保德信金融集團 (PRU) 2006 Q2 法說會逐字稿

Good morning, good afternoon, and welcome to Prudential announcing their second quarter 2006 earnings conference call. At this point we have all of your phone lines muted or in a listen-only mode, but after management discussion today there will be opportunities for your questions. (OPERATOR INSTRUCTIONS). As a reminder, today's call is being recorded for replay purposes. That information will be announced at the conclusion of today's release. So that being said, we'll get right to the second quarter agenda. Here with our opening remarks is Prudential's Head of Investor Relations, Mr. Eric Durant. Good morning, sir, and please go ahead.

Thank you very much. Good morning to all of you. Thank you for joining Prudential's second quarter call. Before turning over to Art Ryan and Mark Grier for their comments, I have a brief commercial message.

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 second quarter of 2006 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 business. Adjusted operating income excludes net investment gains and losses, other than those representing profit or loss of certain of our businesses with primarily originate investments for sale or syndication to unrelated investors and those associated with terminating hedges of foreign currency earnings, current period yield adjustments and product guarantees and related charges and adjustments, as well as results from divested businesses.

Adjusted operating income also excludes recorded changes in asset values that will ultimately accrue to contract holders and recorded changes of contract holder liabilities resulting from changes in related asset values. The comparable GAAP presentation and the reconciliation between the two for the second quarter are set out in our earnings press release on our website. Additional historical information relating to the Company's financial performance is also located on our website. Art?

Thank you and good morning, everyone. I have just a few opening comments and then Mark will review the second quarter results in detail. Overall, our results this quarter are on track with our objectives for the year.

We had a 25% increase in earnings per share based on adjusted operating income. Our annualized return on equity for the year to date, again based on adjusted operating income, was 13.6%. Although market conditions were less favorable than expected in the second quarter, our businesses continued to perform well. We are raising our guidance for Prudential's 2006 common stock earnings per share to a range of $5.50 to $5.70, based on adjusted operating income.

This guidance assumes appreciation in the S&P 500 index of 2% per quarter for the balance of the year.

Let me now touch on a few other topics. First, our acquisition of Allstate's variable annuity business closed on June 1. We added more than $16 billion of variable annuity assets. We gained exclusive access to Allstate proprietary channel and we added complementary distribution in both the broker and bank channels. Our initial investment in this business is $600 million and was funded by general account assets. We expect to achieve an unlevered double-digit return on this investment during the first year and beyond.

While it is early days, results thus far are encouraging.

Second, our retirement business is back on the offensive. Integration of the all CIGNA retirement business is behind us and we are now focused on growing our full-service retirement business. We don't expect instant gratification, but this change in focus as well as investments we have made to enhance our capabilities should in time lead to increases in planned sales.

And finally we continue to enhance breath and depth of our distribution to third party channels. In our international division, our main emphasis is and will continue to be sales of protection life insurance products through proprietary channels. Continued growth of our Life Planner business is contributing to our results and our overall returns.

At the same time, we seek out attractive opportunities to enhance our international results. Our Gibralter Life Company in Japan has begun to develop a bank channel for distribution of our U.S. dollar-denominated fixed annuity product. Our first bank distributor came on board in the third quarter of last year and we launched a major distribution management arrangement with Bank of Tokyo Mitsubishi UFJ in March of this year.

In the second quarter, bank sales of U.S. dollar fixed annuities accounted for $19 million in Gibralter's annualized new business premium. Enough to move the needle. We believe that substantially that this entire amount is additive to the sales of Gibralter's Life Advisers.

Finally on market timing we have made substantial progress toward a settlement of the market timing issues regarding Prudential Securities. We expect to achieve a settlement without material additions to our reserves for estimated settlement costs. I will not be able to comment any further at this time nor will I address any questions you may have on this subject. Now let me turn it over to Mark to go into some detail about the results this quarter.

Good morning, everyone. Thanks, Art. I'll start with an overview of second quarter results for financial services business. We reported common stock earnings per share for the financial services business of $1.40 for the second quarter, compared to $1.12 for the year ago quarter. These results are based on after-tax adjusted operating income and amount to a 25% increase in earnings per share.

The vital signs are strong. Reported results for the quarter were dampened somewhat by mortality less favorable than our average expectations in several of our insurance operations, but our businesses continued to perform well and are on track with our objectives for the year as a whole.

Before I get into the business discussions, I would like to go through a short list of unusual or possibly unsustainable items that affected our results this quarter. First, income related to a single transaction in our asset management business contributed $0.03 per share.

In the retirement business reserve refinements and mortgage prepayment income contributed a total of $0.02 per share. In going the other way true tops of policy liabilities at Gibralter Life reduced our earnings per share for the quarter by $0.02.

In addition, mortality was less favorable than our average expectations in both individual and group life and in Gibralter Life. We estimate that this quarter's mortality experience in these businesses, compared to our average expectations, amounts to a negative of about $0.06 per share incurrent quarter results.

