保德信金融集團 (PRU) 2007 Q2 法說會逐字稿

Good morning, good afternoon to our global audience. Welcome to Prudential announcing their second-quarter 2007 earnings release. Now at this point and during the presentation, we do have all of your phone lines muted or in a listen-only mode. However, after management's prepared remarks, there will be opportunities for your questions. (OPERATOR INSTRUCTIONS) So with that being said, here with opening remarks and to introduce the executive team, head of investor relations, Mr. Eric Durant. Good morning, sir, and please go ahead.

Thank you, Brad. Good morning. Thank you for joining us. We always welcome the opportunity to tell our story. Today that is especially the case. Art Ryan will kick things off this morning. After that, Rich Carbone, John Strangfeld, and Mark Grier will walk us through the quarter. Then we will welcome your questions.

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 and Non-GAAP Measures of earnings press release for the second quarter of 2007, which can be found on our website at www.investor.prudential.com.

In addition, in managing our businesses we use a non-GAAP measure we call adjusted operating income to measure the performance of our Financial Services Businesses. Adjusted operating income excludes net investment gains and losses, as adjusted, 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 reported changes in contractholder liabilities resulting from changes in related asset values. The comparable GAAP presentation and a 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.

Our first speaker is Art Ryan.

Thank you, Eric. Good morning and welcome. Prudential continues to perform well. Our annualized return on equity for the year-to-date was 16.4%, based on adjusted operating income. On the same basis, earnings per share increased by 34% in the quarter, and by 38% in the first half, compared to the corresponding periods of last year.

Our business momentum is broadly based, and our results also reflects favorable market conditions, especially for equities and commercial real estate through midyear. That said, market dislocations are a fact of life for any financial institution. So recent turmoil in equity and credit markets did not shock us. We believe that the quality of our business models, the staying power of our value propositions in the marketplace, and our financial strength prepare us to weather volatile market conditions.

We also believe that stormy markets create new opportunities to serve our customers while demonstrating our skills as risk managers. Annuities are a case in point. The decline in the equity markets in the early 2000s was painful for annuity companies and their customers; but this unhappy experience created demand for risk management features and guarantees that continues unabated. Companies with the skill sets and the capital strength to meet this demand have flourished. Those lacking them have exited the business or fallen by the wayside.

More broadly, unfavorable market conditions provide a test of a company's risk management, beginning with its diversification of risk. Prudential has a portfolio of businesses that I believe is unusually diverse. Our businesses served both individual and institutional clients. We operate in the United States and abroad. We manage a broad set of insurance and market risks that to a great extent are uncorrelated. We select the particular risks we take carefully, based on our proven skill sets. For example, management of credit risk is a demonstrated core competency of Prudential, of long-standing.

Prudential's balance sheet is exceptionally strong. Our credit exposures are well within our risk tolerance standards, which we believe are consistent with our AA ratings aspirations. Rich Carbone will have more to say on this subject in a few moments.

Prudential's capital position remains rock solid. We estimate that excess capital, which includes untapped capacity to issue capital debt and hybrid securities, as well as equity on the books, is in the range of $7 billion or more. This is a static measure. Share repurchases, common dividends and acquisitions reduce this total. But a significant portion of earnings -- we estimate about 60% of our after-tax adjusted operating income -- increases it.

In the first half of this year, we repurchased $1.5 billion of common stock. This is in line with our Board authorization to purchase up to $3 billion this year. As I said at our last investor day, as a base case, we expect annual share repurchases of $3 billion through at least 2009.

Prudential's election of the look-back option with respect to our investment in Wachovia Securities has not changed this expectation.

Finally, I will update earnings guidance for the full year. Earnings power in the first half is running well above our current guidance for full-year 2007. Our businesses continue to perform well.

We are raising our guidance for Prudential's 2007 common stock earnings per share to a range of $7.20 to $7.40 based on adjusted operating income. This guidance reflects our consideration of a wide range of circumstances, including seasonal patterns and lumpy revenues and expenses. In addition, our guidance assumes stable equity markets over the balance of the year.

Now I will ask Rich Carbone, John Strangfeld, and Mark Grier to review the quarter in some detail for you. After that, we look forward to hearing your questions. Rich?

Good morning. I will start with an a review of the second-quarter results for the Financial Services Businesses. As you have seen from yesterday's release, we reported common stock earnings per share for the Financial Services Business of $1.87 per share for the second quarter compared to $1.40 for the year-ago quarter. These results are based on after-tax adjusted operating income and amount to a 34% increase in EPS.

Our current-quarter results benefited from business growth, improved mortality experience in our domestic protection business, favorable equity markets, and a continued strong commercial real estate market. Our annualized ROE based on after-tax adjusted operating income for the second quarter was 16.3% and amounted to 16.4% for the first half.

The list of items in this current quarter resulting from unusual or nonrecurring items is very short and contributed only about $0.04 per share. Income from our commercial mortgage operation within the Asset Management business benefited from mark-to-market on hedging instruments and was especially strong in relation to the average of the recent quarters. That added about $0.02 per share.

In Gibraltar, income from a single joint venture investment contributed another $0.02 per share. Each of our three operating divisions contributed to this EPS increase, registering double-digit increases in adjusted operating income. John and Mark will speak to our detailed business results in a moment.

Corporate and Other operations reported a loss of $8 million for the quarter compared to adjusted operating income of $40 million a year ago. The swing in Corporate and Other results reflected, among other things, a fluctuation in deferred compensation liabilities that we marked-to-market as this rise in the equity markets required us to increase the liability. In addition, the contribution from our real estate and relocation businesses included in Corporate and Other results were down $11 million for the quarter from a year ago, reflecting lower transaction volume and a less favorable residential real estate market.

