保德信金融集團 (PRU) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the second-quarter 2008 results conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. Eric Durant. Please go ahead.

Thank you very much. Good morning and thank you for joining our call. Before we go any further, I want to apologize for the late start today. For some inexplicable reason, AT&T did not think it was appropriate to let us join our call. But we're here now, and we're looking forward to a good call with you for the next hour or so.

Our participants today will be familiar to you. They are John Strangfeld, Rich Carbone, Mark Grier, Bernard Winograd, Ed Baird and Peter Sayre. John, Rich and Mark have prepared comments, and after that 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 our Earnings Press Release for the Second Quarter of 2008, 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 reported changes in asset values that will ultimately accrue to contract holders and recorded changes in contractholder liabilities resulting from changes in related asset values. The comparable GAAP presentation and the reconciliation between the two for the second quarter are set out in our earnings press release on our website. Additional historical information relating to the Company's financial performance is also located on our website.

John?

Thank you, Eric. Good morning, everyone, and welcome. The performance of our businesses was strong in the second quarter. Adjusted operating income was $2.02 versus $1.84 a year ago, an increase of 10%. Our annualized return on equity in the quarter was 15.8% based on an after-tax adjusted operating income. Financial market conditions remain challenging and had a negative effect on market values in our investment portfolio contributing to a decline in net income. We recognized roughly $550 million in other than temporary fixed-income and equity impairments during the quarter. These were driven primarily by accounting rules rather than by credit-related loss of contractual cash flow. Rich Carbone will have more to say on this subject in a few moments.

While market conditions bear watching, we remain confident that we are on track to achieve earnings over time that are consistent with our long-term goals. This path is unlikely to be linear, but our earnings power in normal markets remains intact. Our investment portfolio is solid, our capital position is strong, and our businesses are well-positioned with attractive opportunities. Many of our businesses recorded strong sales and flows in the quarter, in particular our individual life insurance, annuities and retirement businesses in the US, as well as Gibraltar Life in Japan.

Our Asset Management segment also registered healthy institutional and retail flows. We believe strong sales or flows demonstrate that we provide products and services that meet the needs of our clients, and secondly, our success demonstrates our reputation for quality in the markets we serve.

I will now address our capital position and expectations for share repurchases over the balance of this year. At June 30 we estimate that excess capital amounted to approximately $4 billion, which is the sum of roughly $1 billion in excess common equity on the books and $3 billion untapped capacity to issue capital debt and hybrids. Clearly we are in a position of strength.

That said, we're taking a more measured approach to managing capital in this environment. Volatility and uncertainty remain high. We expect to see opportunities in our businesses, including the possibility of opportunistic acquisitions, and we want to maintain flexibility to pursue them.

On the other hand, market conditions for the issuance of certain capital instruments such as hybrid securities are unfavorable now and argued for a timeout.

So where are we? We expect to repurchase roughly $2.5 billion in common stock for the full-year 2008 under our current board authorization. We repurchased $1.75 billion in the first half and expect to repurchase roughly $375 million per quarter in the second half. We continue to target a capital structure of 70% common equity, 20% capital debt and 10% hybrids. We will update you on our expectations for share repurchases beyond this year at Investor Day in December.

Finally, I will update earnings guidance for the full year. Our guidance for the full year is unchanged. Based on adjusted operating income, we continue to expect Prudential's 2008 common stock earnings per share will fall within a range of 750 to 780(Sic - see press release). Given the environment, we believe results are more likely to fall within the lower half of this range.

As usual, this guidance reflects our consideration of a wide range of circumstances and a few key assumptions. First, we assume that equity markets as measured by the S&P 500 Index appreciate by 2% in each quarter over the balance of the year. To be clear, the starting point for this assumption is June 30 at which date the S&P 500 stood at 1280.

Second, we expect our share of transition costs for the integration of A.G. Edwards into the Wachovia retail brokerage joint venture will stay at the first half level, roughly $0.08 a share per quarter.

And third, as I just mentioned, we expect to repurchase approximately $375 million of common stock per quarter in the second half. Of course, we review repurchase activity with our board every quarter.

Now Rich and Mark will walk you through the details, and then we will welcome your questions. So Rich, over to you.

Thanks, John. I'm going to begin with an overview of the second-quarter adjusted operating income. I will try to go a little slower than the last time, so you can absorb what I'm about to say. All references and descriptions I'm about to make are for the Financial Services business.

As you have seen from yesterday's release, we reported common stock earnings per share of $2.02 for the second quarter compared to $1.84 for our year ago quarter based on adjusted operating income. While difficult financial market conditions had a negative impact on fees and other drivers in some of our businesses, I would consider this a strong quarter with annualized ROE of 15.8% based on an after-tax adjusted operating income. The current quarter and the comparable quarter of the prior year were relatively clean in terms of items that I would consider unusual or nonrecurring.