Summing up, the items are mentioned together with current quarter mortality experience in comparison to average expectations were net negative of about $0.03 per share reflected in current quarter results.

Now I will review our business results for the quarter. Starting with the insurance division. Adjusted operating income from our individual life insurance business was $96 million for the current quarter, compared to $119 million a year ago. Mortality experience was less favorable than a year ago and, as I mentioned, was also less favorable this quarter than our average expectations, which we reset at the beginning of this year looking back over five years of experience.

We also had greater amortization of deferred policy acquisition costs and related items this quarter than a year ago. Most of our individual life DAC is amortized based on actual and expected gross profits and the equity market downturn was the leading cause of the increase in amortizations quarter.

The mortality swing and greater DAC amortization more than offset an improvement in spreads on our general account business as yields on the shorter duration part of our investment portfolio increased and lower yielding securities in the longer-term portfolio were sold.

Sales excluding COLI amounted to $101 million in the current quarter, unchanged from a year ago. Sales in the Prudential agent channel were down $9 million, reflecting a decline in agent count. The agent counts stood at just under 2850 at the end of the second quarter. This count is essentially unchanged from the first quarter but down about 500 from a year earlier due to attrition mainly of lower producers reflecting measures we took last year to increase cost-effectiveness in this channel.

At the same time, we are continuing to grow third party production which accounted for more than half of our sales this quarter. Sales from third party distribution were up $9 million, or 19%. Our annuity business reported adjusted operating income of $122 million in the second quarter, compared to $101 million a year ago, which included a $6 million benefit from a reserve true-up. Stripping out that year ago item from the comparison, results were up $27 million, including an $8 million contribution from the first month of results of the variable annuity business we acquired from Allstate Financial.

The remainder of the increase came mainly from higher asset-based fees, driven by market appreciation, together with over $2 billion of net sales of variable annuities over the past year. Our gross variable annuity sales for the quarter were $2.5 billion, including about $130 million in June from the new distribution that came to us with the acquisition of the Allstate business.

The Allstate business included several major wirehouse relationships, bank distributors and Allstate's proprietary channel. We believe we will start to realize the full potential of this new distribution capability as we introduce our Prudential and American Skandia products later this year in the new wirehouses relationships and proprietary channels, with the introduction of the Allstate branded Prudential designed product expected to follow early next year in the bank channel.

We think our products will be an excellent fit for this expanded distribution and we are bolstering our wholesaler force to take advantage of the opportunities. Excluding the initial contribution from the acquired business, our sales were up 33% from a year ago. Our product lineup with a full suite of living benefits continues to perform well in each of our distribution channels.

Our Lifetime Five feature continues to be very successful in the income for life market, and the spousal Lifetime Five feature we added to the portfolio late in the first quarter has attracted over $250 million of account values through June 30.

The group insurance business reported adjusted operating income of $29 million in the current quarter, compared to the $46 million a year ago. The downturn in results came from a fluctuation in group life mortality, which as I mentioned earlier was less favorable in the current quarter than our average expectations. A fluctuation came from a combination of claim count and average claim size across various parts of the business and we view it as essentially random in nature.

The negative swing in mortality in group more than offset improved disability claims experience and a greater contribution from investment results in the current quarter.

Group Insurance sales amounted to $43 million in the second quarter. This compares to $76 million a year ago when we recorded sales of two large disability cases and received premiums in return for assuming existing case liabilities. Most of our Group Insurance sales are registered in the first quarter, based on effective dates of the business sold.

Turning now to the investment division, the retirement segment reported adjusted operating income of $142 million for the current quarter unchanged from a year ago. Results for the current quarter benefited from $10 million of mortgage prepayment income and $9 million of reserve releases.

Results for the year ago quarter benefited from similar items which totaled $35 million, but a year ago we also absorbed $8 million of transition costs from our integration of the retirement business we acquired from CIGNA. This integration was completed in the first quarter of this year on schedule.

Stripping out these items from the comparison, results in retirement were up $8 million from a year ago, mainly as a result of expanded investment income margins from guaranteed investment contracts and other institutional investment products, where we have added new business with more favorable margins than the older business rolling off.

Less favorable case experience on some of our legacy products largely offset higher fees from growth in full-service retirement account values which are up $6 billion from a year ago. Gross sales of full-service retirement business were $4.1 billion for the second quarter, which included about $1 billion from two large cases resulting in positive net flows of about $700 million for the quarter. This compares to gross sales of $2.7 billion in negative net flows of about $200 million last year.

With the business integration just recently completed we are now able to fully participate in the bid process for new cases. However since it can take as long as 12 to 24 months to record a sale, starting from the beginning of a bid process, it would probably not be realistic to expect to see a dramatic change in the average level of quarterly sales in the near-term.

