Operator: Welcome to the Prudential Fourth Quarter 2009 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given to you at that time. (Operator Instructions). And as a reminder, today’s conference call is being recorded.
I would now like to turn the conference over to Mr. (Eric Durant). Please go ahead.
Eric Durant - IR: Cynthia, thank you very much, and good morning to all of you. Thank you for joining our call. In order to help you to understand Prudential Financial, we will make some forward-looking statements in the following presentation.
It is possible that actual results may differ materially from the predictions we make today. Additional information regarding factors that could cause such a difference appears in the section titled Forward-Looking Statements and Non-GAAP Measures of our earnings press release for the fourth quarter of 2009, which can be found on our website at www.investor.prudential.com.
In addition, in managing our businesses, we use a non-GAAP measure we call adjusted operating income to measure the performance of our Financial Services Businesses. Adjusted operating income excludes net investment gains and losses as adjusted and related charges and adjustments, as well as results from divested businesses. Adjusted operating income also excludes recorded changes in asset values that are expected to ultimately accrue to contract holders and recorded changes in contract holder liabilities resulted from changes and related asset values.
The comparable GAAP presentation and the reconciliation between the two for the fourth quarter are set out in our earnings press release on our website. Additional historical information relating to the company’s financial performance is also located on our website.
Okay. We will begin today with comments from John Strangfeld, and then Rich Carbone, our Chief Financial Officer, and Mark Grier, who will walk you through the fourth quarter results. After that, Bernard Winograd, Ed Baird and Peter Sayre will join John, Rich and Mark for the Q&A. John?
John Strangfeld - Chairman, CEO and President: Thank you, Eric, and good morning, everyone. Thank you for joining us. Now that we’ve closed the books on 2009, I’ll kick things off with some high level comments regarding the year as a whole. All in all, we feel we’ve succeeded in meeting the challenges of a very difficult environment.
First, earnings; our earnings for 2009 more than doubled from 2008, based on after-tax adjustment operating income of the Financial Services Businesses. Return on equity recovered to 11.2%. Excluding from earnings the items we consider discrete are market driven. The full-year result would equate to just under a 10% ROE. While we expect to do better over time, this is a step in the right direction.
Second, capital; net income for the year amounted to $3.4 billion, including the $1.4 billion after-tax gain on sale of our investment at Wachovia Securities. Even without that gain, net income would have been a healthy $2 billion. We sold 1.4 billion in common shares in June and our flagship Life Insurance Company issued exchangeable surplus notes to raise an additional $500 million.
Total debt for the Financial Services Businesses declined by $6 billion during the year. Book value increased by $5.5 billion. Book value per share increased over 15% from $46.91 to $54.18 in the last 12 months. These measures exclude the impact of unrealized gains and losses on investments and pension and post retirement benefits. As you know, we do not participate in TARP. All in all, a very strong capital story.
And then finally business momentum; we’ve emerged from this difficult period in excellent shape as strong sales or flows virtually across the board will attest. For the year, individual annuities had record gross sales. Full service retirement had record gross deposits and sales and international insurance recorded its highest ever annualized new business premium.
In short, we believe we have enhanced our longer-term strategic trajectory while taking significant actions during the year to make our company stronger.
Looking forward, we view our financial strength as an enabler to pursue exceptional organic growth opportunities just as you have seen. We will also consider opportunities to enhance Prudential's financial performance and strategic positioning through acquisitions. We will evaluate potential acquisitions with our customary great care, fully cognizant of the risk they present and of the need to generate returns that are appropriate for those risks.
We've often described Prudential as a balanced portfolio of businesses and risks. We actively manage this portfolio and that's very evident when you look at our actions over a longer-time horizon. Over the years, we've acquired significant businesses including Gibraltar, American Skandia, and CIGNA Retirement. We've also divested businesses such as our healthcare company and P&C. In this quarter, we sold our stake in Wachovia Securities for $4.5 billion in cash. The overall return to Prudential on the Wachovia investment equates to an annual after-tax rate of return of roughly 25% on our initial $1 billion investment at a time when the S&P was in the single digits.