Now John Strangfeld and Mark Grier will review our business results for the quarter. I will turn over to John for the domestic business.

Thank you, Rich. I will begin with the Insurance Division. Adjusted operating income from our individual life insurance business was $141 million for the current quarter, up $45 million from a year ago. Current-quarter results benefited from improved mortality experience compared to a year ago, when claims experience was less favorable than our average expectations.

We also had lower 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 profits. The uptick in the equity markets in the current quarter, together with improved persistency, both contributed to higher expected revenues and were the major causes of the lower amortization.

Sales, excluding COLI, amounted to $118 million in the current quarter, up $17 million from a year ago. The sales increase came mainly from our term insurance products and were primarily driven by our continued development of third-party distribution relationships, including direct response agents who specialize in term insurance as well as national and regional brokerage organizations.

In addition, in April this year, we fine-tuned our pricing to improve our competitive position, lowering rates for term insurance cases of 1 million or more in selected underwriting categories, while raising rates for some smaller face amount policies.

We are also beginning to register sales from a recently added return of premium term product that appeals to clients who want affordable term insurance and funds [they] use for other purposes after the protection period.

Overall, third-party sales were up 36% from a year ago and accounted for about two-thirds of our total second-quarter non-COLI individual life sales.

The Prudential agent count stood at about 2,500 at the end of the second quarter, down about 330 from a year ago. We hold agents to minimum production standards on a calendar year basis, and the decline mainly reflects attrition of lower producers at the end of last year coupled with selective hiring. Sales by Prudential agents declined by 7% from a year ago, less than the 12% decline in headcount.

Our annuity business reported an adjusted operating income of $180 million in the second quarter, up $58 million from a year ago. The variable annuity business we acquired from Allstate contributed $18 million more to earnings than in the year-ago quarter, when we reported its first month of operations following the acquisition in June of '06.

The remainder of the increase came mainly from higher asset-based fees, driven by market appreciation, together with strong net sales of variable annuities which have amounted to $1.6 billion over the last year.

Our gross variable annuity sales exceeded $3 billion for the first time this quarter, up 21% from a year ago, including nearly $500 million from the new distribution that came to us with the acquisition of the Allstate business.

In addition to expanded distribution, our sales are benefiting from the popularity of our highest daily or HD, Lifetime Five feature that we introduced last November. Over $600 million of our current-quarter sales included this feature. Our overall take rate for living benefits in the quarter was over 80%. As clients increasingly think of variable annuities with living benefits as a retirement income solution, our product innovation and risk management skills are a significant advantage in the advisor sold market.

I should mention that we just received Insurance Department approval for sales of HD Lifetime Five in New York in late July, and expect to rule out the feature in that market shortly.

Lifetime Five account values on the books, including the original version introduced in early '05, the spousal product introduced early last year, and the new HD product, reached $12.4 billion at the end of the quarter, an increase of more than $2 billion from the first quarter and $7 billion from a year ago.

Gross variable annuity sales in our largest channel, independent financial planners, were a record $2 billion this quarter, up 13% from a year ago. Sales by insurance agents were $660 million for the quarter, including nearly $300 million from Allstate's proprietary channel, where we introduced our products last August. Sales in the wirehouse channel, including the relationships that came to us with the Allstate business, are up $110 million or 41% from a year ago.

The Group Insurance business reported adjusted operating income of $69 million in the current quarter, up $40 million from a year ago. The increase came mainly from improved life claims experience in the current quarter compared to a year ago, when group life mortality was less favorable than our average expectations.

Group disability experience was also more favorable than a year ago, with higher expenses a partial offset.

Group Insurance sales were $52 million in the current quarter compared to $43 million a year ago. Most of our Group Insurance sales are registered in the first quarter, based on effective dates that the business sold.

Turning to the Investment Division, the Retirement segment reported adjusted operating income of $138 million for the current quarter compared to $142 million a year ago. Results for the year-ago quarter benefited from $10 million of mortgage prepayment income and $9 million of reserve releases, while the current quarter benefited only $5 million from similar items. Stripping these items out of the comparison, results were up $10 million from a year ago, mainly as a result of greater investment income net of interest costs, reflecting the growth of balances for institutional investment products.

In our full-service business, we are continuing to invest in our product and service capabilities, including those that address the retail rollover and income product markets. Higher expenses essentially offset the growth in fees for full-service retirement where account values have increased $12.5 billion or about 14% over the past year. Gross deposits and sales of the full-service business were $3.2 billion for the current quarter, compared to $4.1 billion a year ago, which included about $1 billion from two large cases.

Withdrawals and other outflows in the current quarter were $3.2 billion or 3% of beginning values compared to $3.4 billion or 4% of beginning values a year ago.

Our net flows in full-service retirement were disappointing in the current quarter. Our persistency remained strong and the shortfall is a function of sales softer than what we are targeting. Our main focus is on the mid to large case market. We typically sell several large cases per year; and in the first half of this year we have not registered these large case sales. However, we see nothing of systematic concern, and we remain confident that the long-term prospects for this business are favorable.

The Asset Management segment had adjusted operating income of $190 million in the current quarter, up $53 million from a year ago. The increase reflected greater performance-based fees, mainly related to real estate investment management, and growth in Asset Management fees. Roughly one-quarter of the segment's revenues come from incentives, transaction, principal investing, and capital markets activities. But we would estimate that the earnings contributions of these activities is closer to half of the segment's reported results for both the current quarter and the first half of the year.

