保德信金融集團 (PRU) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Prudential third-quarter 2005 earnings call. At this point all the participant lines are in a listen-only mode. However, there will be an opportunity for your questions and instructions will be given at that time. (OPERATOR INSTRUCTIONS) As a reminder, today's call is being recorded. I would now like to turn the call over to Mr. Eric Durant, Head of Investor Relations. Please go ahead.

Thank you, John. Good morning and welcome to Prudential's third-quarter earnings call. Art Ryan and Mark Grier will begin with prepared comments then we'll address your questions. Joining us for the Q&A are Rich Carbone, CFO; Peter Sayre, Controller; and Dennis Sullivan, Principal Accounting Officer.

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 third quarter of 2005 which can be found on our website at www.invester.prudential.com.

In addition to 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 that investment gains and losses other than those associated with terminating hedges of foreign currency earnings and current period yield adjustments and related charges and adjustments as well as results from divested businesses. Adjusted operating income also excludes recorded changes and asset values that will ultimately inure 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 our earnings press release on our web site. Additional historical information relating to the Company's financial performance is also located on our web site.

And here is Art Ryan.

Thank you, Eric, and good morning. In a few moments Mark will review third-quarter results in detail. But first I want to provide an overview of the quarter. I would characterize our results this quarter and for the year to date as strong. In the third quarter we had a 57% increase in earnings per share based on adjusted operating income and each of our divisions is performing well. In particular, I would highlight strong sales results in annuities and international insurance as well as the continued good performance of our recent acquisitions.

As all of you know, Prudential has had a long-standing goal to achieve return on equity of 12% this year. The year is not over but our ROE through September is 13% so obviously we are encouraged. Our increased financial returns reflect underlying improvement in the capabilities and performance of our businesses. We believe we are well positioned to help our clients to grow and protect their wealth.

Our continuing focus on expense and productivity management as well as on disciplined capital management support our improving returns and strong strategic positioning.

Within the broad savings and retirement market, the business we acquired last year from CIGNA is performing well. Integration is on schedule for completion early next year. Retention of business continues well within expectations. Earnings from the acquired business for the year to date before transition costs are consistent with our expectations.

Last March our annuities business introduced a new generation product, The Lifetime Five living benefit guaranty. Excellent market acceptance of Lifetime Five has driven a sharp increase in our variable annuity sales and market share which achieved a new high during the quarter according to a well-known survey. In addition, our annuities business continues to take measures to expand distribution especially in the wirehouse channel where we have historically lagged.

Domestic protection businesses, individual life and group insurance are also performing well. Each focuses on profitable growth and maintenance of appropriate returns. In the third quarter, for example, results in individual life again benefited from a reduction in cost structure. For the first time sales from third parties exceeded those from our agency system.

Our Asset Management business continues to enjoy particularly strong results. Growth in assets under management reflecting appreciation and excellent flows is driving increases in asset based fees. We are a leading manager of commercial real estate investments principally for institutional investors and market conditions in this asset class have been especially favorable lately.

Finally our international business continues to excel. The Aoba block of business which we acquired last November has enhanced the already strong earnings performance of our life plan of business. In addition, our businesses in Japan have benefited from improvements in their investment spreads resulting from actions we have taken to restructure their portfolios.

Now I'll turn to capital management. We estimate that our excess capital including untapped borrowing capacity now exceeds $3.5 billion. This estimate factors in the reduction in our tax liabilities from completion of an IRS examination as we first disclosed in our 8-K last week. On the other hand our estimate makes no provision for possible inclusion of preferred stock in our capital structure.

Our strong capital position means that we are able to pursue opportunities to improve Prudential's business and financial performance but we are committed to doing so in a highly disciplined way. As for acquisitions, we are interested only in those that make business as well as financial sense.

We also use share repurchases to manage our capital. In the third quarter we repurchased $623 million of common stock. While we will review purchase or repurchase activity with the Board regularly, we believe that repurchases of roughly 625 million per quarter is a realistic base case for Prudential at this time.

Finally, I'll update our earnings guidance for the full year. We now believe that Prudential will achieve common stock earnings per share in the range of $4.85 to $4.95 for the year 2000 based on adjusted operating income. This represents an increase from our earlier guidance of $4.50 to $4.60. This guidance reflects our consideration of a wide range of circumstances including seasonal patterns and lumpy expenses. In addition, our guidance assumes stable equity markets over the balance of the year.

Now I will turn it over to Mark.

Thanks, Art. Good morning everyone thanks for joining us. I'll start with an overview of third-quarter results for the Financial Services Businesses. We reported common stock earnings per share for the Financial Services Businesses of $1.46 for the third quarter compared to $0.93 per share for the year ago quarter. These results are based on after-tax adjusted operating income and amount to a 57% increase in EPS.

This was a very strong quarter for us with core earnings performance from each division contributing to the EPS increase. Now that our most recent major acquisition, CIGNA's retirement business, is more than a year behind us, our quarterly results are essentially comparable between years and the organic growth of our business is starting to become more visible in our results. Our current quarter results also benefited from several items that are of a non-recurring nature or may be unsustainable. Before I get into the business discussions, I'd like to go through these items.

In the annuity business, we had a net favorable unlocking of DAC, other amortization items and our reserve for guaranteed minimum death benefits which contributed about $0.08 per share. Income from our commercial mortgage operation within the Asset Management business was especially strong in relation to the average of recent quarters adding $0.03 per share. Mortgage prepayment income in the retirement business contributed $0.02 per share. An additional $0.02 per share came from mortality more favorable than our average expectation in our individual life business and in our international insurance businesses, reductions in our liabilities for the Japanese guaranty fund and reserve refinements (ph), contributed another $0.02 per share.