I only have two items in the current quarter that I would like to mention. In our Asset Management business, income from investment results and a proprietary fixed-income fund contributed $0.07 per share, and going the other way, our financial advisory segment absorbed $0.08 per share of transition costs for the integration of Wachovia Securities -- for the integration of A.G. Edwards, I should say, into Wachovia Securities.

If I net out these two items, our earnings per share increased roughly 10% from a year ago, about the same as our reported EPS. Before Mark reviews our business results for the quarter, I would like to make some comments on net income and the investment portfolio.

GAAP net income was $575 million or $1.35 per share for the second quarter as below the line items partially offset our operating results. This compares to net income of $835 million or $1.80 per share a year ago. Current quarter GAAP pretax results include amounts characterized as net realized investment losses of $486 million. This compares to net realized gains of $34 million a year ago.

Similar to the first quarter of this year, the vast majority of these losses are accounting-driven, based on market value changes rather than expected cash flows. The $486 million of net realized investment losses mainly reflect a decline in value of securities that met the criteria for other than temporary impairment. This amount was partially offset by changes in value of derivatives we use in our currency hedging programs.

Other than temporary impairments reflected in the 486 of net realized losses amounted to $553 million. This amount includes $452 million for fixed maturities and $95 million for equities. Of the $452 million for total fixed-income, approximately $500 million are accounting driven impairments resulting from spread widening and $48 million represents credit losses, $23 million of which came from subprime paper.

In addition, losses on sales from credit impaired securities amounted to $13 million in the quarter. The $452 million of fixed maturity impairments for the quarter compares to $247 million of unrealized losses of 20% or greater at March 31 that we disclosed in our first quarter 10-Q in the three to six-month band.

Now if nothing else changed, you could expect for this to be the impairment for fixed-income securities in the second quarter. Our general guideline is that for 20% or greater declines due to spread widening, we impair at six months. The increase in impairments to $452 million came primarily from declines in value of 50% or more that were in the zero to three-month category at March 31. For declines of 50% or more, we don't wait six months to impair.

Now while there is no bright line under GAAP, we feel that our approach for recording other than temporary impairments is appropriate. But it is also fair to point out that as an investor, our focus is on expected cash flows, which for the vast majority of these holdings have not significantly changed. Since the beginning of the year, our fixed-income impairments have amounted to $840 million, including $728 million that are accounting-driven rather than credit-driven. Under GAAP we now expect these impairments will largely be accretive back through net investment income generally over the lives of the individual securities. This accretion did not have a significant impact on our reported results for the quarter. Nearly all of our subprime holdings are floating-rate securities, and the accounting-driven impairments we have recognized are almost entirely related to widening of credit spreads in an illiquid market rather than changes in base interest rates.

Now let's look more specifically at the subprime holdings -- at our subprime holdings. The $452 million of total fixed maturity impairments for the quarter included $375 million of impairments taken on subprime holdings, including the $23 million out of the $48 million of credit-related losses that I mentioned earlier. We are continuing to monitor the delinquency rates and cash flows for the collateral underlying our subprime paper. Our current estimate of the potential loss of principal from subprime holdings on distress scenarios assuming no recovery from monoline bond matures increased $100 million to about $500 million after-tax over a five-year period. This estimate is based on our current evaluation of expected cash flows considering the incident and severity of defaults under stress scenarios. Our stress scenarios imply -- continue to imply, I should say, a decline in housing prices underlying these securities of 40% from peak to trough.

And now lastly, realized losses on substantially all the impairments on equities relate to holdings in our Japanese operation and reflect the general declines in the Japanese equity markets.

Next to gross unrealized losses. On fixed maturities in our general account stood at $3.9 billion at the end of the second quarter. Of this amount roughly $900 million relates to total subprime holdings of $6.3 billion at the end of the quarter based on amortized cost. Virtually all of our subprime holdings were priced as of the end of the quarter using third-party pricing services. Rating agency downgrades affected about $1.6 billion of our subprime holdings during the quarter with roughly 700 million related to downgrades of monoline bond insurers. Nonetheless, our subprime holdings are still substantially all investment grade with roughly 70% at AAA and AA, and paydowns of principal were run at a consistent rate of about $400 million per quarter, in line with our expectations.

At June 30 the general account fixed maturity portfolio included roughly $700 million of commercial mortgage-backed paper -- mortgage-backed securities, excuse me. Over 90% of these holdings have AAA ratings, and gross unrealized losses stood at $212 million.

