保德信金融集團 (PRU) 2003 Q3 法說會逐字稿

Ladies and Gentlemen, thank you for standing by, and welcome to the Prudential Financial Third Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. If you should have a question, please press star, then 1 on your touch-tone phone. You may remove yourself from queue at any time by pressing the pound key. If you are using a speakerphone pick up the handset before pressing the numbers. If you should require assistance during the call please press star, then 0. As a reminder this conference is being recorded. I would now like to turn the conference over to our host, Mr. Eric Durant.

Thank you, Marla. Good morning. Thank you for joining our call. Representing Prudential today are Art Ryan, Chairman and Chief Executive, Mark Grier, Vice Chairman of Financial Management, Rich Carbone, Chief Financial Officer, and Buddy Puzel, Controller.

In order to help you understand Prudential Financial we may make some forward-looking statements in the following presentation. It is possible that actual results may differ materially from the predictions we make today. Additional information regarding factors that could cause such a difference appear in the section titled Forward-looking Statements of our earnings press release for the third quarter of 2003 which can be found on our website at www.investor.prudential.com on the Investor Relations page. In addition, in managing our businesses we use a non-GAAP measure we call Adjusted Operating System to measure the performance of our financial services business. The comparable GAAP and the reconciliation between the two for the third quarter are set out in our earnings press release on our website. Additional historical information relating to the company's financial performance is also located on our website on our Investor Relations page. Now I'm pleased to introduce Art Ryan.

good morning and thank you for joining us today. I'm pleased to report that Prudential is making good progress. Mark will do the detailed review of third quarter results. So I'll start by talking about overall I'd characterize the results for the quarter and the year to date as meeting all of our expectations. As you're well aware, capital management is central to our plan to improve Prudential's return on equity.

Our acquisition of American Skandia and the transaction with Wachovia both contributed to improving results in our domestic business in the third quarter. American Skandia's results are included for the entire quarter. The acquisition closed on May 1st, and they already are fulfilling our expectations. Earnings are solid, sales on both a gross and net basis have increased significantly under Prudential's ownership. Integration is proceeding as planned, and we're confident that we will achieve our expense reduction objective with minimal disruption to the business.

The combination of our retail securities business with Wachovia closed July 1st. We expect to benefit from enhanced returns as integration proceeds and cost savings are realized. With these two transactions we strengthen two important domestic businesses while I believe using our capital more effectively.

Our international insurance business also continues to perform well. These businesses achieved 16% growth in adjusted operating income in the third quarter compared to the prior year. This includes the results of Gibraltar Life which Prudential acquired in 2001. Gibraltar has been a great financial transaction for Prudential. It has produced consistent 20% returns on our investment. But Gibraltar is also making strides as a business. This is evident in Gibraltar's strong sales performance. Annualized new business premium for the third quarter increased by 18% year-over-year on a constant-exchange-rate basis. Gibraltar now has sales productivity well above the norm for Japanese insurance companies.

In Prudential's home-grown international insurance business our productivity is already exceptional, sales advanced 19% year-over-year. We will continue to pursue acquisitions like Gibraltar and American Skandia that make business and financial sense. But we are equally committed to ensuring that the capital we've already invested in our businesses is earning appropriate returns.

Within the last week our sales of Prudential's nationwide and New Jersey property and casualty businesses closed. The property and casualty business did not earn an appropriate return for us, and these sales will free up about $1 billion in capital that we expect to redeploy to our shareholders' benefit.

Share repurchases are another device we've used to manage our capital. We believe that repurchases are an appropriate way to return excess capital to shareholders. In the third quarter we repurchased 7.1 million shares of common stock at a total cost of $261 million. We continue to believe that repurchase of roughly 250 million per quarter is a realistic base case for Prudential. We are also evaluating our dividend payout but I won't be able to share our thinking on this topic with you today.

A second theme we've stressed is expense management. As you know, we have a goal to reduce expenses by a total of $300 million in 2003 and 2004. We have already achieved more than 150 million in savings through September, and we are confident that we will reach our two-year goal. We plan to update you on our expense reduction objectives when we provide 2004 earnings guidance. We expect to do this at our investor meeting on December 4th.

Finally, I'll update our earnings guidance for 2003. We are increasing our range for common stock EPS from $2.25 to $2.40 previously given to you, to $2.40 to $2.50 today based on after-tax adjusted operating income. Our guidance includes the impact we expect from the American Skandia and Wachovia transactions, including additional charges of 5 to 10 cents per share in the fourth quarter related to the combination of the retail securities brokerage operations. This guidance also assumes stable equity markets over the remainder of the year. Again, thank you very much for being with us. Now I'll hand it off to Mark.

Thanks, Art. Good morning everyone. I'll start with an overview of third quarter results for the Financial Services Businesses. We reported common stock earnings per share for the Financial Services Businesses of 70 cents for the third quarter, compared to 54 cents per share for the year-ago quarter, a 30% increase. These results are based on after-tax adjusted operating income, which is before realized investment gains and losses, before results from divested businesses, and before discontinued operations.