In addition we had a slightly lower effective tax rate in the quarter than our full-year expectation which is between 30% and 31% which contributed another $0.04 per share. In total these items contributed about $0.21 per share to our current quarter results.

Transition costs are not a major item this quarter amounting to $0.01 per share for the integration of CIGNA's retirement business. We don't expect significant integration costs in the remainder of the year.

Now I'll review our business results for the quarter, starting with the insurance division. Adjusted operating income from our individual life insurance business was $120 million for the current quarter up $19 million from a year ago. The increase came essentially from lower expenses reflecting actions we initiated late last year to reduce headcount and occupancy costs in our Prudential agent distribution system. Both the current quarter and year ago quarter benefited mortality better than our average expectation. We recalibrate these expectations annually on a calendar year basis looking back over five years of experience.

Individual life and the other insurance division businesses review their policy experience and assumptions annually with completion of the review generally targeted for the third quarter. For the individual life business this review resulted in an increase of about $90 million to DAC amortization. This was largely offset in the change in reserves which we include in insurance and annuity benefits in the income statement.

Sales excluding COLI amounted to $103 million in the current quarter compared to $101 million a year ago. We are continuing to emphasize cost effectiveness of our Prudential agent channel while growing third-party distribution. With attrition mainly of lower producers, the Prudential agent count has declined from just under 4000 a year ago to about 3200 at the end of the current quarter while the productivity of the remaining agents has increased 16% from a year ago. Sales by Prudential agents declined $8 million from a year ago reflecting the reduced headcount.

On the other hand sales through the third-party distribution channel increased more than 20% over the year ago quarter resulting in an overall sales increase for individual life.

Our annuity business reported adjusted operating income of $161 million in the third quarter compared to $96 million a year ago. Current quarter results included a $57 million benefit from the DAC unlocking I mentioned earlier. The unlocking came mainly from two factors. First, more favorable actual and expected death claim experience than our earlier expectations resulting in a decrease in our reserve for guaranteed minimum death benefits. And second, the benefit of our investment portfolio and crediting rate actions on the profitability of the fixed income portion of our annuity book of business.

Stripping out the unlocking, current quarter results were up $8 million from a year ago benefiting from growth in asset-based fees, tracking market appreciation together with more than $800 million of positive net sales of variable annuities over the past year.

Our gross variable annuity sales for the quarter were nearly $2 billion, up 53% from a year ago on the continued strength of a major new product feature we introduced in March, our Lifetime Five Living Benefit which combines a lifetime income guaranteed with the flexibility and control of principle offered by guaranteed minimum withdrawal benefit products.

The group insurance segment reported adjusted operating income of $60 million in the current quarter, up $12 million from a year ago. The increase came mainly from group disability and reflected a benefit from updating claims reserves based on the periodic review which I mentioned earlier.

Group insurance sales amounted to $47 million in the third quarter down from $72 million a year ago when we recorded two large case disability sales.

Turning now to the investment division. First, the retirement segment reported adjusted operating income of $110 million for the third quarter, up $16 million from a year ago. The business we acquired from CIGNA contributed $43 million to current quarter segment results compared to $46 million a year ago. Results for the current quarter and the year ago quarter each include absorption of $11 million of integration costs. We are nearing the final stages of the business integration and are on track for completion by the first quarter of next year.

The full-service stable value products we offer are a major competitive advantage for us especially in relation to noninsurance companies. Substantially all of these products are experience rated, meaning that we can pass investment experience through to customers by crediting rate adjustments. In addition, these products have low crediting rate floors and are generally subject to semiannual rate resets. Our skills and asset and liability management especially in the management of private placement fixed income securities and commercial mortgages allow us to offer an attractive value proposition to clients on a product that provides us with favorable returns.

However, we have to consider competitive factors as well as contractual features in setting crediting rates on stable value products. When there is a relatively flat yield curve as we have seen this year, alternatives such as money market funds that reflect short-term rates are more competitive with our stable value products. We increased crediting rates on some of these products in the current quarter and this was largely responsible for the modest decline in earnings.

The retirement segments original retirement business reported adjusted operating income of $67 million for the third quarter, up $19 million from a year ago. This increase reflects $15 million of mortgage prepayment income included in current quarter results. The remaining increase reflected improved results on our defined contribution business. The segment, including the CIGNA business, had gross sales of $4.4 billion for the third quarter, bringing sales for the first nine months to $13.5 billion.

Net sales moved to the positive column for the quarter with lapses on the business we acquired from CIGNA continuing to be well within our expectations and guaranteed product sales benefiting from a $500 million contribution on a single case.

The asset management segment had adjusted operating income of $116 million in the current quarter, up $58 million from a year ago. Our asset management business is continuing to benefit from a strong commercial real estate market. The increase in adjusted operating income came mainly from our commercial mortgage operations which had nearly $800 million in securitizations during the current quarter and none in the year ago quarter. And from growth and asset based fees which benefited from market appreciation over the past year.

The financial advisory segment had adjusted operating income of $31 million this quarter compared to a loss of $76 million a year ago. Our 38% share of the results of the Wachovia joint venture resulted in pretax income of $59 million.

Now that the integration of the retail brokerage businesses is complete. transition costs are no longer a factor in quarterly results. This quarter's $59 million of pretax income compares to $28 million a year ago before transition costs with the $31 million increase reflecting increased fee income and the achievement of a lower expense structure in the joint venture.