Now, as I've told you in the past, we have no significant exposure to CDOs. General account holdings at June 30 are about $200 million with virtually no underlying subprime exposure in the CDO mix. The remainder of the $3.9 billion of gross unrealized losses on fixed maturities or $2.8 billion relates primarily to increases in risk free rates underlying investment grade securities. The uptick in base interest rates during the second quarter was also the main driver of a $1.5 billion decline in our gross unrealized gains, which today stands at about $2.1 billion. Net unrealized losses of our total $100 billion fixed maturity portfolio were $1.7 billion at the end of the quarter.

A few of you have asked whether we would apply a bright line impairment test to all declines in bond values of 20% or more at six months. If we experience declines in value that result primarily from changes in underlying risk free interest rates, this would be a different situation than we have encountered up to now. And any impairment decision would consider the extent to which the declines in value is from base interest rates.

In summary, a good quarter with EPS at 10% and ROE at 15.8%. We remain comfortable with the level of risk in our investment portfolio.

And now on to Mark to discuss the businesses.

Thanks, Rich. Hello, everyone. I will start with the Insurance division. Adjusted operating income from our individual life insurance business was $103 million for the current quarter compared to $141 million a year ago. More than half of the decline in earnings came from mortality experience, which was within our band of expectations but less favorable than a year ago.

In addition, amortization of deferred policy acquisition costs and related items was roughly $15 million higher than a year ago. The downturn in the equity markets compared to strong equity market performance a year ago was largely responsible for the unfavorable swing in amortization. Sales, excluding COLI, amounted to $131 million in the current quarter, up $13 million or 11% from a year ago. Strong current quarter sales of large case, variable and universal life business through third-party distribution drove this sales increase. Overall third-party distribution sales were up 22% from a year ago and accounted for more than two-thirds of our current quarter individual life sales.

Life Insurance sales by our Prudential agents were $38 million for the quarter, down from $42 million a year ago, reflecting both a lower agent count and a change in mix as agents met a growing demand among their clients for our variable annuity products. The Prudential agent count stood at about 2450 at the end of the second quarter compared to roughly 2500 a year earlier.

Our annuity business reported adjusted operating income of $154 million in the second quarter compared to $180 million a year ago. Lower asset-based fees contributed to the decrease. Our fees on variable annuities are generally based on daily account values. Market-related declines in these account values concentrated in the first quarter of this year when the S&P 500 was off 10% more than offset the contribution of strong net sales in each of the last four quarters.

Over the last four quarters, net sales have totaled $2.3 billion and amounted to $555 million in the current quarter. All-in average separate account values in the current quarter were down roughly $3 billion from a year earlier.

The remainder of the decrease in year-over-year results was due primarily to a swing from small positive hedge breakage last year to small negative hedge breakage this year. Hedge breakage reflect differences between changes in the values of our living benefit guarantees and our hedging instruments. We include this in adjusted operating income.

For the current quarter, we experienced negative breakage of just $2 million after related amortization of DAC and other costs on more than $20 billion of account values hedged. This compares to positive breakage of $6 million a year ago, producing a negative swing of $8 million year-over-year in our reported results.

Our hedging program has been highly effective over time. The net of all breakage since we implemented the program in 2005 through June 30 of this year is essentially zero.

Our gross variable annuities sales for the quarter were $2.7 billion compared to $3 billion a year ago. Not surprisingly with the recent volatility in the equity markets, we have seen a lower level of sales activity in the independent financial planner and wirehouse channels, and a greater emphasis on fixed annuities rather than equity-based products in the bank channel.

That said, our living benefit guarantees are very popular among customers and their financial advisors who are now focused more than ever on retirement income security. And we feel that our sales have held up quite well in relation to the overall market. Based on eligible premiums, our take rate for living benefit features in the second quarter was more than 80%, and nearly half of our current quarter sales had income guarantees based on highest daily value, a feature made possible by our product innovation and risk management skills and not offered by any other company. We think of the equity market risk on our highest daily or HD features as essentially self hedging since the customer agrees to our daily rebalancing from the selected funds to fixed-income investments in support of the guarantee when there are equity market declines.

Our transition to these HD features is reducing our risk profile and decreasing our exposure to changes in hedging costs. As of the end of the second quarter, 43% of our account values with living benefits had this self-hedging feature compared to 34% a year earlier.

Turning to Group Insurance, the Group Insurance business reported adjusted operating income of $80 million in the current quarter, up $11 million from a year ago. The increase came almost entirely from improved life claims experienced in the current quarter.

Group Insurance sales were $47 million in the current quarter compared to $52 million a year ago. Most of our Group Insurance sales are registered in the first quarter based on effective dates of the business sold.

