保德信金融集團 (PRU) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Good morning, good afternoon, good evening and welcome to Prudential's second quarter 2002 earnings conference call. At this time all phone lines are muted or in a listen-only mode. However, after our panel's presentation today there will be opportunities for questions. And we certainly encourage your participation. To queue up for a question, press the 1 on your phone keypad.

Also, should you require assistance, you may reach an AT&T operator by pressing zero then star. As a reminder, today's call is being recorded for replay purposes. With that being said, here with our opening remarks is Prudential's Director of Investor Relations, Mr. Eric Durant. Please go ahead, sir.

Thank you very much for joining us today. Our presenters are our Chief Executive Officer, Art Ryan; Mark Grier, the head of Financial Management. Also with us today are Rich Carbone, Chief Financial Officer, and Buddy [Pizele], Controller.

In order to help you understand Prudential and its results, we will make some forward-looking statements. It is possible actual results may differ from the predictions we make today. Additional information regarding factors that could cause such a difference appears is in the section titled "Forward-Looking Statements" of our earnings press release and annual report on Form 10-K for the year ended December 31, 2001. Art?

Good morning. Thank you for joining us today. I apologize for the slight delay, but there were a sizeable number of phone calls that were coming in right around 11:00.

Our second quarter results are on track. Strong performance in our international division and expense cuts have mitigated the impact of difficult equity market conditions on a number of our businesses. We're also pleased with the market acceptance of our new Universal Life, our repriced term insurance and some of the other retail products that have allowed us to build some sales momentum in what is clearly a difficult environment. So, in summary, strong international, continued expense cuts and growing sales momentum in some important product areas are the headlines for this quarter.

Mark will be giving you a full review of the second quarter results, but I want to highlight a number of areas. And I'll start on the expense front. As you know, we have a two-year goal to reduce expenses in comparison to their 2000 level. We reached our objectives for 2001, and this year our target is to reduce expenses by an additional $250 million. And we're well on the way to achieving this goal.

Through the first half, expenses have been reduced by $200 million, including $114 million in the second quarter compared to the equivalent period in 2001. So, we are tightening our belts, and we will continue to do so.

Last quarter we predicted our earnings expectations on the assumption that equity market conditions would stabilize over the balance of the year, including minimal change in the S&P 500 index. Unfortunately, the S&P 500 has declined by nearly 18% in the three months since we last updated our guidance.

Today we expect that our common stock earnings per share for 2002 will be at the lower end of our existing $2.10 to $2.30 range. And that is based on adjusted operating income. This assumes that equity market conditions stabilize over the balance of the year, including essentially no further decline in the S&P index from today's level.

I also want to comment briefly on the management structure changes that will be made during the third quarter. The new organizational structure will reduce our operating divisions from four to three, and we'll in turn establish an office of the chairman. Our operating divisions will be insurance, investments, and international insurance and investments. We are not exiting any businesses as a result of this move, but the businesses that were housed in the employee benefit division will migrate to the new insurance and investment divisions.

The insurance division will consist of our individual insurance, property and casualty insurance, individual annuities and our group insurance business. The investment division will consist of Prudential Securities, our asset management businesses, guaranteed products, retirement services, and retail investments, which includes our mutual fund and managed account business. The third, the international insurance and investment division, includes our international insurance and international investment businesses.

Vivian Banto will lead the insurance division, John [Strangfel] the investment division, and Roger [Lawson] our international insurance and investment division. Each has been promoted to vice chairman and has been named to the office of the chairman. In addition, the office of the chairman will include newly promoted vice chairman, Mark Greer, who heads our financial management activities.

This reorganization is intended to improve alignn't of our product and distribution capabilities, and I believe will improve our effectiveness. Moreover, I expect these changes will result in annual expense savings of approximately $20 million. I should mention that our expectation for this year's common stock earnings per share incorporates roughly $15 to $20 million in implementation costs in the second half of the year associated with the reorganization.

Before handing off to Mark to talk about the business results, let me update you on the subject of share repurchases. As you'll recall from last quarter, we believe that the overhang issue of policyholder sales is substantially behind us. In May, as I told you I would, following discussions with our board we began share repurchases as part of a capital management strategy. As a result, we were in the market for only a portion of the second quarter.

In addition, during the quarter participants in some deferred compensation plans took advantage of their first opportunity to allocate a portion of their balances to company stock. This created some additional demand requirements to manage our repurchasing activity to avoid causing any market disruptions.

I'm going to report to you through July. In our release, we reported through June, as would be expected in any second quarter report. But through July we have now purchased 5.8 million shares of our common stock at a total cost of $188 million, including 1.7 million shares for the deferred compensation plans.

We continue to believe that Prudential will have more capital than it will be able to invest to earn an appropriate return. And as I've said many times, we do not intend to hold capital that cannot be effectively deployed. We believe that an ongoing program of share repurchase is an appropriate way to reduce excess capital and will continue to report our activity to you every quarter.

