保德信金融集團 (PRU) 2004 Q3 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by. We appreciate your patience today and good morning or good afternoon. Welcome to the Prudential third quarter 2004 earnings conference call. At this point, all of your phone lines are muted or in a listen-only mode. However, later during the earnings release, there will be opportunities for your questions and those instructions will be given at that time. Just as a note, if you should require any assistance during the call, you may reach an AT&T operator by pressing star then 0 on your phone keypad. As a reminder, today's call is being recorded for replay purposes and we ask that you stay on-line at the conclusion of our conference to receive that replay information. Well, with that being said, let's get right to this quarter's agenda. Here with our opening remarks is Prudential's head of Investor Relations, Mr. Eric Durant. Please go ahead, sir.

Thank you, Brent. And thank all of you for dialing into our call. First of all, I want to assure you that our decision to release earnings on Election Day was not politically motivated, and we promise to be resolutely nonpartisan in our comments to you today. Our agenda will be familiar to you. Art Ryan and Mark Grier will share their thoughts on the quarter and some other subjects. And then we will take your questions. Joining us for the Q&A, in addition to Mark and Art, are Rich Carbone, Chief Financial Officer; Peter Sayre, Controller; and Dennis Sullivan, Principal Accounting Officer.

And now, just for a little break before we head into the program, forward-looking statements. In order to help you 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 third quarter of 2004, which can be found on our website at www.investor.prudential.com. 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. Adjusted operating income also excludes recorded changes in asset values that will ultimately renew to contract holders and recorded changes in contract holder liabilities resulting from changes in related asset values. The comparable GAAP presentation and the reconciliation between the two for the third quarter are set out in and our earnings press release on our website. Additional historical information relating to the Company's financial performance is also located on our website. And with that, I give you Art Ryan.

Thank you for joining our call. Mark will give you a full review of third quarter results in a few minutes, but first I'd like to highlight a few items. Earnings per share based on adjusted operating income increased by 35 percent in the third quarter. For the nine months, earnings per share increased 38 percent compared to the same period of 2003. These results reflect the actions we've taken to strengthen our core business while managing capital effectively. Return on equity for year-to-date reached 10 percent, compared to 7.6 percent for the first nine months of last year. These results continue to be burdened by transition costs, particularly in our financial advisory segment, which includes our interest in Wachovia Securities. These transition costs are running their costs and are expect -- and we expect the targeted expense reductions to emerge next year. We remain confident that we will achieve our 12 percent return on equity objective next year.

Our annuities business continues to benefit from the acquisition of American Skandia. The third quarter is the first period for which year-over-year results for our annuities business are comparable. American Skandia became part of Prudential in May of last year. And the business achieved a 23 percent increase in adjusted operating income. The American Skandia acquisition represented a $1.2 billion commitment of funds. On the other hand, our individual life insurance business has been able to demonstrate that less is more. One way is through expense reductions over the last several years. In addition, individual life insurance has reduced its required equity by roughly $600 million in the last year. That's nearly 20 percent. Thus, while adjusted operating income for the business has declined by 3 percent for the year to date, return on equity now exceeds the 12 percent level we consider appropriate for this business.

Third quarter results include a contribution from the CIGNA retirement business, which became part of Prudential on April 1. The contribution to earnings of 6 cents per share for the quarter is in line with our expectations. More importantly, integration of CIGNA's business is proceeding on schedule. Systems enhancements are scheduled to begin this quarter and to be substantially complete by the first quarter of 2006. Novation, which is the legal transfer of policy holder obligations from CIGNA to Prudential insurance entities began at the sponsor level in late August and is continuing. Thus far, positive responses have met or exceeded our expectations. In short, we are confident that the acquisitions of American Skandia and CIGNA, as well as that of Hyundai, will continue to contribute to Prudential's improving results.

In addition, we continue to use share repurchases to manage our capital. Through September, we have repurchased 1.1 billion of common stock under a current 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 repurchases 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 Prudential's 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. We received a ratings upgrade from A.M. Best in February, and as you may have seen, Moody's upgraded Prudential Insurance to AA-3 last month. We are gratified by these actions and they are good for business and they represent important third party validation.

Now I'll comment briefly on another recent development. Like other major insurance companies, we have received requests for information from regulators in connection with their investigations into payments to insurance and intermediaries and certain other practices that could be viewed as anti-competitive. We are cooperating fully with these inquiries. It is Prudential's long-standing policy to conduct its business in compliance with the letter as well as the spirit of all anti-trust and business practice laws. Clearly, manipulation of bids or quotes would be in violation of these policies. We are reviewing our affected business to determine whether there have been any violations. I appreciate that there is a great deal of public interest in these regulatory inquiries. However, in light of their preliminary and ongoing nature, we will not be providing any additional comments at this time.