Turning now to the Investment division, the retirement segment reported adjusted operating income of $141 million for the current quarter compared to $138 million a year ago. The increase reflected more favorable case experience on traditional group annuity products. Current quarter results in retirement include a negative contribution of $6 million from the full-service retirement business we acquired in December from Union Bank of California, reflecting integration costs of $4 million and expenses under a transition services agreement. The integration is now substantially complete.

Gross deposits and sales of full-service retirement business were $4.5 billion for the current quarter compared to $3.2 billion a year ago. New plan sales were $1.7 billion in the quarter compared to about $500 million a year ago. Current quarter sales included three large cases that contributed a total of about $1 billion.

Net additions for the quarter amounted to $164 million as our strong sales were partially offset by expected shock lapses on the business we acquired from Union Bank of California. Shock lapses in this acquisition accounted for about $850 million of our planned lapse activity during the quarter.

Clients are more apt to put their cases out for bid when they face a platform conversion, and our completion of the conversion process produced a concentration of the expected case departures in the current quarter. With this process now behind us, we would expect the bulk of the shock lapses activity to be behind us as well. Absent the impact of the acquired block of business, our full-service persistency was over 95% for the quarter.

The Asset Management segment had adjusted operating income of $190 million in the current quarter, up $23 million from a year ago. More favorable results from the segment's proprietary investing business drove the increase.

We coinvest with our institutional clients in funds we manage including fixed-income, public equity and real estate strategies, and we record changes in the value of our interest in these funds. A favorable swing from these investment results, including the current quarter gain of roughly $40 million in a fixed-income fund that Rich mentioned compared to a $10 million gain a year ago, and was the main cause of the increase in proprietary investing results.

Performance-based fees were down from the level of a year ago. We recorded no real estate incentive fees this quarter, while the year ago quarter benefited from a stronger commercial real estate market. The decline in these performance-based fees was partly offset by higher asset management and transaction fees and a greater contribution from securities lending activities. Net inflows of third-party institutional funds were more than $6 billion for the quarter, driven by both equities and fixed-income investments.

The Financial Advisory segment had adjusted operating income of $23 million this quarter compared to $72 million a year ago. This segment reflects our interest in the retail brokerage joint venture with Wachovia. Wachovia combined the acquired retail securities brokerage business of A.G. Edwards with our joint venture on January 1. Prior to the combination, we had a 38% share in the joint venture. But our initial share of earnings and transition costs from the date of the combination will be based on a diluted ownership percentage which is still in the process of being finalized. We are now reporting results based on our estimate of the percentage, and we don't expect a material impact on results from any difference between the finalized percentage and our estimate. Our estimated share of the joint venture contributed $35 million to the segment's adjusted operating income for the current quarter after absorption of $47 million of transition costs. This compares to a $93 million share in joint venture earnings a year ago.

The segment's expenses for retained obligations in the current quarter were $9 million lower than a year ago, partly offsetting the impact of the lower joint venture income.

Within our International Insurance segment, Gibraltar Life's adjusted operating income was $167 million in the current quarter, up $10 million from a year ago. This increase came mainly from improved investment margins as we implemented strategies to lengthen maturities and increase US dollar investing based on our economic investment in Gibraltar and we grew our book of US dollar fixed annuity business. The improvement in investment margins from these activities more than offset a $14 million benefit to results in the year ago quarter from investment income in a single joint venture reflecting the sale of real estate within that venture.

In addition, Gibraltar enjoyed more favorable mortality experience in the current quarter than that of a year ago. Sales from Gibraltar Life based on annualized premiums in constant dollars were $147 million in the current quarter, up from $97 million a year ago, a 52% increase. Life Advisor sales were $125 million in the current quarter, up $33 million from a year ago. The sales increase came mainly from a recently introduced Yen-based endowment policy which contributed $19 million to current quarter sales and from greater sales of our US dollar fixed annuity product. These products are especially attractive to our Teachers Association market, and their sales tend to be concentrated in the second quarter when teacher retirements produce funds to invest. We have spoken in the past to you about our growing emphasis on retirement products for the Teachers Association.

Current quarter sales at Gibraltar also benefited from the recent introduction of the endowment product and the current strength of the Japanese Yen in relation to the dollar, which tends to make US dollar products such as our fixed annuity more attractive to Japanese consumers.

Bank channel distribution contributed $22 million to Gibraltar sales in the current quarter compared to $5 million a year ago, substantially all representing sales of our US dollar fixed annuity product.

Over the past year, we have transferred about 90 of Prudential of Japan's Life Planners to Gibraltar, primarily for further development of the Bank channel where we see a good long-term opportunity for complementary distribution. Only a few of these agents are within our Life Advisor count as most are now transitioning to sales positions in the Bank channel.

Gibraltar's Life Advisor count stood at about 5900 at the end of the current quarter, about 80 higher than a year ago. Late last year we tightened our recruiting standards based on our experience and observations on critical success factors, and as a result, we are hiring at a slower pace than a year ago.

