保德信金融集團 (PRU) 2004 Q1 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by. Good morning or good afternoon, and welcome to Prudential's first quarter 2004 earnings conference call. Now, at this point all of your phone lines are muted or in a listen-only mode. However, later during the conference, there will be opportunities for questions. And those instructions will be given at that time. Should you require assistance during today's earnings release, you may reach an AT&T operator by pressing star then 0 on your phone keypad. And as a reminder, today's call is being recorded for replay purposes. With that being said, let's get right to today's agenda. Here with our opening remarks is Prudential's head of Investor Relations, Mr. Eric Durant. Please go ahead, sir.

Thanks to all of you for dialing into our call today. Our speaker's this morning, once again, are Art Ryan, Prudential's CEO and Mark Grier, Vice Chairman for Financial Management. Joining us in the Q&A are Rich Carbone, Chief Financial Officer and Buddy Piszel, Controller. In order to help you to understand Prudential Financial we will 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 appears in the section titled forward-looking statements of our earnings press release for the first quarter 2004, which can be found on our web site 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 income to measure the performance of our financial services businesses. Adjusted operating income excludes net investment gains and losses and related charges and adjustments and results from divested businesses. The comparable GAAP presentation and the reconciliation between the two for the first quarter are set out in our earnings press release on our web site. Additional historical information relating to the company's financial performance is also located on our website on our investor relations page.

Mr Ryan.

Thank you, Eric. Good morning or good afternoon, everyone, and thanks again for joining us. As we've done in the past, I'll give you an overview and then Mark will review the first quarter results in some detail. Overall I characterize our results as right on track with our expectations for the year. We believe that the quarter demonstrates excellent balance in our business mix as well as overall improvement in performance. Each of our divisions contributed to our earnings growth, which resulted in a 32% increase in earnings per share.

We were particularly encouraged by strong sales in individual life insurance, annuities, as well as group insurance. Our insurance division continues to benefit from our acquisition of American Skandia. In 11 months of Prudential ownership, American Skandia has generated a return on equity of over 15%. Just as importantly, it has produced a strong and improving trend in sales, primarily as a result of American Skandia's leading position in the independent financial planner channel. Our investment division reflects the combination of our retail securities business with Wachovia, which closed July 1st of last year. This venture is off to a promising start and we expect to benefit from enhanced returns as integration proceeds and cost savings are realized.

Next quarter's results will include a contribution from the CIGNA retirement business, which became part of Prudential on April 1st. We remain confident that this investment will generate attractive returns while significantly upgrading Prudential's positioning in the important retirement marketplace. The acquisition also enhances Prudential's position as a global asset manager. Our international division also continues to perform well. The insurance businesses, Gibraltar and Prudential's home grown Life Planner business achieved 23% growth in adjusted operating income in the quarter compared to a year ago. In addition, we closed our acquisition of 80% ownership of Hyundai Investment and Securities in February.

We were able to finance most of this acquisition by re-deploying capital from our international insurance operations, capital that was earning relatively low returns. As a result, we expect the Hyundai acquisition to be accretive to Prudential's EPS immediately. As you know, capital management has been central to our plan to deliver our 12% return on equity objective. The acquisitions we have made have contributed to the company's improving results, and we are confident that they will continue to do so. In addition, share re-purchases are another device we've used to manage our capital. In the first quarter, we re-purchased 372 million of common stock under a board authorization to purchase up to 1.5 billion this calendar year.

While we will review activity under this authorization with the board regularly, we believe that the re-purchases of roughly 375 million per quarter is a realistic base case for Prudential at this time. While I'm committed to improving Prudential's financial performance, maintaining our financial strength is of equal importance to me. We have maintained a superior balance sheet and capital position, and we intend to continue to do so. Indeed we believe that Prudential is a stronger company today in every important aspect than it was two or three years ago. We were gratified to receive a rating upgrade from AM Best in February, and we are hopeful that moody's decision to place Prudential insurance on review for possible upgrade will lead to a favorable outcome.

Finally, our earnings guidance for 2004 is unchanged. We continue to believe that Prudential will achieve common stock earnings per share in the range of $3.05 to $3.25 for the year 2004 based on after-tax adjusted operating income. This guidance includes expected charges to be absorbed within the 2004 adjusted operating income of approximately 25 cents per share from the combination of the retail securities brokerage operations and approximately 10 cents from the integration of the CIGNA retirement business. About 4 cents of the Wachovia charges have already been absorbed in first quarter results. This guidance also assumes appreciation in the S&P 500 index of 8% for the year.

Again, thanks for being with us, and I'll hand it off to Mark.

Thanks, Art. Good morning, everyone. Thanks for joining us today. I'll start with an overview of first quarter results for the financial services businesses. We reported common stock earnings per share for the financial services businesses of 74 cents for the first quarter compared to 56 cents per share for the year ago quarter, a 32% increase. These results are based on after tax adjusted operating income, which includes the absorption of about 4 cents per share of one-time costs relating to the combination of our retail securities brokerage business with Wachovia.