The asset management segment had adjusted operating income of $137 million in the current quarter, up $32 million from a year ago. The current quarter and the year ago quarter each benefited by $23 million from single transactions, in both cases reflecting strong real estate markets.

The increase in earnings came mainly from growth in asset-based fees which have benefited from a $25 billion, or 7% increase in assets under management over the past year, driven by positive net flows and market appreciation, and the earnings increase was also driven by a greater contribution from our commercial mortgage operations.

The financial advisory segment had adjusted operating income of $37 million this quarter, compared to a loss of $97 million a year ago. Current quarter results absorbed expenses of $30 million for retained obligations, including customer cases that predate the formation of the Wachovia joint venture in 2003.

The loss in the year ago quarter included $136 million of expenses from our retained obligations mainly related to our reserve for market timing and $9 million of transition costs in the joint venture.

Stripping out these items, the financial advisory segment operations contributed pretax income of $67 million to current quarter results, compared to $48 million a year ago, reflecting a greater contribution from our retail brokerage joint venture with Wachovia which benefited from growth in fee income.

Turning now to the International Insurance and Investments Division. The International Insurance segment reported adjusted operating income of $324 million for the current quarter, compared to $327 million a year ago. The segment's results included adjusted operating income of $102 million from Gibralter Life in the current quarter, compared to $144 million for Gibralter Life year ago.

Gibralter's current quarter results included charges of $17 million to true-up policy liabilities mainly based on refinements of data in connection with the end of its fiscal year in Japan, while results for the year ago quarter benefited by $9 million from reserve refinements.

Stripping out these items, Gibralter's adjusted operating income was down $16 million from a year ago, mainly due to a mortality fluctuation. Gibralter's results and the results of our Life Planner business continue to benefit from the strong mortality margins in Japan. However, actual mortality experience can fluctuate from one quarter to another.

In the current quarter, Gibralter's experience was less favorable than a year ago, and we estimate about $10 million less favorable than our average expectations. The mortality swing more than offset a benefit of $4 million from translation of the yen earnings at a more favorable rate.

Sales from Gibralter Life, based on annualized premiums in constant dollars were $137 million in the current quarter, up from $92 million a year ago. This increase was driven by growth in sales of U.S. dollar-denominated fixed annuities, which contributed $79 million to current quarter sales, compared to $10 million a year ago when we introduced the product.

Our U.S. dollar fixed annuity is very attractive to Gibralter's customer base and has expected returns comparable to the overall Gibralter product portfolio. The product is also an excellent fit for the bank channel in Japan, and we recently added bank distribution which contributed $19 million to current quarter sales.

Sales of other products at Gibralter were $58 million in the current quarter, compared to $82 million a year ago, as the new U.S. dollar annuity product displaced some sales of older yen-based investment type product, such as endowment business.

Gibralter had about 5700 life advisers at the end of the second quarter, up about 900 from a year earlier. During the second half of last year, we increased the pace of recruiting to take better advantage of the opportunities in Gibralter's market, especially the teachers association.

Our Life Planner business, the International Insurance operations other than Gibralter Life, contributed $222 million of adjusted operating income in the current quarter, up $39 million from a year ago. The increase came mainly from business growth, particularly in Japan and Korea.

In addition our Life Planner results benefited by $12 million from more favorable foreign currency translations. Sales from our Life Planner operations, based on annualized premiums in constant dollars, were $185 million in the current quarter, compared to $245 million a year ago.

The sales decrease is entirely a result of the bulge in Japanese sales last year from our U.S. dollar-denominated retirement income and whole life products, which contributed $28 million to current quarter sales compared to $105 million a year ago.

The year ago sales of these U.S. dollar-denominated products reflected both the initial demand from Prudential of Japan customer base, following their introduction, and accelerated purchases in advance of rate increases.

If we go back two years before we introduced these new products and compare Prudential of Japan sales in the second quarter 2004 to sales in the second quarter of 2006, the increase is 26% for a compound growth rate of 12%, at the upper end of Prudential of Japan's historical rate of growth in sales.

Looking through the impact of recent product related fluctuations, we are very much on track. Life Planner sales of all other products for the current quarter were up 12% from a year ago. Our Life Planner count in Japan was about 2850 at the end of the second quarter, up over 9% from a year earlier.

Life Planners in other countries which mainly reflects our Korean operation stood at about 2900, essentially unchanged from a year ago, reflecting heightened competition for sales representatives in Korea, coupled with our maintenance of very selective recruiting standards, consistent with the Life Planner model.

The International Investments segment reported adjusted operating income of $34 million for the current quarter, up from $19 million a year ago. The $15 million increase came from more favorable results from sales and trading operations and a greater contribution from our international asset management businesses.

Now to Corporate and other. Corporate and other operations reported adjusted operating income of $37 million for the second quarter, compared to $59 million a year ago, with a lower contribution in the current quarter from investment income net interest expense.