However, our adjusted operating income does include the transition costs relating to the combination of our retail securities brokerage business with Wachovia, which closed on July 1st, offset by a small gain we recognized during the quarter from that transaction. The transition costs this quarter were less than we expected, and the net of these two items was a negative of about 3 cents per share in the third quarter results. Overall pre-tax adjusted operating income for the Financial Services Businesses was $535 million for the current quarter compared to $427 million for the year-ago quarter.

Let me start with the insurance division. The insurance division had adjusted operating income of $197 million in the third quarter, compared to $76 million in the year ago quarter. The current quarter results include a $59 million contribution from the American Skandia business we acquired in May. Including that contribution, our individual annuity business reported adjusted operating income of $78 million for the quarter, compared to a $69 million loss in the year ago quarter. Last year's third quarter included an $89 million charge for additional amortization of deferred policy acquisition costs, DAQ, on our annuity business, resulting from equity market conditions that caused us to lower our estimate of profitability on the book of business at that time. The current quarter's results benefited from the improved equity market conditions but there was no DAQ adjustment in either direction since our expected profitability continued to be within our assumed range.

Our total annuity sales, including the contribution of the American Skandia channel, were $1.5 billion for the current quarter, and net sales grew to over 260 million in the quarter. Up from 89 million for the second quarter of this year when we registered our first net positive in several years with the benefit of the first two months of American Skandia production. Substantially all of the current quarter's growth sales were variable products, and less than 10% of those sales went to the fixed bucket, excluding dollar cost averaging accounts. Adjusted operating income from our individual life insurance business was $89 million for the current quarter, down 26 million from the year-ago quarter.

Claims experience in this business tends to fluctuate within a band from one quarter to another. And this quarter's experience was less favorable than the strong third quarter of last year or the earlier part of this year. However, results are continuing to benefit from this year's equity market up-turn which increased variable life asset sales. This contrasts to the year ago quarter when downturns in the equity markets led to higher DAQ amortization driven by variable life policy lapses. The relief from last year's adverse market conditions partly offset the swings in claims experience.

The sales, based on first year premiums and excluding C OLI,amounted to $66 million in the current quarter, just below $68 million for the year-ago quarter. Our universal life and term products, which we updated in June, both registered substantial increases over the year-ago quarter. Our universal life products contributed $22 million to this quarter's sales, a 38% increase over the year-ago quarter. And term sales at $25 million registered a 47% increase. The momentum from these products roughly offset a $16 million decline in sales of variable life which continued to be negatively affected by the equity market volatility of the past several years. Our total sales for the quarter, including a small amount of COLI business, amounted to $68 million, versus $89 million in the year ago quarter which included $21 million of COLI sales.

Our Prudential agent count was essentially unchanged from last quarter and stood at about 4,300 at September 30th. We are focused on selective recruiting so that we don't rush to the high turnover rate of the expensive past, and our first year agent retention was 80% as of the end of the third quarter. Third quarter agent productivity stood at $38,000, up from $36,000 a year ago.

The group insurance segment reported adjusted operating income of $30 million in the current quarter, unchanged from a year ago. Stripping out benefits from reserve refinements of $8 million in the current quarter and $19 million in the year ago quarter, the segment's adjusted operating income would be up $11 million from last year's third quarter, when we experienced unfavorable disability claims activity.

Group life and disability claims inherently fluctuates from quarter to quarter but is tracking our expectation on a year-to-date basis with the segment's adjusted operating income for the first nine months averaging about $40 million per quarter, 18% ahead of the first nine months of last year. We continue to follow a strategy of selective repricing of existing business and pricing discipline in writing new business, and believe that this strategy is contributing to improvements of the segment's results over time.

By implementing rate increases on both group life and disability on a selective basis we have been able to retain profitable business. Persistency through the third quarter was 94% for group life and 88% for group disability. Our annualized premiums from new sales of group insurance were $54 million in the current quarter compared to $61 million in the year-ago quarter. The sales decline came mainly from group life insurance and reflected our continuing pricing discipline.

Turning to the investment division. The investment division reported adjusted operating income of $83 million in the third quarter, up $32 million from 51 million in the year ago quarter. The financial advisory segments result for the current quarter reflect the combination of our retail securities brokerage operation with Wachovia on July 1st. The segment's results included adjusted operating income of $4 million from the retail securities brokerage business, which consisted of the following: Pre-tax income of $47 million, representing our 38% share of the results of Wachovia Securities before transition costs; Expenses of $28 million, from obligations we retained in connection with the contributed businesses primarily from retained litigation; $34 million of transition costs, partially offset by a $19 million pre-tax gain that we recognized on completion of the transaction. Again, the $4 million results from 47 million of income, minus 28 million of retained obligations, minus 34 million of transition costs, plus $19 million in a pre-tax gain on the transaction.

The financial advisory segment also includes our equity sales and trading operations which were not contributed to the Wachovia venture. These operations had a small loss for the quarter, bringing the segment's overall adjusted operating income to $2 million. The segment had a $15 million loss in the year ago quarter. The retirement segment had adjusted operating income of $39 million in the current quarter compared to 24 million in the year ago quarter. The segment's guaranteed products business benefited from improved investment performance in the current quarter, reflecting favorable market activity and about $5 million of income from investment pre-payments. This contrasts to the year ago quarter when market declines put negative pressure on the segment's results. The division's two other segments, Investment Management and Other Asset Management, reported adjusted operating income of $42 million in the current quarter, unchanged from the year-ago quarter.

