1.1

Total                         $      29.3        $        2.2        $      13.0        $        4.0        $         0.4        $ 48.9

Percentage of total                    60 %                 4 %               27 %                 8 %                  1 %         100 %

Although we may have the ability to lower crediting rates for those contracts above guaranteed minimums, our willingness to do so may be limited by competitive pressures.

Our domestic Financial Services Businesses also have approximately $13 billion of insurance liabilities and policyholder account balances representing participating contracts for which the investment income risk is expected to ultimately accrue to contractholders. The crediting rates for these contracts are periodically adjusted based on the yield earned on the related assets. The remaining $90 billion of the $152 billion of insurance liabilities and policyholder account balances in our domestic Financial Services Businesses represents long duration products such as group annuities, structured settlements and other insurance products that have fixed and guaranteed terms, for which underlying assets may have to be reinvested at interest rates that are lower than portfolio rates. We seek to mitigate the impact of a prolonged low interest rate environment on these contracts through asset/liability management, as discussed further below.

For the domestic Financial Services Businesses' general account, assuming a hypothetical scenario where the average 10-year U.S. Treasury rate is 2.75% for the period from April 1, 2014 through December 31, 2015, and credit spreads remain unchanged from levels as of March 31, 2014, we estimate that the unfavorable impact to net interest margins included in pre-tax adjusted operating income of reinvesting in such an environment, compared to reinvesting at current average portfolio yields, would be approximately $11 million in 2014 and $47 million in 2015. This impact is most significant in the Retirement and Individual Annuities segments. This hypothetical scenario only reflects the impact related to the approximately $49 billion of contracts shown in the table above, and does not reflect: i) any benefit from potential changes to the crediting rates on the corresponding contractholder liabilities where the Company has the contractual ability to do so, or other potential mitigants such as changes in investment mix that we may implement as funds are reinvested; ii) any impact related to assets that do not directly support our liabilities; iii) any impact from other factors, including but not limited to, new business, contractholder behavior, changes in competitive conditions, and changes in capital markets; and/or iv) any impact from other factors described below.

In order to mitigate the unfavorable impact that the current interest rate environment has on our net interest margins, we employ a proactive asset/liability management program, which includes strategic asset allocation and derivative strategies within a disciplined risk management framework. These strategies seek to match the characteristics of our products, and to closely approximate the interest rate sensitivity of the assets with the estimated interest rate sensitivity of the product liabilities. Our asset/liability management program also helps manage duration gaps, currency and other risks between assets and liabilities through the use of derivatives. We adjust this dynamic process as products change, as customer behavior changes and as changes in the market environment occur. As a result, our asset/liability management process has permitted us to manage


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interest-sensitive products successfully through several market cycles. Our interest rate exposure is also mitigated by our business mix, which includes lines of business for which fee-based and insurance underwriting earnings play a more prominent role in product profitability.

Japanese Insurance Operations

Our Japanese insurance operations have experienced a low interest rate environment for many years. As of March 31, 2014, these operations have $128 billion of insurance liabilities and policyholder account balances, which are predominantly comprised of long duration insurance products that have fixed and guaranteed terms, for which underlying assets may have to be reinvested at interest rates that are lower than portfolio rates. Also included in the $128 billion are approximately $7 billion of insurance liabilities and policyholder account balances with crediting rates that may be adjusted over the life of the contract, subject to guaranteed minimums; however, for these contracts, most of the current crediting rates are substantially at or near contractual minimums. Although we have the ability to lower crediting rates in some cases for those contracts above guaranteed minimum crediting rates, the majority of this business has credited interest rates which are determined by formula. Our Japanese insurance operations employ a proactive asset/liability management program in order to mitigate the unfavorable impact that the current interest rate environment has on our net interest margins, and includes strategies similar to those described for the domestic Financial Services Businesses above.

Results of Operations

Net income of our Financial Services Businesses attributable to Prudential Financial, Inc. for the first quarter of 2014 was $1,225 million compared to a net loss of $735 million for the first quarter of 2013.

We analyze performance of the segments and Corporate and Other operations of the Financial Services Businesses using a measure called adjusted operating income. See "-Consolidated Results of Operations-Segment Measures" for a discussion of adjusted operating income and its use as a measure of segment operating performance.

Pre-tax adjusted operating income for the Financial Services Businesses for the first quarter of 2014 was $1,571 million compared to $1,478 million for the first quarter of 2013. Shown below are the contributions of each segment and Corporate and Other operations to our adjusted operating income for the periods indicated and a reconciliation of adjusted operating income of our segments and Corporate and Other operations to income (loss) from continuing operations before income taxes and equity in earnings of operating joint ventures.


