保德信金融集團 (PRU) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the third-quarter 2006 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session with instructions given at that time. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded.

I would now like to turn the conference over to Mr. Eric Durant. Please go ahead.

Thank you, Julie, and thank all of you for joining us today. In a moment Art Ryan and Mark Grier will be making their presentations. And then after that they will be joined by Rich Carbone and [Peter Sayer] for your questions. And now a commercial message.

In order to help you to understand Prudential Financial, we will be making some forward-looking statements on 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 2006 which can be found on our website at www.invester.prudential.com.

In addition, in managing our businesses we use a non-GAAP measure we call adjusted operating income to measure the performance of our Financial Services Businesses. Adjusted operating income excludes net investment gains and losses other than those representing profit or loss of certain of our businesses which primarily originate investments for sale or syndication to unrelated investors and those associated with terminating hedges of foreign currency earnings, current period yield adjustments of product entities and related charges and adjustments as well as results from divested businesses.

Adjusted operating income also excludes reported changes in asset values that will ultimately accrue to the contract holders and recorded changes in contract holder liabilities resulting from changes of 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 website. Additional historical information relating to the Company's financial performance is also located on our website. Art?

Good morning and thank you for joining us. Prudential's third-quarter earnings per share based on adjusted operating income increased 18% compared to the third quarter out last year. For the year to date, earnings per share are up 19% on the same basis. These results reflect solid performance across our portfolio of businesses.

As you know, we consider return on equity to be the single best measure of Prudential's financial performance. For some time our goal for return on equity had been to reach the 14% threshold by 2007. We are ahead of that target. Our ROE through September is 14.5% based on adjusted operating income. Excluding the impact of unusual or potentially non-recurring items, our return on equity for the year to date would still exceed 14%. We will update our return on equity goals at this year's investor day on December 6th.

Our growth and increased financial returns reflect underlying improvement in the capabilities and performance of our businesses. We believe that 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, our acquisition of Allstate's variable annuity business has increased the scale of our annuities business as well as broadened its distribution. We gained exquisite access to Allstate's proprietary channel and we added complementary distribution in the broker and bank channels. We expect to achieve an unlevered double-digit return on our $600 million investment during the first year and beyond. While it is early days, results thus far are matching this expectation.

Domestic protection businesses, Individual Life and Group Insurance are all also performing well. Each focuses on maintenance of appropriate returns. Growth is desirable but growth is secondary consideration. It must be profitable growth.

Our international division continues to excel. In spite of very challenging comparisons, the division recorded a 12% increase in adjusted operating income for the third quarter lead by the life planner operations which increased by 14%. Our main emphasis is and will continue to be sales of protection products through proprietary channels.

That said, our Gibraltar Life Company in Japan is developing a bank channel for distribution of a U.S. dollar-denominated fixed annuity product. This product meets our profitability objectives and we believe that substantially all of our sales through banks is additive to the sales of Gibraltar Life advisers.

Our capital position remains very strong. That means 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 sense and pencil out.

We also use share repurchases to manage our capital. In the third quarter we repurchased $625 million of common stock. While we review repurchase activity with the Board regularly, we believe our capacity for share repurchases is undiminished.

Finally I'll update earnings guidance for the full year. We now believe that Prudential will achieve common stock earnings per share in the range of $5.90 to $6.00 for the year 2006 based on adjusted operating income. This represents an increase from our earlier guidance of $5.50 to $5.70. This guidance reflects our consideration of a wide range of circumstances including seasonal patterns and lumping expenses. In addition, our guidance assumes stable equity markets over the balance of the year.

Now I will turn it over to Mark for more details on the performance.

Thank you, 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 $1.72 for the third quarter compared to $1.46 for the year-ago quarter. These results are based on after-tax adjusted operating income and amount to an 18% increase in earnings per share.

I view our core earnings performance this quarter as a very strong, and very much in line with our objectives. 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.

Our Individual Life, Individual Annuity and Group Insurance businesses completed their annual reviews of experience and actuarial assumptions in the third quarter. This resulted in favorable unlockings of DAC and other amortization items along with reserve refinements for a total contribution of about $0.15 per share. Our Individual Life business received compensation based on multiyear profitability of third-party products distributed by our agents contributing $0.04 per share. And in Gibraltar Life, income from a single investment together with a concentration of dividend income on equities in the current quarter contributed another $0.02 per share.

In total, the items I've mentioned contributed about $0.21 to our current quarter results. In addition, mortality was more favorable than our average expectations in both Group Life and our International Insurance Life planner business. We estimate that this quarter's mortality experience in these businesses compared to our average expectations added about $0.03 per share to current quarter results.