Our Life Planner business, the international insurance operations other than Gibraltar Life, reported adjusted operating income of $286 million for the current quarter, up $33 million from a year ago. The increase tracked continued business growth, mainly in Japan and Korea. The Life Planner operations also benefited from improved investment margins reflecting some of the same portfolio strategies as those I mentioned for Gibraltar.

In addition, the level of policy benefits, which includes mortality, surrender activity and reserve refinements, was more favorable than a year ago. Sales from our Life Planner operations based on annualized premiums in constant dollars were $188 million in the current quarter, unchanged from a year ago. Sales in Japan are $124 million for the current quarter, up 5% from a year ago. Our Life Planner count in Japan was roughly 3100 at the end of the current quarter compared to about 3000 a year earlier. Adjusting for the transfers of Life Planners to Gibraltar that I mentioned, Prudential of Japan's Life Planner count would be up roughly 5% from a year ago.

Our recruiting of Life Planners for the current quarter was somewhat below the year ago level as we focused on the appointment and training of new sales managers to help build the sales force going forward. For our operations outside of Japan, which mainly represents our Life Planner business in Korea, sales were $64 million in the current quarter, down from $70 million a year ago. We continue to face difficult competitive conditions in Korea, and our Life Planner count there stood at about 1600 at the end of the second quarter, roughly equal to the level of a year ago.

Competition for agents and sales managers remains intense in this market, and our Life Planner recruiting has essentially kept pace with resignations.

Foreign currency translation was not a major factor in the comparison of our international insurance results due to our currency hedging programs.

The International Investment segment reported adjusted operating income of $26 million for the current quarter compared to $43 million a year ago. The decrease came mainly from the segment's Asset Management operations with a lower contribution from operations in Korea. Results from the segment's trading operations were also below the year ago level.

Corporate and other operations reported a loss of $5 million for the current quarter, essentially unchanged from an $8 million loss a year ago. Our real estate and relocation business, which contributed pretax income of $18 million a year ago, swung to a $3 million loss for the current quarter, reflecting difficult conditions in the residential real estate market. The negative swing in real estate relocation results was largely offset by lower expenses, including some employee benefit costs that are nonlinear.

And briefly on the Closed Block, the results of the Closed Block business are associated with our Class B stock. The Closed Block business reported net income of $15 million for the current quarter compared to $11 million a year ago. The current quarter results reflect $348 million of pretax net realized investment losses, including $350 million of losses from impairments in sales of credit impaired securities, which were offset by a reduction in the liability for policyholder dividend obligations that we had established due to cumulative experience more favorable than expectations. We measure results for the Closed Block business only based on GAAP.

Turning back to the financial services businesses. As Rich told you, our reported net income continues to reflect impairments, which are largely accounting-driven and related to fluctuations in market values of investments that we believe are largely unchanged in terms of what is most important to us -- their credit quality and cash flow prospects. Our business performance was strong this quarter with good product flows despite headwinds from difficult financial market conditions. Our domestic retirement and savings businesses are benefiting from positive net flows. Turbulent financial markets encourage clients and their financial advisors to sharpen their focus on retirement income security, and our innovative products, as well as our reputation, serve this market need well.

And our international businesses are benefiting from continued business growth in our insurance operations and increased investment margins as we continue to apply portfolio strategies, including increased US dollar investing and duration lengthening.

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

(OPERATOR INSTRUCTIONS). Suneet Kamath, Sanford Bernstein.

Just two questions. First, on the Wachovia Securities joint venture, would there be any impact on the put options that you have with respect to that business if Wachovia was acquired?

And then sort of related to that, if Wachovia decided to sell the Wachovia Securities business, would they need your approval before they sell it?

And then second on the capital, I think, John, you mentioned the slowing of the buyback program was due to a couple of things -- sort of the environment business growth opportunities and the cost of capital securities. Would it be possible to rank those in terms of how they are influencing your thinking about reducing the buyback program? I guess what I'm trying to figure out is, what should we be looking at as an indication of when you might be more aggressive with buybacks or go back to the level that you talked about in the past?

Let me comment briefly on Wachovia, and then we will turn it back to John. I don't want to get into speculation about hypothetical transactions or every deal would have its own unique characteristics. But in general our rights would survive the overall sale, and we don't have to approve a transaction related to the sub.

This is John. I am responding to your second question with regard to the buyback. Our reduction reflects our decision to manage capital this way. We are doing what we think is appropriate in the environment in which we are operating.

In terms of sources of capital, we continue to have access capital. You know, part is on the books; part is debt; part is hybrid capacity. Having said that, the issuance conditions for hybrids are not that favorable.