Now turning to International Insurance and Investments. The international insurance and investments division had adjusted operating income of $223 million in the third quarter, up 35 million from 188 million in the year ago quarter. Substantially all of the division's results came from our international insurance operations. The international insurance segment reported adjusted operating income of $215 million for the current quarter, up from 186 million for the year-ago quarter. The segment's results included adjusted operating income of 104 million from Gibraltar Life in the current quarter which compares to 102 million in last year's second quarter. Both the current quarter and the year-ago quarter benefited by $9 million from true-up's of our estimated liability for the Japanese guarantee fund. These true-up's are based on information from the regulators that become available in the third quarter.

Now that we are past the initial two years following the acquisition of Gibraltar, when shock lapses were a factor, we have implemented investment strategies to help improve Gibraltar's portfolio yield by lengthening maturities and moving to more U.S. dollar investment. The benefit from improved investment margins more than offset a negative impact of about $5 million from currency exchange rates.

Our international insurance operations other than Gibraltar Life contributed $111 million of adjusted operating income in the current quarter, up $27 million from the year-ago quarter. Foreign currency fluctuation didn't affect the comparison. These operations benefited from continued business growth in Japan and Korea and from a more favorable level of policy benefits and expenses in the current quarter. On a constant dollar basis, new annualized premium from sales in Japan increased 19% to $160 million in the current quarter compared to the year ago quarter. Sales from Gibraltar Life were $71 million in the current quarter up 18% from the prior year. We are continuing to benefit from the increased productivity of Gibraltar's life advisers, whose compensation has been transitioned to a more variable basis, allowing us to sell substantially more business with a smaller, more cost effective, distribution channel.

Sales in Japan from our Prudential of Japan life planner sales force were $89 million in the current quarter, up 19%. Sales from other countries were $50 million in the current quarter, bringing total third quarter international sales to $210 million. Our Life Planner Force stood at about 4,900 life planners at the end of the third quarter, up 12% from a year earlier. This is in addition to over 4,800 Gibraltar Life advisors.

Corporate and other operation reported adjusted operating income of $32 million for the third quarter, down $80 million from the year-ago quarter. There are two key factors in the decrease. First, uses of cash in other assets formerly within corporate and other, and a portion of our borrowing capacity to fund activities including the acquisition of American Skandia and our share repurchases. And secondly, a reduced level of income from our own qualified pension plan as we anticipated. We plan to announce next year's assumption for our pension plan when we provide earnings guidance for 2004 later this year.

I'd like to turn to several items outside of adjusted operating income that are included in net income in the Financial Services Businesses. Realized investment losses for the Financial Services Businesses net of related adjustments amounted to $46 million in the current quarter. This realized loss amount happens to be equal to the current quarter's losses from impairments and sales of credit impaired securities, which are down dramatically from last year and are also down from $80 million in the second quarter. Our gross unrealized loss on fixed maturities stood at about $370 million at September 30th, less than one-half of 1% of the Financial Services Businesses overall investment portfolio. And only about $15 million of these gross unrealized losses relates to bonds that have declined in value by 20% or more.

The increase from about $160 million at June 30th to $370 million at September 30th is essentially interest-rate related. Non investment grade fixed maturities comprised just over 7% of the Financial Services Businesses fixed maturity portfolio at September 30th, down slightly from both June 30th and year end.

Third quarter results also include a net pre-tax loss from divested businesses and a $36 million loss net of taxes from discontinued operations. The discontinued operations loss came mainly from exit costs relating to our former international retail securities brokerage operations.

Commenting briefly on the Closed Block Business. 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 pre-tax income from operations of $120 million for the third quarter of 2003 compared to a pre-tax loss of 142 million for the year-ago quarter. We measure results for the Closed Block Business only based on GAAP rather than adjusted operating income. The current quarter included realized investment gains of $119 million while the year-ago quarter reflected $126 million of realized investment losses.

Turning back to the Financial Services Businesses and summing up. Our domestic businesses are showing good progress toward our targeted return, with benefits from: Our strengthened annuity operation, with the first full quarter of operations from the American Skandia business, our first quarter of operations of the combined retail securities brokerage business with Wachovia, and a return to equity market conditions more in line with our expectations in comparison to last year's unfavorable conditions. And our international businesses continue to produce solid results with momentum in both earnings and sales contributing to positive overall results this quarter. Thank you for your interest in Prudential, and now we look forward to hearing your questions.

Question & Answer

Ladies and gentlemen, if you wish to ask a question, please press star, then 1 on your touch-tone phone. You will hear a tone indicating you have been placed in queue. You may remove yourself from queue at any time by pressing the pound key. If you are using a speakerphone please pick up the handset before pressing the numbers. Once again, if you have a question please press star 1 at this time. And our first question comes from the line of Jason Zucker with Fox-Pitt Kelton. Please go ahead. Ladies and gentlemen, please -- thank you. And our next question comes from the line of [inaudible] O'Donnell.

could we hear from Jason?

J.P. Morgan, please go ahead.