Let me discuss the insurance division first. The insurance division had adjusted operating income of $211 million in the first quarter compared to $163 million in the year ago quarter. The current quarter results include a $61 million contribution from the American Skandia business, which we acquired in May of 2003. American Skandia's strong results in the current quarter bring us overall pre-tax contribution to about $230 million for the first 11 months of operations. This represents an annualized return of over 15% on our average investment based on after-tax adjusted operating income. The original Prudential annuity business reported adjusted operating income of $37 million for the first quarter up 14 million from the year ago quarter.

The increase was driven by higher asset-based fees and lower cost for guaranteed minimum death benefits tracking the improvements in the equity markets from a year earlier. Our annuity sales, including the contribution of the American Skandia channel reached $1.8 billion in the current quarter, registering a 17% increase over the average per quarter from the second half of last year. Consistent with earlier quarters, substantially all of our current quarter annuity sales were in variable products. And the fixed bucket portion of these variable annuity sales, excluding dollar cost averaging accounts, was negligible.

Our sales momentum is being driven by our cultivation of the distribution channel that came to us with American Skandia and by our offering of a full array of living benefit features on our annuity products. We continue to evaluate hedging strategies, but given the recent introduction of American Skandia's new guaranteed minimum income and withdrawal benefits we are still at a point where the bulk of our living benefits on the books are from our guaranteed return option or grow feature. This is a guaranteed minimum accumulation benefit where a portion of the customer's funds are re-allocated on a daily basis to fixed income assets in support of the guarantee. Net sales in annuities after withdrawals have grown to over $400 million in the current quarter up from an average of about 325 million per quarter in the second half of last year.

Adjusted operating income from our individual life insurance business was $87 million for the current quarter compared to 106 million in the year ago quarter. Nearly half of this decline came from a lower investment income contribution that was mainly a result of a $600 million decrease in average equity attributed to this business compared to a year ago. Late last year, we reduced the level of equity required to support the individual life insurance business by use of captive re-insurance for new term business and the reduction of some redundant statutory reserves. While these actions resulted in a decrease in our reported results for individual life insurance they allowed us to free up capital for re-deployment at higher returns. The rest of the decline came mainly from lower recovery of our agency distribution system costs as a result of the sale of our property and casualty business last year.

Our agents now distribute only third party property and casualty products, while the agency system is still compensated for its P&C sales the compensation structure is less favorable than it was historically. The near-term impact is consistent with our expectations and we are pursuing opportunities to make the owned distribution channel more cost effective in order to mitigate this impact over time. Mortality experience was about at the expected level both in the current quarter and in the year ago quarter. Sales, excluding COLI, amounted to $90 million in the current quarter, an 11% increase from $81 million in the year ago quarter. The increase was driven by continuing momentum in our universal life and term life products, which we updated last year.

Both our third party distribution channel and the Prudential agent channel contributed to sales growth in the quarter, with third party sales distribution accounting for about one-third of total non COLI sales. Our Prudential agent count stood at about 4,150 at the end of the first quarter, a decline of about 170 from year end. We are continuing to emphasize cost effectiveness in this channel and productivity per agent in the quarter was $36,000 up from $34,000 in the year ago quarter. The group insurance segment reported adjusted operating income of $26 million in the current quarter, a decline of $8 million from the year ago quarter. The main cause of this decline was erosion of portfolio yields. Also, our disability experience in the current quarter was slightly less favorable than in the year ago quarter.

There is some seasonality in life claims with the first quarter historically the least favorable. Experience in our group life business in the current quarter was essentially unchanged from a year ago but down from the fourth quarter. Turning to the investment division. The investment division reported adjusted operating income of $96 million in the first quarter, up $23 million or 32% from $73 million in the year ago quarter. We've combine the results of our former investment management and other asset management segments into a new asset management segment. Our hope is that one less moving part will be helpful. This asset management segment had adjusted operating income of $58 million in the current quarter, up $13 million from a year ago.

The increase came mainly from greater transaction and incentive fees primarily from our real estate management operation and greater asset based fees tracking the improved equity markets. The financial advisory segment had a loss of $14 million in the current quarter. This compares to a $25 million loss in the year ago quarter. The financial advisory segment's results for the current quarter reflect the combination of our retail securities brokerage operation with Wachovia which happened last July. Our 38% share of the results of Wachovia Securities resulted in pre-tax income of $54 million before one-time costs.