Segment results for the current quarter absorbed expenses of $22 million from obligations in costs we retained in connection with the contributed businesses, our former PSI retail business. Results for the year ago quarter included $39 million of these expenses as well as $59 million of transition costs.

Turning to the international insurance and investments division. The international insurance segment reported adjusted operating income of $358 million for the current quarter compared to $239 million a year ago. The segment's results included adjusted operating income of $141 million from Gibraltar Life in the current quarter, up $41 million from a year ago. Gibraltar's current quarter results benefited by about $10 million from a decrease in our estimated liability for the Japanese guaranty fund. The remaining increase came mainly from improved investment income margins reflecting strategies we implemented to lengthen maturities and increase Gibraltar's U.S. dollar investments. In addition, results benefited by $6 million in the comparison from the translation of yen earnings at a more favorable exchange rate.

Sales from Gibraltar Life based on annualized premiums and constant dollars were $83 million in the current quarter, up from $68 million a year ago. The increase was driven by a recently introduced U.S. dollar-denominated fixed annuity product which contributed about $20 million to current quarter sales. This product has targeted returns consistent with Gibraltar's overall product portfolio and is attractive to a substantial portion of Gibraltar's customer base making it an excellent complement to the protection products that are the main focus of the life advisers.

On a constant dollar basis, the insurance revenues we report for Gibraltar including premiums, policy charges and fee income amounted to $688 million this quarter, an increase of $113 million from a year ago. This is largely the result of our application of a policyholder dividend under the terms of Gibraltar's restructuring in 2001 to provide policy credits. Since this is offset in policyholder benefits, there is no net impact on our adjusted operating income.

Gibraltar had more than 5300 life advisers at the end of the third quarter, up nearly 600 from a year ago. Most of the increase came during the current quarter and reflects two bimonthly recruiting cycles as well as an increased pace of recruiting in comparison to earlier quarters. We believe the expansion of our sales force will help us take better advantage of the opportunities in Gibraltar's market especially the Teacher's Association.

Our life planner business, the international insurance operations other than Gibraltar Life, contributed $217 million of adjusted operating income in the current quarter, up $78 million from a year ago. Current quarter results included decrease in our estimated liability for the Japanese guaranty fund and reserve requirements on newer products for a total benefit of about $10 million. The remaining increase of $68 million came mainly from two drivers; business growth, reflecting a 20% increase in constant dollar insurance revenues including the contribution of the Aoba business we acquired late last year. And enhanced investment income margins which benefited from portfolio strategies similar to those we implemented at Gibraltar. In addition, our life planner results benefited by $7 million in the comparison from more favorable foreign currency translation.

Sales from our life planner operations based on annualized premiums and constant dollars were $177 million in the current quarter, up 16% from a year ago. The increase was driven by our growth in life planner count which is up 9% from a year ago and the continuing popularity of U.S. dollar-denominated products which we introduced earlier this year that combine a protection element similar to our whole life policies with a retirement income feature.

Current quarter sales benefited from customer purchases in anticipation of a premium rate increase on our retirement income products. While there are fluctuations in sales from quarter to quarter due to product introductions, rate changes and other factors, when viewed over time, our life planner sales have broadly tracked our growth in the life planner count.

The international investment segment reported adjusted operating income of $26 million for the quarter, up $5 million from a year ago driven by stronger results from our asset management business in Korea.

Turning now to corporate and other, corporate and other operations reported adjusted operating income of $47 million for the third quarter compared to $54 million a year ago. Corporate and other operations include our real estate and relocation business which contributed $43 million of the current quarter adjusted operating income essentially unchanged from a year ago.

Let me comment now on net income. Net income for the Financial Services Businesses was $1.3 billion for the third quarter compared to $548 million a year ago. Net income for the current quarter includes a benefit from reduction of our tax liabilities due to the completion of an IRS examination as we disclosed in an 8-K last week. The total contribution is $720 million with $692 million of that amount outside of adjusted operating income.

Realized investment gains before taxes were $80 million in the current quarter after related charges and adjustments. Impairments and credit related losses were insignificant in the quarter amounting to just $22 million.

Our gross on realized losses on fixed maturities stood at 547 million at the end of the quarter with the vast majority on investment-grade securities and essentially interest rate related. Non-investment-grade fixed maturities comprised less than 6% of the financial services businesses fixed maturity portfolio at the end of the quarter.

And briefly on our closed block business. The results of the closed block business are associated with our Class B Stock. The closed block business reported net income of $42 million for the current quarter compared to $180 million a year ago. We measure results for the closed block business only based on GAAP rather than adjusted operating income. The decrease from last year reflects a lower level of realized investment gains.

Turning back to the financial services businesses and summing up. The insurance division is benefiting from reduction of the cost structure in individual life and the growth of our annuity business is contributing to results. In our investment division, the integration of the retirement business we acquired from CIGNA continues on track with client retention well within our expectations. And our investment in the Wachovia joint venture is contributing to results with the business integration now complete. Asset Management results are continuing to benefit from a strong commercial real estate market.

Our international businesses reported a significant earnings increase for the quarter with continuing growth of our life planner insurance businesses together with increased investment income margins reflecting our implementation of portfolio strategies. And the strong results from our domestic and international businesses were complemented by several items, all positive, of a nonrecurring nature that added to reported results for the quarter.

Thank you for your interest in Prudential. We look forward to hearing your questions.