To sum up, we've never been stronger in terms of our individual businesses and their prospects, our overall balance and mix of those businesses, our financial strength and the quality of our talent and the leadership team. Our sales and flows demonstrate our business momentum. We clearly have attracted internal growth prospects. We will also consider acquisitions. We’ll do so with the same care that’s reflected in our track record.
With that, now Rich and Mark will walk you through the details of the fourth quarter and then welcome your questions. Rich?
Richard Carbone - EVP and CFO: Thanks, John, and good morning, everyone. I’ve got a little cold so I may be interrupted with sips of tea. As you’ve seen from yesterday’s release, we reported common stock earnings per share of $1.07 for the fourth quarter based on adjusted operating income for the Financial Services Business. This compares to a loss of $2.04 for the year-ago quarter.
Let me start with some high level comments on the current quarter. We’re benefiting from solid performance in our major businesses, as well as improvements in financial markets, strong sales and net flows virtually across the board will also help drive growth in our account values. Mark will talk more about this later on.
On the other hand, commercial real estate market conditions are continuing to have a negative impact on the results of our Asset Management Business. In addition, the cost of holding excess liquidity, which is showing up as a negative spread, mostly in Corporate and Other, we’ll talk about that later, was a drag on results from the current quarter.
The list of significant market driven or discrete items affecting current quarter results is very short, probably the shortest in the last two years, (along all) within the annuity business and I’ll go through these items now.
Mark-to-market of hedges and embedded derivatives, including breakage on our living benefit hedging, the market-based adjustment for our own non-performance risk and the hedge we put on to protect capital from adverse swings in the equity markets had a negative impact of about $0.17 per share. We had a benefit of about $0.07 per share from the release of a portion of our reserves for guaranteed minimum death and income benefits and we had a benefit of about $0.05 per share from a positive unlocking of debt which reduced amortization of deferred policy acquisition and other costs.
In total, the items I just mentioned had a net favorable impact of about $0.05 on our earnings per share for the fourth quarter.
Stripping out these items from adjusted operating income will bring us to earnings per share of about $1.12 for the fourth quarter of 2009. For the year as a whole, a similar calculation will bring us to $4.80 per share. This full-year result would equate to an ROE just under 10%, consistent with the baseline we showed at our Investor Day in December. As we mentioned at Investor Day, we don’t plan to revisit earnings guidance on a quarterly basis.
That said, there are few items to keep in mind that when thinking about our prospects for 2010 in light of the quarter we just reported. After payment of current taxes, we will have roughly $3.7 billion of investable proceeds from the sale of our investment in the Wachovia Securities joint venture. $3.3 billion is at Prudential Insurance and about $400 million is at the parent company.
We expect to deploy a significant portion of these funds over the course of the year in some combination of financing a business growth and longer-term investments.
Total cash and short-term investments at the parent, net of short-term intercompany borrowings and commercial paper amounted to roughly $2.8 billion. We expect to utilize about $1.3 billion of this amount for tax payments and intercompany tax settlements that leaves about $1.5 billion, $500 million above the $1 billion cushion that we believe is appropriate.
Results for our International Insurance business will be bolstered by a more favorable yen/dollar exchange rate in 2010, in comparison to 2009 as a result of our currency hedging programs. As I mentioned at Investor Day, our Japanese yen earnings will translate at a rate of �99 to the dollar in 2010, compared to �106 to the dollar for 2009.
We also expected to benefit from growth in many of our businesses and from reasonably stable financial markets. While conditions remain challenging in the commercial real estate market, we’re starting to see signs of improvement.
As an overall comment, we ended 2009 pretty much in a position we expected when we gave our views on 2010 at Investor Day. Our situation has not changed much in eight weeks.
Moving to the GAAP results of our Financial Services Businesses; we reported net income of $1.8 billion or $3.79 per share for the fourth quarter. This compares to a net loss of $1.7 billion or $3.89 per share in the fourth quarter of 2008.
