保德信金融集團 (PRU) 2009 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the second-quarter 2009 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given to you at that time. (Operator Instructions). As a reminder, today's conference call is being recorded.

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

Thank you, Cynthia. 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 2009, which can be found on our website, www.investor.prudential.com.

In addition, in managing our businesses, we use a non-GAAP measure we call adjust 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 recorded changes in contract holder liabilities, resulting from changes in related asset values. The comparable GAAP presentation and the reconciliation between the two for the 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.

Okay, now that we are legal, John Strangfeld will lead off with his comments, followed by Rich Carbone and Mark Grier, who will walk you through the second quarter. After that, John, Rich, and Mark will be joined by Peter Sayre, Ed Baird, and Bernard Winograd for your Q&A. We expect to wish you a good day around noon today. John?

Thank you, Eric, and good morning, everyone. We thank you for joining us and we appreciate your interest in Prudential. As Eric mentioned, as is our practice, Rich and Mark will walk you through the specifics on the quarter, but first, I would like to kick things off with some high-level comments.

I would like to begin by saying that we remain very positive about our mix of businesses, the quality of the businesses that make up that mix, and the momentum we see even in the face at what remains a difficult business environment. Overall and because of these factors, we believe there is ample evidence that we are gaining ground in the marketplace.

Second-quarter results obviously reflect improvements in financial markets, though in many ways more importantly indicate clear trends that we are improving our competitive position. In some areas, it is absolute. In others, it's relative, but the signs are unmistakable. Adjusted operating income in the quarter nearly match the strong result of a year ago and several of our businesses have never been healthier. We consider the earnings performance of our businesses respectable under the circumstances and we believe we are well positioned to do better over time.

Sales and flows are even better measures of the progress our businesses are making. They were solid virtually across the board in the second quarter and the first half overall. Our individual annuities business posted record variable annuity sales in the quarter. VA sales were up 23% from the prior year and net variable annuity sales topped $2 billion, more than 3 times our previous record.

US individual life insurance also registered favorable sales results, a year-over-year increase of 17%. Importantly, our sales through third-party distribution increased by 35% and now represent roughly 75% of total sales in the business.

In Group Insurance, annualized new business premium increased in the second quarter. For the year to date, sales are up 48%. Persistency has also improved. In group life, persistency is 96% and group disability persistency is 94%. We believe these are strong indicators of extraordinary client satisfaction.

Full service retirement had modest but positive net additions one quarter after posting a record increase. Unlike the first quarter, full service retirement landed no large cases in the second quarter and new business opportunities were more scarce. As in previous quarters, persistency remains strong at 95%, another important indicator of client satisfaction.

Institutional investment products had a net addition to account values of $1 billion, our first net addition in more than a year, benefiting from strong sales in several classes of guaranteed products. In our asset management business, third-party institutional and third-party retail flows were both positive.

Finally, international insurance achieved solid sales results although annualized new business premium declined modestly from the second quarter of 2008. Last year's second quarter benefited from a new product introduction at Gibraltar. In addition, the Japanese economy has weakened in the last year, hampering Prudential of Japan's sales to its business clientele. Continuing growth in Gibraltar's bank channel was a partial offset.

Overall, as you can see, business fundamentals meaning underlying drivers remain relatively strong. We are by no means immune to these markets. These are tough times, but we are holding up well. And as evidenced by our sales and flows, we believe we are gaining ground on our competition virtually across the board.

Our strong fundamentals provided a positive backdrop for our recent capital raises. As you know, we issued $1.4 billion of common stock and $1.0 billion of public long-term debt in June. At the same time, we declined the opportunity to accept CTT funding. These capital raises give us greater resources to pursue organic growth and they tangibly validate the concept of strengthening a strong Company. We believe we are seeing and benefiting from a flight to quality and we want to have the resources to support the growth that is associated with this flight to quality.

And at the same time, having recently been through a challenging environment, we want to fortify ourselves against a scenario if the markets once again going into the abyss. Simply put, we want to maintain distinctive strength in the event of another adverse environment so we can benefit from a flight to quality in that environment as well.

