保德信金融集團 (PRU) 2002 Q3 法說會逐字稿

Good morning, welcome to the Prudential Financial third quarter 2002 earnings conference call. Now at this point, all phone lines are muted or in a listen only mode. However, after the executive panel's discussion today, there will be opportunities for questions and the instructions will be given at that time.

Should you require assistance during your conference, you may reach an AT&T operator by pressing 0 then star on your phone keypad. As a reminder, today's call is being recorded, Wednesday, the 6th November, 2002 for replay purposes, With that being said, here now with our opening remarks is Prudential Financial's Director of Investor Relations, Mr. Eric Durant. Please go ahead, sir.

Thank you, Brad. Good morning, we want to greet participants from the [INAUDIBLE], as a principle of conference calls and any other calls that may have preceded ours this morning. We applaud your stamina, and we welcome you to Prudential's call. In a moment, Arthur Ryan and Mark Grier will give their presentations followed by a Q&A. Also here today are Richard Carbone and Buddy Fazzell. Now, a commercial message. In order to help you understand Prudential and its results, we will make some forward-looking statements.

It's 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" of our earnings press release and our annual report on form 10-K for the year ended December 31, 2001. Now, I give way to you, Art.

Good morning and thank you for joining us today. I apologize for the delay in the start, but there was a -- a large demand to join this conference call, and so we wanted to make sure that as many people as possible got on the call before we started. Mark will be giving you a full review of third quarter results, so I'm going to limit my comments to a few of the headlines.

In this environment, I think it's fair to say that having a diversified source of earnings, effective management of expenses and strong capital is indeed a plus for our company and for others in that position as well. Domestic markets, um, continue to be weak, our international business, however, has helped to mitigate the effects of the weak security markets for those domestic businesses. On the expense front, we have made significant progress. We have already achieved savings of nearly $300 million through the first nine months of the year, exceeding our full year goal of $250 million.

In the third quarter, we reduced expenses by 92 million in comparison to third quarter 2001. Importantly, we will continue to tighten our belts, we have begun work on an additional 300 million of cost savings for 2003 and 2004, and we hope to achieve more than half that amount in 2003.

As for our balance sheet and capital position, we believe they're in a superior position. At September 30th, our parent company held about $2 billion of cash, which is readily available to us. In addition, we have roughly $3 billion of unused borrowing capacity. These numbers, however, shouldn't be added. The parent company has had some cash needs, and, of course, we'll always want to keep some dry powder, but I do want to leave with you the thought that we have on hand, and have ready access to, substantial amounts of cash.

Over and above that, we have the reasonable expectations of cash flow in the form of dividends from our subsidiaries. When we demutualized, we substacked our subsidiaries, so Prudential Insurance is one of many subs that is a potential source of cash for the parent company. All in all, we consider it reasonable to conclude on the basis of cash now on hand, unused borrowing capacity, and expected parent company cash flow from subsidiaries, that Prudential Financial would have the ability to repurchase $1 billion a year in common stock for the next three years, should the company elect to do so.

We believe that a program of this size would be sustainable, even if no cash in the form of so-called excess capital were made available to the parent company or from the insurance company. On that subject, our views are substantially unchanged. We continue to believe that Prudential has, in addition, over $2 billion more capital within the domestic insurance company, than it needs to support the risks in its business.

I am sensitive, however, to concerns of regulators and rating agencies in terms of their view of the life insurance industry in general. That's why Prudential's balance sheet and superior capital position are especially important sources of strength today. While we continue to believe that we'll be able to redeploy some of the capital now invested in our domestic life company, we don't need to do that now in order to achieve the goals I just stated. On a related subject, I will take this opportunity to update you on share repurchases. During the third quarter, the company repurchased 14.6 million shares of common stock at a total cost of $444 million.

Since launching share repurchases in May, we have repurchased 17.8 million shares of common stock at a total cost of $550 million. Approximately 10% of the shares repurchased were reissued directly to certain company-deferred compensation plans. Our commission-free program for shareholders with fewer than 100 shares began on August 8th and will end on November 25th. Under this program, odd lot shareholders can round up to 100 shares or sell their holdings without incurring a commission.

They may, of course, also do nothing. More than 4 million shareholders holding roughly 30% of our shares are eligible for this program. The communications guidelines agreed upon with the regulators preclude me from discussing the program activity; however, similar programs on have attracted participation rates in the range of 15 to 20% or more. Finally, on our earnings guidance for this year, last year we conditioned our earnings expectation on the assumption that equity market conditions would stabilize over the balance of the year, including no change in the S&P 500 index.

Obviously the S&P declined from our last update through the end of the third quarter. Although the market has recovered somewhat since then, we're still feeling the effects of the last quarter's decline. We expect our common stock earnings per share for 2002 will be approximately $2.10 a share, based on adjusted operating income, which is within our previously stated range of 2.10 to 2.30. Again, I assume no significant change in the market conditions from about where we are at this point in time. We do hope that many of you will be able to join us for our Investor Day on December 4th.

At that time, we plan to update you on our longer-term goals for return on equity and importantly, to discuss our expectations for 2003 earnings. Again, I thank you very much for being with us, and I'm going to turn over to Mark, who is going to give you more details on the earning this is quarter.

Thank you, Art. Good morning, everyone. Welcome to the call and thanks for your interest in Prudential Financial. I'll start with an overview of the third quarter results for our financial services businesses. In the third quarter, our adjusted operating income amounted to 54 cents per share of common stock, compared to 18 cents per share in the years ago quarter.