Michelle O’Donnell: Good morning, I have a few questions. I was hoping that you could comment on the NASD investigation, what your position is. Have you done your own internal review, and is this problem contained to the Boston office, and any other details you can give us on this in terms of litigation expenses you have established for this and any future litigation expenses you expect to put up for this, then I have a couple of follow-up questions.

Okay. In September, we filed a case with the SEC that we had received formal request for information from a wide range of regulators. At that time we said we were cooperating with the inquiries, and we obviously continue to do so. In addition, we said we were conducting our own internal review, to answer that question. As I'm sure you can appreciate, this is a fairly large task, and our internal review is not yet complete. And, therefore, I don't feel I can appropriately comment additionally on the matter. As it relates to any particular reserves or the like, it is way too early, premature, to consider that, and there was none taken in the third quarter.

Michelle, it's Mark. We have no basis on which to make any financial entries.

Michelle O’Donnell: Okay. And then just secondly, Mark, on the restructuring cost, it looks like the restructuring costs associated with the Wachovia deal is a little bit lower this year than you had originally expected. Is it going to be a little bit lower overall or were you just pushing a little more of the restructuring costs out into 2004?

It's really both, Michelle. It will be a little bit lower, and there's a few costs that have probably moved into 2004 from 2003. Our best guess at this point is maybe 3 cents moved into 2004. But as we update in December, our 2004 guidance to you, we'll be more explicit around it. Importantly, nothing has slipped. We're on track to do the deal as we had said, and as I said, we've benefited a little bit, so there's going to be some reduction, as evidenced by the 2003 forecast, and a little bit might slide into 2004 but it's not a substantial amount.

Michelle O’Donnell: Could you update us on the capital position, how much excess capital do we have at the end of the quarter, the RBC ratio, and your discussions with the rating agencies at this point?

Sure. Let me comment on the rating agencies, then I'll turn it over to Rich Carbone to comment on capital. We're in the middle of our annual review process now, so I'm going to lay low on this question and tell you we're working through things with them. We're optimistic that we've addressed the issues that we've talked to you about as well as the rating agencies over the past couple of years, and we continue to hope that we're on track to realize our ratings aspirations, but I don't want to pre-empt the process at this point. Let me ask Rich to comment on capital.

Our capital capacity at this point comes in two flavors. We've got about 1.4 billion of excess capital capacity on balance sheet, and we've got about $2.1 billion of additional capital borrowing capacity that would simply bring our ratios up to our peers. So in total we look at about $3.5 billion of excess or capital capacity, I would rather call it, currently at 930.

Michelle O’Donnell: And what about your intention to reinsure some of the closed block to free up some more capital? Any update on that?

We're right at the leading edge of doing about 48% of the reinsurance transaction during 2003, and we expect to put the second leg object to bring the total insurance up to about 90% of the $2 billion that we think is trapped inside the closed block sometime in the end of '04 or early '05.

Michelle O’Donnell: Thank you.

One thing, that would not prevent us from using that capital today within the insurance company itself.

Michelle O’Donnell: Very helpful.

Jason did not get his question, at least we didn't hear it, so I don't know whether you want to go back to that or just move along.

Thank you. Our next question comes from the line of Joan Zief with Goldman Sachs. Please go ahead.

Thank you, good morning. I have two questions. The first relates to your variable annuity business. Could you talk about where you're seeing which distribution channels have the greatest sales demands, what sort of products that you've just introduced, and a discussion about how you're planning to either reinsure or hedge the guarantees and the risks associated with that? That's my first question.

Why don't I start with the second part, which is the question of hedging the guarantees. We track this very closely. We have a pretty granular view of the risks that are embedded in our annuity portfolio, and we're constantly evaluating the cost of hedging versus our perception of our ability to bear that risk, and the way it relates to the returns. We are not currently hedging embedded guarantees in our annuity products, but it's in front of us, and we watch it closely. Right now we feel like it's a manageable risk for us and consistent with our return objectives and our overall risk profile.

In terms of the sales side; sale are up in both channels. In other words, by that I mean both Prudential's captive agency, or I'll call it the old Prudential business, as well as the channels associated with the American Skandia acquisition. I think that our total sales year-over-year, the Skandia sales I guess gross in the quarter were 936 million, and so in both cases we're up substantially.

Importantly, we're also up on the net category in both the, quote, "Old Prudential" as well as the new business. Our belief and, of course, we haven't seen third quarter numbers, is that we continue to gain market share through the combination of both channels. We'll obviously know better as the market data is released probably later this month or early next month. So in general we're very, very satisfied with where we are on the annuity business.

My art question, Art, is, I just wanted to hear your view on this, over the last multiple years you've been at Prudential you've dealt with a lot of issues and resolving issues, like the sales practice and the race-based pricing and the tax shelter issues, and I was wondering if you're approaching the current inquiries from a process standpoint in the same way, if you think that this reminds you of those types of inquiries you've dealt with in the past or if you're really seeing this as new territory.

Well, no, it doesn't remind me of the past. If you recall, the issues that we had to address in 96, 97, and 98 were of a substantial magnitude, and they also reflected over a 14-year period; going back as to the period that was covered, where the various problems of market conduct existed, whether it was in the insurance side of the business, and probably over 10 years as it related to some of the other areas. Clearly this does not appear to have that magnitude.