So, again, thanks for being with us. I'll now turn over to Mark, who will go through some of the details, and then, as was stated, we'll be delighted to answer any questions you might have.

Thank you, Art. Good morning. Welcome to our second quarter conference call. I'll start with an overview of the second quarter results for our Financial Services Businesses.

In the second quarter our adjusted operating income amounted to 54 cents per share of common stock compared to 45 cents per share in the year ago quarter. As you know, our common stock reflects the performance of our financial services businesses. Adjusted operating income is before realized investment gains and losses, results from difficult vested businesses and demutualization expenses in the year-ago quarter. Pretax adjusted operating income for our financial services businesses was $478 million for the second quarter of 2002, an increase of $117 million, or 32%, from $361 million in the year ago quarter.

Starting with the U.S. consumer division: the U.S. consumer division had adjusted operating income of $117 million in the second quarter, compared to $82 million in the year ago quarter. Within the U.S. consumer division, the individual life insurance segment had adjusted operating income of $130 million for the quarter, an increase of $43 million from a year ago.

The year-ago quarter absorbed a charge of $12 million for implementation costs of our program to take costs out of the distribution system. The rest of the increase came primarily from the benefit to current quarter results from the expense savings we've realized, which Art referenced earlier. We have achieved the year's expense reduction target for this business ahead of schedule.

Sales, based on first year premiums, were $148 million in the second quarter, up from $97 million in the year-ago quarter mainly because of greater COLI sales, which tend to come in unevenly. Excluding COLI, sales were $72 million in the second quarter compared to $69 million in the year-ago quarter.

The Universal Life products we introduced last November, and our term products, which we repriced late last year, continued to gather momentum with sales growing in the second quarter in relation to the first quarter. Our Universal Life products contributed $15 million to this quarter's sales, and term sales also $15 million, registered a 36% increase over the year-ago quarter. However, our variable life sales continue to be negatively affected by equity market conditions, dampening the overall sales increase.

Our Prudential agent count increased to more than 4,500 at the end of the second quarter, marking our second consecutive quarter of growth in the agent count after years of decline, providing further confidence that our captive agent force has stabilized. Second quarter agent productivity was $38,000, well above the level of last year's second quarter and above the level of the full year 2001.

Our third party sales other than COLI are up $2 million from the year ago quarter. This channel felt the effects of reduced variable life demand, but continued to benefit from our repriced term products and our new Universal Life products and accounted for about one quarter of our total non-COLI sales for the quarter.

Turning to the Private Client Group: the Private Client Group had a loss of $29 million for the quarter compared to a $98 million loss in the year-ago quarter. The year-ago quarter in the Private Client Group absorbed charges of $39 million for employee termination and facilities consolidation costs as we took actions to bring costs in-line with the declining level of investor activity.

The reduction in the segment's loss came from the savings we realized from our cost reduction measures. The lower level of expenses more than offset the further decline in individual investor transaction volume and margin loan balances that have resulted in decreased commissions and net interest revenues in the year-over-year comparison.

The retail investments segment reported a loss on an adjusted operating income bases of $2 million in the second quarter. The loss reflects a $48 million charge for additional amortization of deferred policy acquisition costs, DAC, on our annuity business as well as lower based fees in comparison to last year's second quarter. Adjusted operating income was $60 million in the year-ago quarter.

The DAC charge reflects our lower estimate of profitability of the annuity book of business due to equity market conditions. The purpose of the adjustment, in a nutshell, is to bring our assumptions of equity returns over the remaining lives of these contracts in-line with our reasonable expectations given the starting point of the June 30th market level.

Although the individual annuity business is a relatively limited part of our overall results, I'd like to give a brief overview of our approach to evaluating DAC, deferred acquisition costs, each quarter and how we arrived at the adjustment. When we evaluate the deferred acquisition cost on our balance sheet each quarter, we compare our actual profitability to our expectations. If the experience deviates by only a minor amount, we don't unlock or accelerate the amortization of DAC. But if the deviation is more than minor, we use a reversion-to-mean approach.

Under the reversion-to-mean approach, we consider a six-year period consisting of two prior years and four future years over which we expect the investments underlying the annuities to grow at a targeted return. We refer to the four future years as the look-forward period.

We calculate the rate of return over the look-forward period, which together with the actual results for the previous two years, would get us to our targeted return for the full six-year period. If that calculated rate is reasonable, we use it to project the asset growth for the next four years. But if we believe the rate that we would have to realize in the next four years is not reasonable, we would adjust it downward.

After the look-forward period, we project asset growth at our long-term rate. The fees we expect to earn based on that pattern of asset growth are what we consider when we evaluate DAC. Our downward adjustment of the calculated rate in the second quarter of 2002 contributed to our $48 million negative unlocking or accelerated amortization of DAC. Our long-term rate for equity returns; that is, the rate beyond the look-forward period, is 8.85%. For the average remaining life of the book of business, about eight years, the rate would be about 11.5%.