Finally, I'll address our earnings guidance for the full year. We believe that Prudential will achieve common stock earnings per share in the range of $3.30 to $3.40 for the year 2004 based on after-tax adjusted operating income. This represents an increase for our most recent guidance of $3.15 to $3.25. This guidance includes expected changes to be absorbed within 2004 adjusted operating income -- excuse me, charges of approximately 35 cents per share relating to the combination of the retail securities brokerage operation and the integration of the retirement business acquired from CIGNA. A total of 21 cents per share of these charges has already been absorbed in results for the first nine months. The 2004 expectation also assumes stable equity markets over the balance of the year. Again, thank you very much for being with us, and now I'll hand it off to Mark.

Thanks, Art, good morning, everyone. Thanks for your participation this morning. I'll begin my remarks 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 92 cents for the third quarter compared to 68 cents per share for the year-ago quarter. These results are based on after-tax adjusted operating income, which includes the absorption of about 9 cents per share of transition costs relating to the combination of our retail securities brokerage business with Wachovia and includes another 2 cents per share of transition costs from our acquisition of CIGNA's retirement business. On the basis of adjusted operating income, the EPS increase is 35 percent. This was a strong quarter for us with contributions to EPS growth from our domestic and international businesses and a growing share of overall results from retirement and annuities. Now comprising nearly 1/3 of the quarter's adjusted operating income, compared to less than 20 percent in the first quarter of 2003 before our two major acquisitions. The headlines of our EPS increase for the quarter, are our first earnings growth in our retirement net annuity businesses, bolstered by the CIGNA retirement an American Skandia acquisitions. Secondly, more favorable mortality compared to a year ago in both individual and group life. And thirdly, continued strong results from our international businesses.

Before I get into the business discussions, I'd like to mention two items that benefited our reported results. Mortality for both individual life and group life was within the range we've experienced in recent quarters but in both cases, in the favorable part of that range. This is similar to the result we had in the second quarter. If we were to compare this quarter's experience with our average expectations, the benefit would equate to about 4 cents per share. In addition, while our expected tax rate for adjusted operating income remains at 30 percent for the year, we had a favorable catch up of tax liabilities in the quarter, which equated to a benefit of about 3 cents per share.

Now I'll review our business results for the quarter. I'll start with the insurance division. Our annuity business reported adjusted operating income of $96 million, up $18 million from the year ago quarter. The third quarter of last year was our first full quarter of reporting American Skandia results, so the quarters are now comparable and the increase in adjusted operating income reflects the growing contribution of our combined annuity business. Results this quarter in the annuity business benefited from higher asset-based fees, tracking both market appreciation and nearly $1 billion of variable annuity net sales over the past year. And increased spreads on general account products, reflecting both higher portfolio yields and credited rate reductions earlier in the year. Our gross annuity sales for the quarter were $1.4 billion, including $175 million from fixed annuities reflecting a product we introduced earlier this year in the bank channel. The quarter's gross sales were down 5 percent from a year ago, tracing a slower level of retail activity and to some degree impacted by our focus on the integration of the Prudential and American Skandia administrative platforms. Our completion of the administrative platform integration in October marked the last major milestone of the overall integration progress.

Adjusted operating income from our individual life insurance business was $101 million for the current quarter, up $26 million from the year-ago quarter. The increase was essentially driven by improved mortality experience compared to a year ago. Sales in individual life insurance, excluding coally [ph], amounted to $101 million in the current quarter, a 44 percent increase from $70 million in the year-ago quarter. Most of the increase came from universal life, reflecting the market's current emphasis on that line and the traction of our products, which we updated in June of last year to include more flexibility of guarantees as well as survivorship policies. We also enjoyed a 25 percent increase in variable life sales and an 8 percent increase in term. Nearly all of our sales growth in the current quarter came from the third party distribution channel.

The group insurance segment reported adjusted operating income of $48 million in the current quarter, up $18 million from the year-ago quarter. The increase was driven by improved life claims experience. Our disability claims experience continues to be less favorable than our targeted level, mainly due to a slower pace of claim resolutions than we would like to achieve. We expect our recently-opened disability claims office in Portland, Maine, to reach its full staffing level this month, expanding our claims-handling capabilities.

Turning now to the investment division, in total, the business we acquired from CIGNA contributed $55 million to the investment division's adjusted operating income for the third quarter. The integration of this business remains on track with no major surprises. Since the acquisition brought us about $28 billion of propriety assets to be managed by the asset management segment, it is contributing to the adjusted operating income we report for both retirement and asset management. The retirement segment reported adjusted operating income of $94 million for the third quarter, including a $46 million contribution from the CIGNA business. The segment's original retirement business reported adjusted operating income of $48 million for the third quarter, up $9 million over last year. With benefits from both improved spreads and higher asset-based fees.