Results from these activities reflect market conditions as well as the success of investment strategies we implemented for our third-party clients and our own co-investments in proprietary investments.

We continued to benefit in the current quarter from a strong commercial real estate market as well as favorable performance in a proprietary fixed income fund investment. Current-quarter results also benefited from growth in Asset Management fees, reflecting a $47 billion or 13% increase in assets under management over the past year, driven by market appreciation and positive net flows.

The Financial Advisory segment had an adjusted operating income of $72 million this quarter, compared to $30 million a year ago. The $42 million increase came mainly from $33 million greater income from our share of the retail brokerage joint venture with Wachovia, which benefited from growth in commissions and fees. In addition, the segment's expenses for retained obligations in the current quarter were $9 million lower than a year ago.

Now I will turn it over to Mark for the international businesses.

Thank you, John and Rich. The international insurance segment reported adjusted operating income of $412 million for the current quarter compared to $324 million a year ago. The segment's results include adjusted operating income of $159 million from Gibraltar Life in the current quarter, up $57 million from a year ago. Gibraltar's current-quarter results include $14 million of investment income from a single joint venture, reflecting the sale of real estate within the venture. Results for the year-ago quarter included charges of $17 million to true up policy liabilities. Stripping out these items, Gibraltar's adjusted operating income increased by $26 million from a year ago.

This increase came mainly from improved investment income margins, reflecting a continuation of our portfolio strategy to lengthen maturities and increase US dollar investing, as well as growth of Gibraltar's US dollar fixed annuity business, where account values stood at $2.3 billion at the end of the second quarter, approximately twice the level of a year ago.

Sales from Gibraltar Life, based on annualized premiums in constant dollars, were $105 million in the current quarter compared to $121 million a year ago. The decrease came entirely from lower sales of our US dollar fixed annuity product, which represents substantially all of the sales reported for Gibraltar's bank channel, and contributed $30 million to current-quarter life advisor sales, compared to $41 million a year ago. Sales of this product in the year-ago quarter benefited from initial customer demand following the product introduction and from yen-dollar exchange rates that were more attractive to Japanese consumers than the recent exchange rates.

Gibraltar had about 5,800 life advisors at the end of the second quarter, up about 130 from a year earlier, but below the count at the end of the first quarter. We continue to focus on quality of the field force, which drives both productivity and the persistency of business sold. Earlier this year, we re-enforced our selection standards in hiring based on our observations about critical success factors. In addition, we hold our life advisors to minimum production standards based on semi-annual evaluation periods, and we experienced some attrition of lower producers.

Our Life Planner business, the international insurance operations other than Gibraltar Life, contributed $253 million of adjusted operating income in the current quarter, up $31 million from a year ago. The increase came mainly from continued business growth. In addition, our Life Planner results benefited by $8 million from more favorable foreign currency translation, mainly related to our Korean operation.

Sales from our Life Planner operations, based on annualized premiums in constant dollars, were $186 million in the current quarter compared to $192 million a year ago. Sales in Japan are $121 million for the current quarter compared to $123 million a year ago.

In April of this year, we increased pricing for the income feature of our US dollar-denominated retirement income product. This accelerated some sales that might have taken place during the second quarter into the first quarter as customers purchased policies in advance of the repricing. For the first half, sales in Japan are up 5% compared to a year ago, roughly in line with the 6% increase in Life Planner count.

For our operations outside Japan, which mainly reflect our Korean Life Planner business, sales were $65 million in the current quarter compared to $69 million a year ago. The Life Planner count in Korea stood at just over 1,600 at the end of the second quarter. The count has essentially returned to the level of a year ago after declining through most of last year, as we experienced difficult competitive conditions and poaching of Life Planners. We recently implemented some fine-tuning of our compensation structure in Korea, including features to encourage sales of life insurance to new customers. While it is still early to draw conclusions, the initial results were positive in terms of improved Life Planner retention, which contributed to the net increases in Life Planners during both the first and second quarters of this year.

In our insurance business, we always have things going on quarter to quarter. The fundamentals of the business are sound, and I believe that we remain on track to deliver our expected business growth and return results over time.

The international investment segment reported adjusted operating income of $43 million for the current quarter compared to $34 million a year ago. The increase came from more favorable results from our international asset management businesses, mainly in Korea.

Now I will turn it back to Rich.

I'm going to comment on net income and the investment portfolio with some detail on a specific asset class. Net income for the Financial Services business was $835 million for the second quarter compared to $424 million for the year-ago quarter. Current-quarter results include pretax realized investment gains of $32 million, net of related charges and adjustments. These realized gains came mainly from sales of equity securities in our Japanese and Korean insurance operations.

Credit-related losses and impairments were $17 million in the current quarter. Our gross unrealized losses on fixed income maturities in our general account stood at $1.3 billion at the end of the second quarter, with the vast majority related to interest rate movements on investment-grade securities. Only $92 million of the gross unrealized losses relates to noninvestment grade securities.

Substantially all of the increase from the first quarter, when gross unrealized losses were $551 million, is interest rate-related.

Noninvestment grade fixed income maturities comprised about 6.5% of the Financial Services business fixed maturity portfolio at the end of the second quarter, essentially unchanged from the year-ago quarter. Our exposure to residential mortgages is through the mortgage-backed and asset-backed securities included in our fixed maturity portfolio, and is virtually all investment-grade.