That said, we recognize that challenges remain with respect to the economy and the markets. Our earnings guidance continues to reflect a cautious approach to setting expectations, including the deployment of cash and market conditions. Considering results for the first half as well as financial market conditions, we now believe that Prudential Financial will achieve common stock earnings per share of $5.00 to $5.20 based on after-tax adjusted operating income of the financial services business.

This guidance compares to our old guidance of $4.80 to $5.20 per share. This expectation assumes average appreciation of 2% per quarter in the S&P 500 index, commencing with its close as of December 31, 2008. This is the same assumption for full-year market appreciation as the one we made in May when we last updated our guidance. What is different is that this guidance incorporates the effects of our June capital raise, both the incremental interest costs associated with the debt and the additional shares associated with the equity.

To sum up, we like our business mix. We like the quality of the businesses that make up that mix. Business conditions are tough but improving and we are gaining ground in an absolute sense, a relative sense, or both. We have the resources to pursue our business opportunities in favorable and unfavorable economic environments and we are feeling very confident about our prospects.

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

Thanks, John, and good morning, everyone. As you have seen from yesterday's release, we reported common stock earnings per share of $1.88 for the second quarter. This compares to $1.96 for the quarter a year ago and is based on adjusted operating income for the financial services business.

Now, during the quarter at a very high level, we benefited from good performance in our major businesses, offset in some cases by cumulative market declines in account values over the past year reducing fee income. Also the cost of holding excess liquidity which is showing up as a negative spread was a drag on results for the quarter.

On the other hand, improving financial market conditions contributed to favorable results mostly through unlocking adjustments. And in past quarters, operating results of some of our businesses are affected by discrete items. I will go through the major ones right now.

At our individual annuity business, we released a portion of our reserves to guaranteed minimum debt and income benefits resulting in a benefit of about $0.46 per share and we had a positive unlocking of DAC also in annuities. Reducing amortization of deferred policy acquisition and other costs, reducing a benefit of $0.24 per share. Our individual life insurance business also recorded a reduction in net amortization of DAC and related costs of $0.04 per share reflecting the recovery of account values.

Now going back to annuities, this gets complicated. In the annuity business, we include the impact of hedging breakage in our adjusted operating income. The hedging breakage represents the difference between the change in the value of the derivatives we used to hedge our annuity living benefit guarantees and the changes in the value of the embedded derivative liabilities for these guarantees. The change in the fair value of the embedded derivative liabilities includes an adjustment for a measure of our own credit or nonperformance risk which was a benefit to results in the first quarter of 2009 but is a negative to ROI for this quarter.

The impact of the adjustment for nonperformance risks on our overall embedded derivative liability became less significant in the second quarter as the liability for living benefits guarantees decreased, in essence in substance, the estimated cash flows for those guarantees went down and our spreads narrowed, reducing the discount rate we apply to those lower cash flows.

As a result, the negative spread of our nonperformance risk more than offset the favorable breakage in the net mark-to-market of the embedded derivative liability and the related hedging instruments, resulting in a next charge in NOI and related DAC amortization of $0.09 per share. It gets a little easier.

Our retirement business had a similar charge for remeasurement of nonperformance risk of about $0.02 per share. In our international insurance business, refinements from the implementation of the new policy evaluation system partially offset by technology improvement costs resulted in a net benefit of $0.02 per share. In total, all the items I just mentioned had a net favorable impact of about $0.65 per share on our earnings in the second quarter.

Now moving to GAAP results and once again of course for the financial services business, we reported net income attributable to Prudential Financial of $538 million or $1.25 per share for the second quarter as below the line items partially offset our operating results. This income -- the net income attributable to Prudential Financial was $566 million or $1.32 for the comparable period of the prior year.

Our current quarter GAAP pretax results include amounts characterized as net realized investment losses of $877 million. This loss includes a mark-to-market loss on derivatives of $519 million mainly used in our duration management programs and was driven by changes in interest rates. The remaining net realized loss of $358 million for the quarter reflects impairments on credit losses of fixed maturities of $353 million, impairments of equity securities of $64 million, all of which were partially offset by gains in other portfolio holdings.