Our results a year ago also benefited from favorable unlockings and other items of a non-recurring nature with an estimated contribution of about $0.21 per share that we identified then. Taking these items out of both the current and year-ago quarters, our EPS increase would still be 18%, the same as the percentage increase for our reported numbers.

Now I'll review our business result quarter. I'll start with the insurance division. Adjusted operating income from our Individual Life insurance business was $183 million for the current quarter compared to $120 million a year ago. Current quarter results included a $46 million benefit from the DAC unlocking and reserve refinements I mentioned earlier which came mainly from updating our actuarial assumptions to give effect to mortality experience over a five-year period. And a $25 million benefit from the compensation we received from distribution of third-party products.

Stripping out these current quarter benefits, results were $8 million below the year-ago quarter. Mortality experience for the current quarter was about in line with our expectations but was less favorable than the year-ago third quarter. Sales excluding COLI amounted to $94 million in the current quarter compared to $103 million a year ago.

Our Universal Life sales were down $20 million from a year ago. Pricing for secondary guaranty products has become more competitive and we have chosen not to adjust our pricing now with our main focus continuing to be on writing new business with appropriate returns. We are exploring options for capital management relative to these products which can allow us to price them more competitively without compromising our target returns. The drop in Universal Life sales more than offset a 22% increase from a year ago in sales of variable life and term life.

Our annuity business reported adjusted operating income of $192 million in the third quarter compared to $161 million a year ago. Current quarter results benefited by $37 million from the DAC unlocking I mentioned earlier which came mainly from improving profitability of the fixed income portion of our annuity book of business. Results for the year ago quarter also benefited from a favorable unlocking which amounted to $57 million.

Stripping out the unlockings from the comparison, results were up $51 million including a $24 million contribution from the first full quarter of results of the variable annuity business we acquired from Allstate. 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 $2.3 billion including about $360 million from the new distribution that came to us with the acquisition of the Allstate business.

We think our products will be an excellent fit for this expanded distribution and we have recently begun the process of introducing our portfolio of variable annuities both in Allstate's proprietary channel and in late September on Morgan Stanley's system replacing the former Allstate products. We also expect to introduce an Allstate branded Prudential designed variable annuity product in the bank channel early next year.

Net sales associated with the Allstate business for the current quarter were negative consistent with our expectations pending the introduction of our products in the new distribution systems. This was the largest factor in the downturn in our reported net variable annuity sales from a year ago.

The Group Insurance business reported adjusted operating income of $90 million in the current quarter, up $30 million from a year ago. Current quarter results included a $19 million benefit from group disability reserve refinements. The remainder of the increase came mainly from improved disability claims experience.

Group Life mortality which was less favorable last quarter than our average expectations returned to the favorable column this quarter. Group Insurance sales amounted to $127 million in the third quarter compared to $47 million a year ago. We record sales based on the effective dates of the business and several large new cases had effective dates in the current quarter including one national account with about $50 million of Group Life annualized premium.

Turning to the investment division. The retirement segment reported adjusted operating income of $109 million for the current quarter essentially unchanged from a year ago. Results for the current quarter benefited from $5 million of mortgage prepayment income compared to $15 million of prepayment income a year ago. On the other hand results for the year-ago quarter absorbed $11 million of transition costs from our integration of the retirement business we acquired from CIGNA which was completed in the first quarter of this year.

With the business integration behind us, we are investing in our full-service retirement capabilities focusing on operations and systems enhancements. We are also investing in new product development including retirement income products where we see a major opportunity to leverage our risk management skills and our experience in the annuity business in a market with substantial growth potential. Higher expenses more than offset growth in fees from our full-service retirement business where account values are up more than $5 billion from a year ago.

Gross deposits in sales of full-service retirement business were $2.9 billion in the third quarter compared to $3.5 billion a year ago which included a single client deposit of almost $600 million for an existing plan. Sales of full-service cases especially in the large case market are lumpy from one quarter to another. For the first nine months, full-service gross deposits in sales are $12.4 billion, ahead of last year by $2.5 billion. Net sales are modestly positive for the first nine months.

Gross additions for institutional investment products were $2 billion in the third quarter, up from $800 million a year ago mainly due to higher sales of funding agreement products. The Asset Management segment had adjusted operating income of $100 million in the current quarter compared to $116 million a year ago.