Corporate and other operations includes our real estate and relocation businesses which contributed about $30 million of adjusted operating income both in the current quarter and a year ago.

Moving to net income, net income for the financial services businesses was $424 million for the second quarter, compared to $754 million a year ago. Current quarter results included pretax realized investment losses, including related charges and adjustment of $311 million. These realized losses came mainly from sales of fixed-income securities and fluctuations in the value of hedging instruments covering foreign currency and other risks.

Credit related losses and impairments were just $22 million in the current quarter. Our gross unrealized losses on our fixed maturities in our general account stood at $1.9 million at the end of the second quarter, with the vast majority on investment-grade securities and essentially interest rate related.

Non investment-grade fixed maturities comprise about 6% of the financial services businesses fixed maturity portfolio at the end of the second quarter.

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 $29 million for the current quarter, compared to $129 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 came mainly from realized investment gains and losses.

Turning back to the financial services businesses and summing up. The insurance division is benefiting from continued growth of our annuity business, and our recent acquisition of Allstate's variable annuity business is beginning to contribute to results.

In the Investment Division, our asset management business registered strong results, reflecting growth of asset-based fees and a continued benefit from a strong real estate market.

Our international results benefited from continued business growth in our Life Planner insurance operations and results of our domestic insurance protection businesses and Gibralter Life were hampered by negative mortality swings, which more than offset a short list of nonrecurring benefits in our results this quarter. Thank you for your interest in Prudential. And now we look forward to hearing your questions.

(OPERATOR INSTRUCTIONS). Suneet Kamath, Sanford Bernstein.

Two questions, please. First on international, on its conference call I guess last week, Aflac talked about the impact in Japan of the FSA imposing sanctions on some insurance companies and apparently they felt that had slowed the market in terms of medical insurance.

I was wondering, first of all, if you have any outstanding issues with respect to these sections, but also if there is any impact from that activity on your business and the second question is just on guidance. If I take your new guidance sort of back out what you have done in the first two quarters of the year and divide by 2, I get kind of a run rate for the second half of 137 to 147, and that compares to I guess your normalized 143 in this quarter.

Given that you only had one month of Allstate and you're going have obviously three months for the next two quarters, as well as the impact of ongoing share buybacks, are you just been conservative here, or are you worried about the operating environment, the equity markets, or kind of -- what would cause the run rate in the back half of the year to kind of be below where you are in the second quarter? Thanks.

Thank you for the questions. This is Art Ryan. On the first one, there is no question that the FSA has been more aggressive in the market, but we at Prudential of Japan and at Gibralter, we have no sanctions nor do we have any issues at this point in time with the regulatory bodies in Japan.

We have not seen an impact on our business as a result of any of those activities. In most cases our business is in the protection life business, which has not really been affected as much by some of the activities going on.

We did see a change in a year-over-year and that really dealt more with what we have talked about, that the first half of 2005 had record sales as a result of retirement products that we were able to sell.

But our Life Planner growth is a little over 9% in Japan quarter over quarter. We are very comfortable with our results. Now we don't see any issues along those lines that should affect our business in Japan.

In terms of the earnings guidance, I mean obviously earnings guidance is a reflection of what I believe the expected outcome is going to be. It doesn't reflect any undue optimism nor any overt pessimism on my part but expected outcome.

I think if you look at the year, it's somewhat interesting in the sense that in the first quarter we had an awful lot of things that on the margin were positive. In the second quarter we had a few on the margin that were negative, like in the mortality area.

And so I am really just looking out, as I look at the market as they exist today, and what I expect to be the outcome. So I am trying to give the best estimate I can. I think in Mark's comments on the details, we tried to provide you with as much insight into the fact that we feel very good about how the businesses are doing.

Our annuity business is doing very well. Our retirement has, as I used in my expression, moved on the offensive. International, a few one-off items in Gibralter continues to be good, so I feel quite good about the businesses, but reflecting on the market and the results to date, that is my best guess as what I think the outcome is going to be for the year.

Nigel Dally, Morgan Stanley.

Just a follow-up on international question. In additional to the FSA actions, there has been a growing concern that domestic Japanese companies are getting more aggressive. So I was hoping you could discuss your views on whether the competitive conditions are heating up the market (indiscernible) for Gibralter and [PHA].

Second given the success of your fixed annuity product in Japan, can you discuss whether you will potential reconsider your stance on offering any variable annuity in Japan. And then third, with a high debt (indiscernible) that we saw in individual life, I know it related to the weaker equity markets, but in prior quarters when the markets were down, I don't think we saw the same level of pressure, so why was the impact this quarter so much larger even though the markets were only down 2%? Thanks.

In terms of competition in Japan, I don't think there is any question that the domestic companies are improved over where they were. Of course, we have competed against them when they have been in good shape and then not so good shape, and again I think what distinguishes us in Japan is our distribution capabilities.