We are starting to see a benefit in structured settlement sales from the AM Best upgrade of Prudential Insurance from A-plus earlier this year, and expect that the Moody's upgrade to AA-3 in October will also be a positive for our retirement business. The asset management segment had adjusted operating income of $58 million in the current quarter, up $16 million from the year-ago quarter. The segment's current quarter results include the remaining $9 million contribution from the CIGNA business as well as greater asset-based fees from rapped fee and managed account programs as we took on administrative responsibilities under agreements with Wachovia.

The financial advisory segment had a loss of $76 million in the current quarter as we continue to absorb retained costs and transition costs related to our retail securities brokerage joint venture with Wachovia. The segment essentially broke even a year ago. Our 38 percent share of the results of Wachovia Securities resulted in pretax income of $28 million before transition costs. This compares to $47 million a year ago and reflects lower retail investment activity. The segment's results absorbed expenses of $39 million in the quarter from obligations and costs we retained in connection with the attributed businesses, primarily from retained litigation and regulatory matters, as well as $59 million of transition costs. After absorbing the total of $98 million in these retained and transitioned costs, the retail securities brokerage operations reported a loss of $70 million for the quarter.

Turning to the international insurance and investments division, the international insurance segment reported adjusted operating income of $239 million for the current quarter, up $24 million from $215 million in the year-ago quarter. The segment's results included adjusted operating income of $100 million from Gibraltar Life in the current quarter. In last year's third quarter, Gibraltar contributed 104 million, including $9 million from a true-up of our estimated liability for the Japanese guarantee fund. Stripping out the true-up last year, Gibraltar's results for the quarter are $5 million ahead of a year ago, reflecting the benefit of a strengthening yen. Gibraltar continues to enjoy stronger persistency than we expected and its block of business has been essentially stable for several quarters, with growing premiums on new business replacing the attrition associated with aging of the $30 billion block of business we acquired. We are adding new business with overall margins comparable to and in some cases greater than the acquired business. Sales from Gibraltar Life, based on annualized premiums in constant dollars, were $64 million in the current quarter, compared to $77 million in the year-ago quarter. The apparent decline in sales came from a drop in sales of single premium business, reflecting a credited rate cut that we implemented on savings-oriented policies last year. Stripping out single premium business, Gibraltar's constant dollar sales for the quarter are $55 million, an increase of 15 percent from a year ago. Gibraltar's life advisor count declined by about 130 in the third quarter, reflecting some expected attrition of lower producers as we completed our phase-in of minimum production requirements.

Our life planner business, the international insurance operations other than Gibraltar Life, contributed $139 million of adjusted operating income in the current quarter, up $28 million from the year ago quarter. Foreign currency fluctuations had only a minor impact on 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, life planner sales in Japan, based annualized premiums, were $102 million in the current quarter, up from $97 million a year ago. These reported sales figures include single premium business, which is fairly limited at Prudential of Japan but does distort the comparison this quarter. Excluding single premium business, life planner sales in Japan increased 9 percent for the quarter to $101 million, roughly in line with the percentage increase in life planner count, which tracks our historical experience.

Also on a constant dollar basis, sales from other countries were $48 million in the quarter, compared to $51 million a year ago. Our sales outside of Japan mainly reflect our operations in Korea, where we've taken a number of our best life planners into agency management as part of our expansion of the agency system this year. We've opened a total of 23 new agencies in Korea during the first nine months of the year, including 6 more in the third quarter, bringing the total number of agencies in Korea to 77. While we continue to feel some negative impact on sales from the economic downturn in Korea, and from the redeployment of many top life planners, there has been a historically strong relationship between life planner growth and sales. And our expansion of the agency system is intended to help continue that growth.

The international investment segment reported adjusted operating income of $13 million for the quarter, up $5 million from a year ago. Our acquisition of Hyundai Securities earlier this year contributed $16 million of adjusted operating income in the third quarter, in line with our expectations. This was partly offset by lower results from the segment's legacy businesses. Turning now to corporate and other, corporate and other operations reported adjusted operating income of $55 million for the third quarter, compared to $32 million a year ago. The current quarter's results include seasonally strong adjusted operating income of $42 million from our real estate and relocation business, up $13 million from a year ago on the strength of greater transaction volume and home sale prices. Current results in corporate and other also included a $13 million quarterly benefit from a new Medicare program, which will defray our costs to provide prescription drug benefits to eligible retirees on a continuing basis. This program started to benefit our results in the second quarter.

Now I'll shift to net income. Net income for the Financial Services Businesses was $548 million for the third quarter, compared to $220 million in the year-ago quarter. Current quarter net income includes two line items outside adjusted operating income that we introduced in the second quarter. These line items essentially capture interest rate-driven changes in assets and liabilities relating to the experience-rated retirement business we acquired from CIGNA. This amount, this quarter -- I'm sorry, the amounts this quarter a $208 million pretax increase in net income from asset value changes and a partially offsetting $100 million decrease from liables reflect the retreat of interest rates from the second quarter. These adjustments will behave much like the unrealized gains and losses we record under FASB Statement No. 115, except that they are in GAAP net income and excluded from our adjusted operating income. Realized investment gains before taxes were $38 million in the current quarter after related adjustments. These gains were net of impairments and credit-related losses, which were insignificant in the quarter amounting to just $14 million. Our gross unrealized losses on fixed maturities stood at $429 million at the end of the quarter, almost entirely on investment-grade securities and essentially interest-rate-related. Noninvestment grade fixed maturities comprised just 6 percent of the financial services businesses' fixed maturity portfolio at the end of the quarter.