Turning to property and casualty, the property and casualty insurance segment had adjusted operating income of $18 million in the second quarter compared to $33 million in the year-ago quarter. The current quarter's results benefited by $43 million from stop loss reinsurance recoveries, prior year reserve releases and a change in our liability under New Jersey auto insurance profit regulations. While the year-ago quarter included a benefit of $58 million from these items. If we strip these items out of the segment's results for each period, they would be unchanged from the year-ago quarter.

We benefited in the current quarter from more favorable catastrophe experience and expense savings that we realized. But these positives were offset by continued adverse experience, including that from business written through several alternative channels that we curtailed last year.

We are continuing to reunderwrite, increase rates, cancel and unrenew the unprofitable business as permitted contractually and by regulation. But this business will continue to affect our results as it runs off.

Turning now to the International division: the International division had adjusted operating income of $176 million in the second quarter compared to $120 million in the year ago quarter. The International Insurance segment reported adjusted operating income of $187 million for the current quarter, including $101 million from Gibraltar Life. Last year's second quarter included $59 million for Gibraltar Life, as it was only included for two of the three months in the quarter. Our International Securities and Investments segment was adversely affected by the same market conditions that affected our domestic securities operations, resulting in a modest loss for the quarter.

Gibraltar Life's $101 million adjusted operating income reflected refinements in estimates mainly of amounts to policyholders and gains from policy surrenders. The net of these items reduced the adjusted operating income in the current quarter by about $20 million. However, mortality experience was favorable in the current quarter in comparison both to our expectations and to the earlier quarters. So, the reported results are generally in line with what we would think of as a run-rate result.

Adjusted operating income from our insurance operations other than Gibraltar Life increased by $3 million from the year-ago second quarter, which benefited from an $8 million reserve refinement. The continued strong results from business growth in Japan and Korea were partly offset by a negative impact of about $6 million from currency exchange rates.

Excluding the impact of the reserve refinement in last year's quarter and the impact of currency fluctuations, these operations would have registered a 23% increase in adjusted operating income.

On a constant dollar basis, new annualized premiums from sales in Japan were $132 million in the current quarter, including $63 million from Gibraltar Life. This compares to $103 million in the year-ago quarter when Gibraltar agents were selling products for our existing Japanese operations as we introduced the new products we'd developed for Gibraltar.

Sales in Japan for the year-ago quarter also benefited significantly from policies that were purchased in anticipation of a rate increase a year ago. Sales from other countries contributed new annualized premiums of $49 million in the current quarter, down from $61 million in the year-ago quarter, which also benefited from business sold in anticipation of a rate increase in Korea.

Our International Life planner force stood at about 4,200 life planners at the end of the second quarter, up about 14% from 3,700 a year earlier. This is in addition to 5,500 Gibraltar Life advisors, down from 6,100 at year-end, reflecting actions we've taken to make this distribution force more cost effective.

The International Securities and Investments segment reported losses of $11 million in the current quarter and $22 million in the year-ago quarter. Key factors in this business are similar to those affecting the domestic securities operation, and the reduction in the loss reflects actions we've taken to reduce the cost structure of these operations.

The Employee Benefits division reported adjusted operating income of $94 million in the second quarter, a $42 million increase from the year ago quarter. The Group Insurance segment reported adjusted operating income of $36 million in the current quarter versus $9 million in the year-ago quarter, which reflected a net charge of $13 million for changes in our estimates of incurred but unreported claims and returned premiums. Stripping out those items from the results, adjusted operating income in Group Insurance increased $14 million, mainly reflecting improved disability claims experience.

During the first half of the year we have reviewed pricing and implemented rate increases where appropriate on Group Life business representing about 30% of our premiums in force, and we are starting to see the impact of the repricing on our loss ratios. We expect to have about 50% of our overall Group Life business covered by the repricing program by year-end.

Despite the rate increases, our life persistency for the first half of the year stood at 96%. And the cases we lost had an average benefit ratio in excess of 100%.

The Other Employee Benefits segment had adjusted operating income of $58 million in the current quarter, up $15 million from the year-ago quarter. The segment benefited from mortgage prepayment income of $30 million in the current quarter. This was partially offset by lower margins from investment results.

The Asset Management division reported adjusted operating income of $56 million for the quarter, a $24 million increase from the year-ago quarter due to improved results from both segments in the division.

The Investment Management and Advisory Services segment had adjusted operating income of $33 million in the current quarter, a $10 million increase from the year ago quarter. We absorbed $6 million of employee severance and facilities consolidation costs in last year's second quarter and benefited from a lower expense level in the current quarter. The expense comparison more than offset the effect of market value declines in our equity assets under management.