The $353 million of impairments and credit losses for fixed maturities includes about $30 million for sales of credit impaired securities, about $200 million of fixed income credit losses on subprime ABS, and about $120 million on corporate holdings mainly in the manufacturing and services sectors.

Now as you may recall, for equity securities, we record impairments for declines value of 50% that exist for six months or for any decline in value that exists for 12 months. We also impair equities for declines in value if we don't expect to hold them until recovery. The $64 million of equity impairments came mainly from declines in value reaching the 12-month mark and from identification of securities that we intend to sell primarily in the Japanese equity portfolio.

Now let's turn to capital and liquidity. We began the year with a solid capital position and our position was significantly enhanced during the quarter -- during the first half of the year, particularly in the second quarter. We issued $1.4 billion of common stock in early June and at the same time issued $1 billion of long-term debt. Both the death and the equity issuances were oversubscribed with substantial interest from high-quality investors. These issuances increased our ability to take advantage of growth opportunities in our businesses as well as to continue to see a flight to quality in both the domestic and international markets, or as we see, a quiet flight to quality in both the domestic and international markets.

They also provide a substantial buffer against market deterioration. In the near term, we are retaining most of these proceeds at the holding company. Also at the time of these issuances, we announced our decision not to participate in the government's capital purchase program under TARP.

As you have seen in the past, especially in the past several quarters, our equity-sensitive businesses' statutory capital decreases when the equity markets decline and increases when the equity markets are up. The 15% increase in the S&P index for the second quarter reversed a proportion of the capital erosion that was reflected in the last quarter.

Now for our capital position. First, RBC and Prudential Insurance. We began the year at a 452 RBC ratio. If we were reporting RBC for Prudential Insurance at June 30, we believe it would be above 400. Keep in mind this is somewhat hypothetical since RBC is an annual calculation, we have not done a bottoms up estimate, but 400 is a pretty good benchmark.

None of the proceeds from the securities we issued during the quarter were downstream to Prudential Insurance to bolster that RBC I just mentioned. In addition, the estimate of RBC includes no benefit for the gain we expect to realize on the sale of our investment in the Wachovia joint venture. We believe the benefit from the gain will add over 100 points to RBC, including certain tax benefits. We are on track for closing the Wachovia transaction in 2010.

In evaluating our capital position, we also take a look at stress scenarios including another sharp drop in the S&P 500 Index combined with investment portfolio credit losses and impairments that would be significantly more adverse than our base case. Under a scenario where the S&P closes 2009 at 600 and where investment portfolio credit losses and impairments amount to $2.8 billion or 2% of the fixed income bonds and mortgages of Prudential Insurance and its insurance subs for the full year 2009, we believe that we would end the year with an RBC at Prudential Insurance in excess of 300.

This considers the use of actions that we believe would be available to us but not the expected gain on the Wachovia joint venture or any use of proceeds from the June capital raises.

Under a scenario where the S&P 500 closes the year 2009 at 600 and stays there through 2010 and assuming a total of $4.3 billion in credit losses and impairments, we expect to be able to manage to an RBC level that is at or above 300. This includes the expected gain on the Wachovia joint venture put. Remember, the investment in Wachovia is held in Prudential Insurance but does not include -- so this 300 does not include any use of proceeds from our June capital issuances. We consider this RBC level to be acceptable in that stress outcome. Of course as time goes on or actually as we look further out in time things, get more uncertain.

Our Japanese insurance companies, Prudential of Japan and Gibraltar, each reported solvency margins for their most recent fiscal year March 31, 2009 comfortably above their benchmark for AA balance sheet strength. Despite recent actions of the rating agencies, we continue to manage our insurance companies to a capital level that we believe is consistent with the AA rating.

To sum up on the capital points, we believe we can manage the capital position of our insurance companies to a high standard under stress scenarios in both the equity and credit markets. Our capital position gives us a buffer in these stress conditions and flexibility to support growth of our businesses and take advantage of market opportunities.