Adjusted operating income is before realized investment gains and losses, before results from discontinued operations and domestic businesses, and before demutualization expenses incurred in the years ago quarter. Pretax adjusted operating income for our financial services businesses was $427 million for the third quarter of 2002, an increase of $167 million or 64% from $260 million in the years ago quarter.

We decreased the tax rate applied to adjusted operating income in the current quarter, and had increased that tax rate in the year-ago quarter, which was our last full quarter as a mutual life insurance company. These changes contributed about 4 cents per share to current quarter results, and about 15 cents per share to the year-over-year comparison. In August, we announced that we were realigning our management structure during the third quarter, reducing our operating divisions from 4 to 3. We have aligned our segment reporting with the new structure, and in October, we provided a financial supplement presenting our historical results under the new structure. We're now reporting segment results based on our three divisions -- insurance, investment, and international insurance and investments -- as well as corporate and other operations. Let me go through these divisions now.

The insurance division had adjusted operating income of $76 million in the third quarter, compared to $82 million in the year-ago quarter. The individual life and annuities segments had adjusted operating income of $46 million for the quarter, down $38 million from the year-ago quarter. This decrease is the net of a $39 million increase in earnings from our individual life insurance business, and a $77 million decrease from individual annuities; which was largely the result of a DAK unlocking in the third quarter. The individual life insurance business had adjusted operating income of $115 million for the quarter. Compared to $76 million in the year-ago quarter.

The year-ago quarter included $32 million of losses related to the September 11th terrorist attacks. Absent those losses, results were up $7 million year over year. We benefited in the current quarter from a lower level of expenses, increased investment income, and continued favorable mortality. However, these positives were largely offset by higher DAK amortization, driven by an uptick in variable life insurance policy lapses that resulted from the prolonged equity market downturn.

Sales of life insurance based on first year premiums, were $89 million in the third quarter versus $179 million in the year-ago quarter, which included a single $100 million COLEY sale. Excluding COLEY, sales were $68 million in the current quarter compared to $62 million in the year-ago quarter. The universal life products we introduced last November and our current products, which we repriced late last year and updated this September, continue to be well-received in the market.

Our universal life products contributed $16 million to this quarter's sales,and term sales totalling $17 million registered a 55% increase over the year-ago quarter. However, our variable life sales continue to be negatively effected by equity market conditions, dampening the overall sales increase. Our Prudential agent count was just under 4,500 at the end of the third quarter. Reflecting some attrition of lower-producing agents during the quarter, but representing an increase over year end 2001, providing further confidence our captive agent force has stabilized after many years of decline. Third quarter productivity was $36,000, well above the level of last year's third quarter, excuse me, and above the level of the full year 2001.

Our third party sales other than COLEY are up $9 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 1/4 of our total non-COLEY sales this quarter. Our individual annuity business reported a loss on an adjusted operating base, operating income basis, of $69 million in the third quarter. This loss reflects an $89 million charge for additional amortization of deferred policy acquisition costs on our annuity business. Adjusted operating income was $8 million in the year-ago quarter, which included a $27 million DAK charge. The $89 million DAK charge in the current quarter reflects our lower estimate of profitability of the annuity book of business due to equity market conditions.

We used a reversion to mean method to evaluate DAK, which has not changed since we described it last quarter. Our long-term assumptions have also not changed. We assume an 8% rate of return for the overall mix of separate account assets underlying on the individual annuity business, and 8.85% for equities. Given a starting point of the September 30th market level, our assumed rate of return for the average remaining life of the book of business, about eight years, is approximately 10% for the overall mix of assets underlying the annuity contracts. This reflects an assumed annual rate of returns of 11 1/2% for equities over that period.

The group insurance segment reported adjusted operating income of $30 million in the current quarter, compared to a loss on an adjusted operating income basis of $7 million in the year-ago quarter. Which reflected a charge of $24 million for an increase in our estimate of incurred but unreported claims. Stripping out the $24 million charge in the year-ago quarter, adjusted operating income increased $13 million. Current quarter results benefited by $19 million from refinements in our estimates of disability claim reserves, but this benefit was partially off set by unfavorable disability claims experience in the early part of the quarter.

Results from group life insurance were sufficiently unchanged from the year ago quarter. At the beginning this year, we began to review pricing and implement rate increases where appropriate, on our group life business. We expect that this process will cover about half of our business in force by the end of this year, and nearly all of the remainder during the following year. Our ability to increase rates on existing business and to sell new business at rates we believe would offer attractive returns has been limited by a highly competitive market. As a result of the competitive conditions we've encountered, our rate increases are being implemented on a selective basis. This strategy has allowed us to retain profitable business, and our life persistency for the first nine months of the year stood at over 95%. The cases we have lost had an average benefit ratio in excess of 100%.

We continue to believe that our repricing and pricing discipline in writing new business will allow us to achieve gradual improvement in our loss ratios. The property and casualty insurance segment had a break-even result on an adjusted operating basis in the third quarter, compared to adjusted-operating income of $5 million in the year-ago quarter. We benefited in the current quarter from expense savings we realized and more favorable catastrophe experience than the year-ago quarter, but these positives were offset by less favorable prior year reserve developments and continued adverse experience, including that from business written through several alternative channels that we curtailed last year. We are continuing to reunderwrite increased rates, cancel and nonrenew the unprofitable business as permitted contractually, and by regulation. Bur this business will continue to effect our results as it runs off.

The investment division reported adjusted operating income of $50 million in the third quarter, compared to a loss on an adjusted operating income basis of $1 million in the year ago quarter. The investment management segment had adjusted operating income of $29 million in the current quarter, down 12 million from a year ago. The decrease in the segments earnings came primarily from market value declines and the equity assets we manage. The resulting decline in our asset-based fees was partially offset by lower-expense levels. The financial advisory segment, which is primarily our domestic securities business, had a loss of $16 million for the quarter, compared to a $48 million loss in the year-ago quarter.