Assets under management by the Asset Management division were $284 billion at the end of the second quarter, down about $16 billion from a year earlier. The Other Asset Management segment had adjusted operating income of $23 million in the current quarter, up $14 million from the year-ago quarter when we absorbed $12 million of employee severance and facility consolidation costs.

Corporate and other operations resulted in adjusted operating income of $35 million in the second quarter compared to $75 million in the year-ago quarter. Hedging that we retain at the corporate level, which contributed a benefit of $48 million to the year-ago quarter, was the main driver of the decrease. Current quarter results include investment income from assets transferred from the former traditional participating products segment when we formed the closed block business at the time of demutualization.

I'd like to comment for a moment on the realignment of our businesses that we're executing in the third quarter. As Art mentioned, we will align our segment reporting with the new structure effective with our third quarter reports. We plan to provide a financial supplement in October, well before we release third quarter earnings, that will present our historical results as they will appear under the new structure.

Turning to the investment portfolio, realized investment losses for the financial services businesses net of related adjustments amounted to $343 million in the second quarter, compared to realized gains of $75 million in the year-ago quarter when we had gains from sales of fixed maturity investments in a declining interest rate environment.

The current quarter's realized losses include $254 million from fluctuations in the value of hedging instruments that cover our foreign currency and interest rate risks. These are mark-to-market entries that are reported in realized gains and losses. We use a rolling hedge for our earnings from Japanese insurance operations over a number of quarters to mitigate the risk that unfavorable exchange rate changes will reduce our dollar equivalent earnings, and we hedge the value of foreign denominated bonds in our portfolios.

We also hedge our exposure to interest rate risk as part of our asset liability management program. The strengthening of the yen and declines in interest rates during the quarter produced the negative mark-to-market results which we report as a realized loss.

Realized losses for the current quarter also included losses of $83 million from the sale of substantially all remaining WorldCom holdings and $137 million from impairments and sales of other credit impaired securities. These losses were partially offset by gains from fixed maturities, including prepayments.

Non-investment grade fixed maturities comprised about 8% of the financial services business's fixed maturity portfolio at June 30th, essentially unchanged from year-end.

Let me comment briefly on the closed block business. Starting at the demutualization date and going forward, the results of the closed block business are associated with the class B stock, which we sold in a private placement. The closed block business reported a $254 million loss from earnings before earnings from income taxes for the second quarter of 2002 compared to a loss of $103 million for the year-ago quarter.

We measure results for the closed block business only based on GAAP rather than adjusted operating income. What we report for the closed block business for the year-ago quarter represents the results of our former traditional participating products segment. The $151 million increase in the pretax loss came primarily from lower investment income and an increase in realized investment losses during the current quarter.

Turning back to the financial services businesses and summing up: the actions we've taken to reduce the cost structure in our domestic businesses have helped mitigate the effects of the difficult environment, and we've benefited from the diversity of earnings, bolstered by the continued strong performance of our International Insurance operations. Thank you for your interest in Prudential. Now we look forward to hearing your questions.

Thank you, sir. And ladies and gentlemen, as you just heard, if you do have any questions or comments, we invite you to queue up at this time by pressing the 1 on your phone keypad. You'll hear a tone indicating that you've been placed in queue. And just as a note, should your question or concern be addressed before you're called on, you may remove yourself from the queue by pressing the pound key. Once again, to queue up for a question, just press the 1 on your touch-tone phone. Representing Banc of America Securities, our first question comes from the line of Jason Zucker. Please go ahead.

Great. Thank you. Two quick questions for you. Given that 2002 cost savings appear to be ahead of schedule this year, do you expect to still got the full $300 million of cost savings in 2003 and 2004? And could you also comment on the declining financial advisors at Pru Securities?

Good morning, Jason. This is Art Ryan. The simple answer on your expense question is yes, but I do want to separate the two. While we are ahead for 2002 and expect to stay ahead for 2002, it means that we are not only getting the committed saves of the 250 that I've talked about, but we've taken additional actions because of the market conditions to reduce the expenses, and in combination we'll be ahead of 2002. And yes, I am committed to reduce the additional $300 million in '03 and '04 that we have talked about.

Second, on the financial advisors, our -- what we call the "core rate turnover" is somewhere around 10%, which I think is an attractive number. I think it's reflected in the fact that productivity continues to improve. And so while the reported number is higher, it really reflects lower ending FAs, frankly many of them who are not making any money in the business in this particular market who have chosen a new career. So, we're pretty comfortable with the turnover rate given the market conditions that we're existing in.

Great. Thank you.

Thank you, Mr. Zucker. Next we go to the line of Nigel Dailey with Morgan Stanley. Please go ahead.