Mortgage-backed securities amounted to $8 billion at the end of the second quarter. This portfolio accounted for $125 million of our total $1.3 billion gross unrealized loss. About 98% of the mortgage-backed securities are publicly traded agency pass-throughs. These securities are issued by Fannie Mae, Ginnie Mae, and Freddie Mac and supported by implicit or explicit government guarantees. As a result, these securities are rated AA or AAA.

Asset-backed securities amounted to $15 billion at the end of the second quarter and had gross unrealized losses of only $66 million as of June 30. We independently evaluate the underlying collateral, which primarily comprises residential mortgages, credit card receivables, and auto loans.

We have a total of $8.5 billion of securities collateralized by subprime mortgages in the Financial Services business included in this ABS total. $7 billion are 2005 to 2007 vintage. $6.8 billion of the '05 to '07 vintage is rated AAA or AA; and about 60% of that has an average expected life of less than one year. We have no CDOs collateralized by these instruments.

All subprime collateral are first mortgages. We price at the bid; or if the bid is stale, at last trade or collateral settlement values. We do not mark to model. I'm comfortable with the mark-to-market methods.

The gross unrealized loss as of July 31 is not significantly different, although up, from June 30. But obviously, we cannot predict the future.

Lastly, our worst-case estimate of the credit loss on the subprime holdings is approximately $150 million after-tax in total over a five-year period. Less than 1% of our current equity. Let me reiterate, this is the total. The $150 million is the total over the five years, and would result from a 40% decline in housing prices underlying these securities.

Now, briefly our Closed Block Business. The results of the Closed Block Business are associated with our Class B stock. Closed Block Business reported net income of $11 million for the current quarter compared to $29 million a year ago. Current-quarter results include a charge to increase the liability for future policyholder dividends, based on cumulative results of the closed block. We measure results of the closed block only on a GAAP basis.

Now turning back to the Financial Services business and summing up our results. The Insurance division is benefiting from continued growth of our annuity business including the contribution of the variable annuity business we acquired from Allstate. Favorable equity market conditions and improved equity in our protection business has also contributed to the growth in earnings for the quarter. The Investment division benefited from strong results from our asset management business, driven by performance-based fees and growth in assets under management, as well as higher earnings from our retail brokerage joint venture with Wachovia.

Our International business reported a significant earnings increase for the quarter, with business growth in our Life Planner operations complemented by increased investment margins at Gibraltar Life, and an uptick in the results from our international investments business.

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

Thank you very much, Mr. Ryan, Mr. Carbone, and our host panel. We do appreciate that second-quarter update. (OPERATOR INSTRUCTIONS) Sanford Bernstein, Suneet Kamath.

Thanks very much. Maybe two quick ones, one on the subprime and one on the FSA -- sorry, full-service business. On the subprime, you had mentioned that I think half of the $8.5 billion is rolling off in the next 12 months and that is all AAA. But I understand it is also in the '06-'07 vintage. Can you just talk about why stuff that was sort of originated so recently would be rolling off in 12 months?

Then second, on the FSA, the large cases that you mentioned, John, that you are not just closing those -- or you are not getting the new case wins. Is it just a lack of RFPs? Or are you getting the RFPs and you're just not able to close them? Thanks.

Let me have Rich answer the first and then John will answer the second.

Yes, the tranches are both as to credit rating and cash flow positioning. So despite the fact they were issued in '06 or '07, when they were structured those cash flows that we purchased had those maturity dates or those durations.

Vis-a-vis the full-service, we are seeing the business. Our hit rate was just lower than we planned. We came in second more often than we like.

Just a quick follow-up. Is there anything that you would attribute that to?

No, not really, each case has got its own individual attributes to it. There is nothing systematic in that.

Okay, thanks.

Credit Suisse, Tom Gallagher.

Good morning. First, a question on subprime. Rich, just want to get a little bit behind what you were looking at it as the most vulnerable when you were doing your loss estimates. I presume it is the A-rated and below paper. When I look at about $850 million or so of exposure there.

Can you talk a little bit about -- we can see that the pricing on the much more recent vintage paper, '07, in some cases is trading at $0.60 on the dollar. But it looks to me like most of your exposure is pre-'05. Can you talk a little bit about how that paper is currently trading? Is it substantially higher?

Also, a little bit more about which parts of your portfolio you think is more vulnerable right now?

Let me quantify some of the buckets. I can't speak to current pricing at this discrete a level. But we have about $600 million rated A with vintages of 2004 and earlier. We have about $100 million of BBBs with vintages of 2004 and earlier.

We don't -- again, I can't comment as to the daily mark-to-market on those securities. But in the single-A and in the double-B classes of vintages 2005 and later, we have about $150 million in the A category and about $20 million in the BBB category. Again, some of that is current.

As far as the current pricing versus what is in our $66 million as of June 30, it is tough to tell mid quarter, intra quarter.

Okay. Is it fair to say, though, when you look at -- when you have done kind of a worst-case scenario, were most of the losses coming from the '06 and '07 bonds, in terms of when you had done your impairment test?

Yes.

Okay, got it. So in other words, the pre-'04 vintage even for the paper that is, let's say, single-A, BBB, at this stage in the game is much less of an issue; is that fair to say?

Yes.

Okay, thanks. The other question I had was if you look at the international business, you had very strong growth in NII this quarter. Overall premium growth was not as strong. Can you comment about -- is there anything unusual going on, slowing the premium growth there for this quarter?

Also is there any more opportunity for NII expansion in the Asian business? Thanks.

On the second question first, there are still some opportunities. As you know, though, we got a big lift on the investment income side when we restructured the Gibraltar portfolio initially, after we got a lot more comfortable with the liquidity and lapse issues in that business after bankruptcy.