Our net income for the current quarter includes an after-tax gain, net of related expenses of $1.4 billion or $2.95 per share from the sale of our investment in the Wachovia JV on December 31st. This excludes the after-tax gain of $1 billion we recorded directly to equity in 2008 as a result of the combination of the A.G. Edwards business with the joint venture.
We think of the performance of this investment in terms of its overall return to Prudential, the realization of $4.5 billion of cash proceeds we received, together with cash flows during our period of ownership, equates to an annual after-tax return of roughly 25% on our initial $1 billion investment.
Moving to investment results; GAAP pre-tax results for this quarter include amounts characterized as net realized investment gains of $38 million. Realized gains from general portfolio activities during the quarter together with positive mark-to-market on externally managed European securities more than offset impairments and credit losses, which came in at the lowest level in the past eight quarters.
Impairments and credit losses –for the current quarter amounted to $225 million, including $201 million from impairments and credit losses on fixed maturities and $25 million from impairments of equity securities and other investments.
The $201 million of impairments and credit losses for fixed maturities includes roughly $70 million of credit losses on sub-prime securities. The remainder, including sales and credit-impaired securities, is spread across public and private corporate holdings and other securities.
And I'll give you an update on where we stand on capital. We began the year with a solid capital position and it has been substantially enhanced over the year by many of the actions we’ve taken, including the realization of the value of our investment in the Wachovia Securities JV and by market recovery.
Our focus first on the insurance companies. We are continuing to manage these companies to capital levels consistent with what we believe are AA standards. Our closing of the sale of our stake in the Wachovia JV on December 31st added about $2.4 billion to the statutory capital of Prudential Insurance, contributing 100 basis points as we had expected – about 100 basis points. The 500 million exchangeable note we issued out of Prudential Insurance in September, also bolstered our statutory capital position.
The 23% increase in the S&P for the year reversed the portion of the capital erosion that we experienced from the 2008 decline in the equity markets. Most of this capital erosion took place in our annuities business related to our older products that don’t have the auto-rebalancing feature we package with our current living benefits.
We estimate that in 2009 about $900 million of statutory capital return to the annuity business due to the market recovery, which led to reserve releases. Going the other way, credit migration and impairments were consistent with our expectations.
Recent changes in statutory guidance; including the accounting for deferred taxes and capital charges for sub-prime securities and mortgage loans were a modest net benefit for the capital position of our insurance companies. We expect the implementation as of year-end 2009 of the new rules to statutory reserving for variable annuities known as VACARVM, did not have a significant impact on our statutory capital position. Giving effect to everything I just mentioned, we estimate that RBC for Prudential Insurance as of year-end 2009 will be in the mid-500s.
Our Japanese Insurance companies, Prudential of Japan and Gibraltar Life, each reported solvency margins in their most recent fiscal year-end March 31st, 2009, comfortably above their benchmarks for a AA rating. We are confident that the solvency margins will be maintained or improved through the end of this current fiscal year.
Now I’ll move to our overall capital position for the Financial Services Business. We measure our capital capacity by starting with the capital we need to run the company, which we call required equity, and comparing this amount to what we have on the balance sheet, including actual equity and long-term debt that we classify as capital debt. The required equity we consider assumes the amount of capital we need to maintain a 400 RBC ratio, percent that is of course, at Prudential Insurance and solvency margins at our international insurance companies, which we believe are consistent with or above AA rating targets.
On that basis, we estimate on balance sheet capital capacity at year-end 2009 is in the range of $3.5 billion to $4 billion. Capital capacity serves two purposes. It is a buffer against the effects of stressed conditions arising from the markets, and it provides for business growth. We have historically maintained on balance sheet capital capacity in the range of $2 billion to $3 billion and would expect to hold a reasonable level going forward.
Now Mark will comment on the investment portfolio for our Financial Services Business and review our results for the quarter.
Mark Grier - VC: Thank you, Rich. Good morning, good afternoon, good evening, good night, whatever time it is where you are. Thanks for joining us. Financial market conditions improved in the fourth quarter with credit spreads continuing to tighten for many asset classes. As Rich mentioned, our general account credit losses and impairments were at their lowest quarterly level over the past two years. While we may not have seen the last of volatility, we have a very high quality, diversified investment portfolio and remain comfortable with our risk position.