However, with the level of impairments and credit migration over the remainder of this credit cycle still uncertain, financial market conditions still volatile, and the future level of leverage -- or the future leverage levels still up in the air, we continue to believe that it is ill advised to quantify a measure of excess or available capital at this point in time.

Now let's look at liquidity. Our liquidity position is strong and provides us with considerable flexibility. At June 30, we had $4.7 billion of cash and short-term investments at the parent company, PFI. When we look at the PFI cash position, however, we net out any outstanding commercial paper and short-term into Company borrowings. On that basis, we have net cash on hand of $3.5 billion. This is a somewhat conservative view because the short-term inter Company borrowings that I just netted out are fairly consistent and we believe would be available to PFI even under the stress scenarios that I just went through.

The $3.5 billion net cash position compares to $2.8 billion at the end of the first quarter and reflects the June repayment of substantially all of the $1.9 billion outstanding from our 2007 convertible debt and proceeds retained at PFI from our June issuances of $1.4 billion of common and $1 billion of long-term debt. We have no remaining significant debt maturities at PFI until 2011.

At the end of the second quarter, PFI commercial paper borrowings were about $500 million and invested and short-term assets essentially cash, down from $1.2 billion at year-end. We are not dependent on commercial paper for PFI liquidity needs but are keeping this program active to enhance our flexibility in the future or to maintain our flexibility in the future.

Prudential Funding, the financing arm of Prudential Insurance, had commercial paper borrowings of $1.7 billion at the end of the second quarter, down from $4.4 billion at year-end. Based on short-term debt ratings, Prudential Funding continues to qualify for new borrowings under the Federal Government's Commercial Paper Funding Facility or CPFF of up to $9.8 billion. There were no borrowings under CPFF outstanding as of the quarter end.

We have planned our cash flow for 2009 under the assumption that dividend capacity for Prudential Insurance to the parent Company would remain constrained. Given the continued market instability or uncertainty, our current intent is to maintain a cash cushion and short-term investments at PFI representing 18 to 24 months of cash requirements or about $1.5 billion to $2 billion. Of course this is subject to change based on our ongoing assessment of capital requirements of our regulated entities. We will retain these levels until we feel the environment has stabilized to the point that normal cash flows from these regulated subsidiaries to the parent can resume.

Over the next few quarters, we expect to deploy the remainder of the cash now held at the parent in our businesses as needed and end 2009 with about $2 billion of PFI, as I just mentioned. That's that 18- to 24-month cash flow cushion held at the holding company.

At June 30, the financial services business had $6 billion outstanding under securities lending programs, down from $7.5 billion at year-end.

And now Mark will comment on the investment portfolio for the financial services business and review our specific individual business results for the quarter. Mark?

Thank you, Rich. Good morning, good afternoon, good evening. Thanks for joining us on the call.

Let me start on the investment portfolio. We manage our investment portfolio primarily with a focus on its cash flow prospects since our general account investments are mainly supporting long-term insurance liabilities. Despite some recovery of values with credit spreads narrowing on many asset classes during the second quarter, we continue to live with a substantial disconnect between the market values for many classes of investments and their underlying cash flow prospects. With that said, I will start with our fixed maturity portfolio.

Gross unrealized losses on fixed maturities in our general account stood at $7.8 billion at the end of the second quarter. This represents a recovery of about $3.4 billion in comparison to the first quarter, driven by credit spread narrowing across nearly all asset classes. Roughly $2.1 billion of total gross unrealized losses at the end of the second quarter relates to some prime holdings. This compares to $2.6 billion at the end of the first quarter.

Market trading in subprime securities has been limited and has not exhibited the characteristics of an orderly market. In fact, there have been virtually no recent transactions in the securities we hold. Given the lack of an active market, our pricing as of June 30 considers market assumptions apply to our cash flow estimates in combination with third-party pricing.

Total subprime holdings were just under $5 billion at the end of the second quarter based on amortized costs. This represents a decrease of about $500 million from the first quarter, reflecting roughly $300 million of paydowns during the quarter and the $200 million of credit impairments that Rich mentioned.