No one else, other than Sony Life, has a Life Planner system as we do and of course Sony has been doing quite nicely over the years as well, but we don't see direct competition to POJ from the domestic companies in either good times or less good times.

The uniqueness of our Gibralter distribution is that over 50% of our business comes from our affinity groups, principally the teachers association. So again, competition is always there, but no, I don't see it causing us to have any particular concerns about our Japanese business.

As I mentioned in my earlier answer, we saw 9% growth in Life Planner in Japan and we saw a substantial increase in Life Planner advisers in the second half of 2005 and continuing into 2006 in Gibralter. And that really reflects our confidence that we can grow the Gibralter business, not simply maintain the high returns that we have had since the acquisition.

So in the aggregate, I feel very good about our Japanese business. In terms of variable annuities, we have offered very reluctantly some variable annuities more as a defensive posture through our distribution channel. At the present time we're not reconsidering our decision, and we will continue to view it purely as a defensive offering as part of our broader distribution channel but not look to push the product or move more aggressively with the product than we have heretofore. On the DAC amortization, I'm going to let Mark answer that.

Nigel, as you probably know, there a lot of moving parts in DAC, but let me just make a couple of points. One is that in the insurance business we don't use a corridor, so it is essentially real-time DAC adjustments as we move for the quarter.

Secondly, we have primarily discussed favorable mortality and expense reductions over time in the individual life business and just have not necessarily highlighted some of the things that go on below those levels because we have had such big numbers there. But I guess the main point is that it's sort of a real-time number versus a quarter and does fluctuate.

That help will. Thank you.

Tom Gallagher, credit squeeze.

First, another one on international and just a quick one on retirement. I guess, Art, you had mentioned you sound fairly optimistic that, based on what is happening at Gibralter, that you see improvement in growth there. If you look at, at least, the disclosure revenues, at least GAAP revenues continue to go down, but you did have 19% growth in advisers and now you have the addition of bank distribution. How should we think about this, I guess especially with the addition of bank distribution going forward? Should it still just be potentially flattish to maybe modest growth or do you think we can do much better than that?

On Gibralter.

Yes.

I think if you look at some of the revenue numbers, those are little more difficult to track because of the change in the product mix. Depending on the different types of products in Gibralter will cause of the revenue recognition to be skewed or change, so I can give you more detail on that but I wouldn't overly react to that one.

I believe it is a function more of product than any change in the direction. Clearly our growth in advisers last year and our continued growth in advisers this year is as you stated a sign of optimistic that we can grow this business. It takes a little bit of time for the life advisers to come on to be as productive as the more experienced advisers, not dissimilar to any distribution channel.

So when I look at growth in advisers and therefore obviously growth in new business, when I look at opportunities in bank distribution, I believe that we can sustain mid to high single-digit growth rates in earnings in Gibralter.

I think when we acquired it, we acquired it with the expectation of very high returns on capital, but I do believe that the underpinning or the underlying earnings in Gibralter, they are not a Life Planner business. We're not going to get the double-digit growth, but we will get mid to high single digits. So if you use ranges of 6%, 7%, or 8%, that would be over time my expectation for growth in earnings at Gibralter.

Got it. And then I guess just a follow-up on the bank distribution relationship. Are you one -- should we think of proving one of several companies with relationships with Bank of Tokyo in terms of the product you're selling or that exclusive, and are you also exploring other distribution relationships with banks?

We would continue to look for other distribution relationships. What the banks in Japan tend to do is look for is a "primary partner" though it doesn't necessarily endure or insure exclusivity. And so again we would be looking again only in the fixed annuity area, but we would be looking for more bank distribution, not just a few.

Got it. And then last question, improvement in full-service retirement net flows, $700 million this quarter. Based on your commentary about, I guess, having some restrictions on new sales relationships with the CIGNA acquisition, I sort of took that to mean, don't expect continuation at this level. Is that fair to say?

Well, we had a number of sales -- two sales in particular in the large case market that we were very pleased with, obviously, that caused that roughly $700 million increase.

The reason I am a bit more cautious on it is, as you well know, while you're in the midst of a conversion, you're frequently not engaged in all of the RFP activity associated with the business. A lot of the business is driven around early parts of the calendar year, so I am just being somewhat cautious in the nature of when the RFP process will pick up again. And I am looking more towards the early parts of '07, but I am delighted we had the net sale positive in the second quarter and I would be delighted if it were to continue, but again I think I'm trying to be realistic in the sense of when the RFP process occurs, and now that, as I said, we are back on the offensive. It takes a bit longer here than it does in a few of the individual products to get your fair share of the growth in the market that you expect.

It's Mark. It's not really restrictions. It's really just a length of the lifecycle of the sales to we're focused on here.

Got it. Okay. Thanks.

Jimmy Bhullar, JPMorgan.