I’ll start with our fixed maturity portfolio. Our general account fixed maturity portfolio is in a net unrealized gain position, roughly $1 billion at year end. This compares to net unrealized losses of $6.6 billion a year earlier. Gross unrealized losses on fixed maturities in our general account stood at $4.4 billion at year end. This represents a recovery of about $7 billion from $11.3 billion a year earlier. Roughly $1.3 billion of total gross unrealized losses at year end relate to sub-prime holdings. This compares to $1.5 billion at the end of the third quarter and $1.8 billion a year earlier.
Total sub-prime holdings were roughly $4.3 billion at year-end based on amortized costs. This represents a decrease of about $300 million from the third quarter reflecting over $200 million of pay-downs during the quarter and the $70 million of impairments that Rich mentioned.
The insurance regulators have changed their ratings approach for non-agency residential mortgage-backed securities effective with year-end 2009 reporting. Under the new approach, quality classifications and statutory capital charges are based on evaluation by an independent third-party of loss exposure on a security-by-security basis and consider the insurance company’s carrying value as well as the risk of loss given the securities’ cash flow priorities.
Since these NAIC categories drive the capital requirements for our holdings, we’ve adapted new (displays) to the new approach and now distinguish between high and highest quality fixed maturity holdings or NAIC categories 1 and 2 and those in lower NAIC categories 3 through 6, rather than distinguishing between investment grade and below investment grade. Based on amortized costs and the NAIC categories, about 7% of our $135 billion general account fixed maturity portfolio ranks below high and highest quality as of year-end 2009. A year earlier about 7% of the fixed maturity portfolio was classified as below investment grade when rating agency and NAIC categories were essentially equivalent.
One last comment on the investment portfolio. We had $22 billion of general account, commercial mortgage, and other loan holdings as of year-end based on principal balances. At December 31st, the average loan-to-value ratio for our commercial mortgage holdings is 65% and the average debt service coverage ratio is 1.8 times. And I’d remind you of our comments on Investor Day with respect to the conservative cap rates reflected in the loan-to-value ratio. Delinquencies are still light amounting to less than 1% of the holdings.
Now I'll cover our business results for the quarter, starting with the U.S. businesses. Our annuity business reported adjusted operating income of $88 million for the fourth quarter compared to a loss of just over $1 billion a year ago. Results for the current quarter reflect several discrete largely market-driven items that Rich mentioned with a net unfavorable impact of $30 million.
Current quarter results include a net charge of $109 million from mark-to-market of hedging positions and embedded derivatives for our living benefit guarantees. This charge includes $71 million representing the breakage between changes in the value of our living benefit guarantees and the related hedging instruments including changes in the market-based measure of our non-performance risk, reflecting the tightening of our credit spreads during the quarter. The remainder represents mark-to-market on hedges we put on in 2009 to help protect our capital from exposure to lower equity prices and was driven by the uptick in the equity markets during the quarter.
Going the other way, current quarter results include a benefit of $47 million from the release of a portion of our reserves for guaranteed minimum death and income benefits and a further benefit of $32 million from reduced amortization of deferred policy acquisition and other costs, both cases reflecting favorable market performance.
Results for the year ago quarter included a $907 million negative effect from unfavorable unlockings, reserve strengthening, and market-driven true-ups; $130 million of negative hedging breakage; and a charge of $97 million for a goodwill write-off. Stripping all of these items out of the comparison, annuity results were up $23 million from a year ago reflecting higher fees due to growth in our account values over the past year driven by improving financial markets and over $9 billion of positive net flows.
Our gross variable annuity sales for the quarter amounted to $4.8 billion compared to $2.1 billion a year ago. Our Highest Daily, or HD living benefit guarantees, have provided us with a substantial competitive advantage in the variable annuity market. These products include an auto rebalancing feature that shifts customer funds to fixed income investments to protect account values and support our guarantees in market downturns.