On the other hand, to suggest that I'm modestly unhappy over this would be an understatement, and, yes, I will approach it with the same rigor and vigor that I have approached these problems in the past, and resolve them as quickly as possible, but at the present time I have no indication that they would represent anything approaching some of the earlier problems I had to deal with.

Thank you.

And we have a question from the line of Jason Zucker with Fox-Pitt Kelton.

There you are, Jason.

I'm sorry, it will be just a moment.

We're not hearing him.

We're having some technical difficulties with Mr. Zucker's line. We have a question from the line of Andrew Kligerman with UBS Securities

First, earlier, I think Mark or Art mentioned that you would look for acquisitions to generate an appropriate return. I know I've heard in the past commentary on that. Could you specify what an appropriate minimum return would be on a U.S.-based acquisition on its own as well as an international acquisition? What's your minimum hurdle rate for a deal?

Well, again, I think I have to put it in the right context. The context is that we have committed to producing a 12% return on equity in 2005. We've said that was a very important financial objective, especially coming out of a, quote, "mutual company," with a relatively low return on equity, and so that is the overriding consideration that I look at in terms of any acquisition. I certainly looked at that when we did he [inaudible], I certainly looked at that when we did Skandia.

In terms of targets, obviously we would look for a 12% plus return in order to determine, you know, a reasonable contribution toward our overall goal. In the international arena we tended to have higher standards because of the nature of some of the risks associated with some of the international operations. So our standards really have not changed. I think we have to accept and deliver on the promises we've made on our return on equity. In order to do that we've got to have reasonably high hurdle rates in order to do that.

Great. Now, moving over to the operations, Group Life and Disability sales were down in the quarter year-over-year, and you mentioned underwriting discipline. Is that any reflection of a more competitive environment? Are you seeing a lot of competition and the need to kind of tighten things up to avoid getting burned?

I don't think it's any more, but it's certainly not any less. It is a highly competitive market. While there are not hundreds of players, as you see in some of our other businesses, those players who do compete in this line of business are extremely competitive, and so I would leave it as it's still highly competitive. We'll maintain that pricing discipline, and maintain we would expect our strong position in the market, but at this point do not have any objectives to increase market share. Our objective is more around maintaining pricing discipline and maintaining the return on equity.

And you feel like you're on track in that area?

Absolutely. We're absolutely on track for the financial returns for group life.

Lastly, any countries outside of Japan and Korea that you see as sort of rising stars right now that might be big crib Torres in the next two or three years?

Probably not in that time frame. Obviously Taiwan is an area where we have been working for the last six, seven, or eight years, and we would expect over that -- I'd use a longer time frame than two years, to see improved earnings there.

We would also expect that Mexico where, we've had a strong retirement business, to begin contributing returns, and most importantly, all of the startup operations have now reached a point where they are approaching break-even status, so that there would not be any drag on the other start-up operations. As we've explained in the past we have a terrific business model that over time gives us a strong competitive advantage and strong earnings, but it takes awhile to get there, and we intend to maintain that discipline as we go forward.

Excellent. Thanks.

Thank you. And our next question comes from the line of Tom Gallagher with Credit Suisse First Boston.

Good morning. Couple questions on retirement. The first is, I notice GIC sales moved up this quarter and you were almost break-even on net flows. I would have thought that you needed a ratings upgrade to start growing this business and to get into positive net flow territory. Can you just comment on what's going on here? Was there anything unusual in the quarter?

I don't know of anything unusual, but let me turn to my colleagues.

We did have one very large sale that, of North Carolina that was reflected both in the D.C. part of that segment, added $1.6 billion to sales there, and in the guarantee products part where it added $650 million. So I think that is the better part of your answer, Tom.

Gotcha. Okay. And then as a follow-up to that, is this sort of a one-off situation in terms of that large sale, or do you see pension becoming more of an area of focus?

Clearly we like the retirement business, and, you know, we hope it's not all one-off, but obviously you're not going to get a sale the size of North Carolina on a quarterly basis for sure. I think your initial question is the right one, which is we continue to grow the retirement business and we're satisfied with it, but a substantial change in our GIC business will require a rating change, so you will see periodically what we just described here with North Carolina, we hope more frequently than not, but I can't guarantee that. But the broader question about when you would have the opportunity to really leverage the balance sheet greater I think is still tied to a rating increase.

Last question is, related to your mutual fund business and Pru securities, can you just comment on over the last month or so if you have seen any material negative impact on your underlying result? Thanks.

Well, ironically, the results, if you look at the quarter, are quite positive in terms of what has happened relative to the combination with Wachovia. Our mutual fund business, there were no surprises in the business. I think that, you know, the real question, obviously, is dealing with the current allegations and dealing with that, but, no, we have not seen anything negative at this point as it relates to the business and quite the opposite in terms of the early stages of the combination are going quite well.

And, Art, that also refers to some initial signs that you've seen thus far into 4Q or does that just strictly apply to 3Q?

We've seen no impact on the business at all. It's been quite consistent, as it normally would be with equity market activity, and obviously the gains we're seeing through the combination on the brokerage side and we've seen no real change on the mutual fund front even through the first month of the fourth quarter.