On the other hand, in terms of the uses of capital, our first priority has been and continues to be our business. And we do expect we may see more opportunities in the M&A space prospectively than we have in recent times, and we certainly want to have the opportunity to pursue them.

So it is hard to rank order those factors, but what I would say is all those factors together caused us to conclude that we should take a more measured approach on buybacks. (technical difficulty)-- what we would then do is update you all on the outlook beyond this year at the December Investor Day.

Just one clarification. We don't have to sell our stake if there is a transaction involving Wachovia Securities. We make our own decision there.

Nigel Dally, Morgan Stanley.

Just following up on the buyback, you mentioned opportunities for acquisitions as one of the reasons. Should we be reading into that that you're now beginning to see a pipeline of potential acquisition candidates? And perhaps if you can also give us an update as to if you were to make some acquisitions, which areas would you be most interested in?

Let me speak broadly that and then come a little more specific to your question.

As you know, we have had a strong acquisition track record both in the US and abroad, and we obviously have the capital to pursue acquisitions. Our pattern has been to do more acquisitions in shopping markets than frothy markets. So whether it is Gibraltar, American Skandia, CIGNA, they are all examples of that. So, in theory, the pendulum is moving our way.

And having said that, however, acquisitions for us are nice to do, not have to do, which is very different than where we were three or five years ago where we are at time where in a number of our businesses we needed to either double up or get out.

It is important to say, though, along those same lines that we do not need to do M&A to achieve our long-term targets for ROE and growth rates. So we have the capital. We have the track record. It's a more favorable environment. But it's not essential we do it to fulfill our targets.

Now more specific to your comment about the environment, the businesses we are most interested in would be in the annuities, retirement and selectively in the international businesses. These are not businesses that are necessarily themselves in distress. In fact, in most cases they are not. So we're more relying on circumstance where someone who owns one of these businesses decides it is not core. And I think what we think is we may start to see more of an environment here where certain companies find dispositions a more attractive way of raising capital than through primary offerings.

I cannot say we have seen that many examples of that yet, and I think it in part depends upon how deep and protracted some of the effects of the market turmoil are. But we think there is certainly a reasonable prospect of seeing more activity prospectively than we have seen in the past, and it would be our desire to use adversity to our advantage.

Darin Arita, Deutsche Bank.

I had one question and then our bank analyst, Mike Mayo had a question. In terms of the Japan Life Planner sales manager initiative, can you talk a little bit more about that and how you're measuring the success of it?

Sure, this is Ed Baird. The sales managers are key to attracting and developing Life Planners. That is true in all locations for us. It is essential to our business model. So one of the things we have been successful in doing recently is in focusing on developing Life Planners who have a specific interest in moving into management.

And so with that in mind, we have during the second quarter promoted a number of Life Planners into that sales management role with the hope and expectation that in turn they will help us grow Life Planners in the quarters ahead.

Okay, John, how are you doing?

Greetings. How are you?

Doing great. Can you help me with my analysis of Wachovia? What is the likelihood you put back your interest in the Wachovia brokerage business?

Mark, do you have a thought on that?

As you know, we have exercised the look back option, which allows us to wait about a year and a half more from now and make a decision about the lay of the land at that time with respect to a couple of different choices that we will have. We're very comfortable with having exercised the look back option, and we have said several times that we're anticipating favorable outcome with respect to where we go with this venture given the choices that we have and given their proven track record of executing, particularly in acquisitions.

So right now we are on a track to play out the look back option and see where we are when the time comes to make that decision.

So we should be surprised if you made any announcement in the next year?

That would be inconsistent with what we have been saying about playing out the look back option and deciding where we will go from there.

Okay. So bottom-line takeaway? That last one I did not really understand. That would be inconsistent -- it was like a double negative I think.

It was. Bottom-line takeaway is that we have no change in what we said when we exercised the look back option, and we expect to continue on this path.

Jeff Schuman, KBW.

I just wanted to come back to the capital issue one more time. Probably beating this to death, but I want to make sure I understand. There is no change in your views in terms of ultimate capital structure and ultimate leverage. The 70/20/10 is still the template. So we should understand your comments today as just suggesting that you're going to move towards that target maybe on a little different trajectory and consider the mix of share repurchase versus the acquisitions and other investments? Is that the right way to think about it?

That is a correct way to think about it.

Okay. Great. Thanks.

Ed Spehar, Merrill Lynch.

A couple of questions. First, could you, Mark, give us any thoughts on the likelihood of the international investments earnings rebounding from the current quarter level? I know they were at a low level, and you cited I think two factors, including one that was trading-related. So I'm just wondering was there any sort of unusually weak results there that you would think you might see some kind of a bounce back without any major change in the environment?