Three questions. First, on capital: assuming that you don't have any large acquisitions, is there a run rate for stock buybacks that we can think of on a quarterly business? Second, with regard to your pension income, I'm just wondering how much it contributed to the current quarter's results and if you've thought about how this may change in 2003 given the equity market declines? And lastly, on Prudential Securities, you've done a great job of reducing expenses here, but are you still looking to turn a profit by year-end; is that still realistic, given the equity market declines?

Thank you very much, Nigel. This is Art Ryan. Let me take them in reverse order. I'll talk about Prudential Securities, and I'll ask Mark to address your questions on capital and pension income.

When we had talked about Prudential Securities breaking even earlier in the year, we certainly had different expectations for the stock market and the level, I should say, as well as different expectations on transaction volume. As you know, in the securities business you get affected both ways by both the level of the assets as well as the amount of volume, unlike your traditional asset management business which is more affected by the level of assets.

We are seeing little or no improvement in retail volumes in the securities business. I don't think our situation is unique. At this point in time the retail investor appears to be sitting on the side lines. So, for us to meet the target of getting to breakeven, we will need some help. We will need some help on retail volume along the lines that I've talked about in the past, a 10% improvement, as well as some stabilization in asset values.

That's pretty hard for me to predict at this point given the stock market, but the conditions under which we would get the breakeven really haven't changed. And in fact, the expense cuts have been somewhat greater than I had said that we would be doing. So, we'll just have to wait and see how the market plays out and the volumes play out over the next 60 to 90 days for me to be better able to more definitively answer your question.

Thanks.

On the other two, with respect to capital and share repurchases, we are on track with respect to the commitments that we've made about excess capital and the redeployment of capital. I don't think I would say anything different than we've said in the past. Art mentioned how much stock we bought back beginning just after the middle of May through the end of July. So, I guess I would suggest that you put those two things together, and I think the conclusion is that we're on track to do what we've committed to do.

On the pension income, it was $125 million in the quarter. We reevaluate the pension situation at the end of September, and we'll be doing that as a result in a couple of months, considering what impact that may or may not have on 2003 earnings. It will not affect 2002 earnings.

We do look at the consistency of all of our assumptions everywhere, so we'll be thinking about this in light of all the things that are impacted by forward-looking market assumptions. I can't tell you more than that at this point. We'll do that evaluation in September and see where we come out.

Great. Thank you.

Representing Deutsche Bank next we go to Vanessa Wilson. Please go ahead.

Thank you. Good morning. Could you give us your statutory operating income for the quarter and talk a little bit about how the rating agencies are looking at your capital position relative to your feelings that there's significant excess capital here?

Good morning, Vanessa.

Hi, Art.

Let me try and answer the question on the -- your second one, and then I'll have Buddy [Pizele] answer your question on the statutory earnings.

We're in the process of discussions with the rate something agencies as one would normally do at this point. I think importantly their outlook for the company is a stable rating, which is fairly positive in this particular market. The discussions are ongoing on the capital. I think, broadly speaking, the rating agencies are in full agreement with our assumptions and our assessment of capital. And we will continue to have discussions with them relative to the objective that I've stated in the past in terms of a rating increase for the insurance company to help some of our businesses there. But by and large I don't think we have any disagreements with the rating agency at this point in time. Quite the opposite; I think we're pretty much in agreement on everything. Buddy, on statutory?

Vanessa, for statutory, this is for PICAO only, and we're all having a modest gain of PICAO, the Prudential Insurance Company of America Only, we'll have a modest gain from operations for the first six months of the year, but we will have a net negative change to surplus because of the capital losses in the insurance company. And we expect the RBC ratio to be in excess of 350% as of June.

Are you at a positive in the international operations?

Definitely, yes, on a statutory basis.

And Art, just one more thing. Are you still on track to give us a plan by the end of the year for the P&C business?

Yes, I am, Vanessa.

Thank you.

And thank you for your questions, Miss Wilson. Goldman Sachs' Joan Zeith has our next question. Please go ahead.

Thank you. I have a few questions. The first is on the international securities business. If -- it seems as if this is a very difficult time in the securities business, and I was wondering what gives you confidence in that business that keeps you focused there and adding to it through small acquisitions? So, Art, I just wanted to know how you're looking at that international securities business. I mean, you have such a successful international insurance business. What gives you comfort that you can actually do a strong international securities business?

The second question I have is you talked about the closed block and the net loss in that. Is there an issue with the cushion that you have in the policyholder dividends? So, do we as, you know, people who look at Prudential Financial have to be sensitive to that?

And then the last question I have relates to your return on equity target for the ends of 2004 or beginning of 2005. How are you feeling about that? You've started the buybacks for your excess capital, but I guess unless you can turn around the underperforming businesses or make a big acquisition, it's -- or actually increase the buyback authorization significantly, it may be difficult to reach that. Can you just tell me how you're feeling about that?

Let me take the three questions. Let me start with the return on equity. Obviously the markets have had some impact on a number of our businesses during the second quarter of this year. But my outlook for the end of '04, early '05 is really unchanged. I'm confident that we can reach our objectives principally through the methods that you mentioned, short of a need for a major acquisition.