Thanks.

We have a question from the line of Eric Berg with Lehman Brothers. Your line is open.

Thanks.

Hello, Eric.

Good morning to everyone. Can you provide us any detail at all with respect to the indemnification agreement that you have with Wachovia? That is to say, if it should come to pass that you have to make a payment, pardon me that, Prudential Securities does have a problem in Boston, can you provide us with any sense at all as to what extent that would be your problem rather than Wachovia's problem?

We're responsible. I think the deal is fairly simple. Anything that happened before the combination is the responsibility of the individual partner, whether it's in Wachovia or whether it's in Prudential. Prior to July 1, which was the closing date, so we would be responsible.

Okay. And finally, understanding that you are trying to show discipline in the group insurance area, we nonetheless are seeing sort of a, I think, a declining top line as measured by earned premium. This is an important business for Prudential, the group life areas, I believe you're one of the largest players, participants, in this business, number two or three, certainly in the top five. When would you anticipate being able to expand the business to grow it?

Well, I don't think I agree with you. I think the top line is growing. It's just not growing as it -- as rapidly as it once did. If you recall a number of years ago we had very substantial growth in it, we also had some pricing issues, I guess this goes back to 2001, but I do believe the top line has grown. Somebody is going to take a look.

I'm referring to page 18, the earned premium line if one eye-balls it and just looks at the trend in the earned premium, Eric Durant or Neil and I can debate this off line, but it looks pretty flat to me. I'd like to get a sense for when you feel you can begin expanding the business.

When the pricing is right. I mean, the key for us, Eric, this is an important business. But as you can look at our overall earnings, it does not drive our bottom line as it might for a number of our competitors. Important, yes, but we certainly do have, I think, a diversification of businesses where we would expect to have the opportunity to see substantial growth.

The answer is when we can get the right prices, we'll grow it. If we can't get the right prices, we'll continue as we are presently doing it, and I just think that's the way we have to approach it now. It's the discipline side that's driving my thinking, not the market share side.

Thank you, Arthur.

If there are any additional questions, please press star 1 at this time. And we will go to the question from the line of Colin Devine with Smith Barney. Please go ahead.

Good morning, gentlemen. I have a couple of questions. I guess the first question with respect to Gibraltar. You know, the number of policies there continues to decline, albeit it's slowing down. I'm wondering when you think that might turn around.

Secondly, if we could talk about what's really driving your stock price the last two days, and that is the situation up in Boston. I appreciate, Art, that you can't comment on pending litigation. I have two simple questions. The first is yes or no. Did Prudential receive as [regulators] allege between 25,000 to 30,000 complaints about what was going on. And then the second question is, given this situation, and the actions we've seen taken by some other mutual fund companies, maybe could you explain the thinking behind rehiring the former head of Pru securities both within the environment we're in but also given that that was a business you just got out of.

Let me -- let's start with your question on Gibraltar. The number of policies declined has slowed dramatically, as we've talked about. There is a two-year period of what you might want to call lapse shock. As we've reported in early quarters, the amount of lapse shock we've had is substantially less than we had planned for, which I think is good news going forward. So I don't see any issues whatsoever. It is a large book of business. And so you are going to see some decline in policies, especially as we have restructured the sales force. As you know, we've done there similar to some of the things we did in the United States. The sales force is about half the size it was, and twice as productive. And so there are going to be, you know, some lapse there, but that's well within the parameters of what we would have expected, and I think we're in pretty good shape there. Anybody want to add to that?

Well, if I could just embellish Art's response, not only has the rate of decline in the force slowed dramatically but the rate of decline in the number of agents who we call life advisors has also slowed dramatically. Their productivity is now substantially above industry norms, the rate of growth in sales is nearly 20%, so without predicting the future, if these trends that are very clear in the numbers were to continue, then it ought not to be too long before the in force begins to grow.

In terms of the other questions on Boston, Colin, the first, I think, was did we receive the number of letters that have been stated in the newspaper? The answer is no. Second, in terms of -- and we don't know where that number came from.

The second, in terms of Mike [Rice], we have retained a fair number of executives who were at Prudential Securities to assist us in terms of the enormous conversion going when you put two securities companies together. In the case of Mike, Mike was going to be part of the ongoing team in Richmond, only Mike, for personal reasons, namely his own family and his new baby, decided that he was not able to move to Richmond, and therefore he has been brought back, if you want to use that phrase, to Prudential to assist in the conversion and the consolidation of the two companies. Bottom line, if Mike had not considered going to Richmond in the first place, he would have been part of the team that would have remained to assist John in that conversion. So I don't think there's any more to it than that, and that's exactly what happened.

Okay. Then one follow-up. I'm still pondering why you brought him back. With respect to the capital numbers that Rich provided, do those include any capital released from the reinsurance of the closed block, or would that up to 2 billion be incremental to the numbers?

Incremental.

Thank you.

Cash and borrowing capacity, the reinsurance would be incremental.

Our next question comes from the line of Vanessa Wilson with Deutsche Bank. Please go ahead.

Thank you. Also on Colin's question about the --.

Vanessa, I can't hear you.