We have completed our transition to our new HD 6 Plus living benefit product feature, which was introduced in August. About $1 billion of the current quarter sales, substantially all in the first month of the quarter, represented spillover sales of the earlier HD 6 product – of the earlier product, HD 7 Plus. Significantly, monthly sales continued at a similar level in November and December suggesting that our new product is still attractive in the marketplace. Our take-up rate for HD features, the percentage of eligible premiums where the customer has elected the benefit, was over 90% for the fourth quarter. The popularity of these features has driven the growth of our auto rebalancing book-of-business, reducing our risk profile and limiting our exposure to changes in hedging costs. As of year-end, about two-thirds of our account values with living benefits are subject to auto rebalancing, compared to just over half of the account values a year earlier. The auto rebalancing algorithm is functioning as intended, returning customer funds to participate in market appreciation as account values become adequate to support our guarantees.
With the improving financial markets about $6.3 billion of account values that had been rebalanced to fixed income investments during the market downturn returned to client selected investments over the past three quarters. As a result, less than one quarter of account values for auto rebalancing products were in our fixed income rebalancing accounts as of yearend, compared to nearly 80% a year earlier.
Net variable annuity sales were very strong in the quarter amounting to $3.2 billion bringing net sales for the year to more than $10 billion. Retirement segment, reported adjusted operating income of $133 million for the current quarter unchanged from a year ago, results for the year ago quarter benefited by $33 million from refinement of our reserve for a block of traditional group annuity business based on an actuarial review of the beneficiary population.
Stripping that reserve refinement out of the comparison, results for the retirement business were up $33 million from a year ago, driven mainly by higher investment spreads. The higher spreads reflects crediting rate reduction, coupled with growth imbalances in our full service stable value business and the maturity of a guaranteed investment contract dating back to before demutualization that was generating a negative spread.
Current quarter full service gross sales and deposits were $4 billion compared to $6.5 billion a year ago, which included two large case wins totaling $2.4 billion. The current quarter gross sales and deposits brought our full service gross inflows for the year to a record high of $23 billion, up more than 20% from 2008. Our full service persistency was 98% and net flows were $900 million for the quarter, bringing our positive net flows for the year to $8.8 billion, also a record high.
The asset management segment reported a loss of $6 million for the current quarter compared to a loss of $69 million a year ago. The reduction in the loss reflect an improved investment results associated with proprietary investing activities which contributed income of about $10 million in the current quarter compared to losses of about $150 million a year ago. The year ago quarter losses came mainly from investments and fixed income and equity funds that we managed which we later redeemed.
The reduction in proprietary investing losses was currently offset by unfavorable results from commercial mortgage operations, largely driven by charges on interim loans we hold in the asset management portfolio, resulting in current quarter reserve expense of about $100 million.
Adjusted operating income from our individual life insurance business was $141 million for the current quarter compared to $9 million a year ago. Results for the year ago quarter were negatively affected by accelerated amortization of DAC and other items together with related costs, driven by unfavorable separate account performance linked to the 22% decline in the S&P 500. We estimate that the swing in these largely market driven charges had a favorable impact of about $115 million in the comparison of current quarter results to a year ago. The remainder of the improvement in results came mainly from more favorable mortality experience in the current quarter.
Sales amounted to $91 million in the current quarter compared to $86 million a year ago. The increase was driven by strong performance of our universal life and term products. Our sales have benefited from market opportunities due to the retrenchment of some carriers and from our competitive positioning. Pricing in this market has generally trended upward and we began to implement a new round of price increases for universal life and term during the fourth quarter.
Group Insurance business reported adjusted operating income of $69 million in the current quarter, unchanged from a year ago. We have not seen a measurable impact on our report results from general economic conditions. Our current quarter benefit ratios for both group life and group disability are reasonably consistent with the levels of a year ago and two years ago.
Sales for the quarter were $62 million compared to $102 million a year ago. Group Insurance sales don’t follow a linear pattern, with large case sales following a lengthy bid process and most of our sales are recorded in the first quarter based on the effective dates of the business.