The reduction in the segments loss came from the savings we realized from our cost reduction measures, lower expenses and improved results from our institutional equity business more than offset the further decline in margin loan balances and asset values that resulted in decreased net interest revenues and asset-based fees. The retirement segment reported adjusted operating income of $24 million in the current quarter compared to a loss on an adjusted operating basis of $4 million in the year-ago quarter. Last year's third quarter included a $29 million charge for an increase in our estimate of policy liabilities relating to prior periods.

Absent that charge, results for the current quarter were about equal to the year-ago quarter. The other asset management segment had adjusted operating income of $13 million in the current quarter. Up slightly from $10 million a year ago. The international insurance and investment division had adjusted operating income of $180 million in the third quarter. Unchanged from the year-ago quarter. The international insurance segment reported adjusted operating income of $186 million for the current quarter, compared to $202 million a year ago.

The segments results included adjusted operating income of $102 million from Gibraltar Life in the current quarter, and $126 million from Gibraltar Life's last year's third quarter. Last year's third quarter in Gibraltar Life benefited from $50 million of surrendered gains. The surrendered gains resulted from what we refer to as shock lapses during the initial period after Gibraltar Life's restructuring concurrent with our acquisition of Gibralter in April 2001.

Stripping out the surrender gains from the year-ago quarter, Gibraltar's Life's current quarter adjusted operating income of $102 million represents a $26 million increase, reflecting a more favorable level of policy benefits and expenses now that we have emerge period from the initial period after the restructuring and completed the integration of the acquisition. Results also benefited from a $9 million reduction this quarter in Gibralter Life's estimated liability for the Japanese Guaranteed Fund. Adjusted operating income from our international insurance operations other than Gibraltar Life increased by $8 million from the year ago third quarter, which included a $5 million charge to true up the guaranteed fund liability. The continued strong results from business growth in Japan and Korea were partly offset by a negative impact of about $8 million from currency exchange rates.

Excluding the impact of the guaranteed fund true-up in last year's quarter, and excluding the effective currency fluctuations, these international insurance operations would have registered a 14% increase in adjusted operating income. On a constant dollar basis, new annualized premiums from sales in Japan were $140 million in the current quarter. This compares to $121 million in the year-ago quarter. The 16% increase came from growth in sales in Gibralter Life. Sales in Japan from our Prudential of Japan life planner sales force was $78 million in the current quarter, about equal to the year-ago quarter, which benefited significantly from policies that were purchased in anticipation of a rate increase. Sales from other countries contributed new annualized premiums of $43 million in the current quarter, down from $51 million in the year-ago quarter, which also benefited from business sold in anticipation of a rate increase. Our life planner force stood at about 4,350 life planners at the end of the third quarter, up about 9% from 4,000 a year earlier.

This is in addition to 5, 200 Gibraltar life advisers, down from 6,100 at year end, reflecting actions that we've taken to make this distribution force more cost-effective. The international securities and investment segment reported losses of $6 million in the current quarter, and $22 million in the year-ago quarter. Key factors influencing this business are similar to those in the domestic securities operation. The reduction in the loss came from earnings from recently-acquired asset gathering and management businesses and actions we have taken to reduce the segments cost structure.

Corporate and other operations resulted in adjusted operating income of $121 million in the third quarter. This compares to a loss on an adjusted operating income basis of $1 million in the year-ago quarter, which included losses of $46 million from hedging that we retained at the corporate level. 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 date of demutualization.

This investment income and a $22 million increase in adjusted operating income from our real estate and relocation business were the main drivers of the remaining increase. Corporate and other results for the current quarter include income of $126 million from our own qualified pension plan. About $10 million less than the contribution to last year's third quarter. We are now finalizing our pension calculations for 2003, and we plan to reduce the expected rate of return on plan assets from 9.5% to 8.75%, and the discount rate from 7.25% to 6.5%.

Giving effect to the new assumptions, we expect the income from our own qualified pension plan on a pretax basis will be about $120 million to $140 million less in 2003 than its contribution to results in 2002. Realized investment losses for the financial services business, net of related adjustments, amounted to $142 million in the current quarter compared to $322 million in the last year's third quarter. The realized losses in the third quarter included losses of $308 million from impairment and sales of credit impaired securities, a broader definition than just impairments.

These losses were partially off set by realized gains from fixed maturities, including private bond prepayments and equity securities. Not investment grade fixed maturities compromised about 7 1/2% of the financial services business, fixed maturity portfolio at September 30, 2002, down from about 8% at the end of last year.

Turning to 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 $142 million loss from operations before income taxes for the third quarter of 2002, compared to a loss of $354 million for the year-ago quarter. We measure results for the close-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 product segment. The loss for last year's third quarter included a charge of $160 million to establish reserves for policies where we have received a death claim -- where we have not received a death claim but where death has occurred. This followed our substantial to locate policyholders in connection with our demutualization. The decrease in the loss also reflected a reduction in realized investment losses of the closed-block business, offset by lower investment income.

Before I leave the financials, let me comment on one additional item. We're sometimes asked about statutory results, which apply only to the insurance company. Year to date, the statutory gain from operations after-tax in the insurance company is $720 million. And net income in the insurance company, on a statutory basis was approximately $50 million. Thank you for your interest in Prudential, and we look forward to hearing your questions.