(OPERATOR INSTRUCTIONS) Jason Zucker with Fox-Pitt Kelton.

Great, thank you and good morning. A couple of questions. The first I wanted to focus on the individual life expenses. They have been running at around 200 to $215 million a quarter. And I was wondering whether or not you could comment on whether that number could continue to move down as we've seen year-over-year?

And then the second question, you know it appears now that you're going to hit your 12% 2005 ROE target. Would you be willing to discuss the next set of targets that will influence management compensation?

Let me take the second one first. We should correctly point out the performance shares that are part of the long-term comp for the 30 most senior managers in the company do reflect a return on equity target. We would expect to continue to include return on equity targets in that compensation formula. And over time to introduce earnings per share increases as a complement to return on equity as we achieve consistent performance in the 12 to 14% range which is what I've talked about in the past.

So we will look at both -- I think ROE was very, very important when we started because we were at such a low level. We were at 4 or 5%. We still consider it to be extremely important and we will continue to include it and we will as I said over time be adding other market measures like earnings per share in order to justify or validate the compensation that is paid.

We'll lay that out at the end of each year as we normally do in terms of what the specific targets will be for the ongoing years. But as I said in the past, our consistent or long-term objectives are 12 to 14% ROE range and double-digit growth in earnings per share. And I don't anticipate any significant changes from those expectations.

In terms of the expenses, the likelihood of us having substantially reduced expenses is not high. That is a positive. I mean if you look at our life insurance business in the United States over the last five years, we've taken out over $500 million in expenses. But we will continue to manage aggressively expenses in productivity. As I've talked about, I don't believe there is substantial growth necessarily in the near term in life insurance unlike retirement, annuities and international. And therefore the watchword around return on equity disciplined expense management and productivity will continue as we go forward.

Thank you.

Saul Martinez with Bear Stearns.

Good morning. I have two questions as well. On the capital front, you've in the past highlighted the prospects of perpetual preferred securities as management and you highlighted it again this morning. Can you give us an update as to what you are thinking there? Are you waiting for some of the new tax deductible technologies or would you rather issue debt to fund buybacks at this time given your still low leverage capacity?

And my second question is just on M&A, can you give us an update on your views on the M&A market? You've been a little bit cautious in the past in terms of M&A opportunities. But do you see any opportunities out there in particular lines of business or geographies?

Let me first talk about the perpetual preferred. I mentioned the perpetual preferred because when I gave the estimate of excess capital, we did not include that when we talked about having in excess of 3.5 billion. Our preference to date and will continue to be to use the lowest cost of capital available first which in our case is debt. And then we can consider shifting to hybrids for various capital needs. So that will continue to be our game plan. So we do not have any immediate plans to issue a perpetual at this point in time.

In terms of the M&A front, as you correctly pointed out, there has been a resurgence in the market over the last years; prices are higher, so we had not made acquisitions as we did in the United States with the acquisition of Skandia and CIGNA and the like over the prior few years. I think there are numerous opportunities out there but again the pricing has to be consistent with our return objectives.

In the areas that we will look are the ones that I've always talked about. We will look in the retirement space. We will look in the annuity space and of course we will look in the life insurance space as well. But again, it has to meet both those business objectives but importantly, the financial hurdles we've set.

I say that because I have a great deal of confidence in our growth capabilities with what we have now so I don't feel a need from a scale point of view or other measures to make an acquisition that is not both a good business and a financial deal for us.

Outside of the United States, we would continue to look in the markets that you are familiar with where we have a strong presence, namely in Asia, possibly in Mexico. And again there it is very, very difficult to predict what will become on the market. Fortunately we have a strong presence in each of those markets as well as others and we will respond accordingly. So a long answer to a short question. We are opportunistic. I have no particular deals in mind at this point in time.

Thanks a lot.

Suneet Kamath with Sanford Bernstein.

Just one question on the CIGNA retirement business. I calculate these at a normalized third-quarter ROEs -- that's excluding the transition costs at around 7%. I know your goal is to get to 12. Can you get there just on cost savings or do you need some help from sort of this steepening yield curve given the stable value product? And if the yield curve does steepen, how quickly can you reposition your bond portfolio or adjust those crediting rates? Thanks.

Well, I think the 7% is understated. I think (technical difficulty) the reported number in the segment that would call the CIGNA retirement business. What you are excluding is the asset management side of it. If you look at the earnings we have in the asset manager, remember when we bought the CIGNA business we took the operating component and put it in the segment we call PRIAC but the assets that we -- were part of the deal were put in our asset management. If you add those two together, you'd probably get a lot closer -- in fact you would get a double-digit return on equity for the first nine months of 2005.

What that excludes are certain other costs like corporate overhead that are built in there that would not normally be in your deal calculation. And as I said, we still have some additional savings to do. And of course we have some money we're spending as we want to come out of a box in order to improve our sales. Your 7% number I think is low. The correct number to date is a double-digit around 10%. And yes, we do expect to get in all-in 12% return after we complete all of our activities.

Is that 12% in the current interest rate environment?

Well, as best as I can see it. I mean obviously I'm not going to talk about an inverted yield curve or a perpetually flat yield curve as being able to sustain return. Spreads are tight so under normal conditions, yes, I think that is about we have. I'd have to go back and look at what deal parameters we looked at when we first gave the number. But I think we're talking basis point differences. In the aggregate, yes, we're talking about a 12% return.

Colin Devine with Citigroup.