At June 30, the general account fixed maturity portfolio included $7.9 billion of commercial mortgage backed securities at amortized costs. Over 94% of these holdings have AAA credit ratings. Super senior AAA securities with 30% subordination represent roughly 80% of our holdings. Our exposure to CDOs is limited, with general account holdings at June 30 under $150 million. We also have very limited exposure to hybrid security, which amount to less than 0.5% of the general account portfolio.

Based on amortized costs, non-investment grade securities comprised about 8% of the $127 billion fixed maturity portfolio at the end of the quarter, essentially unchanged from the first quarter and up from about 7% at year-end, mainly as a result of rating agency downgrades on a portion of our subprime holdings earlier in the year.

One last comment on the investment portfolio. We had $22 billion of general account commercial mortgage and other loan holdings as of the end of the quarter. At June 30, the average loan to value ratio for our commercial mortgage holdings is 62% and the average debt service coverage ratio is 1.8 times. Delinquencies continue to be insignificant at less than 0.5% of the holdings.

Now I will cover our business results for the quarter starting with the United States businesses. Our annuity business reported adjusted operating income of $432 million for the second quarter compared to $154 million a year ago. Results for the current quarter include several discrete, largely market-driven items that Rich mentioned with a net favorable impact of $361 million.

Current quarter results include a benefit of $274 million from the release the portion of our reserves for guaranteed minimum death and income benefits, reflecting the equity market uptick in the quarter. This benefit to earnings represents the reversal of just under half of the reserve increases we recorded over the past two quarters, largely for our older products that don't contain the auto rebalancing feature we package with our current living benefits.

The improvement in the equity markets also resulted in a release of about $500 million of statutory reserves for our annuity guarantees with a corresponding restoration of the decline in statutory capital that came from the earlier equity market declines.

Current quarter results also benefited from reduced amortization of deferred policy acquisition and other costs amounting to $142 million, reflecting market performance. Going the other way, the breakage between changes in the values of our living benefit guarantees and our hedging instruments resulted in a net charge of $55 million to current quarter results after related amortization of DAC. Adjustments of amortization and reserves to reflect actual experience together with hedging breakage did not have a significant impact on results in the year-ago quarter.

Stripping these items out of the comparison, annuity results were down $79 million from a year ago, reflecting lower fees in the current quarter due to the market-driven declines in account values over the past year with spread income from funds rebalanced to the general account a partial offset. All of the variable annuity living benefit features we offer today come packaged with an auto rebalancing feature where customer funds are reallocated to fixed income investments to support our guarantees in the event of market declines.

Given the popularity of these features over the past several years driven by our highest daily benefits, nearly 60% of our account values with living benefits at June 30 are subject to auto rebalancing, reducing our risk profile and limiting our exposure to volatile costs in hedging.

As of the end of the second quarter, we are hedging about $27 billion in annuity account values with primary focus on the equity risk on our older living benefit features that don't incorporate our auto rebalancing feature. We feel that our hedging program is operating well and in the first half of 2009, we have seen the reversal of most of our negative breakage through the highly volatile market environment of late 2008. We are now in the process of expanding our hedging program in order to adapt to the new statutory reserving rules for variable annuities that are coming online at the end of this year and to enhance the protection of our statutory capital under various market scenarios.

As part of this process, we are beginning to implement limited hedging of our guaranteed minimum death and income benefit exposure. Our gross variable annuity sales for the quarter reached a record high of $3.4 billion compared to $2.7 billion a year ago. Our highest daily or HD living benefits coupled with our auto rebalancing feature that protects account values in market downturns has provided us with a substantial competitive advantage in the current market. Where other companies using more traditional product designs have pulled back at the same time that clients and their advisers are focused on retirement income security more than ever.

Later this month, we are introducing the next generation of our living benefit product feature called HD 6 Plus. As implied by the name, this feature will offer a 6% annual rollup for protected value rather than the current product's 7% and a higher but still competitive fee structure. We believe that our product will continue to offer a superior value proposition in this market while further benefiting our risk profile. Net sales were very strong in the quarter, amounting to $2.1 billion.