I think that we are targeting around the growth in the businesses that you know of. And clearly I have to turn around the underperforming businesses. That's a given. If I don't do that, then obviously I can't achieve that objective, and probably my successor will have the opportunity to do that. And so, no, I think we're on track, and I think we know what we have to do, Joan.

In terms of the closed block, no, I don't think there's any concerns that you should worry about. The cushion on the dividends is $30 billion, present value, obviously. So, no, I don't think you have any concerns there.

On the first question, what I'd like to do is separate -- there are two components to what we include in international securities and investments. And it is just that, international securities and international investment businesses. The international securities businesses, which in many cases are branch extensions of our domestic securities business, are really subject to the same issues that our domestic securities business is; namely, that they principally trade in dollar-based products, but they happen to be located offshore.

So, the challenges we have with our domestic securities business are equally those in the international securities business. We have not made acquisitions in international securities. We are looking at that in the same light as we do our domestic securities business.

In terms of international investments, and again let me clarify the difference. International securities are offshore branches that are principally dollar-based products. International investments are basically local full-service capabilities; namely, they have distribution, they have product, and they have local portfolio management. An example would be our partial interest in CJ Securities in Korea; our ownership of Masterlink in Taiwan.

All of these are part of a strategy to have both protection and investment in each of those markets, not unlike what we have in the United States. We now have it in Japan. We now have it in Korea. We now have it in Taiwan. The difference, obviously, is our international insurance business is 14 years old. These businesses are about two and a half years old. The acquisitions, albeit small, that we've made recently in Germany and the joint venture that we did in Italy are all part of producing local distribution, local portfolio management in those companies. And I believe they will be positive contributors in the near future.

So, even though the lines are combined, you've got to separate international securities from international investments. I do not see significant acquisitions in this arena, but as we add to our capabilities in the 10 to 12 markets around the world, we think it produces a similar strategy to what we have in the United States, which is grow and protect in each of the markets in which we serve.

Thanks so much, Art.

And thank you, ma'am. Next we go to the line of Andrew [Klegerman]. Mr. Klegerman representing Bear Stearns, your line is now open.

Good morning. First, maybe you can help me get a better sense of the DAC unlocking. You unlocked retail investments $48 million this quarter. Just to get a sense of the magnitude, could you specify what the unlocking would be next quarter, the third quarter, if the market were flat? And maybe if it were flat in the fourth quarter, what would the unlocking be?

Secondly, with this acceleration of cost saves in the first half of the year, how many people have been laid off in the insurance area, and how is that affecting morale? And then thirdly and lastly, can you specify your excess capital position? Thanks a lot.

Andrew, this is Eric. Let me take the DAC question. Yes, we would expect a further unlocking if current equity market conditions are unchanged over the balance of this year. And we have factored that into the earnings guidance we've given you.

Would $48 million be the run rate, Eric?

Oh, I'm not gonna quantify what it would be. But again, the key point is that whatever we think it would be is included in the guidance we've given you for earnings per share for the full year.

Andrew, let me come back to your question on head count, and then I'll have Mark talk about excess capital.

Our total head count on a year-over-year basis is down 12%, which, as you could well imagine, is a fairly sizeable number. A good percentage of that obviously comes out of our U.S. consumer group. That would include not only life insurance, but our securities and investment activities, as well. That's where the majority of the reductions have occurred.

I don't think you could ever say that reducing headcount does not cause people to be concerned, but I think there are a couple of things that I would high light that we try to look at here. First, the headcount is really in our head office activities. As was reported, this does not include sales personnel, so in the case of life insurance agents they're actually up. In the case of FAs in the securities business they're slightly down. So, the headcount reduction I've talked about really excludes our sales organization.

Second, it's the only meaningful way to insure you get the expense cuts. And thirdly, we target it. So, we look based on both profitability, margins, i.e. expense to revenue ratios, and those types of numbers to target where we would look to. We do not do simply across the board expenses.

Now, for people who are affected by it, obviously that doesn't changes their mind. But, importantly, what I communicate to the organization is that we have to do what we have to do to meet our profitability objectives, but we're not going to do it in a haphazard fashion or do it in a way that penalizes areas for which growth is appropriate. So, it does have an impact, but I think the results would indicate that we're managing through that impact, and we will continue to manage through those types of impacts. Let me have Mark talk about capital.

There have been no material changes in our capital position, as we anticipated it would unfold. The two key points there are the availability of in the neighborhoods of $2 billion in cash at the holding company level and our expectation that we can free up over the next 18 months or so about $3 billion from the insurance company.

Thank you.

Did you have any follow-up?

No. Thank you very much.

Thank you, sir. Next we'll go to the line of Ed [Spehar] with Merrill Lynch. Please go ahead.