However, the segment's results absorbed expenses of $41 million in the quarter from obligations we retained in connection with the contributed businesses, primarily from retained litigation and regulatory matters. The segment's results also absorbed $30 million of one-time costs. After absorbing a total of $71 million in these retained and one-time costs, the retail securities brokerage operations reported a loss of $17 million for the quarter. The retirement segment had adjusted operating income of $52 million in the current quarter, essentially unchanged from $53 million in the year ago quarter. The acquisition of the CIGNA retirement business, which did not impact the first quarter, brings significant scale to this business, doubling our defined contribution record-keeping assets and brings total Prudential retirement assets to $120 billion based on year end numbers.

The business was purchased for cash by Prudential Insurance, allowing us to utilize $2 billion that was previously invested in general account assets to finance the acquisition, and leaving our debt to capital ratio, which was 11.2% at March 31st, intact. By using this structure, we redeployed equity within Prudential Insurance for higher expected returns without the need for an extraordinary dividend. The acquisition brings us about $50 billion of assets under management, including about $30 billion of proprietary assets. As a result, it will contribute to our asset management business as well as to our retirement business.

Turning to international insurance and investments. The international insurance and investments division had adjusted operating income of $219 million in the first quarter compared to $178 million in the year ago quarter. The international insurance segment reported adjusted operating income of $215 million for the current quarter, up $40 million from $175 million for the year ago quarter. The segment's results included adjusted operating income of $94 million from Gibraltar Life in the current quarter, up 19 million from a year ago. The increase came mainly from a lower level of expenses, partly a result of actions we took last year to reduce the cost structure and partly because of some nonrecurring expenses a year ago.

Gibraltar's results also benefited about $4 million from currency translations compared to the year-ago quarter. During the first quarter of last year, Gibraltar Life provided $15 million of increased reserves due to stronger persistency than we had expected at that stage of it's operation. Persistency of the business we acquired has continued to be stronger than our expectations at the time of the acquisition, meaning that we were able to retain profitable business that we expected to lose. As a result, we recorded a similar, although somewhat smaller, reserve increase in the current quarter. Our international insurance operations, other than Gibraltar Life, contributed $121 million of adjusted operating income in the current quarter, up $21 million from a year ago. These operations benefited from continued business growth in Japan and Korea.

Additionally, the year ago quarter absorbed some costs of relocating our Japanese operations to a new home office in Tokyo. On a constant dollar basis, sales from Gibraltar Life, based on annualized premiums, were $58 million in the current quarter, compared to $67 million in the year ago quarter. However, single premium sales had a negative impact of $15 million on the year-over-year comparison, reflecting a credited rate cut that we implemented on savings oriented policies last year. Excluding this product, sales in Gibraltar were up 12% year-over-year. Also on a constant dollar basis, sales in Japan from our Prudential of Japan Life Planner sales force were $119 million in the current quarter, up 9% from a year ago. Sales from other countries were $49 million in the current quarter bringing total first quarter sales to $226 million.

Sales in Korea were temporarily slowed down as we redeployed sales agents to support opening 17 new agencies on a base of 54 agencies. Our Life Planner force stood at just over 5,000 life planners at the end of the quarter, up 10% from a year earlier. Together with 4,800 Gibraltar Life Advisers, we now have a total of nearly 10,000 international insurance representatives. Turning to the corporate and other segment where we reported adjusted operating income of $23 million for the first quarter, which compared to $18 million in the year ago quarter. At the net income level, net income for the financial services businesses was $290 million for the first quarter, up 47% from $197 million in the year ago quarter.

I'd like to mention two items outside of adjusted operating income that are included in net income of the financial services business. First, a charge for cumulative affect of accounting change. And secondly, realized investment gains and losses. Net income for the first quarter includes a charge of $79 million net of taxes for our adoption of AICPA Statement of Position 03-1. This new accounting standard requires us to set aside part of the fees we receive on variable annuities to cover future guaranteed minimum death benefits and to apply book value accounting for some contracts that we formally treated as separate accounts, meaning that we marked assets and liabilities to market. We don't expect a major impact going forward, but the new treatment should relieve our quarterly results from some of the mark to market volatility.

Realized investment gains and losses were not significant in the financial services businesses this quarter amounting to a $1 million pretax gain after related adjustments. Impairments and credit related losses, which are reflected in the net gain, also were a nonevent for us at just $27 million in the quarter. Our gross unrealized losses on fixed maturities stood at $276 million at the end of the quarter, almost entirely on investment grade securities and essentially interest rate related. Non investment grade fixed maturities comprised just 6% of the financial services businesses fixed maturity portfolio at the end of the quarter. The results of the closed block business are associated with our class B stock.

The closed block business reported net income of $111 million for the current quarter, compared to a $1 million loss in the year ago quarter. We measure results for the closed block business only based on GAAP rather than adjusted operating income. The current quarter includes $205 million of pre-tax realized investment gain compared to $41 million of gains in the year ago quarter. To wrap up, I'd like to make a few observations on a subject that has gained a great deal of recent attention. That is the potential impact of a rising interest rate environment. In general, we believe that a moderately rising interest rate environment would be helpful over the long-term.