Indeed, thank you, sir. Ladies and gentlemen, as you just heard, if you do have questions or comments, we ask that you would queue up at this time by pressing the one on your phone keypad. You will hear a tone indicating you have been placed in queue, and just as a note, you may remove yourself by pressing the pound key. Once again, to queue up for a question, just press the one on your touch-tone phone. And representing Goldman Sachs, our first question comes from the line of Joan Zeith. Please go ahead.

Good morning, um, I have a few questions. The first is on the buyback, you had a large, um, buyback program in the third quarter, um, and I guess my question is: Do you -- are you going return in the fourth quarter to your billion dollar a year run rate around $250 million or are you looking at the third quarter and saying, well, I have already done a huge amount so I don't really have to do as much in the fourth quarter. So that's my first question. Um, my second question relates to, um, Pru Securities and the property casualty company, um, the change in, um, ratings and -- or outlook for those. The downward change by, um, the rating agency. Do you think that has any implication to the businesses to your ability to, um, divest the property casualty company, and I guess I wanted to know if there was any update you could give us on the timing of, um, what's going on with the property casualty.

And then my third and final question is, Art, are you going to be able to review with us now the return on equity targets and, um, are you still feeling comfortable with the targets that had been out there of 12% sometime in 2005?

I think that was more than three, Joan. [ Laughter ] Let me try in sequence, um, the buyback program, um, that I spoke of during my opening remarks of approximately 1 billion per year over the next three years, will not be effected by anything that happened in the third quarter, so, yes, that program will continue as I have stated it and hopefully restated it this morning.

Second, on the property and casualty business, the downgrade is not surprising, um, given the announcements that had been made relative to the, um, the fact that we were looking at strategic alternatives. I think more importantly in the announcement was the positive outlook that was given to Prudential Financial and the insurance company, um, but that was not part of your question. In the case of property and casualties as I reported, we have requested expressions of interest, um, we are reviewing, um, all of the various responses.

I still hope to be able to make a final decision by the end of the year, um, but I have no additional information for you at this point in time. On Prudential Securities, I think the whole issue of retail brokerage has obviously been affected throughout the market. I think that earnings, if you look at everyone in the retail brokerage business, not simply ourselves, um, are not where anyone would like them to be, um, and so I think the comment on PRU Securities is nothing specific to Prudential Securities but more related to this day of affairs and the entire retail investor or retail broker business.

In addition on Prudential Securities, um, importantly a couple of points, I guess around both the strategy and where we are, um, changing the strategy, which we did a little over two years ago to separate the issue aside from the investor side. I think has proved to be a very wise decision. Second, if I look at the numbers that we have produced, um, I would have to say we're pretty well on track, X the bottom line, um, now that's not to make an excuse for that. I understand what has to be produced, but if you look at the productivity numbers, if you look at the expense numbers, um if you look at our relative share, um, we're moving along the game plan that we had set about, um, right in line with what we had said.

The market obviously has been very poor, um, not only of the level of the market but the volume in the market as you well know, um, the retail business is affected by both activities at the level of the various indices, but importantly, the activity levels of retail clients. Those activities have been relatively nonexistent, um, through most of this year and so what I'm looking for is continued improvement internally, um, clearly a modest market improvement would help substantially, and as I said earlier this year, that I expected it would be about a two year time frame for us to make a decision to ensure that the strategy we have chosen, which not only do we like, but obviously others think it's a good strategy as well, can deliver the financial performance that both the marketplace and I expect from it, um, and I will continue to drive against that objective.

Jane, this is Mark. Let me make one more additional comment on the rating side and turn it back to Art to answer your last question about the 12% ROE. We're now in a destacked environment. As you know, when we demutualize, we move the subsidiaries -- so you're talking about right now -- out from under the life insurance companies as subsidiaries of the holding company. It should be no surprise that there may be a little more disposition in ratings as a result of the financial configuration, but it's no reflection on the fundamental financial strength of the company and we're very encouraged by the positive outlook for the life insurance company.

So, you do need to to partly interpret these things in light of the complete financial reorganization of the company last year.

My, um in, terms of the last point, Joan, my ROE objectives have not changed, and I'll be able to give a little more you in line when we talk about 2003 guidance on December 4th, um, a more complete update on exactly where we are, but it's not fundamentally different than what I have been talking about, relative to the overall performance of the businesses, and the underperformance in a number of our businesses. I don't think you should expect any surprises out of it, but I will be able to give you more details on December 3rd when I talk about 2003 -- excuse me, December 4th, when I talk about 2003 guidance.

Thank you very much.

Did I get them all?

Yes, you did.

Thank you.

Thank you, next we go to the line of Vanessa Wilson with Deutsche Bank. Please go ahead.

Thank you, and, Art, I understand you want us to wait a little bit for the full 2003 picture.

Right.

For your meeting, but you have given us a few pieces on this call, and I want to make sure that I have the pieces together correctly. You have given us 120 to 140 million dollar negative swing in the pension, but then you have given us some offset with about half here, new 300 million cost savings in the same time horizon and you have layered on an additional billion dollars of buyback.

That's correct.

Are there anymore, um, you know, sort of big pieces that we should think about, and you have also given us the option expense, which is tiny, but anything else, I mean to the extent you -- you sell a business or, um, you know, think about something else strategic. Is there anything else we should think about before your December meeting?

The reason we have talked about them are all because they happen to be in the public demand and have been disclosed. There has been a lot of discussion on the pension. I could have waited until December 4th to do it, but there has been a lot of questions, so I felt it would be more timely to, um, disclose it at this point in time. The expense saves, um, are consistent with what I said in the last quarter call, um, that we had talked about a $300 million expense save in '03 and '04, and I expect more than half of it to occur in '03, so that is also consistent, um, so I don't think the buyback we have talked about, I don't think there are any others.

