Prudential’s Earnings Helped By U.S. Retirement Growth, International Operations Disappoint

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Prudential Financial

Prudential Financial (NYSE:PRU) reported strong earnings for the first quarter of 2014, swinging from a net loss of $735 million in Q1 2013 to a net profit of $1.23 billion. After-tax adjusted operating income, which is a Non-GAAP metric used by the company to measure operational performance, increased 6% over the prior year. The U.S. retirement solutions business, which accounts for more than half of the company’s operating income, observed a 23% surge in pre-tax adjusted operating income while income from the company’s international operations fell 5%. Earnings from the U.S. retirement business were driven by growth in account values, leading to higher fees earned by the company.

Our $86 price estimate for Prudential Financial’s stock is in line with the current market price.

See our full analysis of Prudential here

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Growth In Retirement Business

Prudential’s U.S. retirement solutions business consists of three sub-divisions: Individual annuities, retirement and asset management. The first two sub-divisions each account for about 40% of the division’s operating income, while the asset management sub-division accounts for 20%. For these divisions, the company primarily earns revenue from fees charged on the basis of account values. Account values are driven both by sales and the impact of market changes

The retirement division offers retirement income products and services to employers in the U.S. For the first quarter, retirement account values increased 9% over the prior year, helped by a 51% surge in sales and a positive impact of $2 billion from changes in market values. The division’s earnings were also helped by a $123 million greater contribution from investment results, driven by the company’s non-coupon investments. As a result, the adjusted operating income increased 60% over the prior year. We expect Prudential to maintain momentum in this domain.

Operating income for the individual annuities segment grew 4% over the prior year, with a 9% increase in account values. The sub-division offers variable and fixed annuity products to individual customers across the U.S., targeting mass affluent customers. Prudential reported $2.3 billion in total variable annuity sales for the first quarter, of which around 70% came from the Highest Daily Suite product. However, after accounting for benefit payments, surrenders and withdrawals, the net flows were negative and the growth in account values was largely driven by a $2.2 billion positive impact from changes in market values.

Prudential is the sixth largest seller of annuities in the U.S., with a market share of 7%. It is the fourth highest seller of variable annuities, with a market share of close to 10%. [1] More than 95% of the company’s annuity sales are through variable annuity products. Prudential uses a distribution network of independent financial planners, wirehouses, banks, and insurance agents, with over 300 wholesalers across the country. We expect the company to maintain its position in the market, while exercising caution to maintain profitability in a volatile market.

Currency Fluctuations Continue To Affect International Earnings

Prudential has established operations under the name “Pramerica” in countries including Japan, Taiwan, Italy, Korea, Brazil, Argentina, Poland and Mexico. Premiums from these operations grew at a CAGR of 36% from 2008 to 2012, but were affected by currency fluctuations in 2013 as Asian currencies weakened against the U.S. dollar. For the March 2014 quarter, net premiums, policy charges and fee income from international operations were down 24% on a reported basis and 18% on a constant currency basis. The annualized new business premiums – or the premiums from new sales expected to be collected over the year – fell 14% on a reported basis and 8% on a constant currency basis.

A large portion of the company’s international premiums come from operations in Japan, where earnings have been impacted by foreign currency fluctuations. The quarterly weighted average exchange rate for the Japanese Yen to U.S. dollars has increased 17%, from 88.43 Yen per dollar in March 2013 to 103.15 Yen per U.S. dollar. [2] This was one of the major reasons for the decline in reported international premium volume. However, the number of individual policies in force in Japan (excluding Gibraltar Life) actually went up from 2.8 million at the end of the March quarter of 2013 to 3 million. The Gibraltar Life individual policies fell from 7.4 million to 7.2 million, but the face amount of individual policies remained the same.

Japan is the second largest life insurance market in the world after the U.S., accounting for 20% of the world’s premiums and more than half of the premiums originating in Asia. [3] Prudential entered the Japanese market in 1988, focusing primarily on the business and professional market as well as the mid-affluent to affluent customer base. It acquired Gibraltar Life Insurance Company, Ltd in 2001 and expanded its offerings to the mass middle market in the country. [4] Prudential primarily relies on its retail banking network for distribution activity, with sales made via insurance agents. The company has around 3,137 life planners in Japan and is expanding its bancassurance model to mega and regional banks, which currently encompasses over a hundred distributors across the country.

While a recovery in Japan will help Prudential’s future results, it is also looking to expand operations in markets such as China, Argentina, Poland, and Mexico. We believe that Prudential is currently going through a trough and will be able to regain momentum in international markets in the coming years. You can modify the interactive chart below to gauge the effect a change in forecast would have on our price estimate.

Hartford Acquisition Helps U.S. Life Insurance Results

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. For the March quarter, the company incurred $8 million in integration costs related to this acquisition which, along with a less favorable claims experience and a 3% decrease in premiums, led to a 9% decline in operating income for the U.S. life insurance segment.

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%. [5] We expect the company to focus on profitability in the coming years, even at the cost of market share.

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Notes:
  1. LIMRA SRI U.S. Individual Annuities Sales Survey []
  2. AIG 10Q Filing []
  3. Swiss Re’s World Insurance []
  4. Prudential Targets 19% Returns Outside U.S in 2013 []
  5. NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS LIFE AND FRATERNAL INSURANCE INDUSTRY 2012 TOP 25 GROUPS AND COMPANIES BY COUNTRYWIDE PREMIUM []