Positive benefits include the ability to reinvest assets, including those representing the equity supporting our businesses, at higher returns. The reduction of the risk of approaching interest rate floors, especially on older annuity business in force. And higher discounts, higher discount rates, meaning lower present values for long tail obligations including our pension plan. Our exposure to outflows of customer funds from fixed income products in a moderately rising interest rate environment is limited by two factors. First is the use of portfolio rates. In many cases the rates we credit are based on portfolio yields, which we would expect to remain higher than available new money rates absent a very sharp increase in interest rates. The second mitigating factor is surrender charges. I would also note that our mix of spread businesses, fee based and equity market sensitive businesses and international businesses makes our overall results less sensitive to any one environmental change than a more concentrated portfolio of businesses might be. Thank you for your interest in Prudential, now we look forward to hearing your questions.

Well, very good. And thank you, Mr. Grier. Ladies and gentlemen, as you just heard, if you do have any questions or comments, we invite you to queue up at this point. Simply press star and then one on your phone keypad. You do hear a tone indicating you've been placed in queue. And should you wish to remove yourself from the queue simply press the pound key. Once again, to ask a question, please press star one on your touchtone phone. Representing UBS Securities, our first question comes from the line of Andrew Kligerman. Please go ahead.

Morning or good afternoon. The rock is getting no respect at all today. But, maybe you could help me out long range. You've done a very nice job in terms of getting the detail across. Can you talk us through the 12% ROE next year? Are you on track there? What's it going to take to get there, and then where are you in terms of excess capital?

Thank you, Andrew. The simple answer, obviously, is we are on track for the 12% ROE. And as I've said many times, the factors that are involved in us achieving it are some of the modest market rate assumptions that we have made, and delivering on our business plans. By that I mean is we don't have to make any additional acquisitions, there are no major dispositions that we have to worry about. It's basically executing our business plan that will get us to the 12% return on equity. Again, I'll repeat myself, we are on track to do that. In terms of excess capital, we've talked about it many times. Obviously we have additional borrowing capacity, given our debt to capital ratio of probably about 2 to 2.4 billion.

We have freed up some capital as a result of the activities in our individual insurance. As you know, we had excess capital in Pru Insurance that we will effectively deploy as part of the CIGNA acquisition. We also have some unused capital in our international operations of between 300 and 500 million. And so those are roughly the numbers that are available for our use. And of course, we continue to have a reasonable aggressive buyback strategy, which, as I announced in my opening remarks, we would be continuing for the foreseeable future. So at the end of the day, you can look at roughly around $3 billion of capital that is available to us to utilize that is not presently deployed against our existing businesses.

All right. I just want to make sure, there was a litigation and legal obligation expense relating to your JV with Wachovia. Do you see that continuing into the future?

Yes.

Five cents a share?

I don't know what the amount will be. It's very hard to predict. But I think what you're looking at there is basically the cost of ongoing arbitration, legal costs for basically cleaning up all of those things that are the normal part of doing the securities business. You would tend to see a bit of a rise after a combination, because at March 31st, I think our obligations are finished in terms of activities that might occur going forward. And so, yeah, for the foreseeable future, we will continue to incur costs both internal legal costs, external legal costs, arbitration settlement and the like. But certainly there is an end to this. It's a little hard for me to predict what it will be. But over the course of the year we'll be able to keep you updated in terms of how we see that winding out. It is a cost that will go away, just more difficult for me to predict when, especially given the length of time that some of these suits take.

Thanks a lot for your time.

Thank you very much, Mr. Kligerman. Next representing Smith Barney we go to the line of Colin Devine. Please go ahead.

Good morning, gentlemen. A couple of questions. First if we could just expand a little bit about what's going on in Japan in terms of life sales there and what you're seeing by product. I realize you sell a couple of different contracts and perhaps you could just flush out the underlying trends both at POJ as well as Gibraltar. Secondly the decline in agents in the U.S. It's certainly been my understanding you're hoping to really start getting the agent force growing again. Perhaps you could talk a little bit about that. And then lastly, while I appreciate it's still a very small part of your business, you seem to rapidly expand into disability in group life this quarter, and I was wondering if there has been a strategic shift or exactly what's going on there. Thank you.

Let me take them in reverse order. There's been no change in our strategy in group life and disability, we just had a very good sales quarter. But I think if you look at the trend lines in persistency and the like, we're not doing anything to simply try and hype the sales in the near term. We've talked about obviously wanting to win as much business as we can but doing it all profitably. That continues to be our strategy and will continue to be our strategy. Over 75% of our business still remains group life. And so disability, while part of it, will continue to probably represent roughly that percentage going forward. So no change in strategy there. On the U.S. agents, I think the impact of the sale on property and casualty caused a higher number of agents to leave than I probably anticipated, not a significant difference.