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                                                                  Three Months Ended
                                                                      March 31,
                                                                2014             2013
                                                                    (in millions)
Adjusted operating income before income taxes for
segments of the Financial Services Businesses:
Individual Annuities                                          $     388        $     372
Retirement                                                          364              228
Asset Management                                                    193              169

Total U.S. Retirement Solutions and Investment Management
Division                                                            945              769

Individual Life                                                     125              137
Group Insurance                                                       6                9

Total U.S. Individual Life and Group Insurance Division             131              146

International Insurance                                             837              877

Total International Insurance Division                              837              877

Corporate and Other                                                (342 )           (314 )

Adjusted operating income before income taxes for the
Financial Services Businesses                                     1,571            1,478
Reconciling Items:
Realized investment gains (losses), net, and related
adjustments(1)                                                       49           (3,305 )
Charges related to realized investment gains (losses),
net(2)                                                              (57 )            302
Investment gains (losses) on trading account assets
supporting insurance liabilities, net(3)                            101               95
Change in experience-rated contractholder liabilities due
to asset value changes(4)                                           (43 )           (143 )
Divested businesses(5)                                               73               29
Equity in earnings of operating joint ventures and
earnings attributable to noncontrolling interests(6)                 11              (34 )

Income (loss) from continuing operations before income
taxes and equity in earnings of operating joint ventures
for Financial Services Businesses                                 1,705           (1,578 )
Income (loss) from continuing operations before income
taxes for Closed Block Business                                      13               19

Consolidated income (loss) from continuing operations
before income taxes and equity in earnings of operating
joint ventures                                                $   1,718        $  (1,559 )

(1) Represents "Realized investment gains (losses), net," and related adjustments. See "-Realized Investment Gains and Losses" and Note 11 to our Unaudited Interim Consolidated Financial Statements for additional information.

(2) Includes charges that represent the impact of realized investment gains (losses), net, on the amortization of deferred policy acquisition costs and other costs, and on changes in reserves. Also includes charges resulting from payments related to market value adjustment features of certain of our annuity products and the impact of realized investment gains (losses), net, on the amortization of unearned revenue reserves.

(3) Represents net investment gains and losses on trading account assets supporting insurance liabilities. See "-Experience-Rated Contractholder Liabilities, Trading Account Assets Supporting Insurance Liabilities and Other Related Investments."

(4) Represents changes in contractholder liabilities due to asset value changes in the pool of investments supporting these experience-rated contracts. See "-Experience-Rated Contractholder Liabilities, Trading Account Assets Supporting Insurance Liabilities and Other Related Investments."

(5) See "-Divested Businesses."

(6) Equity in earnings of operating joint ventures are included in adjusted operating income but excluded from income from continuing operations before income taxes and equity in earnings of operating joint ventures as they are reflected on a U.S. GAAP basis on an after-tax basis as a separate line in our Unaudited Interim Consolidated Statements of Operations. Earnings attributable to noncontrolling interests are excluded from adjusted operating income but included in income from continuing operations before taxes and equity earnings of operating joint ventures as they are reflected on a U.S. GAAP basis as a separate line in our Unaudited Interim Consolidated Statements of Operations. Earnings attributable to noncontrolling interests represent the portion of earnings from consolidated entities that relates to the equity interests of minority investors.


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Results for the periods presented above reflect the following:

Individual Annuities. Segment results for the first quarter of 2014 increased in comparison to the first quarter of 2013, primarily reflecting higher net asset-based fee income, partially offset by an unfavorable impact on reserves and the amortization of DAC and other costs from changes in the estimated profitability of the business due to market performance in relation to our assumptions.

Retirement. Segment results for the first quarter of 2014 increased in comparison to the first quarter of 2013, primarily reflecting higher net investment spread results, including favorable results from non-coupon investments, and higher asset-based fee income, driven by higher investment-only stable value and full service account values.

Asset Management. Segment results for the first quarter of 2014 increased in comparison to the first quarter of 2013, primarily reflecting higher asset management fees, net of expenses, driven by higher assets under management due to market appreciation and positive net flows.

Individual Life. Segment results for the first quarter of 2014 decreased in comparison to the first quarter of 2013 primarily reflecting less favorable mortality experience, inclusive of reserve updates in the current quarter, partly offset by a higher net contribution from investment results driven by higher income from non-coupon investments and higher asset balances.

Group Insurance. Segment results for the first quarter of 2014 decreased in comparison to the first quarter of 2013 driven by a decline from group disability claims experience and higher expenses, partially offset by an increase in income from non-coupon investments.

International Insurance. Segment results for the first quarter of 2014 decreased in comparison to the first quarter of 2013 in both our Life Planner and Gibraltar Life and Other operations, including a net unfavorable impact from foreign currency exchange rates. Results from the segment's Life Planner operations also include an unfavorable impact from reserve refinements, primarily in our Korean operations. Excluding these items, results from the segment's Life Planner operations increased in comparison to the first quarter of 2013 primarily reflecting business growth, partially offset by less favorable claims experience, inclusive of reserve updates.

Results from the segment's Gibraltar Life and Other operations in the first quarter of 2013 included a gain on the sale of our remaining indirect investment in China Pacific Group. Excluding this item, along with the unfavorable impact of foreign currency fluctuations noted above, results increased in comparison to the first quarter of 2013, primarily driven by lower expenses as well as business growth.

Corporate and Other operations. The results for the first quarter of 2014 as compared to first quarter of 2013 reflect an increased loss primarily due to . . .

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