I was really just trying here to, um, focus on those things where there have been questions, there have been, um, comments made in the marketplace, and I wanted to clarify them for everyone, um, and I will put the whole package together, as I mentioned in answer to Jane's question, on December 4th. But I think you captured most of what we talked about.

Thank you, Art. And just one final thing; the um, billion dollar share repurchase annually, do you need to sell any businesses in order to fund that share repurchase?

No.

Okay, so anything would be over and above that?

Yes.

Thank you very much.

And thank you, Ms.Wilson. Representing Solomon Smith Barney next in queue is Collin Devine. Please go ahead.

Good morning, gentlemen. A couple of questions. First, on the private client group, it's my understanding that the fees they earn are calculated at the beginning of the quarter balances. In a sense, the economic performance of that unit in the third quarter really sort of lagged where the run rates usually are going forward. Maybe Mark can give us just some sort of guidance or thought on the what the real impact of that is to start, um, --

Let me just start by answering the first part of the question, you're absolutely correct, um, in the sense where of the balances are calculated. You should obviously -- you obviously know that, um, volumes in the business probably have an even greater impact, um, than the asset balances in that particular business, not true in obviously in asset management, so if you take the June 30 number versus the September 30 number, you would see a rough, um, impact, if you will, in terms of the decline, and I think on September 30, the S&P was -- . 815. But I'll let Mark answer that. Go ahead.

Well, getting at, first of all the general question of equity market sensitivity, which I think is what you're driving at, um, I commented on -- let me talk a little bit about individual life. I want to clarify one thing there -- I commented on lapses on variable life. These are variable life policies that convert to term because of the level of balances held in the accounts, which is impacted by the market.

There is potential for those policies, um, for those policyholders to fund those policies and go back to the variable life product status, which would obviously be favorable for us, but there is some impact on this quarter, and we anticipate a lag effect flowing through in future quarters of those kinds of lapses. With respect to PSI in particular, the order of magnitude of market sensitivity that we're looking at between the third quarter and the fourth quarter is $20 million.

Okay. Um, okay, then could -- on the issue of GMVBs, could you tell us what your stat reserve is and if you have yet to establish a GAAP reserve for that exposure?

Collin, this is Buddy Fazzell. On a stat basis which would, um, exclude the state of Connecticut higher reserve level, is roughly $150 million at the end of the third quarter.

And on a GAAP?

On a GAAP basis, we're not carrying GMBD reserves specifically, but when we calculate our future gross margins for DAK purposes, we include the impact of, um, guaranteed minimum death benefits in the margins.

Uh-huh.

And that depressed the margins by roughly $200 million. So the DAK takes that into consideration, um, based on the [INAUDIBLE] applied to the $200 million.

Okay, if the SOT that is out there now is applied today, what would be the impact, um, economic -- the accounting impact on you as it stands right now. Would you just offset that with a DAK negative unlocking or what would happen?

It would largely -- it would not be the full amount. The number I gave, the $200 million, which is the present value of what is in the margins, that would be about the extent of the reserve, and then the it would be reduced by the amount we have already contemplated within the DAK. So the adjusted would be 30, 40% of that.

So it would be 30 to 40% of 200 million or 150?

200.

Okay, so as it stands today, we should be expecting a 60 to $80 million nonrecurring charge some, at some point over the next, what, 12 to 15 months assuming that standards -- [INAUDIBLE]

That would assume the equity level, the equity markets maintain where they are today. If they improve, that number goes down dramatically.

Okay, um, then if we could turn, Art, to PSI, just sort of -- on Prudential Security -- there is -- they're still struggling. It's my understanding it includes the amortization of about 150 million of forgivable broker loans. Perhaps you could tell us where they are on a cash base terms of the progress we're looking for.

Um, I can get you that number, Collin, I don't have it in front of me. Your assumption on the loans is correct. That's included in the number, and it's a sizable number, um, I'm afraid I don't have that right in front of me, but why don't I get that for you.

Okay, and if you could clarify it, it's my understanding that had about three years to run, and I'm not sure if that's three years from this year or if this year counts as one of the three, but obviously that would be a fairly sizable jump up in earnings.

Well, yeah, it's going to decrease each year going forward, and as most of these loans were bobbed back in what I will call the high points of the market, um, back in the '99, 2000, and parts of 2001 time frame, that is roughly the period, so, yeah, I think your assumption is correct. It's not an elimination. It's reduced, um, over time. It's actually a five year amortization period, but yes, we would be seeing a reduction in subsequent years as if they were a return of that pricing in the marketplace, which is not anticipated at this time.

Okay. Then the final question on share repurchase, we'll come back at this one more time, um, clearly you said at least a billion-dollars per year for the next three years. Is that a rolling year or a calendar year and specifically then, is, you know, is your initial objective of a billion dollars in 2002 still stand? Or is that really a billion-dollar sort of made in May?

Collin, we're contemplating that rip rate for the calendar years '03, '04, and '05. We started late this year. If you recall, we didn't begin our share repurchase program until May. We don't anticipate a billion dollars worth of share repurchases this year.

Okay, thank you very much, and congratulations on the outlook change from S&P. That was a big one, and obviously one you worked hard to get.

Thank you very much. One second, we want to clarify one other point. Back to the question on PSE, the balance sheet amount associated with the amortization of the expense you cited, $410 million at the end of September, that's down from 552 at the end of last year. So you can see have taken a good whack out of it. There is a long tale there but most would be amortized over the three-year period.

The point being on a cash basis they're making money today, is that correct?

Yes. That's correct. This is a noncash charge.

Yeah, okay, great, thank you.

And thank you, Mr. Divine.