But as you said, we're down about 100 plus, and I think we were looking to keep things relatively flat and grow them later during the course of the year. It was a bit higher than I thought, not exceptional, but higher. We continue to recruit at roughly 750 to 1,000 new agents. So I am not changing the recruiting patterns in order to, quote, net out where we had somewhat higher losses, because I want to make sure that we can continue to have great success as we have in the new recruitment program. I'm okay with it, but you're correct in highlighting it. It was slightly higher than I probably anticipated. I'm going to let Mark talk about the Japan sales. Well, do you want me to do it or do you want to do it?

I have the numbers right here, Collin. If we look first at Prudential of Japan, which we have operated since the late 1980s, as you know our emphasis is protection products, principally whole life and term, cause that's where the money is, and we sell on a needs basis, because that is a market need that wasn't being met. We're up 9% there on a year-over-year basis. The agents are up 12% and historically the rate of growth in business has been at least as great as the rate of growth in Asia. So, although I don't see anything in the numbers that looks anomalous, one might expect that the two would be closer together than was the case in the first quarter. At Gibraltar, increasingly our life advisers, as we call agents there, are also emphasizing the same types of protection products that we saw Prudential of Japan. That was not the case to the same degree historically and in fact, one of the reasons why the reported sales number shows a decline is, as Mark mentioned, we have significantly de-emphasized single premium endowment and whole life business, which is much less profitable to us and really doesn't fit our mission. If you strip that out, as Mark indicated, we're actually up 12% on a year-over-year basis.

Lastly, Collin, in terms of markets outside of Japan, we did have a reduction in first quarter sales in Korea. But that was due totally to the fact that we opened 17 new agencies in Korea from 54 to 71. And that obviously means we've redeployed a fair number of people in the life planner channel into sales management and agency manager. So I would conclude on two comments. 220 odd million in sales is probably not matched by anyone anywhere. And number two, the engine is still running well. And we will continue to have strong performance in international insurance.

Great. Thank you very much.

And thank you, Mr. Divine. Next representing Credit Suisse First Boston we go to the line of Tom Gallagher. Please go ahead.

Good morning. Had some questions on asset management flows in your different areas. I'll just hit them one by one. Institutional asset management had strong net flows. Can you just comment on what's driving that? Mutual fund continue to have outflows? Any initiatives under way there? Wrap fee flows were also strong. I assume this is coming from new producers from Wachovia, but can you just comment on the outlook? Lastly, pension flows have been negative. I would assume we'll see some shock lapses continuing for a while after CIGNA comes on board and I realize you probably can't give precise numbers but can you just give directional expectations as to how you expect the retirement business to trend? Do you expect to see very large outflows, then them starting to come in a bit, or do you think that's already kind of occurred and behind us? Thanks.

This is Art, again. On the pension outflow. It's a bit of an anomaly. It shows a net outflow of about 300 million. We had a net outflow of $600 million with the sale of Prudential Securities or the joint venture, I should say, between Wachovia and ourselves, as retirement moved over to Wachovia. We actually had positives ex that. I don't expect to see any shock hits as it relates to the Prudential business going forward. We might see some, as we have talked about in the CIGNA, but right now it's tracking to where we had expected it to be. So that first quarter is actually explainable by the one transaction I mentioned. And we're pretty comfortable about the growth patterns that we're going to see in the retirement business going forward.

Yeah. Couple more comments on the asset management flows. Broadly our performance is good. So we are well positioned in the market and sales are starting to reflect that. Specifically in institutional fixed income, we have had good success with collateralized debt obligations and are managing significantly more assets in that part of the business. So the broad indicators there, in terms of both specific products but more generally performance overall, are moving in the right direction. The mutual fund product tends to reflect more of what's going on in the retail distribution channel, and that's a result that we've been living with now for a number of years. It's early with Wachovia to sort out everything that's ultimately going to happen with both mutual funds and wrap fee products. Although, we do anticipate as we go through the year continued improvement in asset management related to wrap fee products. Part of the deal there is that we will be managing the wrap fee assets for that joint venture. So as that gets sorted out, we anticipate further positive results in that one.

That's helpful. Just one follow-up for Art. You had commented that to attain your 12% ROE you don't need it to do any acquisitions. If you had to put odds or characterize likely course of events here, is it safe to assume '04 is going to be an integration year, or is there still an opportunity, do you think, for more acquisition opportunities if something interesting comes up? Thanks.

Our key focus will be to deliver on what we have promised in the deals that we have already done. And to date, we have been fortunate and been successful in the Skandia area and we expect the same out of the CIGNA deal and the Hyundai deal as well. So clearly that is a principal focus for us. In terms of additional opportunities, I think the real driver of that is really what's happening in the market. You'll know that in many markets, there have been improvements, and therefore there's somewhat higher prices in the market. Plus there are a lot more bidders today than there were two years ago, relative to those who have capital available to do it. So if the right deal comes along that we price properly within our stated objective, we would do it, but I think your assumption is correct, the probability is lower today than it was a year ago in terms of the likelihood of us doing any significant deals.