And then secondly, I was wondering if you could help us at all on how we should think about real estate incentive fees in the third quarter? I think you said there was nothing in the second quarter, and I'm assuming that there -- it is public information about the Chrysler Building, and I am wondering if you can help us at all out even sort of general thoughts of how something would work when I think the stake was -- I don't know it was probably a triple in terms of what you paid for it versus what you sold it for.

I'm going to make a brief comment on international investments and then turn it over to Ed Baird, and then we will windup with Bernard Winograd on the last question.

Just the reference in my talking points using the word trading and international investments is a reference to our global commodities business. And the point of that was that it was more or less a non-event for the quarter. It is not trading as you might think of it in other contexts. And I will let Ed comment on the business prospects for international investments.

Yes, the real action there is on the international investment side, and the core of that activity is in Korea. And, as you know, the Korean market has had the same drop comparable to what has gone on in the states. So we have experienced a hit in terms of the front end fees that we recollect on the brokerage side, as well as the performance fees on the AUM, and that is in contrast to the opposite situation that transpired this time a year ago. So any changes there will be driven by the externalities of that marketplace.

In general, the US commercial real estate market remains subdued. Very few transactions and very little trend of the kind that would trigger incentive fees. Most of the incentive fees that we have recognized in the real estate business so far this year, in fact, have come from overseas. And there were none in the second quarter.

I cannot comment specifically on the Chrysler Building, but I do want to underline the fact that we had -- we were acting on behalf of clients there. And while that closed early in the quarter and the clients certainly had a good result, I don't think you can read into that, that that will give rise to a big fee for us necessarily. The terms of the fees on any individual fund or transaction are very specific to the individual fund, and we would talk about any that became material in the quarter after they had occurred.

Colin Devine, Citigroup.

A couple of questions. First, on the capital management, just so we are clear here, I believe the Company's stated goal, John, was three years to 2010 at $3.5 billion per for the buybacks. Is the reduction today solely for '08, and the previous guidance is unchanged, or are you reducing that?

Secondly,for Rich, you did not talk about the effective tax rate, which I believe was its lowest for, well, in at least the last four years on a quarterly basis. What was going on there? Because as we are starting to look at pretax operating earnings, it seems to us that with the 11% drop through the first half, this may be the first time in seven years proves earnings on a pretax basis actually go down for the year.

Let me comment on the tax rate first, John?

Sure. Go ahead, Rich.

Okay. If you had noticed, in the first quarter, our effective tax rate was 26.5%. We expect our full-year effective tax rate to be 26%. GAAP requires that at each quarter you true-up to your expected full-year average. So the effective tax rate in the second quarter was 25.5%. That got us to a full-year average of 26% year-to-date, which is our expected effective tax rate for the full year.

Should I be drawing any conclusions from the decline in pretax earnings? Is our underlying growth rate then really starting here to slow? Because that certainly will be a record low effective tax rate for Prudential at least in the last what, seven years?

Sure. But the growth rate in earnings is really not connected to our effective tax rate. (multiple speakers)

That is my point, Rich, is on pretax earnings versus the tax rate.

Let me just finish what I was saying there. You might have another thought. But the effective tax rate is not impacted by the growth in earnings. It is impacted by the absolute amount of earnings as the proportion of tax advantaged income looms larger in the effective tax rate calculation.

Now let me -- just one other thing. During the year it is opportunistic. There were certain tax advantage deals that came about in the first and second quarter that we entered into relating to energy, and they are also dampening the tax rate. But I think what is important here is you think about our full-year effective tax rate, it's going to come in at 26%.

I guess, Rich, the point is, why are pretax operating earnings slowing? And well, it could, in fact, be down for the first time in seven years.

Well, pretax operating income is down for all the reasons we've suggested. It is mainly driven by the lower equity levels and the lower fees that we get off those equity levels.

Thank you.

This is John. On the buyback question and the like, as we have phrased before, our view on where we're going from an optimal capital structure remains the same. We will make our recommendations to the Board of Directors in the fall regarding '09. And after their approval, we will let you know, which will be at -- our intention would be at Investor Day.

John, am I mistaken or do you have a publicly stated goal of $3.5 billion for each of the next three years? That is what you stated.

This is Rich. I think those have been in slides at Investor Day, and they are not goals. I think they were scenarios that if we were to buy back at those levels for the next three years, our equity would remain about the same over that period. I don't think they were quite targets or goals. They were scenarios.

And in each year in the past couple of years, we have taken the amount that we were at, it was $3 billion in '96 and $3.5 billion in 2006, and $3.5 billion in 2007 at Investor Day, and we used those numbers to project three years out under scenarios as opposed to a target.