Next in queue is Michele Giordano with JP Morgan. Please go ahead.

Good morning. I had a couple of questions on your group businesses. First on the group life, the persistency has held up quite well despite the price increases. I was hoping we could get more color there, and than as you worked your way through the entire book, where do you expect the persistency to go down to, and um, what kind of a benefits ratio do you think we we wind up with after working our way through the whole book?

Secondly, on the group disability business, I was hoping you could give us more color on, you know, the adverse claims development. How did that just happen for one month and then sort of turn around, you know, and what are you really attributing that to. Were there any kind of patterns in terms of, um, the types of claims that were filed or the occupation classes, or geographic or any other color you can give us on the group disability side. It seems so odd it would happen in one month.

Okay. All right, this is Mark. Let me start off with group life, and um, I'll try to give you some of the color that you're looking for. One of the reasons that persistency is as high as it is that our pattern of repricing has been skewed in favor of smaller policies. What that means is that we where there is a lot of weight, because the premiums are big and that persistency measure is based on premium, where there is a lot of weight because the premiums are big, we have not raced priced that much.

There is a scale of price increases ranging from the order of magnitude, let's say 2 or 3% up to 14 or 15%, the larger price increases are on smaller policies. So, if you peel that onion back a layer and look at the mix of business, one of the reasons that persistency looks so good is that we're doing better in the larger accounts, that are more profitable for us as well. So, there is more art to this than just an across-the-board price increase.

We have been careful about trying to call the unprofitable accounts and as I said, we have also been more aggressive on smaller accounts where there has been more of a challenge than on the larger accounts. The disability issue, our conclusion at this point is that it's just an aberration, as you know, insurance is in some respects a volatile business, and you get a draw from the distribution one way or another sometimes. We have no reason to believe that at this point, that's a harbinger of things to come. We really do believe that it was an aberration in a month.

Okay, just back on the group life, where would you expect the benefits ratio to even out at? Is it because they're smaller cases, is it going to move the benefits ratio down that much?

Well, we're trying to move our benefits ratio toward the 90 to 91% neighborhood. That's what we believe we need to achieve our target or concerns and we anticipate getting there.

Thank you.

Just one more thing on the disability claims, there are no indications of concentrations either by industry or geography in that July number.

Okay.

Thank you. Next we go to the line of Ed Spehar with Merrill Lynch. Please go ahead.

Good afternoon, I think. [ Laughter ] Um, I have a couple of questions on PRU Securities. Art, when you talk about, um, sort of the numbers being on target in -- in areas in that business, maybe, you know, the earnings haven't been there yet, but the numbers are on target, obviously we have all heard the rumors about the joint venture with Wachovia . I don't expect you to comment on that specifically.

But I was just wondering yesterday I said at that point given what you see with the progress of PRU Securities, you know, are you more likely to buy something that might give you the additional revenue that you think you need to get to scale, if you think that is important or sell the business? And I guess related, um, to PRU Securities, a couple of other questions, um, can you give us any sense of what portion of the total assets, um, in client accounts relate to accounts that are below $100,000 and also, on this issue of the um, the forgivable loans, when we talk about the amortization going away to what extent is there a risk that we have to worry about broker turnover increasing because once those, um, those loans are no longer, you know, on the books, obviously the -- some of these brokers are not tied up anymore, I think. Thanks.

Um, in terms of -- of the game plan, um, relative to Prudential Securities itself and around the question of scale, um, there's no question that a business like this benefits from scale, but I think more importantly is what the business is focused on doing. We did not opt to be, um, a smaller version of what everyone else did. And, therefore, we changed the strategy and obviously, um, others are adapting their strategy, but I think the focus around the investor for both the institutional and retail clients, um, can win for us. Scale is important and, um, but it would be something that I would look at much more after I have full comfort and I have been able to deliver the results that you would like to see and I expect to see. So, I am not anticipating adding significantly more capital to this business.

Um, nor am I anticipating doing anything other than what I really said I was going to do, which is to work at the folks at PSI, to deliver the performance that both of us want at this point in time, and I'll work from that point going forward. I don't have an answer to your question on the percentage of assets below, um, where the accounts below 100,000, but I can get it for you. I apologize. I don't have that in front of me yet. If you don't mind, I'll get back to you and we'll definitely put the information out as well. In terms of the amortization, I think one of the keys, um, for us is -- has been the creation of the master share retention program.

Which we put in place two years ago, um, which we think is a way that encourages, um, analysts to stay with us and basically is a matching investment program, um, for our producers, especially our very best producers, so not withstanding the amortization on the loans, we think over time, that is even a stronger program relative to retention. I guess it would not be dissimilar to programs I have seen in other broker dealers. It was, um, a limitation on our part as a mutual company, um, since we didn't have, um, our share of stock to offer in that type of program, which is why it's a relatively new program. We see the growth of that program right in line, um, with the, um, the amortization period, and so, now I don't think it increases the risk of turnover.

Thank you.

And thank you very much, sir. Next we go to the line of Andrew Klegerman with Bear Stearns & Company. Please go ahead.

Afternoon. One quick question on the tax rate. I see you got a nice true up going from I guess 36 1/2% to 34 1/2%. Perhaps you could share with us some of the background as to, um, I think this is the second time this year that you have reduced the tax rates, so perhaps you could give us some of the details behind, um, why it's gone down by such a significant amount, and you know on an even more positive note, is there the possibility that we could see the tax rate, um, be drilled down even a little lower.

I think this is only the first time. I don't think it's the second time, Andrew.

Andrew, what happened was, um, last year when we were giving guidance for this year, our initial guidance for the full year '02 tax rate --

you're right.