The retirement segment reported adjusted operating income of $99 million for the current quarter compared to $141 million a year ago. As Rich mentioned, current quarter results reflected a charge of $9 million from updating our market-based measure of nonperformance risk for retirement product guarantees that we account for as embedded derivatives. Stripping that charge out of the comparison, results for the retirement business were down $33 million from a year ago, primarily due to lower fees resulting from market-driven declines in full-service retirement account values.

Current quarter full-service retirement gross sales and deposits were $3.9 billion, bringing the first-half total to $14.4 billion, including a $4 billion major case win in the first quarter. Large case sales follow a lumpy pattern and emerge after a lengthy bid process. The pace of bid activity in the market over the past few quarters has been considerably slower than typical reflecting the challenges in the general business environment.

Our full-service persistency was over 95% and net flows were positive for the quarter. Our stable value funds have been especially attractive to plan participants who remain wary of the volatile equity markets, growing nearly $3 billion over the past year and reaching $36.7 billion at the end of the second quarter.

The asset management segment reported adjusted operating income of $33 million for the current quarter compared to $190 million a year ago. The contribution to results from proprietary investing activities was down roughly $90 million from a year ago, reflecting less favorable results across several asset classes.

Current quarter results also reflected unfavorable results from commercial mortgage operations, including declines in value on interim loans we hold in the asset management portfolio. In addition, the contribution from performance-based fees was down from a year ago when we benefited from a stronger commercial real estate market.

Adjusted operating income from our individual life insurance business was $138 million for the current quarter compared to $103 million a year ago. Current quarter results benefited from a reduction in net amortization of deferred policy acquisition costs and other items driven by favorable separate account performance as Rich mentioned. We estimate that these market-driven items had a favorable impact of about $24 million in comparison to the year-ago quarter.

In addition, mortality experience was more favorable than a year ago. A lower level of fees reflecting the market-driven decline in separate account balances for our variable life business in comparison to a year ago was a partial offset to the favorable mortality.

Individual life insurance sales amounted to $98 million in the current quarter, a 17% increase from a year ago. The increase was driven by strong performance of our universal life and term products, especially in our third-party distribution channels. We are benefiting from market opportunities due to the retrenchment of some carriers, particularly in the universal life insurance space, and we believe we are seeing a flight to quality benefit as well.

We implemented price increases on our universal life and term products commencing in April and May and believe that our products will remain highly competitive given observed trends in these markets.

The Group Insurance business reported adjusted operating income of $105 million in the current quarter compared to $80 million a year ago. Current quarter results benefited from more favorable claims experience than that of a year ago on both group life and group disability. Sales for the quarter were $61 million, up from $47 million a year ago, with increases in both life and disability.

Turning to our international businesses, within our international insurance segment, Gibraltar Life's adjusted operating income was $150 million in the current quarter compared to $167 million a year ago. Current quarter results include net charges of $7 million from refinements resulting from implementation of a new policy valuation system for Gibraltar's post acquisition business. We expect to extend the new system to the remaining business including the older acquired blocks of business in Japan over the next year.

Stripping these charges out of the comparison, results were down $10 million from a year ago, driven mainly by a less favorable level of expenses and a lower contribution from investment income.

Sales from Gibraltar life based on annualized premiums in constant dollars were $139 million in the current quarter compared to $147 million a year ago when our life adviser channel registered its all-time high sales quarter with the benefit of about $20 million in sales of a recently introduced yen-based endowment policy.

Bank channel sales were $24 million in the current quarter, up from $22 million a year ago driven by sales of life insurance products that more than offset lower fixed annuity sales. Our life planner business, the international insurance operations other than Gibraltar Life, reported adjusted operating income of $315 million for the current quarter, up $29 million from a year ago. Current quarter results include a net benefit of $21 million from true ups resulting from implementation of the same new policy valuation system that I mentioned for Gibraltar partly offset by costs to update our data processing system.

Stripping that net benefit out of the comparison, results are up $8 million from a year ago. The increased tracks, continued business growth mainly in Japan, partly offset by a less favorable level of policy benefits, which includes mortality, surrender activity, and reserve refinements. Sales from our life planner operation based on annualized premiums in constant dollars were $184 million in the current quarter, compared to $188 million a year ago.