I will go back and check the slides, Rich, but I think you just lowered it to $2.5 billion for the 2010. Thanks.

This is Mark. Just one set of comments. With respect to our goals, our goals are the ROE and growth targets and efficient and effective capital management building high return businesses that have good growth prospects. And that is what we're trying to do here and everything that we're doing is in that context and directed at achieving those goals.

Eric Berg, Lehman Brothers.

Two questions. First for Mark, you mentioned that the flows in the 401(k) business, in your defined contribution business were affected by the transition associated with the acquisition of the California Bank's DC business. Can you give us a sense -- I think you already have, and I'm hoping you can either repeat it or build on what you said -- of what the net flows in the quarter would have been if results had not been disrupted by the Union Bank acquisition, what the net flows would have been?

Eric, this is John. I think the specifics on that should come from Bernard, but let me just add a little context as we have talked about retirement on many of these calls in recent times.

Where we began with this was with negative flows in '05 when we started the integration with CIGNA, and we then transitioned to basically breakeven in '06 and then modestly positive in '07. Progress that we expected, although frankly we wanted to see a little more progress than we realized in '07.

What we're now seeing in the first half of '08 is greater progress and the type of progress that we have been confident in achieving in this business. And you are right that you need to peel back the impact of the UBoC lapses to get the true picture on that. Bernard?

Yes, in rough order of magnitude, in the absence of the UBoC shock lapses and I will talk more about just what that is, you would have had roughly speaking $1 billion of net flows in the third quarter.

The shock lapse is essentially what has happened at the end of the period during which the acquired business' clients had to make a decision whether to convert to our platform and system or not. And so essentially we have finished the process of giving everybody the decision, and we now know what the lapses are.

So on the transaction as a whole, we now know that the lapses were less than modestly less than what we anticipated in the absence of the lapse in this quarter would have been roughly $1 billion of client flows.

Eric, does that answer your question?

It does and can I presume from your comments that because they were less than what you had anticipated, Bernard, that lapses have since receded?

Well, since is only three weeks or four weeks since the end of June. But persistency, ignoring this as we've said, it was 95%.

Okay. My second and final question relates to Japan, and it is actually a follow-up to Darin Arita's question. Am I right when I say that the promotion of agents into the manager ranks is really an initiative that has been underway for some time at Prudential of Japan? Is that right?

And relatedly, in the end when can we expect to start seeing what you would consider to be, however you define it, strong agent growth out of PoJ? Thank you.

You are right in that with all we have had an emphasis on encouraging Life Planners to consider a career in management. What has been different more recently is we have been recruiting some Life Planners specifically with the intention of moving them more rapidly into a management career. So rather than it simply being a future alternative for a successful Life Planner, it becomes the primary career goal at the time of higher. And consequently we expect since they play a pivotal role recruiting future Life Planners, that this will help us strengthen and to grow.

Now if you look at Life Planner growth in PoJ and you put in the credits for the transfers that have taken place to Gibraltar and to the best life -- excuse me, to the bank channel, you see that actually the growth is running around 5%. And while that is not as high as we would like it to be, it is not inconsistent with the kind of growth we would like. But we believe that by strengthening the sales management track, we can move that into a higher single digit, which is what we would like to see in a large mature organization like PoJ.

Tom Cholnoky, Goldman Sachs.

Clearly I don't have quite the history with you guys as some of the others do on the line, but I just want to come back to this tax rate question.

At 26%, or I think 26 for the year, you're running a good 250 basis points lower than you did in '06 and '07. And what I'm just trying to gauge, I understand how you can get there through more tax advantage investments and perhaps some of the tax benefits you may have had elsewhere. But is this -- should we think about this as a run-rate going forward as we think about '09, 2010, or is this more of a temporary phenomenon based on the mix of your business and investments?

It is a 2008 phenomenon. And on Investor Day, we will update you on our tax rate in the future.

Okay. So your ability to manage that tax rate is kind of the stars came together this year? Is that kind of the way to think about it?

The stars came together and the relative mix of tax advantage income versus total income.

Okay. Great. And then my only other question was, as you mentioned the impact obviously on your business -- well, you mentioned that you're looking at a 2% gain in the equity markets. Just to clarify, when you do that, are you basing that off of daily averaging or just quarter end to quarter end?

Daily averaging.

Mark Finkelstein, Fox-Pitt Kelton.

My questions have been asked and answered. Thanks.

Thank you. This is all the time we have for questions. I would now like to turn this conference back to our presenters.

Thank you very much. We would just simply like to conclude by saying that we are pleased with our results. We're gratified by the visibility of the performance of our underlying businesses. We are cautiously optimistic about the near-term and remain confident about our our long-term prospects. And we thank you very much for joining us on this call and look forward to future calls.

Have a good day.

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