So there is not as much upside as we have realized over the past few years. But there is still an opportunity to do better in both of the big portfolios, meaning Gibraltar and Prudential of Japan.

Tom, this is Eric. Let me take your question on premium growth. If you look on page 27 of the QFS, and you look at the constant exchange rate basis schedule for net premiums policy charges and fee income, the Prudential of Japan is up 9.5%, which I think is pretty indicative of what one would expect.

All other Life Planner countries are up about 6%, which is a little bit light. I think that reflects more than anything else our recent experience in Korea.

Gibraltar on a reported basis is down from 626 to 611; but you may remember that a year ago we had $23 million of upside sharing dividend. If you strip that out, which is clearly an unusual item, then we have a modest increase of about 1.3%. You know that really isn't very different from what we would expect Gibraltar to produce.

Okay, got it. So it was really the dividend.

Yes.

Okay, thanks.

Jeff Schuman with Kleinwort Benson Wasserstein.

Actually, Keefe, Bruyette & Woods, but thank you. Good morning. A couple questions for Rich. Fascinated by your worst-case loss estimate of $150 million. Comparing that to the $7 billion of lost market cap over the last few weeks. Obviously your earnings performance, earnings outlook continues to improve. So it would seem that we have to attribute most of that lost market value to the market concerns over subprime.

A couple questions. First of all, any thoughts about additional share repurchase to take advantage of the weaker share price?

Secondly, would you be willing to consider maybe some more frequent supplemental updates on the development of the ABS portfolio over the next few months, so that we can get sort of more comfortable and see a little more transparency about how this develops?

I'm thinking in particular of this issue of all this paper with the short expected life. If we could actually see hundreds of millions of this stuff rolling off over the next few months, at or close to par, I think it might go a long ways towards enhancing comfortable with it.

This is Art. Let me try and answer the share repurchase. You know, when we put that program in place the strategy really reflected the fact that we like to put our excess capital where that is in the best interest of shareholders. I think ideally when we can find attractive acquisitions, that we want to do.

In buying back shares, I think it reflects the market conditions we have seen over the last few years, which said that we were better served by giving the money back to our shareholders than simply holding it.

We look at that every quarter to determine whether or not it makes sense to do something a little bit differently. We have under present conditions the ability to continue that not only for this year but also for 2008 and 2009.

So we look at that but my expectation is we will stay on the current course of about $3 billion per year. I think it can get a bit dangerous to reflect on increasing it if the stock price happened to go down versus decreasing it if the stock price happens to go up. Now, we are not naive, which is why I will say we look at it every quarter. But I think the base case of $3 billion per year is a pretty solid number at this point in time.

Jeff, it's Rich. Our disclosures are going to track the SEC filing dates. We will look at the Qs -- we will look at the disclosures in the Qs, and if we can make this more transparent of how this unfolds we will. But we will do it in accordance with the typical SEC filing schedule.

I'm just thinking that given the volatility of this market, three months seems like a long time out. But, okay, thank you.

Morgan Stanley, Nigel Dally.

Great, thank you. Rich, I just want to circle on how you value the subprime securities. If I heard you right, it is based on actionable bids from third parties, not internal models. Is that correct?

That's correct.

Okay, that one's easy. Second, are you still buyers of subprime-backed paper? Or should we expect the exposure to significantly decline, reflecting the expected maturities that you mentioned?

We are still buying.

Okay. With regards to the buying, given the term on the market, I guess how can we be comfortable -- or how can you be comfortable in the quality of purchases you are making? It seems like there's a lot of turmoil in the market; and a lot of the metrics which people traditionally looked at are no longer as relevant.

Nigel, this is John Strangfeld. Just to speak to that, I think one of the things we recognize is that this is not one market; that you have got different levels of collateral, seasoning, subordination, and the like.

So, not surprisingly, we have different points of view regarding different phases of the capital structures in these securities. So what I mean by that is we believe the credit problems are the subprime securitizations, even excluding the CDOs, are largely related to securities below the AA level.

We think there are liquidity issues in the higher-grade securities. I'm referring to there the AAs and the AAAs. That in turn can create investment opportunities.

Okay. Then last question on Japan. Understand the distortion caused by the new mortality tables. But for the first six months, sales growth in Japan was still relatively modest. It seems like the growth in the number of Life Planners is a major factor driving that. Perhaps you can discuss why growth in Life Planner seems to be getting incrementally more difficult for you; and your expectations for Life Planner growth looking forward.

Well, on the last point, I would reiterate the aspirational goal of 10% growth in Life Planners, total, around the world. Japan gets tougher partly because the denominator gets bigger as that force grows.

We also, in terms of the shorter-term impact, have been a little lighter on sales managers this year than we had planned. That has a direct impact on Life Planner recruiting and Life Planner retention. But we don't see any fundamental structural-type problems.

So I do expect that the drivers of the business will be consistent with supporting both the earnings outcome and the return outcomes that we have talked to you about before. Now we bounce around quarter-to-quarter; but broadly over time we aspire to 10% growth in Life Planners. We don't always get there, but we have generally been getting pretty close.

That's great. Thank you.

Citadel Investments, Dan Johnson.

Great, two please. The annuity distribution in the wirehouses, can you talk a little bit about how we are progressing there, and sort of how far along we are in getting to where we would like to be? Then I have got a follow-up.

Sure, okay. Dan, it's John Strangfeld here. Let's hit the primary channels here. IFS is our largest market. It is the largest market, and it is where our strongest market position is. We think we are doing well there and continue to progress nicely.