Good morning. I have a couple of questions. I guess to follow up on the capital question, going back to the rating agencies, and obviously the rating agencies have gotten more concerned about the impact of the equity market on the life insurers, the impact of credit losses on life insurers. I appreciate the excess capital that you have, but it would just seem that there's been some change in the way rating agencies are viewing the industry. Have you any indication at all that this is going to impact how much of that capital? When you say $2 billion at the holding company, free up $3 billion from the insurance company, how much of that could actually come back to shareholders over the next couple years?

And then, the second question relates to the group life business. We've heard a number of companies this quarter talking again about how competitive the large case group life market is. And when we look at the fact that you've renewed, or went through your rate action on 30% of the book, yet your persistency is still 96%, that's sort of in contrast with the type of persistency levels we see for companies when they really go for rate aggressively, which is usually dropping down into the low 80s. So, I was wondering if you could comment a little more on that? Thank you.

I'll take the group life first. As you recall, we've talked about repricing the entire book. And we've repriced about 30%, I think you're right, and 50% by the end of the year. But what we did on the repricing was target the repricing. When we did our analysis on the problems that we had a year ago, we found more problems in the mid and small cases than we did in the large cases. And so, while there was some price increase in the large cases, it was on the average quite modest.

And so, I believe that it is fair to say that in the large case market our pricing changes would not have substantially impacted our competitive position. I think the average increase there was about 2%. So, I think that's what explains the high persistency ratio, which of course is measured against premium.

Where we saw the changes was a lot more in the mid and small cases, which wouldn't affect your overall persistency, since persistency is based on premium. I think that explains why, as opposed to that we somehow are dramatically dropping prices in the large case in order to keep the high percentage or the high persistency; that is not what has happened.

Let me just add one small note to Art's comment. If you look in the QFS at year-over-year or year-to-date sales in this business, even if you exclude a single $100 million case from last year, our group life sales are down 14% year-over-year.

Those, I think, would be indicative of the discipline that we've tried to apply to this particular market.

In terms of rating agencies and excess capital, as I mentioned to you, our rating is stable. And so, I don't think there are any particular concerns that we've had. As you recall, we've also mentioned in the past that we do have the opportunity for reinsurance as it relates to the $3 billion or so in capital that we have potentially available from the insurance company. So, in some ways we would clearly like to free that up without doing it. In other cases, we can exercise reinsurance to free it up.

So, that's why we express such a high level of confidence that we will be able to free up the capital that we have talked about, the combination of those two reasons. Mark, do you want to add anything?

Yeah. Just on the more general point, certainly the rating agencies are more sensitive to the impact of equity markets and also recent credit experience than they have been. In our specific case, though, it's really in terms of our case with the rating agencies a packaged deal reflecting our financial strength, our operating performance and momentum in the core businesses. And things like growth in the agent count and the improvement that we're seeing in sales will be very positive signals with respect to the rating agencies' perception of Prudential, not just a snapshot of balance sheet strength.

So, I would reiterate what Art said. We have options, reinsuring the closed block, for example, could free up about 2 billion of the capital that we mentioned at a very low cost. But there are other things going on, including our ability to deliver on our plan, as well as the core business initiatives that currently for us are on track.

Just one quick follow-up. I want to make sure that I understand. When we talk about freed-up capital, my perception of that means capital that you could give back to owners, use for acquisitions, whatever, you know, today, or at least over the next 18 months. So, that $5 billion is what you're saying out of the $19 billion that you could give back over the next 18 months if you so chose?

That's what's available to us, yeah. The way we look at it is we do a rigorous analysis of what our businesses need today, what our businesses will need in the future. We then look at what would be required to insure that we meet our ratings objectives. And so, yeah, that is the arithmetic on the numbers that we would look at relative to applying that capital to growth in our business, as well as if we chose acquisitions. But there again, I've mentioned many times the discipline that we will exercise around acquisitions in terms of insuring we meet our return on equity objectives and clearly stock buyback.

The last option generally available for that is paying down debt, and obviously we don't have a great deal of debt relative to that. So, the issue that we have is a combination of how much can we hopefully get our businesses to use to grow, what kind of residual cushion that we would always wants at the corporate level for contingencies and other related matters, and then use it the manner that you said. So, I'm not uncomfortable with the range of numbers and the methods for redeploying it.

Thank you very much.

Thank you, Mr. Spehar. Ladies and gentlemen, once again, if there are additional questions or comments, we ask that you just press the 1 on your touch-tone phone. Next let's go to [Sanith Kamoff] with Sanford, Bernstein.

Yeah, I just have a question, again, on the x-capital position. First of all, in past conference calls you talked about some legacy assets, I guess, in the corporate segment that you were hoping to sell which might free up some capital. I was wondering if you could talk about the timing of that? And just in terms of the $2 billion supporting the closed block, I just want to make sure that there wasn't a change in the timing of that. I thought in the past you mentioned 12 months, and I think earlier in the call you mentioned 18 months. So, I just want to make sure that there's not a timing difference there.