Okay. Thanks.

Thank you, Mr. Gallagher. Next we go to the line of Suneet Kamath of Sanford Bernstein. Please go ahead.

Just a question on your ratings. If for whatever reason you end up staying at the A will that have any impact on the returns that you expect from the CIGNA transaction? Thanks.

No. Actually, because it's an upgrade on where CIGNA has been, even the A. And so no, we do not believe that will have an impact on that at all. Also the mix of business there, especially around the stable value side, would also probably be reasonable stable and consistent with the A. That's not to suggest that's what we would like the outcome to be, but there should be no impact if that outcome were to occur.

Maybe just a separate follow up. Just, again, in terms of the 12% ROE. Is there any implicit assumption on interest rates rising that's baked into that forecast? Thanks.

Not really. No, and as Mark answered earlier, a modestly rising environment would actually be beneficial. But again, I think the mix in our business is such that we should not have the kind of Draconian impact if one particular arena is affected. Here I'm talking about the mix between interest rate and equity sensitive activities, as well as the balance between our domestic and international activities. So I think I'm pretty comfortable that the environment, assuming it does not act in what I call Draconian fashion, that's always a wild card, where you can have explosions, those are more difficult to obviously forecast what will happen. But the changes that we would anticipate, no, there would be no change in our outlook. And we fully expect to deliver on the 12%.

Okay. Thank you.

And thank you, Mr. Kamath. Our next participant in queue, we go to Saul Martinez with Bear, Stearns. Please go ahead.

Hi, good morning. Two questions. You mentioned that your ROI on the American Skandia acquisition has been 15% over the first three-quarters of the acquisition. Just kind of wanted to get a sense for you, how much better can that get? What's sort of the normalized return on invested capital or return on equity that you see in that business line. And my second question is sort of related to your 12% ROE goal for '05. I assume that baked into the assumptions is sort of a reduction, or a easing out of all the transition and nonrecurring items that we see in the Wachovia joint venture over the 18 month transition period. In other words, the legacy cost and purchasing accounting adjustments should go away by 2005.

Yeah, let me take them in reverse order. We would expect to have all of the transition costs associated with the joint venture to be incurred in 2004. That is correct. And obviously in addition to the absence of those costs, we would get the benefits of the cost saves which would occur as a result of those expenditures. We are looking at 2005 to be absent the JV transition costs. In terms of the 15%, we use the phrase "return on equity" as opposed to "return on investment," because we do look at the return based on the total calculation of equity ascribed to the business not simply the investment cost, so certainly the amount of equity ascribed will be at least what the investment cost would be.

That 15% is a good number in what I will call a good environment. We're in a good environment right now. Sales are strong. We've got, while not great equity markets, we've got reasonable equity markets. And so in that type of an environment, and with our heavy dependence on the variable side versus the fixed side, that's a reasonable number. When you hear other numbers that are somewhat lower, it generally includes a combination of variable and fixed. Now obviously fixed is a very small part of ours. For other players fixed might be a more important component that tends to have a lower return on equity than the variable side. Given the conditions we're operating in, yes, that is a reasonable and an ongoing return associated with the variable annuity business.

Okay, terrific. Just on the first point with Wachovia, just a followup. You mentioned, yeah, your sort of assuming that the transition costs go away. I know the legacy costs and litigation expenses and purchase accounting adjustments are sort of difficult to forecast with any sort of precision, but I assume that we're assuming that those will also not affect the '05 results as well.

Certainly not the purchase accounting side of it. Some of those litigation costs could continue into 2005, because there's long tails on that because we don't really control it, especial given the proclivity of arbitration processes and the like. We have assumed all of those types of things in our ongoing calculation. But certainly the numbers that we have talked about in terms of the 25 cents and the like, those numbers would disappear. But there likely would be some continuing costs, but we will manage that, and we've incorporated that thinking in our 12% ROE.

Okay, terrific. Thank you.

Thank you very much, Mr. Martinez. Representing Deutsche Bank, the next participant in queue is Vanessa Wilson. Please go ahead.

Thank you very much. Art, at this point your leverage ratio is still very low, your debt to capital ratio. Do you have a sense of where you would see that when you're at your 12% ROE?

We've tended to think about 18%.

What would your full leverage be?

Our full leverage?

Where you've basically capped out?

20% would be the total, but we're not going to cap out there.

20% is probably a good number. That's really driven heavily by our ratings aspirations. If you look at AA you tend to see it in the 20% range. I'm sure there are periods of time where it will go up a little or go down a little, depending upon how you're going to use it. I don't think we're capped anywhere, that would be the range at 20%. It could be a few percentage points below or a few percentage points above depending upon what activity is going on.