Good morning, gentlemen. Obviously evidenced by the stock price this morning it's pretty tough to find fault with the quarter. But, Art, if we look at the year, I don't know what the opposite of a perfect storm is but it seems everything has gone perfectly right this year. And perhaps we can talk about from your perspective maybe what's not going right. Give us a bit of an update on Korea from where we stood a year ago. That strikes me that maybe things there haven't quite developed the way you planned or perhaps as fast as you had. That may not be fair.

Can we also then, the second question, talk about capital management? You know, it was a great idea buying your stock from where are (indiscernible) your company at 2750 but obviously today it's a much different picture. Does that still make sense or is time to really focus on the dividend?

And then, Mark, can we talk a bit about what is happening with the exchange rate on the yen? I appreciate your hedge for this year. I appreciate your hedge for the next year. As we now look toward '07 and what's driving increased (ph) earnings with what 30% give or take coming out of Japan. Clearly the weakening in the exchange rate is going to have an impact on your earnings.

Okay. Let me try and answer the first question. I mean as Mark correctly pointed out in his detailed review, we had very, very strong solid results, good results, very good results in our businesses. And we did benefit from non-recurring events all of which happen to be positive in the quarter. I think as a generalization you are probably right for most of a year.

My answer to that is we don't attempt to mix or mingle nonrecurring events with ongoing performance. In fact we try to go out of our way in both our 10-Q, in this analyst call to make sure that everybody clearly understands the difference between the two. Part of it is to highlight that we do and are comfortable with our earnings growth in terms of the core business. I don't make any excuses for that. I feel very good about that. But I think everyone is wise enough and smart enough to know the difference that periodically you get nonrecurring events and you are right -- we've had a lot of good ones.

But I think our underlying plan is what is working. I mentioned earlier I like our business mix. I like the growth in our return on equity and as I've said many times, if we grow at market rate in each of our businesses, we will just automatically move in that 12 to 14% range. So I'm comfortable with the growth patterns and what we have and the numbers are the numbers. And I think you know as well as I do how to analyze them -- probably better than I do.

In terms of weak spots, I don't we have any weak spots but there is no perfect storm in the sense of using your phrase. Korea has been an enormous competitive market. We do very, very well in Korea. We are growing our life plan but right not at the same level we did in the past and it's mostly competition. We also expanded the number of agencies and we're simply not going to sacrifice quality there in terms of improving agent recruitment when there is that much competition.

You've heard me say in the past, sticking to our business model is more important than what might happen in any given quarter. But I'm very comfortable we're going to continue to have enormous success in our life planner business in Korea. I might add that on the investment side, the Hyundai acquisition is actually performing somewhat better than we had thought. So I think our Korean franchise is very strong and I think we'll do quite well there.

I'll let Mark talk about capital management and dividend.

Good morning, Colin. Thank you. As you know the broad picture for us on capital management is moving toward what we call the market standard or more efficient capital structure. And we've made heavy use of share buybacks in order to get ourselves on that trajectory. The management of the dividend has reflected earnings considerations more than capital considerations and things like fixed cost coverage at the parent company level. And while we recognize it at this level of the price, there is some book value pressure from the share repurchases. We believe that overall we need to stay on track to get to a market standard, lower cost capital structure. And for now, as Art said, we anticipate maintaining the basic share buybacks.

However, as we've also said before, we review this quarterly with our Board; we review it more often internally and in real life we would love to be investing this in our businesses. So subject to the qualifications around opportunities and returns and business positioning, we are trying to do the right thing on the capital structure and still prefer to invest it in the businesses if we can.

On exchange rates, a couple of comments. One is that we have done a material amount of dollar based investing which will mitigate the impact of the exchange rate changes that you are looking at. Forward rates have also not moved as much as spot rates and that is really the arena in which we determine the rate that we'll be translating our foreign earnings in the future. But overall over time the direction of the dollar obviously is sort of going against us. But it will take a while to work through.

Collin, if I may just circle back very briefly to your question on Korea. While we are not now enjoying the exponential growth in earnings that we had until last year I should point out that through September the ALI (ph) for Korea is 123 versus 106 last year. So they are up 16% and the sales are also up by more than 10%.

Thanks. One quick follow up. Perhaps we could comment, there was really no comment made on the retained legals (ph) (technical difficulty) through securities. To be candid, I wasn't totally satisfied with the explanation last quarter as to why it jumped up so much out of the blue. I'm equally somewhat mystified as to why it has dropped down so much this quarter. Can you give us some update as to what is going on there and are we getting closer to a final resolution of this?

There is really nothing new to report which is why we didn't have anything in this particular quarter to reflect on that. We continue to work with all of the regulators. You as well as I would like to see a final resolution but we only go as fast as people want to move. So we continue to work with them. I would certainly hope in the not too distant future we would have a resolution but there is nothing new to report at this point, Colin.

Nigel Dally with Morgan Stanley.

Great, thank you. Firstly, international. Investment income was particularly strong on the back of your portfolio repositioning strategies. Are these changes now complete or should we expect some further pickup in investment income from continued repositioning?

Second, while your asset management results were very strong, one blemish continues to be the net redemptions to mutual funds which deteriorated again this quarter. I was hoping you could discuss what could be done to help turn that around?

Let me take the second one and then I will ask Mark to talk about investment income. If you look at our overall asset management business, we are principally an institutional asset manager when it comes to public securities, namely equities and bonds. Obviously we have highly differentiated position the non-public securities, our private placements are number one, our commercial mortgage activities, our principal investing in real estate. If we are not number one, we are certainly among the leaders in those markets.