And then just on the reinsurance, I mean, if it is low cost, I guess my question would be why not just do it rather than wait 18 months or so to see if you can free up the $2 billion supporting the closed block? Thanks.

This is Mark. I misspoke on the 18 months. I was saying it the same way I would have said it six months ago. So, 12 months is the right answer. I'm not always good with small numbers. So, 12 months is the right answer on that.

We have a full-blown reinsurance project in the works, and we will be ready to execute that as we get into the fourth quarter and the first quarter of next year. As you might imagine, this is a very substantial reinsurance transaction that includes an enormous amount of administrative work. But we're not sitting on our hands. We will be ready to pull that trigger if we decide to sometime probably over the next six months. So, we'll be at least positioned to assess that option on a more current basis between now and early in the year next year.

What was the other part of your question? Oh, legacy assets. We continue to plug away. We are working on structured transactions that free up capital. We are managing assets out of the corporate account and into the businesses where it's appropriate, and we have made progress with respect to freeing up about $300 million of capital so far. So, given the challenge of that, I think on this calendar that's a pretty good result.

Okay. Thank you.

And thank you very much. And our final question today comes from Eric Berg with Lehman Brothers. Please go ahead.

Thanks very much. Actually, two questions, one for Mark and one for Art. Mark, what might preclude, if anything, the reinsurance transaction? In other words, why is it not a certainty? And for Art, when the company was taken public, you articulated a vision for the company, especially, I believe, for the securities broker, as sort of the broker of choice for families seeking advice and choice and independence, I guess, most importantly. Now, I certainly would think that in this environment it's hard to evaluate the success of any initiative, but I would like to know, nonetheless, whether you could point to evidence in the market suggesting that this focus on advice and independence is allowing you to gain share? Thank you.

All right. I'll go first. We've said in the past that we would prefer to free up capital as a result of an agreement on the part of the regulators and the rating agencies that we didn't have to do anything other than calculate our required capital and look at what was there. We continue to believe that on an economic basis that is the correct approach. However, as we've also said, the cost of reinsurance is relatively low. There is a lot of administrative work. But it is an option that we will not hesitate to use if it turns out that that's something that we have to do to achieve our objectives.

It's a gray area. We would rather go down the clean path of not reinsuring, but it's also an option that's entirely feasible in terms of the impact on the company, and we won't hesitate to do it if it turns out to be appropriate.

I think on the question of Prudential Securities, Eric, certainly what we have done in terms of executing the strategy reinforces the notion of the independence of our research and the independence of our analysts who advise choice and the utilization of that research. We started that, I guess, at the end of 2000. And certainly in terms of a positioning and a recognition, that is open some early evidence that ours is a different strategy. And I would have to say prior to that it was very difficult for us to articulate a difference in Prudential Securities. So, I think the recognition in the market is substantially higher, and that would be one source of evidence.

The second source would be the maintaining of the productivity. If you look at our productivity numbers, which is in the QFS, they remain quite substantial. And that's a very good indication. Third, the relative percentage on the fee side and the like is holding. But all of those I would agree with, I think, which is the message is that it's too soon for me to declare victory. This is a very, very difficult market, as I've mentioned in response to an earlier question. It isn't just the level of the market, whether it's the S&P 500 or the Dow. It's the level of activity. And as you well know, share volumes on the stock exchange are not indicative of who are the participants. There's certainly a fair amount of activity every other day or so in the institutional markets. But on the retail side it is dead.

And so, I think the indicators are the ones that I've mentioned. I feel comfortable that it is still something we will achieve, but I don't have more than that to demonstrate it. And in some ways it's why I talked about the time frame for evaluating this, certainly not anticipating this market, but recognizing we're going to have to evaluate it over a variety of cycles; not react to either a boom market or whatever market is today, a low-end market. And we will continue to look at it very hard. And I need to answer those questions for myself, and certainly I'll answer them for you as I get greater confidence.

Thank you, Art.

Mr. Ryan and our host panel, we have no further questions. Please continue.

I don't have anything to continue with. Go ahead. Do you want to close it, Eric?

I think at this point we'll just thank you very much for being with us today, and we'll look forward to being with you again in three months.

Thank you.

Ladies and gentlemen, your host is making today's conference available for digitized replay for 15 days starting at 4:15 P.M. Eastern Daylight Time, August the 7th, through 11:59 P.M. August the 22nd. You may access AT&T's executive replay service by dialed 1-800-475-6701. At the voice prompt enter today's conference ID of 642874. International participants, you may access the replace by dialing 320-365-3844, again with the conference ID of 642874. And that does conclude our earnings call for this quarter. Thank you investment for your participation as well as for using AT&T's executive teleconference service. You may now disconnect.