The wirehouse channel is something that is also progressing well along. We are in all the major wirehouses with the exception of A.G. Edwards; (inaudible) A.G. Edwards is going through change. You can see that is up significantly over the prior quarter. But this is early days. So we think there is a lot of upside there.

With regard to the bank channel that is even earlier for us. We see the opportunities there as well over time. Then of course the other sector would be the insurance agents, both Pru and Allstate. There is more opportunity there as well, particularly relative to the Allstate channel.

So it is a balanced portfolio of multiple channels, but with different stages of maturity.

I think our total in the brokerage channel this time was about 12% to 13% of our total sales. I think for the market, it is closer to 20%. I think that is the incremental range that we would hope to achieve over time to reflect our fair share of that market.

Great, then to follow up on a question you answered a minute ago about still buying subprime paper. I think that would surprise a few people or at least it is probably worthy of wanting to maybe go in a little deeper to explain why that still makes sense from where you are sitting. That will be my last question. Thank you.

Well, Dan, we think there are significant potential losses for BBB rated, particularly '06 and '07 vintage subprimes; and also particularly in the CDO areas that are not collateralized by them. That is not an area where we have any intention to go along in those categories because of the nature of the concern.

Having said that, what we also see is that at the very high end of this, the AAAs and the AAs, some of the spread opportunities that we see are disproportionate to the underlying risk and we think are primarily liquidity driven. As a consequence, we see selective opportunities to take advantage of that.

We have a very dedicated team in the asset-backed area that has just been at this since 1991; and we are quite confident in our view on that.

This is Art Ryan. Let me just add to that, though, that I think it is important that you look at this from a net point of view; you would not expect to see much of an increase. What we are talk about it is the fact that we believe that there are segments in this market where we can be opportunistic in the short term. But we also recognize that this is a market going through turmoil. Therefore you would not expect to see a significant net increase in our outstandings in this category. I think that clarifies it in the way in which I think you are asking the question.

Citigroup, Colin Devine.

Okay, I have a couple questions. First, with respect to the 401(k) operations, if you could give us some sense of when we should expect to see the -- not just the gross sales but the net flows improve; and if there is some sort of target that you are driving that to.

The second question, I noticed a couple days ago the former chairman of Pru Securities, Mike Rice, reached a settlement where I guess he is going to pay a $100,000 fine and is banned from the securities industry for a year, relating to market timing issues at your former brokerage operations.

I was wondering if you could confirm for us one way or the other, since this is obviously still open with the regulatory authorities, John Strangfeld was also the chairman of Pru Securities when the market timing went on. Is John the subject of any regulatory investigation relating to Pru Securities? Or for that matter, Art, are you?

Okay, this is John. Why don't I take the first one? With regards to your 401(k) question, Colin, we think the trend is right. Meaning we had negative flows in '05; we had basically a push in '06; and we expect to have positive flows in '07. So the trend is on track.

Secondly, our lapse experience -- or put it more affirmatively, our persistency has been exceedingly good. It is right around 96%.

Given what we have gone through with regard to integration and the like, we are feeling very, very good about that kind of experience.

So we see more upside in this. We are not content, as I mentioned earlier, with our sales levels; but we think we are on the right track trendwise and we also think we are in solid shape vis-a-vis the persistency decline book.

This is Art, Colin. As I have mentioned I think in the past year, there are no regulatory investigations of any individuals or of the Company related to the market timing settlement of a while ago.

Okay. Then I guess a follow up, with respect to the leadership change at Prudential, is there any update you can give us on that? Since I believe you said you were retiring at the end of the year.

What I said is that the Board would be making a decision on my successor probably around the end of the year and then there would be a transition period. There is no change to that it all. No. We expect that -- I expect that to be the Board's intentions and I expect them to do that around the end of the year.

Thank you.

Andrew Kligerman, UBS.

Good morning. Three questions. First, hedging on variable annuities, we have had a pretty interesting shock to the equity markets in the last few weeks. Could you give a little color around your hedging program and how that is working right now? Then I will follow up.

Yes, go ahead, Rich.

Sure. Yes, we have been pretty successful in our hedges. The volatility has been (technical difficulty) regardless of the markets going up or down, our volatility has been modest in every quarter. In most every quarter but one we had small gains.

We actually looked at the marks last week, and the hedges and the basis risk performed perfectly -- or as best as you could in a hedge like this.

That's great, Rich. Then actually, while you're at it, talking about -- you mentioned earlier worst-case estimate of credit losses on those CDOs exposed to subprime of $150 million over five years. That seems really light. Could you give a little color on how that calculation was made?

I don't have the precise details. But the calculation, remember, is a credit loss. So those are actual defaults on the loans. They're not the spread widening that we're seeing now in the mark-to-market.

So maybe I could follow up and just get a little bit on the math later on.

Then just lastly, I know Mentioned a little bit earlier that Q-over-Q I guess the performance in Korea had improved. But you look at year-over-year, sales were down 6% for all other countries on the Planner basis. Mark, what do you think is the likelihood that Korea will start seeing sales increases over the next 12 months and increases in Planners? Could you give us a lookout maybe a year or two as to what you might expect in Korea?

I think to hit the headline answer, the likelihood is high that we will see improvement in Korea. As I said, looking year-over-year we are now just about flat. But if you look at the first six months, we actually had a respectable growth rate in Life Planners in Korea; and we do anticipate that sales will track that over time.

I believe that Korea has turned the corner in terms of the challenges they have had with Life Planners. I expect them to be very much on track with the broader set of objectives that we have talked to you about for International Insurance.

Great, have a good afternoon.

Jimmy Bhullar with JPMorgan.