Our Commercial Mortgage operation contributed $6 million to current quarter results versus $30 million a year ago. Results for this part of the business tend to be lumpy from one quarter to another since they include fluctuations in the value of hedging instruments we use and also reflect the timing of transactions. The lower income from our Commercial Mortgage operations more than offset growth in asset based fees which have benefited from a $31 billion or 9% increase in assets under management over the past year driven by positive net flows and market appreciation.

The financial advisory segment had adjusted operating income of $43 million this quarter, up $12 million from a year ago. This increase reflects a greater contribution from our retail brokerage joint venture with Wachovia which benefited from growth in fee income. Results for the current quarter and the year-ago quarter each absorbed expenses of $22 million for retained obligations including customer cases that predate the formation of the joint venture in 2003.

Turning to the International Insurance and investments division, the International Insurance segment reported adjusted operating income of $397 million for the current quarter, up $39 million from a year ago. The segment's results included adjusted operating income of $149 million from Gibraltar Life in the current quarter compared to $141 million a year ago. Gibraltar's current quarter results include expenses of $6 million to increase our estimated liability for the Japanese guaranty fund. This compares to a benefit of about $10 million to results a year ago from a decrease in that liability.

The negative swing related to the Guaranty fund offset a $16 million increase in investment income margins. Current quarter investment income included $6 million from a single real estate investment. In addition Gibraltar's portfolio includes about $2 billion worth of equities and dividend income which is generally concentrated in the third quarter in Japan was especially strong in this quarter. Gibraltar's results for the current quarter benefited by $7 million from translation of yen earnings at a more favorable exchange rate.

Sales from Gibraltar Life based on annualized premiums and constant dollars were $93 million in the current quarter compared to $82 million a year ago. The U.S. dollar-denominated fixed annuity product we introduced last year is attractive to Gibraltar's customer base and an excellent fit for the bank channel in Japan. The bank distribution that we initiated earlier this year contributed $20 million to current quarter sales.

A downtick in sales by Gibraltar's life advisers was a partial offset. Sales productivity in the current quarter was comparable to a year ago at 3.6 policies per adviser per month, well ahead of industry standards but average premium per sale was below last year's level. Gibraltar had about 6000 life advisers at the end of the third quarter up by about 700 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 Gibraltar's market especially the Teachers Association.

Our life planner business, the International Insurance operations other than Gibraltar Life contributed $248 million of adjusted operating income in the current quarter up $31 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 $13 million from a more favorable foreign currency translation. Mortality experience was comparable to the year-ago quarter, but as I mentioned earlier was more favorable than our average expectations. We estimate that this benefited current quarter results by about $10 million.

Sales from our life planner operations based on annualized premiums and constant dollars were $176 million in the current quarter compared to $182 million a year ago.

Sales in Japan are $119 million, unchanged from a year ago. In comparing sales results for the Japanese life planner business to a year ago, we are continuing to see the impact of the sales bulge last year that resulted from the introduction popular new U.S. dollar-denominated products. And at the same time accelerated sales in anticipation of premium rate increases that we began to implement around the middle of the year. Concluding with a rate increase on our U.S. dollar whole life product in October of 2005.

While the affect on the comparison is less dramatic than in the earlier quarters of this year, the decrease in sales of our U.S. dollar-denominated products entirely offset a 17% increase in sales of our other products in Japan for the third quarter. Our life planner account in Japan was about 2940 at the end of the third quarter, up 7% since year end 2005.

For our operations outside of Japan which mainly reflect our Korean life planner business, sales were $57 million in the current quarter compared to $63 million a year ago with the decline mainly from savings products that we offer as an accommodation to customers of the life planners. The life planner count has been essentially flat over the past year.

We continue to see aggressive competition in Korea with some companies pursuing growth at the expense of profitability in our view. While we believe that the competitive environment will ease as companies find that some of their approaches are unsustainable, we would not expect dramatic changes in our sales for life planner count in Korea over the next few quarters. Our focus is on growth of high return business and we are strongly committed to the fundamentals of the life planner model including selective recruiting, needs-based selling and emphasis on protection products.

The international investment segment reported adjusted operating income of $31 million for the current quarter, up from $25 million a year ago. The $6 million increase came from more favorable results from sales in trading operations.

Turning now to corporate and other, corporate and other operations reported adjusted operating income of $15 million for the third quarter compared to $50 million a year ago with a lower contribution in the current quarter from investment income net of interest expense. Corporate and other operations includes our real estate and relocation business which contributed about $36 million of adjusted operating income in the current quarter, down $7 million from a year ago reflecting a less favorable residential real estate market.