So the principal area for our public management -- for the management of public securities is in the institutional market. We have a mutual fund capability that we think is good but not really top tier. And we manage it accordingly. They principal reason for the outflows is really the dependence of the mutual fund business on one distributor, namely the Old Prudential securities. As you know in today's environment, it not only is not possible to have a bias toward proprietary, I would argue that in most retail brokerage networks, there is a bias toward -- away from proprietary to the other extreme. So the outflow is really coming from some of the old business that we had to that was principally sold when we owned Prudential securities.

There actually is some very positive flows coming as we expand our distribution which in the past we were not able to do because we had direct ownership of the brokerage channel. It is not unlike what I've talked about earlier why we have been under representative in the other wirehouse channels. We talk principally about the annuity product but it is equally true of the mutual fund product.

As we expand our capability there we will over time see improvements in that business but in the near term, we would expect to see outflows because of the dependence on one channel. This is a business that provides quite attractive returns even though as I said, we would not be viewed in the multi hundred billion dollar mutual fund business. We are a smaller player but it (technical difficulty) complements our institutional business. It builds on the strength of very strong asset management capability in both our public equity as well as our public fixed income.

And so while outflows normally bother me as much as they bother you, in this case I understand what they are and I'm reasonably comfortable as we rebuild our capability there in other channels.

On the investment income question, Nigel, though, the short answer is that we would expect to continue to see marginal improvements, but not on the order of magnitude that we've seen over the past 12 months. Just to give you a quick snapshot. At 40,000 feet what has been happening here has been the lengthening of maturities, particularly with respect to the Gibraltar and Aoba portfolios but also the Prudential of Japan portfolio. And that reflects a starting point that in the case of both Aoba and Gibraltar was a result of their circumstances meaning being sold in one case and going through bankruptcy in the other in which they were very liquid.

There were at a lot of opportunities to make portfolio changes there after the shock lapses and the resolution of the future if you will in those two companies. We also have had an appetite for dollar based assets there because of the capital we have deployed in those markets so we've been able to use that capacity to improve yields by investing in dollar-denominated assets.

Going forward there are a couple of things. One is we will continue to focus on asset mix. We can't move these portfolios as quickly as we might like but we will be improving spreads by improving the amount of spread assets that are on these books.

And secondly, erratically higher interest rates are also at least working their way through the system and will continue to have a positive benefit. But the main things going forward will be around asset mix and the level of rates and to the lesser extent around the opportunities to extend maturities and make broad changes in asset mix.

That is great. Thank you.

Tom Gallagher with CSFB.

A couple of questions. First is just a follow-up on the Japanese portfolio yield. So, Mark, if we think about I guess as you invest new money at higher yields whether it be in additional dollar-denominated securities or longer duration yen, how much do you see the overall portfolio yield trending up? And where do you think we kind of top out? I guess we're what a little over 250 now. Do you have another -- are we talking 10 basis points? Do you think there's another 30 if we think out a year from now? Just as you look at -- assuming interest rates don't move a lot from current levels.

That is a little more specific than we get in our contemplation of where earnings are going to go. We will be talking about guidance on investor day in about a month and you will all of our expectations reflected in those numbers.

Okay. I guess the next question is really on international sales. I guess you've had a mix of protection and retirement products now with more recently on the retirement side. Can you talk about how the sales mix has been trending? And is that fair to say when you look at the 18% sales growth number this quarter, do you feel like that is a fair apples-to-apples comparison or is that number somewhat skewed by the mix here? And what adjustments would you make to try and make that a better apples-to-apples comparison?

Right now the protection -- remember the product we are talking about has a retirement rider associated with it. It is protection insurance. That was about 25% of the sales in the third quarter. And even there you saw on a third quarter was down somewhat from the first and second quarter. And that really dealt with the price increase toward the end of the second quarter and normally when you see that you're going to see a run-up in sales.

One of the interesting things that we try to look at or I look at is the fact that you always want to be introducing new and competitive products, certainly in Japan that is that case. And I think that is not dissimilar to Lifetime Five as we start annuities in the U.S. I would be quite surprised if there's not a competitor reaction that raises the hurdle on what happens next in any and all markets.

I tend to look at these sales numbers in two different ways. One I correlate them to our growth and life planners and productivity which I think over time is a reasonably consistent way or consistent measure for ascertaining and it takes you out of the new product introduction quarter to quarter swings that go on. And then second to look at it over as I said a multi-quarter comparison; year-to-year tends to be a little bit better.

The 18% sales growth is that that's reflecting around about a 10% sale growth in life planners. We do look toward mid double-digit range on an ongoing basis for increase so it's probably not that far off but for any particular quarter I'd have to go to what products have been introduced? What the current mix is? And as I said, that gets down into a more detailed level that obviously we look at but I'm not sure it's particularly helpful if you want to look at the business. Look at the growth in life planners and look at the sustained growth in productivity and that tends to give you the comfort level on what we can sustain over time in terms of our life insurance sales. But it will be affected various quarters based on new product introductions, changes in prices and the like that goes on in the marketplace.

And just one last question. Any planned new product launches in Japan? Are you still on the sidelines with regard to variable annuities or would you consider getting involved there?

We are still on the sidelines. We periodically look at the product but at the moment we don't think it's a product that is priced in a way that makes everyone happy, the customer, the distributor and the manufacturer. So we remain on the sidelines.

Thanks.

Jeff Hopson with A.G. Edwards.