I have a question on mutual funds and then on Gibralter. First on mutual funds, just if you could discuss whether you're making any headway in expanding distribution through wirehouses. I think flows this quarter would have negative, had not been for a few (indiscernible), but -- and then, second, on Gibralter, persistency has held up really well, but what is your outlook for that, given that the block or the surrender charges are going to be declining fairly significantly over the next couple of years?

In terms of the mutual funds, we have had really excellent performance out of Jennison in terms of our mutual funds, not only in the retail market, but also in the institutional market. And we have been very, very pleased with that.

Certainly the increase in the net flows was positive and that was due primarily to some growth in the sub-advisory segment which we view as a very positive channel for Jennison Dryden and mutual funds, so not just simply the direct sale but also the sub-advisory business.

We continue to grow in the mutual fund channel, but as I have said over the years this is a process of moving away from a purely proprietary orientation to one on a broader channel and as you well know, the mutual fund market doesn't lack for competitors. So I would say we're very positive about the progress, but we are not expecting it to be dramatically different than what we have seen over the past couple of quarters.

On the Gibralter persistency, I don't see any reason why we wouldn't continue our persistency as we presently are having it. I don't know of any reason that it would change at this point in time. Anyone else?

We have no expectation of any meaningful change in Gibralter's persistency.

Even as the like [surrender] charges get lower?

That's correct.

Okay. Thank you.

Jeff Hopson, AG Edwards.

Just on the Allstate, so just so we understand from the level here that you talked about, we expect some acceleration, and then can you talk a little bit about the increased spending for marketing, etc. that might come along with that versus the revenues, I guess.

Well, I am a firm believer that revenues grow faster than cost. So that will continue to -- certainly to the best of my ability. Yes, we did have a nice pick up in the first month. There are some cost of funds that get carried in the corporate account in terms of financing the deal, but in general we expect it to add to earnings each month as we go forward.

We had about $130 million of the $2.5 billion in sales came out for the month of June -- came out of the Allstate area which is very good and that is before we have been able to do any marketing and related activities.

We did take on the expense burden of the wholesalers, but certainly as I said even in the first month we have shown a profit associated with it, so I am not expecting any unusual uptick in expenses as a result of this. Certainly the expenses will grow as we continue to expand our capabilities. But we certainly expect the revenue to grow faster and earnings to continue to improve as well.

Okay. And did this quarter redemptions in that block reflect your expectations?

Yes, they did. There was a modest net outflow, i.e. a few more redemptions, but that was expected. And so we are very comfortable with the very early experience we have with our Allstate relationship and a very positive relationship it is.

Tamara Kravec, Banc of America Securities.

Two questions, I know we are not allowed to ask about the settlement, but the litigation costs I just wanted to ask to be certain that those would go away if and when a settlement is reached?

No. There are ongoing cost that have been there. As we said, the cost in that category comprised both that which was for market timing, for which there were no additions in the second quarter and, as I said in my comments, we expect no material additions to that as a result of the settlement.

But the ongoing cost there represent, if you will, the history of the bubble of the late '90s where you have a whole range of arbitration cases, many -- some of which take as long as ten years to get resolved. It is very lumpy but certainly it will go away. What I don't know is when and how long.

But I think there will be some ongoing costs there that just reflect what would be normal. When we did the deal with Wachovia we retained responsibility for those events occurring prior to the joint venture. Similarly they retain the costs associated with their equivalent in the Wachovia system as to all of the other broker-dealers. So as you read about arbitration cases, whether it is with us or Merrill Lynch or anybody else, that is what is in that ongoing channel. So hard to predict, hard to forecast but it will go away eventually.

Okay. And what are your thoughts if you could share with us the put option that you have to put it back to Wachovia? It seems like you would just recoup your book value if you did it before July of '08; after that you could get market value for it. But do you have any thoughts on that?

Yes. Obviously, you have described the opportunities that we have in terms of put at book or at market. It is really not book, it is cost because it does include the numbers that were spent in terms of the conversion course, that is all covered in the put that we have at the moment. If you look at the returns, though, I don't have a better use for the money. We have a lot of excess capital. We will continue to buy back stock at the aggressive pace that we have. If you take the earnings out of the joint venture it's producing about a 13% to 14% return on that capital which in this market is quite attractive.

So my intention is to continue to participate in the joint venture. I think what the market should recognize is that there is value there above the book and the cost value to it. I think there is quite a bit more value to that put option but at the moment it wouldn't seem to make a lot of sense for me to even consider exercising it given the returns that we are getting on the dollars that we have invested there. So I don't expect any changes in the near future.

And my last question is on the group insurance business. You know this quarter it seems like the volatility really came in and I understand it's mortality but that is an operation that you have often talked about as lacking scale and needing to get that. Can you share any updated thoughts you have on that?

I don't think I've used the word lack of scale there. I think I used the phrase it is competitive, but we are number two in the market. MetLife is the market leader in group life. We are number two. We have over $1 trillion in life insurance in force, so we are a pretty good competitor in that.