And briefly on the Closed Block, the results of the Closed Block business are associated with our Class B stock. The Closed Block Business reported net income of $180 million for the current quarter, compared to $77 million 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 $270 million of pretax realized investment gains, compared to gains of $119 million in the year-ago quarter. Turning back to the Financial Services Businesses and summing up, our domestic results benefited from the growing contributions of our annuity and retirement businesses, strengthened by the acquisitions of American Skandia and CIGNA Retirement. Favorable mortality and the insurance division's protection businesses was also a positive for the quarter and our international businesses continue to produce solid results. Thank you for your interest in Prudential, now we look forward to hearing your questions.

[Operator Instructions]. Jason Zucker, Fox-Pitt.

Good morning, thank you, everyone. Couple of questions for you. The first, I just wanted to start with international and, Mark, you mentioned life planner sales being up around 9 percent excluding single premium. Is that in line with future expectations? And does sort of a high-single low double-digit sales number, is that going to produce low to mid-teen earnings growth? And then the second question I had is just more of a numbers question. Are we going to -- should we expect to be getting 2005 EPS guidance at your investor day?

Jason, this is Eric Durant. Let me take a stab at your first question. The 9 percent growth in sales was for Prudential of Japan, X-ing out the impact of single premium sales, which tend distort things, even though Prudential of Japan sells very little single premium life business. That 9 percent rate of growth is in line with the growth in life planners for the year-to-date of also 9 percent. And is consistent with our historical experience that sales and life planner growth rates are highly correlated. It continues to be our expectation that that will be the case. But I -- I don't think I'd be too bold to say that over time we would hope that the growth in life planners in Japan, off of a very high base would be low double-digits, and that in the entire life planner system, the rate of growth in life planners would be greater than that.

I think, though that the general comment of the overall life planner system, if you look at high single digit, low double-digit, which would translate into mid-teens kinds of earnings growth because of the higher margin associated with those business, that's probably not unrealistic in terms of what we would talk about.

Right.

Second, yes, we would expect to provide guidance on 2005 at the investor day conference.

Terrific. Thank you.

Nigel Dally, Morgan Stanley.

Great, thank you. First question, just on interest rates. If interest rates remain unchanged, should we be concerned at all about potential spread compression? Or do you still have ample capacities to further reduce crediting rates? Second, on pensions, similar sort of question. Can you discuss the impact of low interest rates and challenging equity markets on the outlook for pension earnings? Thanks.

On the first one and then I will refer the second question to Rich Carbone. The -- the answer is if the rate environment stays where it is, we should be fine. We've said before that we would benefit somewhat from gradually rising rates, but we're okay in terms of both asset opportunities and crediting rate opportunities. Rich, do you want to comment on --

Sure. On the lower rates, we have -- we haven't disclosed it yet, we will talk about it investor day. We have lowered our yield assumption on pension asset earnings, which will lower pension income going forward. As you know, every -- every 25 basis points reduction in the assumed pension yield is about $25 million in pension earnings.

That's very helpful. Thank you.

Pension earnings are $91 million a quarter.

This quarter.

A quarter this year.

Saul [ph] Martinez, Bear Stearns.

Hi, I just have a question on -- on variable annuities, the variable annuity sale decline, you mentioned that the systems conversion distracted you a little bit in terms of your variable annuity sales. What do you think you need to do in terms of either product features or distribution to get that sales number back on track? And my second question is regarding Gibraltar Life, excluding single premium sales, sales were obviously up nicely year-over-year. At what point do we start to see an inflection point in terms of some of the other indicators like sales force, face amount, number of policies. How close are we getting there?

Let me take the first one. The annuities is really -- it was three factors. One, you've seen it pretty much across-the-board in the industry, a slow down in annuity sales. I think that was partially due to the stock market and few other related activities. Our case was impacted, as you correctly mentioned, by -- basically freezing our systems back in the summertime, in order to allow us to complete the final phase of the American Skandia integration, which was the systems conversion. Which we successfully completed early in October. In terms of going forward, this is a highly competitive industry. I think our opportunity is to continue to look at growing in channels where we historically have been small. We certainly have our fair share of the independent financial advisor channel. We clearly have our own captive distribution, but we historically have been behind in both the bank and the wirehouse channels, and given the changes we made a year ago in terms of the combination with Wachovia Securities of our own retail broker, we now will have opportunities to grow more aggressively, especially in the wirehouse, but also in the bank channel. You might note the growth in our fixed annuities, that was principally through the bank channel or joint venture with Wachovia. We will stay competitive on product features along with everybody else, but I think our real growth opportunity is to grow in channels where we've been historically small and we will get our fair share going forward. I'm cautiously optimistic that we will do quite well in the annuity business going forward.