Now I'll comment on net income. Net income for the Financial Services Businesses was $1.2 billion for the third quarter compared to $1.3 billion a year ago. Current quarter results included pretax realized investment gains including related charges and adjustments of $221 million. These realized gains came mainly from fluctuations in the value of hedging instruments covering our foreign currency risk.

Credit related losses and impairments were just $12 million in the current quarter. Our gross unrealized losses on fixed maturities in our general account stood at $751 million at the end of the third quarter with the vast majority on investment-grade securities and essentially interest rate related. Non investment-grade fixed maturities comprise about 6.5% of the Financial Services Businesses' fixed maturity portfolio at the end of the third quarter.

Net income a year ago included a $720 million tax benefit from the completion of an IRS examination with $692 million of that amount outside of adjusted operating income.

And briefly on the 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 $53 million for the current quarter up from $42 million a year ago. We measure results for the Closed Block Business only based on GAAP rather than adjusted operating income.

To sum up, I'd like to turn back to the Financial Services Businesses and take a look at where we stand for the first nine months. Each of our divisions registered double-digit increases in adjusted operating income compared to a year ago. The insurance division is benefiting from continued growth of our annuity business with our recent acquisition of Allstate's variable annuity business beginning to contribute to results. The business integration and introduction of our products in the new distribution systems are well on track.

In the investment division, our Asset Management business is continuing to register growth of asset-based fees with positive net flows and especially in the earlier part of the year a benefit from a strong real estate market.

With the integration of the retirement business we acquired from CIGNA now behind us we are investing in building out our full-service retirement capabilities to take advantage of substantial long-term market opportunities. Our International results are benefiting from continued business growth in our life planner insurance operations and our ROE for the first nine months based on after-tax adjusted operating income was 14.5%.

Thank you for your interest in Prudential and now we look forward to hearing your questions.

(OPERATOR INSTRUCTIONS) Suneet Kamath with Sanford Bernstein.

Thanks. Two questions. First on variable annuities, it seems like the industry right now is at a much more level of a playing field relative to features in particular the withdrawal benefits with the lifetime guarantees say relative to last year. And with that, do you think we're going to start to see more competition on commissions or commission specials as these companies with similar products really fight for shelf space in some of the distribution channels?

And then second on the [A Triple X], I think you mentioned you were looking at some Capital Markets solutions. I'm just wondering if we moved to a principals based reserving methodology if the whole industry goes in that direction, what is the outcome of these Capital Markets solutions? Does that kind of cure the problem where you don't need to do those solutions or how do think that will play out? Thanks.

This is Art Ryan. Thank you for the question. I'll take the first one and then I'll ask either Mark or Rich to comment on the capital question.

I'm not yet convinced that there will be that much additional competition around commissions. I still think that the majority of the competition in the variable annuities is going to come through the features and through shelf space obviously in the various distribution channels. That being said, I think we are very comfortable with the margins in the business. We would not obviously price below our targeted returns. So while I expect continued strong competition I also feel very good about where our sales were.

You are right, industrywide sales were a bit slower in the third quarter than they were in the second quarter. But while we don't have final market share numbers, we think we maintained our position very, very well and I think a lot of it has to do with the features that we have, the service that we offer and the capabilities that we have in our various wholesaling and distribution channels.

Suneet, on the A Triple X, it is a long ways away. Conceptually I would hope you are right. We would love to see a better alignment between the economics and the numbers. But I think it is too early to be more specific than that.

Just a quick follow-up. The kind of a talk around maybe 2007 having principal space reserving, do you think that is -- we're not going to get there by then?

I don't think we're going to get there by then.

I think that is optimistic.

Okay, thanks.

Saul Martinez with Bear Stearns.

Good morning. A few questions. First of all, can you just give us an update on excess/deployable capital much as you did last quarter?

Secondly, I wanted to ask a question on the returns on the investment in the Allstate deal. If I take the $24 million and annualized that tax effect that you are already running at a double-digit ROI, how should we think about that going forward in terms of incremental opportunities to enhance return or is that is good as it's going to get?

And then thirdly, Art or Mark, if either of you can just comment on the M&A environment and what you are seeing out there both in the U.S. and abroad?

In terms of excess capital, I don't think it is substantially changed than what we have reported in the past. But if you look at what we would have readily deployable in terms of available moneys as well as getting ourselves to the 20% debt to equity, that is about $2 billion. We did not and have not issued any hybrids but as the market appears to move toward a 70% equity, 20% debt, 10% hybrid while still maintaining the double-A criteria, that would be another $3 billion.

