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PRU > SEC Filings for PRU > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for PRUDENTIAL FINANCIAL INC

Form 10-Q for PRUDENTIAL FINANCIAL INC


7-Aug-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 June 30, 2014, compared with December 31, 2013, and its consolidated results of operations for the three and six months ended June 30, 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 sold or exited, including businesses that have been placed in wind down, but that did not qualify for "discontinued operations" accounting treatment under U.S. GAAP.

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 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 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 the 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 $1.166 trillion of assets under management as of June 30, 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 June 10, 2014, Prudential Financial's Board of Directors authorized the Company to repurchase at management's discretion up to $1.0 billion of its outstanding Common Stock during the period from July 1, 2014 through June 30, 2015. 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. We purchased 12 million shares of our Common Stock at a total cost of $1.0 billion, under the prior twelve-month $1.0 billion share repurchase authorization that expired on June 30, 2014, including 5.9 million shares purchased in the first six months of 2014 at a total cost of $500 million.

On each of February 11, 2014 and May 13, 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. Subsequent to the acquisition, we renamed the acquired company Gibraltar BSN Life Berhad.

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.

On June 30, 2014, as a Designated Financial Company, we submitted to the Federal Reserve Board ("FRB") and the Federal Deposit Insurance Corporation ("FDIC") an initial annual resolution plan in the event of severe financial distress as required by the rules of the FRB and FDIC.

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 has focused 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" ("BCR"). The IAIS is scheduled to seek G20 endorsement of the proposed BCR framework in November 2014.

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


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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.

The National Association of Insurance Commissioners ("NAIC"), the NY DFS and other regulators continue to review life insurers' use of captive reinsurance companies. On June 4, 2014, Rector & Associates, Inc., a consulting firm commissioned by the NAIC, presented a revised report to the NAIC's Principle-Based Reserving Implementation Task Force that recommended, among other things, placing limitations on the types of assets that may be used to finance reserves associated with certain term and universal life insurance policies and making adoption of new regulations contemplated by the Rector Report by individual states an NAIC accreditation standard. On June 30, 2014, this NAIC Task Force adopted the regulatory framework proposed by Rector & Associates, including recommendations to have various technical workgroups of the NAIC propose regulations to implement the new framework. In addition, another committee of the NAIC has 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 remainder of this year.

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 $163 billion of such assets (based on net carrying value) as of June 30, 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 $163 billion of fixed maturity securities and commercial mortgage loans are approximately $71 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 June 30, 2014, approximately 80% of these assets contain prepayment penalties.


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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 June 30, 2014, our domestic Financial Services Businesses have approximately $154 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 June 30, 2014, and the respective guaranteed minimums.

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
                                                                             ($ in billions)
Range of Guaranteed Minimum
Crediting Rates:
Less than 1.00%                 $       0.6        $        0.0        $       0.0        $        0.0        $         0.0        $  0.6
1.00% - 1.99%                           1.5                 1.9               10.6                 1.8                  0.2          16.0
2.00% - 2.99%                           2.3                 0.0                0.6                 1.7                  0.2           4.8
3.00% - 4.00%                          24.1                 1.9                0.5                 0.2                  0.0          26.7
Greater than 4.00%                      0.9                 0.0                0.0                 0.0                  0.0           0.9

Total                           $      29.4        $        3.8        $      11.7        $        3.7        $         0.4        $ 49.0

Percentage of total                      60 %                 8 %               24 %                 7 %                  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 $14 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 $91 billion of the $154 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 2.50% for the period from July 1, 2014 through December 31, 2015, and credit spreads remain unchanged from levels as of June 30, 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 $6 million in 2014 and $50 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.


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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 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 June 30, 2014, these operations have $129 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 $129 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 second quarter and first six months of 2014 was $1,049 million and $2,274 million, respectively, compared to a net loss of $517 million and $1,252 million for the second quarter and first six months of 2013, respectively.

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.


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Pre-tax adjusted operating income for the Financial Services Businesses for the second quarter and first six months of 2014 was $1,623 million and $3,194 million, respectively, compared to $1,517 million and $2,995 million for the second quarter and first six months of 2013, respectively. 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.

                                                 Three Months Ended             Six Months Ended
                                                      June 30,                      June 30,
                                                2014           2013            2014           2013
                                                                   (in millions)
Adjusted operating income before income
taxes for
Financial Services Businesses by Segment:
Individual Annuities                          $     390      $     400      $      778      $     772
Retirement                                          286            279             650            507
Asset Management                                    200            172             393            341

Total U.S. Retirement Solutions and
Investment Management Division                      876            851           1,821          1,620

Individual Life                                     158            141             283            278
Group Insurance                                      46             22              52             31

Total U.S. Individual Life and Group
Insurance Division                                  204            163             335            309

International Insurance                             884            850           1,721          1,727

Total International Insurance Division              884            850           1,721          1,727

Corporate Operations                               (341 )         (347 )          (683 )         (661 )

Total Corporate and Other                          (341 )         (347 )          (683 )         (661 )

Adjusted operating income before income
taxes for the Financial Services Businesses       1,623          1,517           3,194          2,995

Reconciling Items:
Realized investment gains (losses), net,
and related adjustments(1)                         (202 )       (2,698 )          (153 )       (6,003 )
Charges related to realized investment
gains (losses), net(2)                              (71 )          468            (128 )          770
Investment gains (losses) on trading
account assets supporting insurance
liabilities, net(3)                                 225           (471 )           326           (376 )
Change in experience-rated contractholder
liabilities due to asset value changes(4)          (189 )          471            (232 )          328
Divested businesses(5)                               47            (84 )           120            (55 )
Equity in earnings of operating joint
ventures and earnings attributable to
noncontrolling interests(6)                          18             24              29            (10 )

Income (loss) from continuing operations
before income taxes and equity in earnings
of operating joint ventures for Financial
Services Businesses                               1,451           (773 )         3,156         (2,351 )
Income (loss) from continuing operations
before income taxes for Closed Block
Business                                             56              4              69             23

Consolidated income (loss) from continuing
operations before income taxes and equity
in earnings of operating joint ventures       $   1,507      $    (769 )    $    3,225      $  (2,328 )

(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."


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(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.

Results for the periods presented above reflect the following:

Individual Annuities. Results for the second quarter of 2014 decreased in comparison to the second quarter of 2013, reflecting an unfavorable comparative impact on reserves and the amortization of DAC and other costs from changes in the estimated profitability of the business, which more than offset higher net asset-based fee income. Results for the first six months of 2014 increased in comparison to the prior year period, reflecting higher net asset-based fee income, partially offset by an unfavorable comparative impact on reserves and the amortization of DAC and other costs from changes in the estimated profitability of the business.

Retirement. Results for the second quarter and first six months of 2014 increased in comparison to the prior year periods. Results for the second quarter reflect higher net investment spread results, a more favorable reserve benefit from case experience, and higher asset-based fee income resulting from increased account values, partially offset by higher expenses. Results for the first six months of 2014 reflect higher net investment spread results and higher asset-based fee income resulting from increased account values.

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