A year and a half ago we had some issues on the disability business. They appear to be behind us. The disability numbers are looking pretty good. And in general I am very, very comfortable with the business, but in the second quarter we did have the mortality adverse, which again if I go back over multiple years, there is nothing unusual. We didn't find any underwriting problem. We didn't find any book of business that we were troubled with. But these are very large books of business, so at times I think we interpret a level of predictability that sometimes isn't always the case. I think it is a well-managed book of business and I am very comfortable with it.

Eric Berg, Lehman Brothers.

So Art, on the international business in general, what I would like to do is just take a step back and look at certain numbers that may not be as detailed as the DAC or the other sort of narrow items, but try to give a big picture of what is going on.

I am thinking about Japanese yen total revenues. I am thinking about the premium and fees component in constant dollars. I am thinking about the number of policies in force and the face amount of the policies.

And my question is all of these numbers, the revenue numbers, the customer count, the face amount, the revenue numbers in constant dollars, they grew at about 3% pace, it turns out all of them year-over-year. My question is if the business overseas for you is prospering in the way that you say it is, with your growing agent count, new products, and so forth why aren't these basic measures of growth and size of the business increasing at a faster rate than 3%?

Eric, this is Eric Durant speaking. If you turn to page 29, let's look at constant exchange rate basis, insurance revenue, net premiums, policy charges, and fee income. Japan excluding Gibralter is up 10%. I don't see the 3% there.

I was talking about the total, Eric.

Let's look at insurance business here. They are up 10%. If you look at Gibralter on the next line, they are down from 636 to 587. But let's back out the single premium FAS 60 business from the second quarter of 2005, which was $89 million and compare it to $41 million in the second quarter of 2006.

So that is $48 million out of the $49 million decrease. Why did that happen? Because of a change in mix. Now we are writing FAS 97 business which isn't reflected in this line. That is all it is.

If you look up above at -- I should say on the very next page, where we are looking at face, you do see a decline in Gibralter's face amount. You do see a decline in the number of policies at Gibralter in the range of about 2%. To some extent that also reflects the change in mix because you won't get any increase in face amount from dollar-denominated fixed annuity product, but it also probably reflects as well some very modest runoff in the block of business because it is very difficult to replace business that was written by 20,000 agents with only 5000 agents that are remaining today. I don't know what more to say.

If I could follow with just one question. With respect to the transition to FAS 97 from FAS 60, wouldn't that be picked up in the total revenue on a Japanese yen basis in the sense that this transition should still lead to higher revenue overall, as premium income is replaced by saying net investment income?

Eric, it's Rich. It's a vast disconnect between the coupon on investment income and a gross premium on which you're earning that coupon. So as you switch from FAS 60 to 97, revenues will drop precipitously.

Thank you.

Saul Martinez, Bear Stearns.

Nice attempt at a Spanish accent by the way with the announcement, my name. But a couple of questions. One on your capital position, I don't recall you guys giving an update of your excess capital during the prepared remarks. If you can just comment on that. And also on your capital position if you could give us on update on your plans to potentially incorporate hybrid securities into your capital structure. And a second part of my question is on South Korea. I mean do you see a light at the end of the tunnel and what do you think needs to happen there to sort of resume planner growth?

Let me answer the career question. I will let one of my colleagues answer the capital. I guess we certainly would not expect to see growth in the Life Planner account in the near-term, by that I mean probably in the second half of the year, but we are cautiously optimistic that we will begin to see it in 2007.

The only thing if you don't mind is that I would not use the word light at the end of the tunnel. There is a lot of light going on Korea. We make a lot of money there. We make over $50 million this quarter in Korea and that is up from about $43 million the year before.

Our sales are also up year-over-year, but there is a lot of competition. I tend to look at it as we not only do well when we don't have any competition, but even when we have competition, we respond quite nicely. So I think -- I am still very optimistic about Korea.

But no question that our recruiting is going fine, but there are a number of competitors who like the way we train and develop Life Planners. We are responding. We will be making changes in some of our compensation structure and a few things but very modest changes. We're not going to change our business model dramatically, but we do recognize that we are an attractive manager in the market and others tend to recruit. I don't believe -- like so many things in Korea they tend to go in spurts. I would hope that by 2007 we will be back into a more normalized version, but again repeating myself, we are very comfortable with our earnings and our business in Korea.

On excess capital?

I am the designated answerer.

Okay. Got it.

In the past when we've talked about excess capital, what we have meant by the term is the amount of capital we could use in short order in order to repurchase shares or pay dividends.

Last quarterly we said the number would exceed $3 billion. This year we are saying it is about $2.3 billion. Remember, we did buy Allstate for about $600 million in the second quarter, and we also bought back $625 million in common stock. That $2.3 billion includes untapped borrowing capacity on the assumption that 20% debt to capital is the max of about $750 million, so the excess common equity in that $2.3 billion total is about $1.6 billion.