We estimate that if we were to look at a significant acquisition and wanted to use more cash we believe we have a very strong gain, if you will, in our joint venture with Wachovia. They have mentioned publicly that they would have an interest in owning 100% and that is undoubtedly worth a few billion dollars as well.

And then lastly, we have additional moneys in our overseas subsidiaries of about $0.5 billion. So if you add it all up, you are in the 8, $9 billion range in terms of available and again, not substantially changed from where we were last quarter or even earlier this year.

In terms of the return on the Allstate deal, you are right, it is a double-digit return based on the earnings to date. We certainly would hope to see an increase but that is going to be a function of our ability to maintain our presence within the captive Allstate channel as well as the complementary broker and bank channels. So we've used the phrase frequently that we expect double-digit returns on these. This one we're getting very early and we would expect our earnings to continue to grow as we are successful in selling to these new channels.

A lot of it on the variable annuities for us, the real opportunity is that we historically have been underrepresented in third-party channels. That is no longer the case. We are in each of the major wirehouses. So our opportunity is just to get our fair share. Allstate of course is unique and of course we still have our own captive channel. And we are still number one in the independent channel. So I feel very good about our annuity business where we are and the fact that by simply getting our fair share we should be able to continue to grow the business quite nicely.

Lastly, in the M&A environment there are obviously -- there have been a number of asset managers that have come on the market and a few others. But my sense is that pricing is still very, very aggressive at least from the asking price from the seller's point of view. So we will be quite cautious in this environment. We have been very successful in being patient and making acquisitions that meet our hurdle rate I do not intend to change the hurdle rate at this point in time.

So I would think that the opportunities for acquisitions are less than they have been over the past few years but we get pleasantly surprised at times and we will continue to look to add to our businesses here in the U.S. as well as in those key international markets that we operate in offshore. And we are prepared to move when it meets our returns.

Thank you.

Nigel Dally with Morgan Stanley.

Great, thank you. First, I believe you are close to launching a new version of your last time [buy] variable annuity product. Hoping to get some data off the product and any initial payback that you've got from distributors?

Second with retirement, you've talked about 2007 as being the year when we should expect to return to net inflows. Any change in that outlook and if not, is it possible to talk about what level of net flows you are targeting? Also, you appear to be spending a lot on growth initiatives in that segment. How much additional spend do you expect or how far through this buildout are you presently? Thanks.

In terms of the second question, the net inflows, I think we are positive this year actually through the first nine months. It was marginally negative in the third quarter, you are correct. But we have about $12.5 billion in sales and deposits and I believe that is about $2.5 billion ahead of where we were last year. As I said, the net is positive.

And so for the first year or in this case six months after the completion of the integration of CIGNA, I'm pretty comfortable with that because certainly during the whole integration period we were not used very often on the consultant list as they knew we were going through this major change.

You are right, the business tends to focus on early in the year first-quarter kind of deals and so the investments we're making at this point certainly are going to serve us well over the long term but we would expect to have certainly the majority of them completed by the first quarter of next year and fully prepared to look for even greater growth in our net flows next year than what we have been able to do so far in 2006.

Nigel, on the new annuity product, we're in the I guess pre-launch stage at this point and we're not currently talking a whole lot more about it beyond that.

Fair enough. Thanks.

Colin Devine with Citigroup.

I have a couple of questions. First, if we could talk a little bit about Gibraltar. It seems that the level of the in-force has finally stabilized. Is that just a one quarter blip or have you finally gotten to the point where you think Gibraltar is actually going to start to grow?

Second on variable annuities and wirehouse distribution, Art or Mark, you frequently have used the term your fair share. I'd like you to expand on that a little bit and frankly first why do you feel entitled to that? But secondly, to just give us some hard numbers? If I look at the first half, [Art's] data I think PRU was reported having about $618 million through the wirehouse channel. Perhaps you could show us how that is improving or changing perhaps what it was for the third quarter so we can get some sense of it?

And then lastly on the 401(k) business, if you can perhaps give us some update as to how you are responding to the Pension Protection Act? Thanks.

Thank you very much, Colin. I think your comment on Gibraltar is exactly right. I think two things give me encouragement on Gibraltar. I mean the first obviously is the stabilization of the in-force but equally important is now the growth in the life advisers that we've now seen opportunities particularly with the Teachers Association which is about half the business there that we can continue to grow, we can attract.

And so I think we have moved the business from one that as I've said many times was a great financial investment to one that I believe gives us single-digit growth opportunities. This is not going to grow in my opinion at the pace our life planner business does but 6 to 8% growth is probably quite reasonable for that business and again, I think that is going to continue to make it an extraordinarily attractive investment.