Good morning, two questions. First in Japan, if we assume the economy is in fact improving there, any thoughts on impact over time to sales recruiting, competition, etc.? And then two, with the variable annuities and the increased penetration in the wirehouse area, can you give us an update on how effective you've been so far? How much more upside and sales potentially could receive from just the wirehouse channel?

In terms of the Japan, the competition. The competition is always strong in Japan. The domestic players while not necessarily global in their reach are quite competitive inside of Japan. And in many cases have different return aspirations frankly than we do. But historically we have done well. Currently we do well and my expectation is we'll continue to well for the simple reason we have a different business model. And so while Nippon Life and Daichi and each of those players are very strong competitors, it's our business model and namely the life planner model that gives us confidence that we can produce superior sales results, higher productivity, higher persistency and therefore continue to have strong results in Japan.

Similarly in Gibraltar while that is much closer in terms of its business model to what these strong domestic competitors have, one in 50% of our sales come from "affinity groups", namely those teacher's association where we had a unique capability to deal with the product offerings that we make to that particular group around Japan. So it is really a function of whether it's strong market or a less strong market. It's the business model that is the difference not the underlying economy that is going to drive our competitive capabilities in that market.

In terms of variable annuities in the wirehouses, we clearly have upside. We have begun to make penetration in those and we would certainly look for increased sales as we go forward. But here again as I mentioned in my earlier comments, these are very highly competitive markets. We as I said introduced Lifetime Five. That was a very, very competitive product and has sold particularly well in the IFA, or the independent financial adviser channel. As we grow and the wirehouse and we keep our products competitive, we certainly expect to see growth but we don't expect the strong competition that is in those businesses to simply walk away and give us the business.

The answer is it is not a significant part of our sales at the moment. It will continue to grow. It takes time to penetrate. The folks that are in those channels are good. We have to offer a very good reason why people should take our product versus theirs. But it certainly gives us some optimism about future sales growth.

Great, thank you.

Vanessa Wilson with Deutsche Bank.

Thank you, good morning. Could you talk a little bit about basically where we are with the yield curve today? Have you seen -- you've certainly had a wealth of good news on a number of areas here but have you seen underlying pressure from where the yield curve is? And now that rates are starting to tick up, what is the magic level that you'd like to see on the ten-year? Is it 5%, 5.5% where you will see new money rates at an attractive level for your spread businesses?

Vanessa, it's Mark. Good morning. As I mentioned in my comments, we are feeling some pressure in the stable value product area and I would just refer back to the same things I said there which is the flattening yield curve and level of rates are putting some pressure on earnings.

Excuse me, Mark. Isn't that in the shorter end though? The stable value business?

Well, the duration of the assets is a bit further out the yield curve. So it really is a mismatch there between in a way competitive rates in the market which are defined more on the short end and the asset strategies that we pursue against those products. Having said that though, I think the broad picture for us is one of being extremely well diversified in terms of the various economic influences on us; equity markets and spreads and the level of rates and mortality and expense profits among other things.

We are not extremely sensitive to any one part of that risk picture but to get back to the point there is pressure in terms of the shape of the yield curve and frankly narrow credit spreads. Spreads are still pretty tight and we do a lot of spread based investing. So if spreads are around 90 or 100 basis points are a lot tighter for us than spreads around 120 to 130 basis points. So those things are at the margin negative but again, we overall are managing through the whole environment pretty well.

In terms of the magic level of rates, gradually higher rates are good for us. We will have stickier liability prices than we will have asset yields. But we don't have a particular level in mind in terms of where we would like to see the ten-year. A steeper yield curve is better and gradually rising rates are better.

Thank you.

And wider spreads are better.

Thank you.

Tamara Kravec with Banc of America.

Thank you. Good morning. A few quick questions. First on the asset management and I apologize if you already addressed this. But the net cash flows that you are seeing on your RAP fee (ph) products, those have really been running about 2.8 billion now for the last three quarters. Do you think that is sustainable going forward?

And then quickly on your headcount, just looking at the number of Prudential agents obviously you mentioned that is declining and your life planner business is growing nicely. Where do you see those counts really settling down? Do you see Prudential agents dropping below 3000 and where are you happy with your amount of your life planners?

The RAP fee (ph) -- it's always hard to predict the future but we're pertinent pretty comfortable with the business model that we have. The platform that we have is very, very powerful and attractive. We've renegotiated the deal with Wachovia and it extends to life there and we're growing it in other channels as well. So that's probably as good a number as any that you might want to look at in terms of being reasonably consistent performance over time.

In terms of the headcount, on agent count in particular, this is where I always look to grow. So certainly in the life planner channel, we certainly want to continue to grow at the rates that we have seen in that past. It is hard to have the high double-digit rates but certainly high single, low double-digit is very important to us in life planner growth. Importantly you saw a nice take up in Gibraltar Life advisers in the third quarter. We had switched from a quarterly hiring pattern to one that was bimonthly, I guess. That is very, very positive. We are one of the few that acquired a distressed old line Japanese Company that has been able to sustain the business and more than sustain it, grow it. Albeit not at the same rates we do our life planner. Bt that is extraordinary performance and one that should give people a lot of comfort in terms of a quite sizable business in terms of our ability to grow it.