Then you have more capacity above that for preferred?

There's a 4 (inaudible) that would allow us to do a additional preferred after RESUs roll off.

So even when you reach this full 12% ROE you're not fully leveraged? You're very under leveraged right now.

We are very under leveraged right now and we're not going to push the envelope when we get there. We've tried to leave so that there's always flexibility that we can do other things. It goes to what I tried to say early on is that we want strong financial capability which means not just strong capital levels but decent leverage ratio, cash at the holding company and the like, so that we have the flexibility to respond in the marketplace. I think that is very, very important, given stuff that goes on, whether it's consolidation, changes in markets and the like. You want to have optimum capital flexibilities. I don't think we'd ever push it to, quote, tap out, other than if we were using it for a very special reason and then we would bring it back to the kind of levels I just talked about.

In addition, I guess Moody's has signaled that they are reviewing you for possible upgrade, and I think we could all pretty well expect you'll get that upgrade relatively soon. What are the benefits going to be? You've talked about being able to sale GICs, you'd have a lower cost of debt and you have very little debt on the books right now, so there could be significant cost savings there. How should we think about the benefits of that upgrade?

I think they are really longer term, Vanessa. I don't think you're going to find any single event in the near term that does it. But over time for the reasons you just talked about. It is a lower cost of debt. It allows us enormous flexibility in the GIC business. It also is representative of how we need to compete in independent channels, whether it's the retirement business or in the high-end life insurance business, that AA is important. It's very hard for me to quantify it. But I do know in speaking with very large independent groups, that all things being equal, if products are comparable, then ratings are going to be part of the decision process. Clearly a number of our competitors are already at that AA level. I think it's a combination of all of those reasons that are very important. Mark, do you want to add to that?

Yeah, there's some specific products in the annuity arena and some other life insurance products, there are channels that we will access as a AA that we just don't access now. I would second what Art says. The wholesale markets are obviously most sensitive. But the broader longer term benefit, as Art characterized it, is in penetrating the retail channels and, as I said, I think specifically it will help our annuity business even more.

Thanks very much.

And thank you, Miss Wilson. Ladies and gentlemen before we go to our next participant, let me just invite you once again to queue up for any questions or comments you might have by pressing star one on your touchtone phone. Our next question comes from KBW's Jeff Schuman. Please go ahead.

Good morning, couple of questions. First on the life insurance front, you continue to grow sales at a nice percentage, but you're still at fairly modest levels given the years of shrinkage in the agency force. Is there anything you can do to more aggressively move life sales to another level distribution wise, product wise? Secondly, back on Wachovia once again, can you kind of give us a qualitative perspective on how the integration is going? I guess based on the way the transition costs have emerged to date one gets the sense that it has moved pretty gradually. Should we think of that as a good thing, that things are moving deliberately or is this the kind of a situation where severance and other issues hang over the work force and need to be dealt with?

On the Wachovia front, no. I would declare it as moving along exactly as we would like. First of all, the operating earnings that we described of 54 million are really quite positive for our 38% participation, albeit, having been absorbed in other costs. But again I talked about those issues earlier. If you look at FA retention, the numbers are very good. If you look at assets under administration, the numbers are very good. So the drivers are solid. And that probably is more important than any other number, especially the absence of the timing associated with certain costs. So, no, I think we're right on track and we're very, very comfortable where we are at this point in time. In terms of life insurance sales, the direct answer to your question is there are not easy ways to jump-start it.

And we have tried to avoid that. Obviously we could reduce our pricing. We could modify our underwriting standards. We could go back to trying to hire 3,000 people a year. None of those worked. And we don't intend to do it again. So we will continue to look to grow our domestic life insurance appropriately. And if we can continue to get the kind of 10, 11% that's well above what the market is growing at, certainly our growth in the third party channel should continue to improve an area we were nonexistent a few years ago. So we want to continue to focus on that, but in the way we've done it and not look to hit the home run if you want to put it that way.

On the other hand, I think it is important in the world in which we live, that one ought to look at global life insurance. And I'm very pleased that we can continue to focus on other markets. And if you look at the total amount of insurance we originate, we certainly are among the leaders in the world in doing that when you add the two. I like life insurance. I don't want to not grow the business, but I don't think there's easy answers to try to simply double up in a particular market. That isn't what we've done internationally, country by country and that's not what we're going to do in the United States either. We're going to continue to grow it, we're going to invest in it, but we're going to meet our targeted returns.

Thank you very much.

And your next question comes from the line of Eric Berg with Lehman Brothers. Please go ahead. And Mr. Berg, your line is opening. If you are speaking, we can't hear you, please check your mute key.