On the question about the capital that Rich had addressed, does that also include the property casualty $1 billion you mentioned, Art, at the beginning?

No.

No.

So that's an incremental 1 billion?

Right, but keep in mind some of that is evidenced by some note agreements and not all of it is cash, so there is some capital, still a bit, I suppose, but it eventually will be.

Yeah, eventually will be. I think he was talking about trying to give you a spot number.

So about [inaudible] of cash and another 650 of notes that can be liquidated over time?

Yes.

And you didn't give Michelle the RBC ratio. Do you have a guess on that?

Let me get it. We've not filed the regulatory statement for November 30th but it's in the zone of where we wanted to be, which is, I think, between 3-10 and 3-25.

How should we think about the regulatory ratio in Japan? Are you way over where you need to be there?

Yes.

Way over.

So you're past the two-year period does, that mean anything, in terms of that capital, or is that just going to be used for Hyundai, or how should we think about that capital? Is that separate from this 310 to 320?

Yeah, it's totally separate from the 310 to 325. I think you have to look at it as available for certain uses. Obviously there are certain restrictions on how it can be used, but it would be in that category of available. So when we give you, you know, and we try to look at this broadly, we talk about that which is available today, that which can be made available through reinsurance and that which presently exists in our Japanese subsidiaries as a result of the earnings over there that can also be used for selected purposes, so those would be the broad category that we would talk about.

But you have 2.4 in Japan between international and Gibraltar, so some of that is excess that's not in Rich's numbers that he gave us.

Yes. But the reason we don't add it directly in, we're not trying not to disclose all of it, because we always talk about all of it, but you have certain limitation. The first number is totally available. Obviously that which is trapped in the insurance company can be freed up through reinsurance or used by the insurance company. Similarly in the international, it can be used for certain international related activities. I.e. it's not all fundable, that's why we don't add them all up together. I do want to explain all three of them.

Yeah, I think it's clear you're being conservative. The other questions I had, on the American Skandia earnings this quarter, was that number in any way depressed by severance or any sort of one-time issues, and are there cost savings we could anticipate to benefit that number, maybe in '04?

Yeah, there was about $5 million in severance costs in that, and, yes, you can expect to see expense improvements in 2004.

Okay. Unfortunately, to follow up further on the litigation issue, Colin asked you if you received 25,000 complaints. My question is, if you did receive the type of complaint that's identified in the newspaper, just from a practical perspective, where would it go, and how would it be captured by the compliance procedures and acted on by Prudential? What would happen?

As I said early on, what I would prefer is let us complete our investigation, and then I will be able to give it to you explicitly. I would be making judgments at this point in time. We just haven't finished the whole review, Vanessa, so let us do that, then I will be more than happy to address all of those questions.

One final thing. Did you have compliance procedures in place?

Yeah, we have compliance procedures in place, and obviously we believe we have a strong system of internal controls. On the other hand, there clearly are areas and issues that need to be looked at. I am not in any way suggesting that there are not things that we need to address and look at. I just don't have all of the answers to all of the questions, and when I do I will be more than happy to share them with you and with everyone else. As I mentioned earlier we are cooperating with the regulators to ensure that all of the information that we have, they have, and what they have, we have, and that's what I'm trying to do right now.

Thank you.

We have a question from the line of Nigel Dally with Morgan Stanley.

Thanks. With regard to the Wachovia joint venture, you said some of the integration expenses are occurring later than expected, with integration expenses being delayed isn't there also a chance the cost savings will be delayed, and second, just on market timing, just wondered if you've discussed the issue with the rating agencies and, if so, do they view this as a significant source of concern that could delay a rating upgrade.

In terms of the first, no, it does not imply a delay. As I said, a number of the expected costs will not be incurred. As I said, about half of that 10 cents or so that we talked about that we are not spending will not occur, and that about 3 or 4 cents, you know, might wind up in 2004, but it's purely a timing issue in terms of recognizing the expense. You've got to understand that, you know, the accounting rules are quite different today than they were a number of years ago. You really can't take the expense until such time it is actually incurred, even if you know it might occur, and so, no, I would not read into it at all that there's been any delay. There has not been any delay. This is a massive undertaking, and to move three or four cents around one year end into the next, I don't think should be any cause for concern.

In terms of the rating agencies no, we've not heard anything explicit, but as Mark quoted, or stated, rather, we're in the muddle of discussions with them, so, no, we've not heard anything specifically on the market timing question. But, you know, I think it would be naive to believe that they're not going to want to have information, as everyone else does, including myself. But, no, nothing explicit at this point in time.

That's great. Thanks, Art.

We have a question from the line of Suneet Kamath with Sanford Bernstein. Please go ahead.

Two questions again on the investigations. I appreciate that you're in the middle of the internal reviews but I'm just wondering if you could give us a sense of how far you think you are through that, even if it's half-way, 25%, 75%. Second, on the same issue, Art, you talked about capital redeployment, and effective capital management, and I guess there's a number of things you can do, whether it's increase the dividend or make acquisitions. I'm just thinking about how this issue is impacting your ability to execute often that strategy, whether it's financially or just as a -- because this issue is taking up some of your management's time. Is there any sort of impact on executing on that strategy? Thanks.