Turning to our international businesses. Within our International Insurance segment, Gibraltar Life’s adjusted operating income was $151 million in the current quarter compared to $160 million a year ago. Results for the year ago quarter benefited by $9 million from the sale of our branch office property.
Current quarter results include income of $11 million from the Yamato Life business, we acquired in May of 2009. Contribution of the acquired business was essentially offset in the current quarter by expenses of roughly the same amount under an ongoing technology improvement program.
Sales from Gibraltar Life based on annualized premiums in current dollars were $151 million in the current quarter up $49 million from $102 million a year ago. Bank channel sales were $47 million in the current quarter, up from $12 million a year ago. The increase was driven almost entirely by sales of life insurance protection products that we began to distribute through banks late in 2008.
Sales from the Life Advisor channel were up by $14 million or 16% from a year ago, also driven mainly by sales of life insurance protection products.
Our Life Planner business reported adjusted operating income of $302 million for the current quarter up $41 million from a year ago. The increase came mainly from continued business growth and more favorable mortality experience in the current quarter. Sales from our Life Planner operations based on annualized premiums in constant dollars were $224 million in the current quarter, up $38 million from $186 million a year ago, a 20% increase.
Sales outside of Japan were up by $25 million mainly driven by increased sales of retirement focused products in Korea in advance of repricing. Sales in Japan were up $13 million reflecting a resurgence from the year ago quarter when sales were negatively affected by generalized market concerns about U.S. companies.
International Insurance sales on an all in basis including Life Planners, Life Advisors and the Bank channel amounted to $375 million for the fourth quarter. For the year, sales reached a record $1.4 billion, an 11% increase over 2008. The sales growth reflects our expanding distribution and our continuing emphasis on products that meet life insurance protection and retirement needs.
Foreign currency translation was not a major factor in the comparison of our International Insurance results due to our currency hedging programs. The International Investment segment reported adjusted operating income of $4 million for the current quarter compared to a loss of $420 million a year ago.
The loss in the year ago quarter was driven by impairments of joint venture investments and goodwill write-offs totaling $426 million. Stripping out these charges, results were essentially unchanged from a year ago.
Corporate and Other operations reported loss of $199 million for the current quarter compared to $288 million a year ago. Results for the year ago quarter included a charge of $117 million to write-off all of the goodwill in our real estate and relocation business and a $32 million gain from early redemption of convertible debt. Stripping out these items, the loss from Corporate and Other operations was essentially unchanged from a year ago.
Our results (are bearing) the costs of negative spread on the liquidity we are holding and higher interest expense on capital debt within Corporate and Other results. Interest expense, net of investment income produced a negative variance in Corporate and Other results, of about $75 million compared to a year ago. The increase in net financing costs was essentially offset by a $36 million reduction in the loss from our real estate and relocation business excluding the goodwill charge and by lower expenses.
And briefly, in our Closed Block Business. Results of the Closed Block Business are associated with our Class B Stock. Closed Block Business reported net income of $77 million for the current quarter, essentially unchanged from $74 million a year ago. We measure results for the Closed Block business only based on GAAP.
To wrap up, I’d like to turn back to the Financial Service Businesses and sum up where we came out for the year. Each of our operating divisions recorded strong results. Pre-tax adjusted operating income for our three divisions was over $4 billion for the year, more than double the level of 2008.
We have enhanced our competitive position and we are building our franchise with strong sales and net flows, virtually across the board. Gross to net sales for variable annuity and full service retirement were at record high levels for the year. And International Insurance sales also reached a record high, up 11% from 2008.
We realized the value from our investment in the Wachovia Securities joint venture with cash proceeds of $4.5 billion and an after-tax net gain of $1.4 billion or $2.95 for common share.
Our strong operating results together with the gain on the Wachovia joint venture contributed to our net income for common share of $7.63 for the year. We bolstered our financial strength and flexibility during the year with issues of common equity and long-term debt totaling more than $4 million. With our strong balance sheet, we are well positioned for business growth and market opportunities.
Thank you for your interest in Prudential. Now we look forward to hearing your questions.