Yes, I was on mute. I apologize and good morning to everybody. I have a followup question to Jeff's regarding life insurance. I know you mentioned that the re-allocation of capital out of the life segment resulted in lower investment income, but it looks to me like investment income was essentially unchanged. I'm looking on page 4 of the financial supplement. I'm also wondering in the income statement as well for individual life, why would there be a doubling, the big increase in revenue seems to be driven by doubling in the line item caption commissions investment management fees and other income. What is that all about? And then I just have a question regarding Gibraltar.

Okay. Let me have Buddy answer the question on the revenue, because there's a corresponding increase on the expense side.

Before the sale of P&C, Eric, we used to receive fees for selling the P&C product and net that down against the expenses. Now with the sell of P&C we're recording the fees and other revenue and there's an increase in expenses that you see in commission and other expense. That's basically just geography.

With respect to the investment income?

On net investment income there was a movement in capital. When we think about net investment income it's the spreads that you think of, so the 8 million is a reduction in the investment income that really (inaudible) to the bottom line of the company.

My question regarding Gibraltar is sort of a high-level one. It is this. It would seem that if one takes out the currency considerations and one looks at the company from a higher level perspective, what's happening with revenues, what's happening with premiums, what's happening with policy count and in force. It looks flat to me. Yet you reported on a yen basis, according to your new disclosure, it looks like 20% earnings growth. My question, I have sort of a two-part question. One, if you're losing policies still, although at a slower pace, if premiums are going down, if revenues are flat, why are you getting 20% earnings growth? What's driving that? And more broadly is Gibraltar going to be a growth company? Thank you.

On the premium line, Eric, the comparative period-over-period is impacted by the exchange rates that were in place quarter-over-quarter. And we're not providing sort of a constant exchange rate basis for those numbers.

Excuse me, Buddy. I'm looking on page 27 of the supplement, which is, I think, it's a relatively new disclosure when where you show Gibraltar Life (inaudible) that controls the currency, it shows revenue flat but at the same time and same date it shows earnings up 20%.

The revenue is flat and the earnings are up by the expense saves that we were able to demonstrate between the first quarter and the second quarter.

Okay.

And the one-time item. We had a one-time pension item in the first quarter of last year.

It cost us to terminate their pension. We also had a somewhat larger reserve catchup, if you remember my discussion of persistency being better, that is resulting in an improving earnings trend because the catchup this quarter was smaller than last. But, the total picture of Gibraltar is about flat, because it's an old book that has runoff. We're adding new business at what we think is a pretty healthy clip. And we're very pleased with what Gibraltar is doing overall.

Let me answer your question broadly on growth at Gibraltar. One, we should never forget when we made the investment, we said that at a minimum, this would be a superior financial return. And superior means north of 20% return on equity. And over time we would want to change it from simply a financial investment to one that provided growth opportunity. That really wasn't trying to hedge anything. When you take a $30 billion company that's been around a long time and hadn't grown in ten years, we knew that we could manage the financial risk, and we are getting a superior financial return. In my opinion, it's a little unfair to criticizes it as absent a strong growth capability, since we know that's not possible. For example, the sales are up substantially.

But when you're adding a couple hundred million in sales to a $30 billion balance sheet, it's a little hard to show double digit returns. Some of the drivers are good. Life adviser productivity is now at around four policies per adviser, which is very different than where it started when it was just above two, but not at the levels of seven or eight that we see in our life planner business. I would say over time, we would look toward single digit growth in this business as being a reasonable expectation. But it will come over time. But in the near term, we will continue to have a superior financial investment. And as we demonstrate our skills, to take a company like that, we would also be able to apply that skill should other opportunities arise as well.

Very helpful. Thank you, Art.

Thank you, Mr. Berg. Our final question today comes from Jeff Hopson with AG Edwards. Please go ahead.

Hi, just a final question on the variable annuity surrender, your sales are up but your surrenders are up a little bit. Anything unusual in there, and where would you expect that to level off?

I think the net sales at about 400 million is a good number, nothing unusual. I think we would view that as very positive, strong performance. Because remember, we do have an old book of business in Prudential that will run off and/or be replaced, because it's outside surrender charges and the like. But in general the net 400 million we view as a very positive number and certainly we would be very pleased if we can continue at those levels going forward.

Okay. Thank you.

Thanks.

Thank you very much, Mr. Hopson. With that Mr. Ryan and our host panel, I'll turn the call back to you.

Thank you very, very much for participating. We look forward to talking to you again at the end of the second quarter. Thank you.

And ladies and gentlemen, your host is making today's conference available for digitized replay for one week. It starts at 4:15 pm eastern daylight time May the 5th all the way through 11:59 pm May the12th. To access AT&T's Executive Replay service, please dial 800-475-6701. At the voice prompt enter today's conference ID of 723946. Internationally, please deal 320-365-3844, again, with the conference ID of 723946. And that does conclude Prudential Financial's earnings conference for this quarter. Thank you very much for your participation, as well as for using AT&T's Executive Teleconference service. You may now disconnect.