In terms of Gibraltar, we're making good progress. In terms of the headcount on our life advisors, we would hope in the very near future we would see that the downward trend would be reversed and we would begin seeing modest increases in the agency count. So, to answer your question, we're just about there in terms of the agency side. And remember, most of the attrition has been driven by us. We set higher productivity standards and right now our productivity in Gibraltar is above 3.5 policies per agent per month, while not at the life planner level, and we said we would never get there. That's 50 percent higher than what the industry has, so, again, we're getting very close on the productivity numbers we're looking for and our persistency numbers are strong, in fact, stronger than we had anticipated when we made the acquisition. So, I would say in 2005, we ought begin to see the improvement around those drivers that we talk about in our other businesses in the Gibraltar activities as well, which gives us great confidence to say we not only have an outstanding financial transaction, but the opportunity to have a business where we can make a significant impact in terms of what historical trend had been and compete with the new distribution system. So, it's a long haul to turn around a company that's as old as Keyway [ph] was, but I think we're just about there on all of the key drivers.

Okay, very good. Thank you.

Colin Devine, Smith Barney.

Good morning, gentlemen.

Good morning.

I had a couple of questions. First, perhaps we can talk a little bit about international. Certainly I recognize the earnings gain, but if we take out the currency impact, earnings growth it seemed to be slowing a bit. Is that a trend we should continue to expect? Secondly, if we might talk a little bit more about the -- I guess particularly defined contribution, but perhaps also the defined benefit business. When will we see -- do you expect to see flows turn positive? I know you commented that what we're seeing is within your expectations. I just want to know what your expectation is for when flows are going to go positive. And Art, if memory serves me correctly, your demutualization lockup expires this December. I was wondering if you might comment on that and your long-term strategic outlook for Prudential?

Let me ask Mark to talk a little bit about the retirement. I can comment on that, as well. But go ahead, why don't you comment.

Yeah, I think the -- the broad theme here is that we had anticipated in everything we've communicated about the outlook for the retirement business that there would be a shock lapse experience as we go through this year and next and that we would really expect to be getting back on track as we get out a couple of years. Without getting a lot more specific than that, what we've been saying, which is still true, is that we're very much within our expectations and very comfortable with lapse on sales results in this business. And, again, consistent with what we've told you guys to expect in terms of the performance of the business. So, yeah, I guess the short answer to your question is we think it's a couple of year process, but we're very comfortable with where we are in that process.

Yeah, I think on the international life, I'm not sure, we might have to see what numbers you're using, but if you look at the life planner business, the impact of foreign exchange was only about $3 million. The yen was clearly stronger, but the wan was much weaker and so the net effect was 3 million. So, I don't see any deterioration in the earnings growth potential of our life planner model or in -- international insurance in general.

In terms of your final question: Yeah, the three-year lockup period that is over, but that's probably not getting very much attention by anybody at this point in time. Obviously, I feel quite comfortable on the outlook. First is our objective that we set at the time of demutualization to achieve our 12 percent ROE in 2005, and as I mentioned in my comments, I'm quite confident about achieving that objective. And at our investor day in December, we hope to spend a great deal of time talking about beyond '05 in terms of what the expectations are, but at this point, I think the business repositioning gives me a great deal of comfort. We all know the strength of the international insurance business that we have. I think our positioning now in the retirement and annuities market in the U.S. is second to none. And I feel very, very comfortable with it and the support that we get out of the life insurance business in terms of the stability, the cash and the other aspects, while achieving excellent ROEs. I like our business positioning and I like some of the business that we were once in that we're no longer in. I like them from the point of view that we're not longer in them. And I don't have to watch the Weather Channel everyday in terms of property and casualty. So by and large, I feel pretty good about about the business mix. I think we're on track for our short-term objective, and as I said, I hope in December to speak in even greater length about why I feel comfortable about beyond 2005.

One quick follow-up, with the Moody's upgrade, I believe you also got a AA-minus from Fitch. Am I correct then you're back in git [ph] business now with two of the major rating agencies having you back in the delay range full-time, you don't really need the upgrade from S&P, if it comes, it's a bonus, but it's not going to impact your ability to compete there?

You know, once you get a little bit, you get a little greedy. So yeah, we'd like to see it across the board, but there's not question that we've begun to see improved opportunities in our git business already, especially in the area of structured settlements, you might have seen. Already we've seen that. We're pretty comfortable that we got what we needed and we certainly hope that S&P follows, as well.

Thank you very much.

Suneet Kamath, Sanford Bernstein.