I'll let Mark cover wirehouse distribution.

Yes. Colin, I think to qualitatively answer the question about why we believe we should be gaining share and I guess the concept around being entitled to our fair share. We have an excellent brand. We have excellent product management skills, supported by excellent risk management skills which make us very comfortable with our ability to design and deliver genuine value-added products in these channels. We have a strong credit rating and we have a business system that is emerging but I would say proving itself in terms of its ability to deliver through these important third-party channels.

The channel that I guess I have focused on more than any other when I talk about this concept is the wirehouse channel. And my market data won't be absolutely current but broadly the industry sells between 20 and 25% of its variable annuities through the wirehouse channel. Our sales through the wirehouse channel in this quarter were 11% of our sales. So if you just think about getting our percentage up to the industry standard, we have a ways to go.

Some evidence of progress is that that 11% is up from 8% several quarters ago and sales and the wirehouse channel in round numbers have risen from $150 million to $250 million over the past few quarters. So I think the concept is based on our strategic positioning and the evidence is that we are making very good progress there.

Lastly on the pension legislation. Obviously that was a very favorable bill to those of us in the retirement business. Some of the features like auto enrollment should help us over time. Today approximately 80% of participants in any particular plan, 75 to 80% are in there. With auto enrollment, that number tends to go closer to 90%. We've surveyed all of our customers and close to 90% have stated that they believe it will be an excellent benefit for their employees. Admittedly those would tend to be somewhat lower balance initially so that is why over time that should be attractive as the balances build up.

Auto allocation features based on changes in job, changes in age and the like, are also I think good features of the bill. The ability to provide advice while not a direct revenue generator is once again I think important from the notion of -- ironically many people in these plans probably take less risk rather than more risk but the whole notion of risk management I think has been net positive. And so all of those activities I believe will be very, very favorable in terms of the outlook of the business as it goes forward.

What I'm particularly enthused about which wasn't directly part of the legislation but is part of the capability is taking our annuity skills around Lifetime Five and the like and applying them within the context of our 401(k) and 403 (b) plans. If you think about the accumulation of savings, one of the issues that most retirees have is the whole question of lifetime income without losing total control of the assets. And I think both have been addressed in many of our annuity product offerings and so I see an even greater correlation between the annuity business and the 401(k) business.

And last but not least, we are significant players in the defined benefit business. And as changes continue to occur there that's additional opportunity. So I think the broad market outlook both through the legislation and the other matters I mentioned, Colin, give us renewed confidence that this is a good business and one for which there are obviously a number of very good competitors. But I really like our position in the business.

Thanks.

Andrew Kligerman with UBS.

Good morning. I have three probably quick questions. First, the Group Life and Group LTD, robust sales. What was driving that with the competitive environment there and what is the outlook?

Secondly just very quickly I know you responded to a question in the pension business and the improved opportunities there. So do you get to positive flows by 1Q '07?

And then lastly on international, the Japan sales, they improved Japan they seem to face very difficult comps. I think you last repriced a product in October of '05 so does not mean as we get to '07 the comps are going to ease up substantially and you could get back to a very positive sales mode?

And Part B to the international sales question is in the other countries I mean is it so tough in Korea right now that we shouldn't expect any sales pick up over the next year or two?

Thank you. On the Group Life and Long Term Disability, it's kind of ironic because in the second quarter our sales were a little bit lower than prior year. And in the third quarter they were obviously higher. It really had to do with a few cases. It was not anything unusual beyond that. The majority of Group Life and Disability sales still occur in the first quarter. Most people do it on a calendar basis.

So second and third and fourth quarter comps are probably not very good in terms of long-term trends. They tend to relate to oneoff deals that do or do not occur. So no, there was nothing particularly unusual with that other than we are always delighted to win $50 million deals. But I wouldn't put that into the kind of ongoing trend line. The key is the annual sales most of which occur in the first quarter. We obviously love the business. We're number two in the market and we make very nice returns in what we do there.

In terms of pension flows as I mentioned, we had about $12.5 billion in sales and deposits through our full-service. That is a positive net flow for three months even though the third quarter was negative. With the investments we've made with the integration completed in the first quarter of the year we certainly would expect positive flows, improved positive flows in 2007.

In terms of Japan, yes, the comparisons you are absolutely right; the last price increase was October of '05. And so the comparisons '07 to '06 should be better and different because of the fact that we don't have that sizable bulge we had in '05. I don't make excuses for it. I like it when we have large sales especially those from -- if I annualize '04 to '06, I'm well in the double-digit range of increases and again, I don't think our business is so perfect that I can do it quarter to quarter but the trendlines there are really good. So this was not a problem. This was just one year just happened to be extraordinary.