In terms of the first, no, I don't have a good answer, because that's one of those things that when I uncover the last area, then I'll know I'm finished, but I'm not able to divide it into arithmetic quarters at this point in time.

In terms of the second, and here I want to, you know, make it very clear that there will not be an impact in terms of our thinking, in terms of what we need to do to achieve our financial objectives. That's not in any way to denigrate the importance of coming to an understanding and a conclusion about these activities. Fortunately, or unfortunately, the reviews generally are conducted through our compliance and through our legal departments. Obviously it includes my involvement. It is one segment, if you will, of our business, and so the majority of our people are working on what they should be working on. So I don't want to sound cavalier about it at all. I take it extremely seriously. We will put all the resources we need on to it, but I really see no impact on us executing against the other components of our game plan, and we fully expect to be able to do that.

Thank you.

We have a question from the line of Jeff Schuman with KBW. Please go ahead.

Just addressed. Thank you.

Thank you. Our final question comes from the line of Ed Spehar with Merrill Lynch. Please go ahead.

Thank you, good afternoon. A couple of questions. First of all, I was wondering, maybe you could just talk a little bit about how you might think about whatever you're going to do with the dividend. I appreciate you're not going to tell us, but in terms of sort of the thought process, would it be reasonable to assume that when you look at the excess capital on the balance sheet today, that you would think about that as more likely to be used for things like share repurchase and acquisitions and that the dividend would be based more on sort of the recurring free cash flow of the company?

Yeah, that's a very fair statement. I think that hits it right on the head.

Okay. And then if that's correct, then, if we looked at, you know, what portion of your free cash flow you might want to use for something that's more permanent, like a dividend, versus, you know, opportunistic things like share buy-back or acquisition, any sense of how you would look at that?

We're balancing credit issues and looking at our coverage ratio and the overall financial picture of the holding company, so there are a couple of things to trade off in considering that question.

Okay. And then, I mean, if I looked at sort of your free cash flow generation going forward, would you -- would a reasonable number, thinking about something like 600 million plus as available for, say, dividends or share buy-back, just on an on an going basis?

Could you be more clear on that number, Ed? We buy back about 250 a quarter in stock today, and that's our objective going forward. The dividend, the annual dividend is about 240 today, so I'm not relating to your $600 million number.

Yeah, I guess my assumption is that a billion dollar annual share buy-back plus a $240 million dividend is to some extent a function of the significant excess capital you have on the balance sheet today, and that that would not necessarily -- I mean, given that your adjusted operating income, I think, is on track for, you know, a billion four this year, I wouldn't think that, you know, you would be able to spend, on an ongoing basis, basically 100% of earnings. I mean, I know it's a GAAP number but, that would seem to be an unsustainable kind of, you know, distribution to shareholders over the long term.

I think, Ed, your initial analysis is right. The excess capital that we presently have is driving the stock buy-backs, or the share buy-backs, as well as the acquisition strategy. I think the issue on what percentage of the cash flow on an annualized basis we would dedicate to the dividend is precisely the question I can't answer for you right now. But I will answer for you as we discuss it with the board.

We certainly are looking at those ratios, and the sustainability of it. I think we understand the importance of a dividend policy and we'll address it, and it would be very difficult for me to deal with the arithmetic you're dealing with now without me telling what you I expect the dividend to be, so let's just say I accept your analysis, and that is exactly how we're looking at it, and I will add to that, my belief in the importance of a dividend.

Okay. I guess I wasn't covert enough with the way I was phrasing it.

No, you weren't.

The final question is, you know, I don't think you ever endorsed the Wachovia math for the joint venture, but can you maybe give us any sense of, you know, is there any reason to -- when you look at what their plan was, you know, any reason to be plus or minus in terms of thinking about what those numbers are going to be over the next couple of years?

Well, Ed, this is Eric. Let me give you a numerical answer, and Art or Mark may want to embellish it. Wachovia's number, which I think they've confirmed subsequent to the close, was to ultimately achieve $364 million in expense saves. If you take 38% of that, which would be our share and tax effective at our 32.5% rate that would generate incremental earnings to us after taxes of almost $95 million.

Yeah, this is Art again, Ed. I have no reason to believe that the cost savings will not -- they will materialize, and I'm pretty confident that we will see the benefits we expect. The uncertainty always deals with the market itself.

I mean, there's no question we can control or through the operation the expense saves can be controlled, who knows what markets are going to do, but it really goes to the logic of the deal, which says that we needed to combine in order to get to scale, in order to get the expense saves out, and I have a lot of confidence in Wachovia management to achieve those expense saves. They've got a good track record in achieving that and I see no reason why it wouldn't be achieved here.

Thank you very much.

There are no further questions at this time. Please continue.

Thank you all very, very much for joining us today. I believe that will be the end of the session. Thank you.

Ladies and gentlemen, this conference will be available for replay after 4:15 p.m. today through Wednesday, November 12th, 2003 at midnight. You may access the AT&T replay system at any time by dialing 1-800-475-6701, and entering the access code, 681468. International participants please dial 320-365-3844. Those numbers again are, 800-475-6701, and 320-365-3844, with access code 681468. That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.