Domestically the challenge for us has always been in terms of the quality recruiting and quality retention, the retention numbers are too low. And therefore we do not go through the exercise of hiring lots and lots of people to sustain a level that is not profitable. So, I know how to keep a level number of agents. If I continue to recruit as long as my recruiting get ahead of my folks who are leaving. But there is a more important number and that is what is the return on investment for the recruiting? And that is why we've had somewhat lower recruiting numbers. Until I see further improvement not only with ourselves, in fact we are ahead of the industry -- but in terms of the industry as a whole. This is a tough time in terms of captive agency systems within the business.

So I don't have any particular number in mind. I want it to grow but it's going to grow profitably and if it does not grow because we are maintaining margin and maintaining our discipline then that will have to be the outcome.

So you are right. We have three different scenarios. We've got our life planner business that is growing rapidly around the world. We've had strong success in life adviser in Gibraltar and we've been challenged in the United States relative to our ability to grow the captive agency system. Obviously the earnings answer to that is why we've seen enormous growth in a third party system so our life manufacturing capability is still quite strong.

Eric Berg with Lehman Brothers.

Thanks very much and I guess it's time to say good afternoon. It's a little after 12. Excellent quarter. I have two questions, one related to retirement and one reference to Mark's comments, we will refer back to Mark's comments about share repurchase. When I look at your retirement business in the funds flow, it strikes me that the trend there is essentially the opposite of what is happening at one of your largest competitors, Principle (ph). They have a solidly positive defined contribution business; solid positive cash flow and yours is still running cash flow negative. They say they can't grow their business because of the low level of interest rates, and your guaranteed product business is growing very nicely.

I mean obviously you will talk to the extent that you would like to about that other company but it's just curious to me if you have this growth business here, we're more than a year after the acquisition of CIGNA -- acknowledging this is a great success you're having almost everywhere in your business. I'd nonetheless like to know why aren't the cash flows positive yet in defined contribution? And how are you growing in this low rate environment, the guaranteed products area when some of the others say it can't be done?

Well, I think there are two answers. And obviously you are right that unnamed competitor is an excellent competitor, a fine company. In terms of the negative, I think you have to look at the whole issue of acquisitions. It is extremely difficult if not impossible to grow during a major acquisition when you're going through integration. Let's use the annuities for example. We had no growth in the first year after we acquired Skandia because we were putting systems together. We didn't have a lot of time to bring the newest products out because you wanted to make the deal work because there was a lot of money involved.

As soon as we got out of that mode and were able to get back into a pure growth mode, I think our performance is rather impressive. I think you're going to be equally impressed over time with our performance in the retirement business. But in the near term, our focus is on making the integration work. There is always a natural outflow during any change. Remember the clients have to novate over to our platform. We just can't move them. They have to approve. I think we've had extraordinarily good success in both the sales and the outflow given our relative positioning. When we finish the integration early next year and as we then focus all of our attention on growing the business, I think over the intermediate outlook the next few years I think you are going to be quite impressed with our performance. So that doesn't surprise me and it is naturally the way we would do it.

On the other hand on the get (ph) business remember we were a single A company for a long period of time. And only recently did we get the AA so we had so much capacity there relative to everybody else. It would be natural that we would see some growth there and profitable growth. And I'll let Mark add onto that a little bit as well.

Yes, just a couple of headlines on that. One is we're not doing anything that doesn't meet acceptable return standards. We have a highly disciplined and opportunistic approach to this so we're not on automatic pilot for growth sake. We're only doing things that meet our return hurdles.

Secondly, as Art mentioned, the upgrade has impacted this business particularly in structured settlements which are not quite the same as the pure Capital Markets wholesale liabilities that fund a spread portfolio that you may be thinking of.

And thirdly, in this quarter we had a $500 million contribution to an existing contract from a particular client. There was also one lumpy even in there. But we're pretty comfortable with where we are. As Art said, we have a lot of capacity and we're not doing anything that doesn't meet our hurdle rate of return.

Thanks, that was very, very comprehensive and helpful. Mark, here is my one follow-up question for you. In the question about share repurchase at the current stock price and the dividend, you referenced your desire at Prudential to have the right capital structure, most efficient capital structure and the lowest cost of capital. But doesn't -- with respect to all this -- doesn't everything else the same -- doesn't continued share repurchase to the extent that it leverages up the Corporation necessarily lead to a higher cost of capital rather than a lower cost of capital?

No. We are trying to lever up the corporation. Our debt to capital is about 15% today and our AA benchmark is about 20%. We've come up from about 6% when we went public. And you can think of it as at the margin substituting a lower cost of capital instrument meaning debt for the higher cost of capital that is associated with equity. Our capital structure continues to be a drag on our return on equity and we've had a major objective since we went public to move toward a market standard competitive efficient capital structure.

Very good. Thank you very much.

Joan Zief of Goldman Sachs.

Thank you. Here is my question that relates to the new earnings guidance. I understand that there is seasonality and lumpy expenses in your business as you move into the fourth quarter. But I guess I wanted to ask you why don't you think the momentum that you are seeing in the international business, the better investment income, the sales, your ability to maintain the significant buyback program, your cost savings, I mean why don't you think that would be enough to offset the seasonality that you would expect normally in the fourth quarter?

Again, I believe that if you take what Mark had said on the $1.46 and we said there was about $0.21 of nonrecurring items. And you take the high end of our guidance, you're talking about $0.05 a share. We know that we do have some seasonality in the real estate and relocation business and we also know that there are other opportunities in the second half of the year in terms of advertising and the like in terms of causing some lumpy expenses. So I don't think it should signal lack of any enthusiasm about the ability of our underlying businesses to perform. But more reflect all of the circumstances I've described and my best guess, Joan.

Okay, thank you.

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