Sales in Japan were down $10 million, driven mainly by the negative impact of economic conditions on our sales in the business and executive markets. This decrease was partly offset by sales growth outside Japan, which mainly represents our operation in Korea.

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 $16 million for the current quarter compared to $26 million a year ago, reflecting a lower contribution from our asset management operations in Korea.

Corporate and other operations recorded a loss of $162 million for the current quarter compared to a $20 million loss a year ago. As Rich mentioned, our results are bearing the costs of our conservative management of liquidity and capital in the current environment. These costs primarily take the form of negative spread within corporate and other results. Reflecting our management of liquidity and capital, interest expense net of investment income accounted for most of the negative swing in corporate and other results compared to a year ago.

And briefly on our closed block business, the results of the closed block business are associated with our Class D stock. The closed block business reported a net loss of $375 million for the current quarter compared to net income of $15 million a year ago.

Current quarter results include amounts characterized as net realized investment losses of $857 million pretax. Of this amount, $440 million represents negative mark-to-market on derivatives we use in duration management and hedging programs, largely driven by changes in interest rates. The remainder mainly represents impairments. We measure results for the close block business only based on GAAP accounting.

To sum up, our business performance was strong this quarter. We are registering solid sales and good product flows virtually across the board and feel that we are benefiting from an enhanced competitive position and value propositions that have become more compelling following the market dislocations of the recent past.

Our reported results and capital position benefited from partial recovery of the accounting adjustments we recorded through the severe market downturns of late last year and early this year.

We remain comfortable with the risk profile of our investment portfolio. We have ample liquidity to fulfill our commitments, and we've taken actions to bolster our capital position, enhancing our buffer against further market dislocations, and increasing our flexibility to take advantage of business growth opportunities.

Thank you for your interest in Prudential. Now we'll look forward to hearing your questions.

(Operator Instructions) Suneet Kamath, Sanford Bernstein.

Great, thanks. Just two quick questions on capital. First, John, I think you mentioned in your opening comments that the capital that you raised would be only used for organic growth purposes. So is it fair to say that if you decided to pursue an M&A transaction that you would use sort of fresh capital, newly raised capital?

Then how do you think about the Wachovia put proceeds, meaning if once you get those dollars, do you think that you want to hold that as a buffer against the downside scenario? Or would you be comfortable putting that money to work in an acquisition if something came up?

Then separately for Rich, just quickly on the 100 basis point improvement in RBC from the Wachovia deal, does that number fluctuate depending on whether or not you get cash versus stock, and how should we think about that? Thanks.

Suneet, John. Let me take the first part, and then I will flip it over to Rich for the part B. On M&A, I think it's fair to assume that anything of significance we have assumed would require external financing, and we would not stretch ourselves with respect to leverage. That's been our mantra on this and that's the way we continue to think about it. That's how we represented it when we did the share raise recently. Rich?

The way we structured the ownership inside of Prudential Insurance of the Wachovia JV, it would not make any difference between cash and stock, but it would be our intent to sell the stock within a very short timeframe.

Okay, thanks.

John Nadel, Sterne, Agee.

Good morning, everybody. A quick one, real quick, following up on the Wachovia put. I was just wanting to go back and sort of think about you guys provided formal notification to Wells about a month and a half ago. As I understand it, they were supposed to come back to you within a couple of weeks after that and give you a sense for the cash and stock mix. Just wondering if you got that notification and if so, can you give us a sense for what's going to come in terms of the cash stock mix?

John, it's Mark. Just as a general statement upfront first. Both of us are complying with everything that we've agreed to and the process is proceeding, I would say, on an orderly basis toward making sure that we get through an orderly settlement of this in January.

Their requirement was to notify us of either stock or cash or a combination of the two. They notified us that they would be delivering a combination of the two, and we are working on how and when we will be more specific.

Okay. Mark, is it fair to assume that at some point, and maybe you've already begun, that Prudential would begin a sort of hedging or forward sale or some sort of transaction to remove the downside risk associated with a drop in Wells' stock price?

