Prudential Gains From Pension Agreements, FX Fluctuations Dampen Results

Prudential Financial (NYSE:PRU) reported a 36% year-on-year increase in pre-tax operating income for its financial services business for the fourth quarter of 2013, helped largely by pension risk transfer transactions with General Motors (NYSE:GM) and Verizon (NYSE:VZ), completed in 2012. ^[1] However, the company was hurt by currency fluctuations. Net changes in value as a result of foreign currency exchange rates led to a pre-tax loss of $1.2 billion. As a result, Prudential reported a net loss of $427 million for its financial services business, down from a loss of $185 million in 2012. The financial services business consists of the company’s continuing operations and does not include the closed block business, the performance of which is reflected in Prudential’s Class B stock.

Our $80 price estimate for Prudential Financial’s stock is in line with the current market price. We will shortly update our model to account for the latest earnings release.

See our full analysis of Prudential here

Retirement Leading The Way

The U.S. retirement solutions and investment management division was the biggest contributor to Prudential’s earnings, accounting for 54% of operating income (excluding the corporate division, which reported a loss of $397 million). Retirement account values grew 11% over the prior year to reach a record high of $323 billion while individual annuity account values increased 14%, crossing the $150 billion mark. Higher fees as a result of the increase in account values as well as a $112 million improvement in investment results led to a 31% increase in retirement operating income. Market performance exceeded Prudential’s expectations, allowing the company to update its estimate of profitability for the annuities unit, leading to a benefit of $108 million. This, coupled with higher fees from account values, led to a 62% increase in operating income for the unit.

The retirement division has greatly benefited from the pension transfer agreement signed last year. The latest study by Mercer shows that pension plans funded ratio (assets to liabilities) reached a five year high of 93% at the end of November, compared to level of 74% at the end of 2012. ^[2] But Prudential believes that there is still potential for further agreements with mid and large cap companies. During the December quarter, the insurer announced agreements with Bergmann Associates and LiveOps to manage the companies’ retirement plans. ^[3] Prudential will assume responsibility for Bergmann Associates’ $33 million retirement plan for 330 participants and LiveOps’ $13 million retirement plan.

International Performance

The international insurance division’s operating income was unchanged from the prior year, at $647 million. Currency fluctuations led to a decline in premium volume; net premiums, policy charges and fee income on a constant exchange rate basis were $4.3 billion, but on an actual exchange rate basis, the figure was just $3.8 billion. A third of the company’s international premiums came from Japan. Premiums from the country were $1.5 billion on a constant exchange rate basis, but just $1.2 billion on an actual exchange rate basis. Prudential employs a currency hedging program to counter the effects of FX fluctuations and reported a bottom line gain of $11 million due to this.

Prudential operates under the name “Pramerica” in countries including Japan, Taiwan, Italy, Korea, Brazil, Argentina, Poland and Mexico, and has been expanding at an aggressive pace. Premiums from these operations grew at a CAGR of 36% from 2008 to 2012, helped by the acquisition of Star Life Insurance Co., Ltd. and Edison Life Insurance Company from AIG (NYSE:AIG). The international division accounted for 35% of the company’s operating income, excluding the corporate division, during the December quarter. We believe there is potential for expansion, particularly in Asia, but Prudential may have to counter currency fluctuations to maintain growth.

Individual Life Helped By Hartford Acquisition

In January 2013, Prudential completed the acquisition of The Hartford Financial Services Group’s (NYSE:HIG) individual life insurance business. This acquisition, through a reinsurance transaction, allowed Prudential to assume 700,000 life insurance policies with net retained face amount in force of approximately $141 billion. The transaction drove a 59% increase in operating income for Prudential’s individual life division during the December quarter. Annualized new business premiums grew 15% over the prior year, with a 21% increase in Universal Life new business premiums.

Prudential is currently the third largest life insurer in the U.S., behind MetLife (NYSE:MET) and Aflac Group, with a market share of 6.14%. ^[4] However, the company has been named as a non-bank systemically important financial institution (SIFI) by the Financial Stability Oversight Council (FSOC). This designation will impose stricter capital requirements along with other regulations which might hamper Prudential’s growth in the coming years. We will keep a close eye on developments and update our model accordingly.

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1. PRUDENTIAL FINANCIAL, INC. ANNOUNCES 2013 RESULTS [↩]
2. 2013 press releases [↩]
3. Prudential Financial Inc : Prudential to Manage Retirement Plans for Bergmann Associates and LiveOps, December 2, 2013 [↩]
4. NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS LIFE AND FRATERNAL INSURANCE INDUSTRY 2012 TOP 25 GROUPS AND COMPANIES BY COUNTRYWIDE PREMIUM [↩]