Thank you, I just have a couple of questions. The first one on Prudential Japan. On the Life Planner count, I think, Mark, you mentioned 10% is your aspiration. You have not done 10% since the first quarter of '05, I think.

So what is a more realistic target, given that the base is a lot higher that you have to grow off of?

Then secondly, on individual life, if you can just talk about competitive environment in individual life in the US, whether you are seeing IOLI table shaving coming back or declining? Your sales especially in the UL business have been relatively modest the last several quarters. Those are the ones I have.

Right, on the Life Planners, the 10% target is for Life Planners globally, understanding that a larger country like Japan may not achieve 10% growth, but smaller countries should achieve growth in excess of 10%. So that is what we aspire to in total.

You are right, we don't always get there. If you look at the average over the last five years, it is more like a 8% or 9%. But 10% is still our target.

Again, there will be mix issues there, with probably somewhat slower growth in Japan, but faster growth in countries that have smaller bases. Taiwan, for example, has been very strong.

So when I talk about the 10% number, it is the total Life Planner business, again understanding that it may be a little bit slower in Japan and faster in other countries.

Thank you.

I do expect that we will be on track for that over time.

In terms of the second question on the investor-owned life insurance or stranger-owned life insurance, as you can see in our own UL sales that has not been a very important part of our business, and not an area of the business that we want to participate in.

I think broadly the industry has seen a slowdown, but I don't think it is 100% slowdown. I still think there are individual companies that appear to have stronger growth rates in some of those categories than the market overall.

But we continue to work through the associations that we are members of, to try and influence regulators to demonstrate how dangerous and how bad that is for the industry as a whole. But from our own perspective, we are reasonably comfortable that we don't have issues in that direction.

And your sales being weak, is that a function of markets, the market environment, lack of good products? What do you attribute your sales (multiple speakers)?

Well, our sales are not weak. I mean, if you looked at what has happened, our life sales are up substantially.

UL. I mean UL.

UL? No, I think that is just more a function of the market at this point in time. We're going to see changes in product mix, obviously. We have focused a lot as we have grown the third-party channel on the term product.

On the other hand, I think in the first quarter, we saw a number of rather large cases that we were able to do through a particular distribution category that was in the UL line. So I don't think quarter to quarter that that -- necessarily any lack of competitiveness or substantial changes. We just, like everyone else, go after the best opportunities available at that point in time.

Okay, thank you.

I'm sorry, did you have any follow-ups, Mr. Bhullar?

No, that's it. Thank you.

Eric Berg, Lehman Brothers.

Thanks very much and good afternoon. Rich, just a couple questions to you, follow-ups regarding the investment portfolio. With respect to this, I think it is the $150 million figure that a number of people have been focusing in on and the size of it.

One, could you repeat? Which portfolio does that sort of tie to? Is that the entire -- is that the CDO portfolio, the ABS portfolio? Remind us, please.

It is the $8.5 billion subprime.

The entire subprime?

That is included in the ABS portfolio.

Yes, that is the entire subprime.

Right, so my question was going to be -- you talked about five years. Most other companies have not only not talked about maximum losses, which is a very helpful disclosure here; but I'm just curious why you chose five years over which these losses would be experienced. Why not three years, why not seven years? How did you arrive at five years?

I guess, first of all, we're looking at credit losses emerging over a period of time. We could pick one year, we could pick three years, we could pick five years. I guess we felt given the weighted average of our portfolio, five years would be the best representation to view or estimate those credit losses.

Okay. The other question I had is a broader one; and it's actually one that I have asked two other management teams, but I would like to ask it to you.

A number of companies, Prudential included, have highlighted the high credit ratings of their portfolios, as you have today. The AA status, the AAA status, and so forth. But I'm just wondering whether you feel it is really fair to make -- whether it is really fair to say or think that these ratings are --. I mean obviously they are entirely different from lower ratings, but whether the two sort of groupings of investments are not connected to each other.

In the sense that, because John has acknowledged that there are going to be losses in the lower-rated tranches, doesn't this mean that as the protection afforded to your tranches is eroded, that inevitably the ratings for these high-rated tranches will come under pressure? Even if you're going to get paid back in full?

Well, Eric, they may come under pressure. But when those lower-rated tranches get hit, there are triggers inside them. So as they default, the cash gets redirected from the lower-level tranches to the higher-level tranches that would have, all things being no defaults, they would have unfolded to the lowers and the highers.

Let me say that again. The lower-level tranches get hurt as defaults increase, because the cash gets redirected to the higher-level tranches.

I think the other thing I would add is, in the worst-case scenario, you are not -- we're not really focused on the credit rating. We're focused on the recovery rate. (multiple speakers) [stress test].

Are you saying, Rich, in other words, that in many of these instances, the level of protection and defense gets replenished or rebuilt after a loss?

I would say it gets strengthened after a loss at the lower tranches.

Thank you.

Eric, one more point on that. We do complete independent credit evaluation of these sureties. We talk about these ratings almost as a shorthand way to characterize this portfolio for you. But we have our own internal ratings, and we have independent credit analysis of these portfolios in depth with extensive resources.

So we are not looking at an off-the-shelf AAA and saying, okay, it is AAA, let's buy it. We will have a thorough, independent review of the underlying collateral and structure, and draw our own conclusion.

So the credit ratings are a convenient language to use to portray this portfolio to you; but you should not assume that that is the end of the game in terms of the work we do to understand what we own.

Thank you, Mark.

Merrill Lynch, Ed Spehar.

