Prudential Financial (NYSE:PRU) delivered a strong operational performance through 2012, despite some hiccups early in the first quarter. Shrewd deals were signed like the acquisition of AIG’s (NYSE:AIG) life insurance and annuity units, Star Life Insurance Co. Ltd. and Edison Life Insurance Company units. The company also capitalized on The Hartford Financial Services Group’s (NYSE:HIG) divestiture, acquiring its individual life insurance business. Other landmarks in 2012 included the pension transfer agreements with General Motors (NYSE:GM) and Verizon (NYSE:VZ), which we believe will open up new avenues for income in the coming years.
Our price estimate of $56 for Prudential’s stock implies a premium of nearly 10% to the current market price.
How Prudential Makes Its Money
Prudential earned about $50 billion in revenues with an 11% operating margin in 2011. The company’s main source of income are its international operations, which along with investment income, account for 30% of the company’s revenues. Group insurance and U.S. retirement solutions are the other major revenue streams, accounting for about 10% of the revenues respectively. Asset management, individual insurance and the closed block business (includes the mutual insurance division) account for rest of the revenues. In terms of contribution to operating income, international insurance accounts for about 40%, investment income around 25% and retirement solutions and asset management around 15% each.
International Insurance In 2012
Prudential has operations in Japan, Taiwan, Italy, Korea, Brazil, Argentina, Poland and Mexico, under the name ‘Pramerica’. Japan is the biggest hub of operations outside the U.S. With the successful integration of the Star Life Insurance and Edison Life Insurance Company units, Prudential was able to expand market share in terms of new business face amount, from 7.3% pre-acquisition to 10.4% post-acquisition.
Japan is currently the world’s second largest life insurance market with premiums worth $525 billion in 2011.  The investable asset pool of currency and deposits at $10.9 trillion is the largest in the world, about 50% higher than the U.S. However, the Japanese insurance market is mature and highly saturated, with intense competition from government supported life insurance cooperatives and postal insurance entities. Prudential has around 3,137 life planners in Japan, and is expanding its bancassurance model to mega and regional banks, which currently includes over a hundred distributors across the country.
At the end of 2012, Prudential also ventured into China with a life insurance joint venture with Chinese conglomerate Fosun International Limited to form Pramerica Fosun Life Insurance Company Ltd. With insurance penetration rate (total premium income against a country’s GDP) below 4%, the country offers tremendous potential for expansion with the world’s largest population and a high GDP growth rate.  To gauge the importance of this, we compare insurance penetration in more mature markets. The U.K. has a penetration of 14%, while in the U.S. penetration is over 8%. 
We believe that Prudential will continue to see growth in its international operations in 2013 and in the near future.
Prudential issued a group annuity contract worth approximately $29 billion to General Motors in June, and followed it up with another agreement with Verizon covering approximately 41,000 members of Verizon’s pension plan and about $7.5 billion in pension liabilities.  We believe that there might be similar deals in the pipeline, the Russell 1000 Index of large U.S. companies, revealed a $435 billion gap between pension liabilities and assets  on the balance sheets of the country’s employers. This is an opportunity for future deals and subsequent revenue growth in 2013.
In terms of individual annuities, Prudential was able to capitalize on MetLife’s (NYSE:MET) decision to pull out of the variable annuities market, and take over the pole position in terms of variable annuity sales. (according to data compiled by LIMRA). Prudential is now second in terms of annuity sales, behind the U.S. subsidiary of its British namesake (Prudential Plc), Jackson National Life, which was actually third last year.
The company’s share in the annuity market has increased from 8.8% to over 10% over the last year. But Prudential primarily offers variable annuities, around 91% of its annuity sales are through variable annuities. In this market, Prudential’s share has increased from 12.7% at the end of 2011 to 14.5%. As MetLife continues to cut back on variable annuities, we expect Prudential to gain more market share in the coming years.
Prudential agreed to pay Hartford $615 million in cash as part of a reinsurance deal in late September. The company will assume coverage for more than 700,000 life policies, and assume investment assets, reserved for future claims on these policies, with a statutory book value of around $7 billion. Prudential’s share of the U.S. individual life insurance market at the end of 2011 was around 2.7%, whereas Hartford’s share was around 1.2%. We expect further growth from the deal in the coming years.
You can modify the interactive chart below to gauge the effect an increase or decrease in market share could have on our price estimate.Notes:
- Prudential Targets 19% Returns Outside U.S in 2013 [↩]
- Foreign insurance companies in China, PWC [↩]
- Presentation To The American Council Of Life Insurers, Goldman Sachs Investment Banking Division, 28th March, 2012 [↩]
- Prudential Financial Inc : Prudential completes pension risk transfer transaction with Verizon, 4 traders, 10th December, 2012 [↩]
- GM Seen Fueling Pension Deals as Employers Face Shortfall, Bloomberg, 19th June, 2012 [↩]