Hi, thank you. Two quick questions. First, if you could talk a little bit about your capital structure and maybe how much more flexibility you have that front in terms of levering up the balance sheet? And then second, again on the defined contribution business, another competitor discussed yesterday some aggressive pricing in that business. I was wondering if you could talk about what you're seeing, you know, in sort of the smaller spaced market for DC. Thanks.

I think that in the first case, our leverage ratio at this point is about 13 to 14 percent. 14 percent is what my colleagues are telling me. We said that we could go as high as 20 percent and still meet all of our financial targets in terms of quality of the balance sheet and the -- the overall leverage ratio. That's about $1.7 billion. That would still be available there. In terms of the retirement market, since we've done so much business in what I'll call the large case market and the mid-case market, we've seen price competition a lot. And so I'm probably not the best person to answer the question on the small case market, but my sense is is that everyone is looking long and hard at employee costs in this market, whether you're a small business, a mid-size business or a large business. You know, given the escalation of healthcare costs and some of the issues that certain companies might have around pensions. So, it wouldn't surprise me. But for most of our retirement activities, we have seen a lot of price competition and we think that more and more it's going to go to those who can provide not only strong pricing capability by having scale and lower costs, but also can offer additional capabilities and more and more where I believe that the scale players are likely to be the long-term winners in this business and not the smaller niche players.

I want to add a small comment to Art's response to your question on capital position, just to give you a -- a more complete response. We also, as you know, estimate the excess equity in our individual businesses and I caution you to think of these as dynamic numbers and not numbers that are unchanged from period to period. And our best estimate of that amount is between 800 million and 1.3 billion. So, if you were to do what we always tell you not to do and add up the untapped borrowing capacity with the excess equity, you'd get somewhere between 2.5 billion and 3. But please don't do that.

I will not. Thanks for the detail.

Andrew Kligerman, UBS Securities.

Good morning. I wanted to just follow up a little bit on the group operations, particularly group disability and the 92.5 percent benefits ratio. Do you think that the solution to these claims resolution issues is just the -- the addition of this Portland, Maine, office to -- to fix things up, or is there more to that? So, I guess the question is can you give us a little more color on what's going on there? What the problem is and if you think with, you know, by next year you'll be content with your claims ratios.

Yeah, I don't think there's any question in this. We talked about it in earlier quarters that we got behind in terms of claims resolution. As we've said, it's not necessarily a change in the pattern on claims, but that we need to improve the speed with which we resolve these particular claims. The opening of the new center in Maine was a significant step in that direction. We've really only recently been fully staffed in that area, so I think your comment about into next year, early next year, we would begin to see some improvement there. We're still quite comfortable, that's the answer to the problem we've had there. We would expect as we go through 2005 to continue to see improvements there.

And are you comfortable with the pricing environment in that product area?

Well, I'm always challenged in terms of the pricing in that area. As you look at our book of business, you can see a much higher percentage in the group life side than in the group disability side and I think that really reflects the buying behavior in the market and our belief that it ought to be a smaller percentage of our business than it might be if it were stand-alone, if you will, separate from what we do in group life. Even on the sale side, you can see that we did have an increase, but they were basically add ons to our existing business. So, we look at it, you know, very, very closely. The low interest rate is always a challenge for that business and so I approach it with a level of caution that I have talked about and I think that's reflected in the overall mix of our business.

Thanks, Art.

Tom Gallagher, Credit Suisse First Boston.

Hi. A couple of questions, first, just as a follow-up on Eric's excess equity capital comment. Does that include Aoba and expected share repurchase? In other words, if we look ahead to by year-end, would that number come down by $500 million?

No, it would not come down by $500 million, but we don't disclose the inner workings of that. I think Eric mentioned a range. The range is 2.5 to 3 billion. Aoba really has no impact on the excess capital position. We're going to use equity over in the international businesses. The buybacks will have some impact.

I mean I think, you know, if you take the direct arithmetic, he did mention the 800 million and the 1.3 billion in the range, and Aoba is $180 million, so, part of that is there. But you've got to remember we'll be generating earnings as well. Which do have an impact in terms of the excess capital. So, we will continue to redeploy it, but that basically represents the sources. The uses, obviously, are a combination of doing an Aoba or stock buybacks. So I'm not sure I would do the direct arithmetic, but your general sense is correct. And that's what we're looking at is put that capital to work in higher-returning activities, which hopefully are acquisitions or in those cases where they're not effective returns in the stock buyback program and yes, we expect to continue the stock buyback program at the levels that I've described.

And Art, just related to buyback, your comment that that number should be a base case. I presume that won't end in '04. In terms of that qualitative comment.

Yeah. As a qualitative, I do not -- we have not yet had board authorization. We go to the Board regularly on this, but yes, in terms of qualitative comment that would be my expectation that it would continue into 2005, as well.

Okay. And just one question on kind of thinking about the glide path of earnings here, I guess for Rich, I know you have restructuring costs from Wachovia and CIGNA running through the P&L. How much of the expected expense savings that you will get from those transactions is reflected in this quarter's earnings? Is most of it on the come in '05? Or do we have a fair part of it that's already reflected in current periods' expenses?