37 1/2%, brought that down to 36 1/2 in the first quarter.

You're right. Let me have Buddy answer your question why it's down where it is today.

Andrew, the decline from the 36.5 to the 34.5 is largely driven by an IRS interpretation on the dividends receive deductions for the equities we hold in separate accounts and we have been using a fairly conservative formula on the year-to-date dividend receive deduction, and with the product base that came from another competitor, we were able to pre-reduce our provision in the current quarter.

Any chance of, um, more of this type action coming down the road?

At this point, we're not predicting, you know, improved rates but when we get to the December meeting, we'll see if there is any different story we have for you.

Okay, thank you.

And thank you very much, sir, next we go to the line of JoAnn Smith with UBS Warburg. Please go ahead.

Good morning, just a couple of cleanup questions. One is on the corporate [INAUDIBLE]. You can kind of give us guidance in terms of what we should look for on a go-forward basis, um, you know, the numbers there look real high. Um, and then get back on the disability question.

I was wondering if you could give us more color in terms of what types of claims you're sewing, are they mental and nervous, anything related to 9/11 that can give us more detail as to why we should feel comfortable, that was a one-month aberration. Thank you.

JoAnn, it's Mark. I mentioned in my discussion of third quarter results the items that are impacting that positive number in corporate and other. Um, we don't give guidance beyond that.

The impact of corporate and other is reflected in the conversations we have had about earnings for this year, as well as the specific item as it relates to the pension plan next year.

Mark, is all the pension expense -- where -- how do you allocate the pension expense, and I guess just on the expense save for next year, where do you see the bulk of those, um, accruing to in terms of the division?

The pension earnings are carried in that corporate account. We don't allocate any of the pension earnings into the businesses. So, that is included in there.

Also, um, when we did the changes in some of our segments, the relocation and real estate business, is included in corporate and other. And that over time, we can talk about as well, and that represented, um, over $30 million of the earnings in corporate and other. Um, those would be the principle drivers that would be in there. As Mark said, um, we'll obviously give the guidance around all of our businesses as well as in the aggregate, but those are some of the explanations in -- in the corporate and other account at this point in time.

Yes, very good. Thank you. And then the 9/11-related claims.

Yeah. No. We did not see anything. We did, as I said, um, while I wouldn't describe our business as volatile, it will have changes month to month, and as best we can tell, the change in July has not repeated itself, um, and was due to, um, no particular discernible reason. Not anything related to 9/11, not related to nervous disorder, not related to a particular industry or geography. Um, and as I said on a month-to-month, those things will occur periodically. We don't see anything systemic at this point in time.

Thank you.

And thank you, Ms. Smith. Next we go to the line of Kaitlin Long with Credit Suisse First Boston. Please go ahead.

Good afternoon. A quick follow-up on PRU Securities, what portion of the sales, um, of Prudential insurance products are contributed by PRU Securities? I know that was one of the reasons why it was considered an integral business within the PRU family, and I'm just curious how much progress you have made in diversifying your distributions so that you don't have as much reliance on it.

In the case of the life insurance and annuities business, um, it's a relatively modest percentage and life insurance is quite small is and even annuities is relatively modest to our total steal sales. Historically, it has been a, um, significant distributor for mutual fund business. Um, as well as for our 401K business. Um, I would say significant there, probably represents um, a half to 2/3 of the volume.

Um, in the case of the managed accounts business, um, it's predominantly Prudential Securities. So it varies by-product. As you might expect, um, on the investment side that which is related to advised managed accounts, it would be a very, very high percentage.

Sure.

For mutual funds and the others, it has moved from what I will say being a hundred percent to closer to about half to 2/3, and I think that's in line with what has changed broadly in the market, um, where there is greater choice being offered through all distribution channels, as well as the advancement of outside or third party channels. So, I think they're -- those numbers probably are pretty in which line, um, with the objectives that we have set out over the past year in terms of what it should be. So.

Okay, that's helpful. Could I also just follow up. Last summer in some of your public appearances you said you were hoping if the markets remain steady, which, of course, they didn't, that you could make PRU Securities break even by the fourth quarter. Any desire to update that goal based on where the markets are right now? How quickly in '03 it might be breaking even?

Well, I obviously didn't deliver on that call, um, um, I think that as I mentioned earlier, if I look at expense saves, they're well ahead of target.

Sure.

If you look at other things, we're in good shape, but the market -- I would be disappointed if we're not profitable relatively early in '03 in Prudential Securities.

Okay, thank you.

Just a quick reminder when we had discussed these goals the S&P was at 1150.

Right.

We had anticipated in our thinking going forward the 2% of quarter increase in the market. Obviously now it's at 920 and that's after coming back up. So, it should be no surprise that we're struggling here that break-even objective was set in a market that has not come true.

Right. Right. Thank you.

And thank you, Ms. Long. Ladies and gentlemen, thank you very much for the strong interest being shown today with time now for two more questions. First we'll go to the line of Eric Berg with Lehman Brothers. Please go ahead.

Thank you very much.

Art or Mark, realizing and fully understanding that we're in a difficult market environment, I nonetheless like to you tell me what are the things that you're looking at or seeing that leaves you to conclude that the strategy in connection with choice and independence at Prudential Securities, above all, and elsewhere in the company is really having an impact. What statistics would you cite that we in the public domain can see? Thank you. And then I have a follow-up, a quick follow-up question regarding relocation.

I think the notion of choice is basically endemic and accepted everywhere in the marketplace.