Thank you. Good afternoon. A couple questions on the Asset Management segments. First, in the Asset Management business, in the DUS piece or what is called Asset Management, if I look at the real estate-related income that you are talking about, or the stuff that is 25% of revenue and closer to 50% of earnings. I believe most of it is commercial real estate-related.

Could you give us some sense of what you think of as a normalized level of earnings and -- revenues and earnings for that category? And maybe some sense of a trough level? So, how much risk is there to that earnings stream which has been particularly good?

Also, how much visibility do you have on the types of deals that lead to the type of income you have been recognizing in recent quarters?

Then finally in the International side, I am wondering if you could tell us, is the level of earnings we saw in the International Investment business sustainable at the 2Q level, assuming no major equity market changes? Thanks.

This is John, responding to a couple of your questions. On the equity real estate front, you're right, that has been a significant contributor. What underlies that is the strong performance you have seen in the equity real estate markets now for a number of years. Where it was up 20% -- if you use [NACRI], the broadbased core measurement -- it was up 20% in '05; up 16% in '06; and we have been expecting to see that moderate, frankly, more than it has. If you look at year to date, it is up about 10%, where our expectation and what we have created for our clients is in the 12%, 10 to 12% type of range.

So we are benefiting from the strong marketplace. But it's not the only thing we do. Having said that, I don't think we are prepared to speak specifically to the normalization or [band].

I think the key, though, is what John spoke of in the separation of how the fees are accumulated at 25% of our incentive. That would mean 75% of them are asset-based and therefore would have a higher level of predictability going forward relative to normal market conditions. That doesn't mean that you can extrapolate it, because prices go up and down.

The second is, the reason that we do so well at this is not because, again, we take deals off the shelf. It is that we do have our own staff that has been dedicated to this for many decades, in dealing and managing first for the Company's own general account; and now for institutional real estate investors.

That is why we believe it is a core and an ongoing capability, not withstanding the highs and lows of the market.

On the International Investment business, we are on a solid up-trend there. But the business is market sensitive. We have benefited from a high level of activity in packaged product, particularly in Korea. The third quarter is always slower in those kinds of businesses, because things really grind to a halt in August in a lot of the markets.

But I think over time we are on a strong up-trend. I guess the best way to say it is that it is market sensitive. It will depend on market conditions and our product flows; but we are on the right track.

If could just have one quick follow-up. If you look at this source of revenue that is in the asset management, that has a whole bunch of different things in it that you have a neat acronym for, which I can't remember. (multiple speakers) Yes. Is running at over a $600 million level right now. I think if you go back a few years ago, that maybe was more -- maybe more than a few years ago. But it was down in sort of the $200 million maybe level.

Is this something that could in a tough environment go down? Or is the something that in a tough environment just stays sort of stable?

I think it is fair to say in a tough environment, it could potentially go down. Because (inaudible) there is an element of this that's market sensitive.

Yes, in a tough environment it could go down.

Okay, thank you,

Joan Zief, Goldman Sachs.

Thank you very much. I have a question on the International front. Thinking about Japan, you have this strong Life Planner network and you have this Gibraltar platform, which seems to be focused a lot on the life insurance side. But the real growth in the Japan market, it seems to me, is in annuities and maybe even in the medical market.

So my first question is, do you have any plans to explore getting into the faster-growing markets in Japan, rather than just staying with the life insurance?

Then my other question is, there is always a possibility sometime in the future of some of these domestic companies in Japan and in Korea to go public. I was wondering if you were seeing any acceleration of that trend or have you heard of accelerations of those trends; and if you think that in the long run that will impact your growth prospects.

All right, I guess the starting point on the retirement question -- and I would extend this beyond Japan, to focus on our skill sets and competitive advantages. The answer to your question is we will be looking at opportunities not just in the annuity business, but broadly in the retirement business in our International markets. I think those are important opportunities for us. As I said, they play to our advantages in terms of our skill sets and our strong brands.

Having said that, we will not conflict with the Life Planner business in terms of either brand (technical difficulty) distribution issues. The Life Planner business is a genuine gem for us, so we will be doing this in ways that are as directly supportive and in as little conflict as possible with the way our Life Planners spend their time and the profitability of those operations as a result.

In Japan now, our activity with the teachers and our bank channel are both generating annuity sales. We don't happen to like variable annuities in Japan, for reasons that we have talked about before. But we are making inroads in the fixed annuity market through both the bank channel and through our Teachers Association relationship. I expect that that would be an effort that we would continue and maybe even broaden around some other aspects of retirement businesses there.

So, the answer to your question is yes, we will be looking not just at annuities, but more generally at retirement opportunities for us in International. But we're going to do it in a way that is very careful not to upset the core franchise in the Life Planner business, but to take advantage of our other skills.

I'm sorry, just before you go on to the other question, does that imply that you're going to build something organically slowly? Or does that imply that you will look for an acquisition?

Well, I will use one of our favor words, which is opportunistic. If we can find the right deal, we would love to do it. But frankly, it is a little bit too early to make a declaration about either possible direction at this point.

On the new public company front, as you know in Korea there is action. The regulators are trying to facilitate companies that want to go public in the life insurance business. It has been pretty competitive in Korea already. I would not expect that that would significantly impact the competitive environment for us. In fact, if anything, the discipline of a public company tends to be more in our favor.

Does the possibility of those companies going public give your more opportunities for an acquisition?

Well, I will go back to that work again, opportunistic. If we find something we like that works, that we can do at the right price, we would love to look at it. As Art said earlier, we would like to be putting this excess capital into our businesses. It is early to see how these valuations are going to come out.

Okay, thank you.

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