In terms of the other countries, if you take out Korea and that is always a risk, but if you take out Korea, our growth in life planners is double-digit. And so as I've mentioned in earlier quarters, the competition has been very, very strong in Korea. I'm pleased that our sales have held up quite well even though we have not had growth in the life planners there because of competition. Principally people recruiting from us in terms of our own employees.

Our earnings obviously continue to be strong. Our persistency numbers remain excellent, and so if you look at the key drivers, persistency is good, productivity is good. But there is no question, there's a lot of competition and hiring and keeping people. And as Mark said, I don't expect that to change in the next couple of quarters.

But again, I think we've demonstrated that we are a resilient player. We have a very, very strong business system in these markets, and we can withstand a little competition every now and then. But the long-term trend, I think, across all of the life planner business is very, very good.

Excellent, thanks.

Jimmy Bhullar, JPMorgan.

Thank you. I have a couple of questions, both on annuities. First on sales by distribution, you've spoken about wirehouses a lot. But if we look at sales by distribution, [general] and variable annuities, most of the growth that you've been getting has been coming through independent broker-dealers, or that has been one of the strongest channels for you.

So if you can discuss what is it that you are doing there, either it's the Lifetime Five or whether you are adding distribution. What is it that you are doing there that is allowing you to grow at such a strong pace?

And then second just on the production, if you can talk about how much production you are getting from legacy Allstate distribution and what sort of upside you have in that as you introduce updated products. I think Morgan Stanley stopped selling Allstate annuities sometime in the third quarter. I'm not certain if you can comment on that.

Sure. This is Art. In terms of sales through the independent channel, I think there's a couple of reasons. Our success there first and foremost is the Skandia acquisition. They had been the leaders in that channel, so our wholesaling capability, our knowledge of the folks in that channel and I believe our support and service is certainly second to none. We've been a leader in there, and so we were the beneficiary of that. But importantly, we kept all of those capabilities as we go forward.

Second, that is a very, very discerning channel, and so being competitive on the product side is very important. And I think we've demonstrated most recently with Lifetime Five, and hopefully continue to demonstrate that we will be at the cutting edge on these products in terms of capability that meet customer needs.

So I think those are the two reasons that we continue to be strong. One, as a result of the acquisition, and the other is our commitment to that particular channel, both from a product and service point of view.

I'll let Mark talk about the Allstate distribution.

Eric has some numbers. I'm going to pass that off to him. He's got a more specific answer.

Well, the sales from Allstate in the quarter were $360 million, which would annualized to $1.440 billion. There were $131 million in the month of June, which was the only month in the second quarter that we owned them. The net sales for Allstate were a -171 as expected. And if you break the sales out for Allstate, $120 million of their sales in the quarter when through their captive channel, which is the only one of their three distribution channels where they have been selling PRU product. So not surprisingly, it is the one that has had the greatest success.

The sales of the wirehouse channel which historically had been about half of their sales were only $93 million in the third quarter, or only about one-third of their sales. And that reflects the fact that we only began to introduce PRU product into the wirehouse channel right at the end of the quarter, so it really didn't have any impact yet.

And finally, everything else which is principally banks were $147 million in the quarter, of which $138 was the banks. And here too, they are still selling if you will old Allstate product. They will continue to sell Allstate branded product, but we will be private labeling for them beginning in the early part of next year. So we see a lot of opportunities ahead of us as we roll out our product.

And just a follow-up for Art. You mentioned at the start of the call your ROE so far this year has been about 14.5. I think if you take out unusuals, it would have been about 14.2. And there is still -- the mix shift is still going on. You are deploying capital. And as you look towards improving from this, is this a base you can build off of next year, or do you think results this year were inflated so that expectations for next year are not going to be as high, in terms of a range for '06, '07.

Yes, I think your arithmetic is right. It is 14.5, and as I said, above 14. It's 14.2 exactly if you take the unusual items. As I said in my comments, each year at the Investor Day, which this year is December 6, we will talk about the outlook. But as I've said many times, we have a strong foundation that I expect to continue to grow, and I'll be able to give you more specific guidance on December 6.

Okay, thank you.

Ed Spehar with Merrill Lynch.