If you look at anybody's offerings, whether it's a wrap product or an insurance product, would suggest that consumers are well educated in one choice, meaning you have to offer choice, um, whether you have proprietary distribution, um, or nonproprietary distribution. What leads me to confidence is, if you look at the aggregate growth in markets even as difficult as annuities have been, as difficult as mutual funds have been, um, given the state of the market, there is still relatively attractive markets, um, managed accounts in particular continues to be an attractive market, so if you take any of the statistics that we reported, um, if you take what we have in our numbers, you can see a growth in the annuity business.

You can see a growth where at least a, only a modest decline in some of the mutual fund and managed account sales, um, and these types of markets, that gives me enormous confidence. Obviously the fundamentals of people's need to save is right there, so I don't think they were talking about long-term market issues. I think we're talking about short-term issues related to level of markets and I think what we all understand to be a high level of uncertainty among people in uncertain markets, they don't do anything. I think the second thing I would look at is that SA productivity is up.

Let me.

Go right ahead.

The insurance agent product sift, and these are very difficult markets and it's not simply reductions at the lower end.

I do look at the productivity levels of all of our various [INAUDIBLE] and segments, and in general, um, the better performance continued to do well even in difficult markets, so I think you're also seeing a fairly significant sea change from where we were three or four years ago, where without trying to sound facetious, it was relatively straight forward and easy to make money. Today, you have to earn it. Mark.

Eric, let me comment on two more thing.

One is where there is an immediate tangible measurable event, we're gaining market share and moving up in the rankings in our institutional equity business where we have directly sold our unbiased research and objectivity. Secondly, there was a speculation when we made the change in strategy that we could not hold a research department together without investment banks.

If you have been reading the rankings coming out recently, we're not just holding together, we're moving up and, in fact, have achieved significant positive positions in some recent articles that came out on research, and we're very proud of how they're doing and not just the fact that they're holding together. So, while we struggle with the market and the impact on the numbers, um, there are some tangible, as well as qualitative indicators that we're doing the right things and we think we're well positioned in a strong market to do very well.

Great, that was on for the additional detail. My follow-up question is, you mentioned the relocation business quite apart from its being reported in sort of elsewhere from a geographic perspective than a year ago, reported much higher earnings than a year ago. I'm sort of puzzled because one would think with corporations, um, facing belt tightening, they would be relocating people less and would be using the services of relocation professionals less. What is going on in that business that would lead to a big jump in earnings? Thank you.

Mark, I'll answer the earnings question.

Your observation is correct. The reason for the change in the reporting, um, was if you recalled, we were doing retail versus institutional, based on a lot of feedback from folks like yourself and others. We went to the definition of insurance investment and international.

Um, and real estate and relocation doesn't fit easily into any of those, um, which is why it's the only businesses that we carry in corporate and other. And as I said in an earlier question, we will be more than happy to, um, talk about those earnings as well, but Mark, go ahead.

Eric, a couple of comments on the numbers. First of all, the third quarter is the strong quarter and, in fact, this business is very seasonal. Most of the moves are clustered in the third quarter. As I mentioned in my discussion, we had a $22 million increase year over year in this business, so seasonality can't account for all of it. We had an acquisition of City Capital and cut expenses materially in the business for the past 12 months.

The growth in the business through acquisition, the driver of expense cuts and, um, a strong seasonal quarter are the main factors behind that performance.

Your analysis on the fact that overall volume levels in the market are down is also correct. So it's the other factors of the acquisition, cutting expenses and the seasonality of it.

Thanks to both of you.

And thank you, Mr. Berg. And ladies and gentlemen, our final question is from Sanith Kamoff with Sanford Bernstein. Go ahead.

Thanks.

Two quick questions, one on the legacy assets of the corporate segment. Wondered if there was any progress there, what do you think of the $2.6 billion of equity. Is your one billion a-year share buyback, does that assume, that you sell those assets -- [ INAUDIBLE] 26.3 billion, and second, just, I don't mean to harp on the corporate segment, but looking at the sequential improvement, 45 -- sorry, 49 million to 121 million, presumably the last quarter, second quarter, had the touching credit, it also had the assets transferred from the proposed block, so I'm just wondering what caused a big pick up there.

Thanks.

Let me comment on the legacy assets. The disposition plans for the legacy assets are fully reflected in everything that we have said about, um, capital flexibility, and excess capital. We're on track to reduce the legacy asset portfolio as we had promised, um, I think we have probably mentioned before that its kind of tough sledding in some respects because of, um, liquidity issues, but we have made a significant impact this year.

Frankly, we sort of view that one as a rounding error relative to what we're doing overall, but we are on track to realize the results that we have promised you there, and as I said, it's fully reflected in everything we said about capital flexibility and share repurchases.

On the sequential quarter improvement and corporate other Sanith, the vast majority is attributal to two things, a smaller loss on hedging, amounting to $25 million, and the improvement in the real estate relocation business, reflecting more favorable seasonality in the third quarter, also had a $25 million. That's 50 out of the $76 million improvement, and the rest is lots of cats and dogs.

Okay, thanks.

And thank you very much, Mr. Karnoff.

We do not -- I don't know what the schedule is for additional questions at this point in time?

You have others queued up there?

Indeed, if you would like to take more questions, once again, ladies and gentlemen, just press the one on your touch-tone phone. Okay. And we are receiving word that we're out of time, gentlemen.

Well, who are you receiving that word from? Hello?

And once again, Ladies and gentlemen, just press the one on your touch-tone phone. And hold please for our next question.l

Thank you. Hello.

One moment, please, while participants queue up, sir. We're out of questions.

If we are out of questions, there is no reason to retain anybody.

One moment, please. Okay, we have no further questions.

Thank you very much. Okay. Thanks, everyone, for joining us. Thank you. Have a good day.

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