Now let's take a broader view and change the definition of what we're looking at and now define excess capital as the hypothetical amount that we could use to finance an acquisition without issuing common stock. So we're starting with $1.6 billion of excess common equity already in our domestic and businesses.

In addition to that, the emerging view seems to be that a capital structure of the Double-A insurance company would be about 70% common equity, about 20% debt, and about 10% hybrids. And you can solve for the amount of hybrids and debt that we could have, given our current common equity of $20,400,000,000. And the number that you would get if you did that is about $4.4 billion less than the amount -- more than the amount we have outstanding today. That is an additional $4.4 billion.

If you were to attach a value to our Wachovia put, on the assumption that the Piper Jaffray sale to UBS is more or less indicated, that was done at 2.9 times book. You can do your own math there, but remember that is a pretax number where book is about $1.2 billion.

I don't want to start any rumors here. That is not in my job description. But that is what the number would be. And a finally, the $1.7 billion that we talked about earlier for excess capital does not include international. And our Japanese insurance operations have about $3.2 billion of equity and have solvency margins in the range of 1000% compared to about 700% to 800% that we think we need to maintain. So that would free up another $500 million to $1 billion. So I think if you add all these things up, you'll probably get a number that is fairly close to $10 billion or so.

But you wouldn't be able to exercise a fair value on the put until the mid part of 2008, correct?

That would be the contractual -- this is Art, again. That's the contractual arrangement. Obviously it would all depend on what the interest were on both sides, but I think both parties are very pleased with a transaction and as I said I think Eric did it properly by separating that which is easily available and that which takes a little bit more time. But we wanted to give full disclosure on where we could get capital and where we can get it in a more immediate time frame.

Okay. And I didn't mean to imply that the financial performance in South Korea wasn't excellent.

Thanks a lot. I appreciate it.

That's why we paid you back with that answer about capital.

And if times allows, Mr. Ryan, we do have a participant just queuing up now. And we will go to the line of Peter Monaco with Tudor Investment Corporation.

Thank you all for your time. Eric, could I maybe turn around or dissect that calculus just a little bit? Let's take WB out of the equation. Let's understand that, as you described, a number of those items aren't free and clear today, but they could be freed over time.

But let's layer in the excess capital that you will generate over the next couple of three years. Not to split hairs, we end up in the same place probably $10-ish billion dollars. So if you guys did nothing but buyback stock and if you barely grew at all, you are still going to drive EPF massively higher, profitability higher, and again this is without considering the potential for more profitability in earnings enhancing acquisitions. Anything wrong with that logical? And then I have a follow-up.

Well, I'm going to defer to my colleagues on the question, Peter.

No, there is nothing wrong. I mean I think the point of the matter is if we are -- if we continue to behave in a disciplined fashion with our capital, we have the capital and earnings potential to grow the EPS double-digit for the foreseeable future which is what I have talked about for quite a while.

We also believe that our earnings can grow at that double-digit rate which would cause the EPS to grow even faster. Now, all of those things are subject to the usual market caveats of what goes on in the place, but I think the fundamentals of the business, as we have tried to describe them, notwithstanding quarter-to-quarter changes, are in the range as you have talked about in terms of capital generation and earnings capability as we go forward.

A quick follow-up. Art, it has not been that long since you revised your sort of targeted or aspirational profitability level. Yet you are already performing at the upper end of that range. In light of that, what are your thoughts about the timing with which you might revisit that target of profitability level?

For those on the call who might not be familiar, we did obviously target 12% return on equity in 2005 which we achieved. At the end of last year I targeted 12% to 14% over the next 18 to 24 months. As is correctly pointed out, we're at about 13.6% which would be at the upper end in our 12% to 14% range.

I would expect that as we have Investor Day at the end of the year, we will talk in greater detail about what might be the expected outcome, but as I have said at a number of public events that we are very happy that we are in the upper end of the range of the near-term objective of 12 to 14 and we don't expect to stop at 14.

Mr. Ryan, I'm going to turn the call back to you for any closing remarks.

Yes, I really have nothing else to add. I think the questions did cover all of the areas that hopefully gave you even greater clarification of the results and I thank you very, very much for your interest in Prudential, and we hope you have continued interest in Prudential and we look forward to seeing you at the end of or hearing or talking to you at the end of the third quarter. Thank you very much.

Ladies and gentlemen, Mr. Ryan is making today's conference available for digitized replay. It's for one full week starting at 4:15 PM Eastern daylight time, August 3, all the way through 11:59 PM, August 10. To access AT&T's executive replay service, please dial toll-free 800-475-6701. At the voice prompt, enter today's conference ID, 821 370. For the international participants on the call today, please dial 320-365- 3844, again with a conference ID, 821370. That does conclude our earnings call for the second quarter. Thank you very much for your participation, as well as for using AT&T's executive teleconference service. You may now disconnect.