Thank you, good morning. A couple quick questions. First, I was wondering if you could help us understand a little bit better how to think about sort of the tail for the retained liabilities in the financial advisory segment? And I guess what I would be curious to know is if you get a new claim in, do you typically set up a reserve, then there's a resolution, and then there is a true-up, whether it was too high or too low? And is there any way to tell us about is a reserve set up most of the time, and historically when there is resolution, has it been pretty much as you expected? Or how can we think about when that sort of goes away?

Ed, it's Rich. FAS-5 really doesn't allow us to accrue for these type of estimates. So it is kind of we get a claim in; we wait until we either have some sort of a court action before we set up a reserve. So there really is no reserve for outstanding claims on the books today unless we have some type of court action or unless we have some sort of out-of-court agreement with the claimant. However, the most important thing when you think about the future of these is the claim count is coming and has been coming down every month for several quarters.

Is there any way to give a sort of magnitude of percentagewise or numbers?

That is tough because while the count is coming down, individual settlements -- they are in the court system from time to time and it is hard to predict what the outcome will be.

I think there is no question that the number of claims has shown the right trend. It is coming down over the last few quarters which is delightful to have. The difficulty is most of these are arbitration and it's getting more and more to be a crap shoot in terms of what arbitration panels are awarding so it is very difficult for us to do it on a dollar basis. But I think that all of us would be disappointed if we don't continue to see the continued downward trend in claims and helpfully a simultaneous downward trend in the 20 million plus a quarter that has been in -- that are in the numbers. So it's going in the right direction.

Okay, that is good. And the one follow-up on the commercial mortgage income, Mark, I think you said was $6 million this quarter versus $30 million in the year-ago quarter?

Yes.

Can you give us any sort of long-term quarterly range for that number? Is that something that is always there at some level and is 6 a low quarter? Understanding that it's volatile but is there some average and standard deviation around that average that we can talk about?

Ed, its Eric. The remarkable thing about this activity is its stability from year-to-year. It produces about $40 million of AOI for a full year so. But it's all over the lot on a quarterly basis. So this quarter was a little bit light. The third quarter of last year was unusually strong that was really the (indiscernible) period.

But, Ed, you've got to understand, the volatility that you are seeing is not economic because the volatility is coming from the disconnect and the accounting. I've got to mark-to-market the hedge and I cannot mark-to-market the underlying. The underlying has gone up in value if I have a loss on the hedge. When I securitize those mortgages, I book the gain. So it is always a quarter or two out of sync.

Okay, very good. Thank you.

Tamara Kravec with Banc of America Securities.

Thank you. My questions have been asked and answered. Thanks.

Joan Zief with Goldman Sachs.

Thank you very much. I have just two questions. First, Art, could you talk and just refresh what your plans are and succession plans for Prudential?

And secondly, my second question is, given Prudential's size from a market cap standpoint, the huge amount of your excess capital that you identified and the attractive valuation, do you think that allows PRU to look at maybe a very large acquisition, a very large merger which might eliminate some of the issues that are impacting as you call it aggressive pricing in the M&A Area?

In terms of the succession planning, there really are no changes. The Board initiated an activity earlier in the year to begin the process of looking at my successor. My expectations is I will certainly be here through the end of next year and I'm rather flexible relative to when the exact moment occurs. But that is really going to be driven by the Board. My sense is that somewhere toward the latter part of next year there would be more clear delineation in terms of what that is going to be.

So really not much of a change at this point in time and the Board is obviously doing a thorough job in ensuring that they do all the things they are expected to do to ensure that there is an orderly transition and that it works to the benefit of our shareholders.

Large acquisitions, without sounding facetious, I'd like to do very large acquisitions but first they have to meet the hurdle rate. By that I mean is that we certainly want to deploy as much of the excess capital as possible into operating businesses but recognize that capital management strategy, stock buybacks, dividends and etc. are also important ways to service shareholders.

I'm not sure there is any greater opportunity for a larger versus a smaller acquisition in the current environment. I think that pricing is quite aggressive but we certainly are available if the right deal were to come along and we could price it properly. But, no, I don't think there is any particular advantage in a larger deal versus a smaller deal at this point in time.

What you consider maybe lowering your hurdle rates if the strategic fit seemed to outweigh that near-term hurdle requirement?

I don't think so.

Thank you.

Is that it?

We have no further questions.

Do we have time for a closing statement? Yes. Well, again, I think the results were quite positive in the third quarter. I'm particularly pleased on the progress we're making on return on equity and continue to make over the years that we built a very strong foundation. As I've tried to answer in terms of the M&A environment, we are very, very much driven by returns and profitability. And we expect to continue to do that.

So thank you very, very much for your participation and I look forward to seeing you again at the next quarter. Thanks.

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