Some of it is reflected in current periods. That would be in your normal operating income. But the overwhelming majority of it is in 2005.

Great, thanks.

Vanessa Wilson, Deutsche Bank.

Good morning. Art, last year at your December conference you were talking about competition in the life insurance market and we weren't seeing a lot of momentum in your life sales at that point. You did comment that you got new products out. I thought those had been introduced prior to the December meeting, and I was just wondering what has changed that you feel more comfortable about life insurance competition and pricing?

Well, I still think the competition is very strong and the pricing is very, very aggressive. But I think the biggest difference is us being able to grow in the third party channel. As you're well aware in the history of Prudential that was not an activity that was pursued. That Prudential had its own captive agency system and that was where its sales were done. Over the last few years, in addition to improving the product, we've really focused our activities to both our own captive system from a productivity point of view, and that still remains a significant part of our ongoing strategy, but all of the growth has come by increasing our share in third party. Even though the products are a bit over a year now, that's a very competitive channel. It takes time, you earn your way in. I don't think you simply introduce a new product and start getting sales, whether it's in the larger groups like the M group or some of the other channels on the third party side. So, I would reflect it much more as our ability to be competitive but get a fair share of the third party channel, which historically we never did.

And, Art, is there anything you've done with reinsurance or with the off shore captive or in the capital markets that has helped you with your returns in pricing?

Yeah, we talked about how much capital we've freed up in individual life. 600 million was mentioned, and that's been a big contributing factor to the improved ROE. And that does reflect use of reinsurance as well as capital market solutions to managing certain reserves.

And just one final question, on the -- the kind of lumpy net investment income that you get in the corporate line, could you give us a sense maybe this quarter, what was the -- what kind of assets is throwing off the income? And what kind of returns did you see this quarter?

Lumpiness is created by equity pickups in JVs. The remaining assets are some dividend income and assets on fixed income securities. The lumpiness is from JV equity pick-ups.

These are what I would call legacy assets back to the mutual days that we moved out of the different businesses and for no other reason have, captured them in the corporate account. Economically, they're very, very fine assets, but they don't produce ongoing or what I would call regular income patterns so that's where the lumpiness comes from. Certainly over time that will disappear, but for the foreseeable future we will have some of that in volatility and we preferred it in the corporate account, and in the business in terms of doing that, but these are good assets and they return money to our company.

And Vanessa, your question suggests I may have misled you last night. Investment income was not a significant variance item for corporate and other, year-over-year, and a link quarter basis, it actually declined by $6 million from the second quarter, which is still not that much. So, it really hasn't been that important a factor in the mix for us recently.

Thank you.

Jeff Hopson, A.G. Edwards.

Hi, good morning. Just to hit on the Wachovia joint venture again, just to make sure I understand this, there hasn't been any change relative to initial expectations in both the amount -- the timing and the amount of income and expense savings that you expect to see in 2005. Is that right?

No, not at any significant amount. I think that in the last earnings report of Wachovia Corporation, they made the comment that a very minor part of the integration costs could spill over into 2005 as it related to systems conversions. We've obviously discussed that and if it is a spill over it will be minor. In terms of the absolute savings, they are right on target for what we had announced when the deal was done. And in terms of overall costs, they're about on target, maybe a little bit lower than when the deal had been done. So, right now we continue to express strong confidence that this will occur. Obviously the proof in the pudding is delivering next year on these savings.

Very good, thank you.

Ed Spehar, Merrill Lynch.

Thank you. Good morning. A few quick questions, I was wondering if you look at your retirement business in total and you look at your share in the various markets, do you have any idea of what type of short-term sales boost or opportunity you will have if you just get your fair share, however you want to define that, of the ratings sensitive institutional spread based sales? I mean, is there sort a sales and a margin opportunity as buyers of these product would like a new name that they could have?

Ed, it's Mark. Certainly there's an opportunity for us with an upgrade to be more active in this market. Part of it is just a fresh name. Part is our own circumstance, where relative to what you would consider market standards, our balance sheet is light in some of these spread products. We will pursue a measured growth strategy here. The upgrades are helpful and we do expect to do more, but we're focused, as you might imagine, very heavily on returns and profitability and we're also very focused on the asset opportunities and making sure that in terms of both yield and credit, we're consistent with the policies that we've set that -- that manage our business the way we believe it should be managed. So, the answer is yes, it's a good opportunity and we anticipate measured growth here, subject to profitability and the availability of appropriate assets.

And then just two quick follow-ups. I'm wondering, on the international investments piece, if we think about sort of a normalized earnings level here and we think about Hyundai, is it reasonable to think that you're sort of targeting like you have with other international acquisitions, like a 20 percent kind of return? And then maybe if we look at the other earnings there, which I know have been lumpy, but maybe if they've stabilized and improved somewhat, for everything else that you have there, is that something that might be a 20 to $40 million pretax, kind of normal contribution, you know, above whatever you get from Hyundai? And then just statutory numbers, I was wondering if you could give us statutory operating earnings after tax for both the quarter and the year-to-date? Thanks.

I'll take the statutory earnings question because it's the only one I can answer. We haven't filed yet so we'd rather not give you a number that's subject to change still.

When do we file?

When do we file, Dennis?

As soon as we file, obviously, we would make it available, but I think our practice has been not to discuss it until we've had the chance to file it to ensure that there are no changes as we complete the process. In terms of the first one, first, I think that the return targets that I've set for international investments tend to be in the mid-teens to the high teens. So, it's roughly in the range that you had spoken of there. Obviously the challenge is when you recognize those particular returns, which is why it's not really possible for me to talk about a specific earnings number. The difference here as opposed to insurance, is twofold. One, the gestation period on the investment business tends to be much shorter than the gestation period on the life plan of business. On the other hand, the acquisitions we've made in the life insurance side as opposed to life planner, have tended to be underperforming businesses that we got at very good prices that we can turn around because of our own experience pretty quickly. That's a long answer to say that '05 and '06 would be periods where we would expect to see stronger reported earnings out of international investments, over and above Hyundai. And the discipline in terms of meeting those targets will be applied as rigorously there as we've done with the other domestic businesses, and that's if we don't meet the targeted returns in reasonable periods of time, we will stop doing it. So, I would expect to see more than just Hyundai in '05 and '06 and that, as I said, would be subject, again, to the targeted returns of the mid teens to high teens.

Thank you.

Joan Zief, Goldman Sachs.

Great. Thank you. I feel like I won the lottery. [ Laughter ]

No, George Bush does.

Well, we are glad to have someone be so happy to get to ask us a question. [ Laughter ]

Here's my question. You talked about feeling comfortable about your business mix, you've made these acquisitions, you now are in areas, whether it's international, retirement, where there is, as you say, opportunities. My question is do you think you're the right size to really be able to take advantage of these opportunities, take advantage of the growth? Is it ultimately -- are you ultimately going to be capital constrained relative to the size of the markets that you're really attacking, and you see the opportunities in?

Well can you know, size is always an interesting question, as you well know, Joan, in terms -- especially the Financial Services Businesses, where you look at other parts of the business where signs -- size seems to have no end. If you look at the banking side, I guess we can now target 2 trillion balance sheets as opposed to simply $1 trillion balance sheets. But I still go under the assumption that you've got to have the quality and the consistency of the earnings and the market position and not simply size as a barometer for success. So, if you start with our businesses, I do believe that we are in the most attractive aspects of the grow and protect portion of the economy, namely the retirement side, the annuity side, as well as insurance and investments. The asset management piece, so I like that positioning. If you look at what we're doing in terms of generating earnings, our earnings are growing faster than we need the capital to support the businesses that we have. So, the likelihood of us ever being capital constrained is pretty low. As it relates to, I'll call it modest to medium-size acquisitions. Obviously, if you were to do a major acquisition and you would have to use stock as opposed to cash, you better have really good valuations associated the return as opposed to continuing to buy back the stock or using it in other ways. I think the key for us is that we have that discipline. It's hard for me to forecast what will or will not happen, but to specifically answer your question, no, I feel no capital constraint at the present time and I don't expect to feel any given the high margins of the businesses of which we're in.

I have just have one quick follow-up. Your equity security units are going to, I guess expire or whatever they do in November. Is there any guidance on how I should think about that from the share count in the fourth quarter?

Yes. I'll ask Rich to do that for you.

Yes, it's a little complicated, so I just want to take you through how it worked. Throughout the year we've used the Treasury Stock method to calculate the diluted effect of the ESUs. So for for the first 3 quarters of the year, there's been about 5 million shares in the share count for calculating EPS. Okay? In the fourth quarter, for the first 45 days, those same 5 million shares stick in, but get diluted by half, okay? Then the rest of the quarter you're going to have the full impact, the additional 15 million shares. Net-net, the increase in shares outstanding for computing earnings per share for the quarter will be 7.5 million shares.

And then when I go into first quarter, it's the full --

15.

The whole 15 million.

15 in the first quarter.

Okay. Thank you.

Thanks, Joan.

And thank you very much, Ms. Zief. And ladies and gentlemen, your host is making today's conference available for digitized replay for one week. It starts at 4:15 p.m. Eastern Standard Time, November 3, all the way through 11:59 p.m. November 10. To access AT&T's Executive Replay Service, please dial 1-800-475-6701 and at the voice prompt, enter today's conference I.D. of 737448. Internationally you may access the replay as well by dialing 320-365-3844. Again with the conference I.D. of 737448. And that does conclude our earnings call for this third quarter. Thank you very much for your participation as well as for using AT&T's Executive Teleconference Service. You may now disconnect.