Well, I don't want to make too many specific comments on that at this point, but we will have an objective to preserve the value of the consideration and also to satisfy the RBC objectives that Rich mentioned.

Okay, great. The last one is just a little bit higher level. John, instead of maybe -- instead of going after the guidance and how it differs versus last quarter and what might have changed or what might have not changed, I sort of thought maybe take a step back and think about the ROE of the Company that the guidance implies. If we strip out the negative effects, the negative one-timers in the 1Q and the positive net one-timers in the 2Q and look at the midpoint or maybe even the high end of your range of guidance for 2009, it implies an ROE on an operating basis normalized around 10%.

And so obviously there's a lot of drags. You are holding high cash balances. The S&P is clearly while rebounding nicely still down meaningfully year-over-year. Real estate-related earnings are down, but ex Capital Management, ex an M&A transaction, that sort of thing, if we just assumed reasonably stable macro conditions from here, where can that ROE go over for the next couple of years?

Okay, John, happy to address that. Actually let me take that and both parts two parts, both because you make references to the run rate earnings, so why don't I address that? And then we'll talk about ROE longer-term.

So if you look at the second half versus the first half run rate, let me just expand on that a little. I appreciate you keeping it at a high level, but let me just expand on it a little in case there's questions about this. If you look at our core run rate earnings from Q1 and Q2, they are right around $1.20 in Q1, $1.23 in Q2.

As we look to the second half and when we were thinking about guidance, we are not factoring in more aggressive investment returns. We are also not factoring in the deployment of the recent capital raise into the businesses. So you do have some of that drag that you were describing.

What we are factoring in is the impact of the capital raise in terms of additional shares and also in terms of additional interest costs. And we figure that those two factors -- the additional shares, the additional interest costs, account for about $0.10 to $0.15 per quarter in terms of their impact. And hence, when we adjust for the capital raise, therefore, we see a lot of consistency between the first half and the second half.

Now your primary question -- so I wanted to just clarify that, but your primary question about long-term, our long-term goal or aspiration is an ROE in the low to mid teens in normalized markets. Now normalized markets has a lot of qualifications to it, whether it's the equity markets, whether it's a level of interest rates, whether it's the commercial real estate markets, institutional retail buying behavior, and also presumed in that is an active management of capital and liquidity as well.

So we think it is obviously pretty hard to define the time horizon for that given all the forces at work, but what underpins our optimism long-term is the quality of our business mix. And we think that's what underpins our long-term aspiration. So that's my response to your two questions.

That's great. Thank you, John.

Nigel Dally, Morgan Stanley.

Great, thank you and good morning. First question, annuity hedging. You mentioned that you've started to hedge the GMDB on a limited basis. With market up around 1000, why not get more aggressive in trying to eliminate some of that risk?

Second, on the losses on proprietary investments in asset management, seems to be a recurring item that we've seen for several quarters now. Can you provide some additional detail on the total level of proprietary investments, the key factors driving those losses? And also is it correct to assume that these losses are on legacy positions which are probably difficult to unwind? Thanks.

This is Mark. I will start with the first question. I don't want to go into a lot more detail about the whole annuity picture. As you are aware, it's fairly dynamic with respect to some of the things happening on the statutory accounting front and we are examining everything that we do there with respect to both stat and GAAP and hedging and products, factoring in the lessons learned over the past 12 months.

You heard on investor day discussions around thinking about variable capital and how it comes back when the market goes up and we are experiencing the benefit of some of that right now and we're going to get back to you at some point. I'm not sure it will be investor day with a broader story about the entire annuity picture for us.

But I would say that we're looking for efficient and effective ways to make sure that we are making the right decisions in the context of the market and the risk and particularly still considering the nature of the risk, meeting some of it genuinely is variable. So I don't want to go too much further than that in terms of talking about what we are doing except that we have become more active around the guaranteed minimum death benefits.

And then I'll let Bernard comment on the proprietary investing.

Nigel, the proprietary investing, the principal driver there of the trends that we have been seeing recently and in particular in this quarter has been the commercial real estate market. We have been in a process of lowering the amount of capital we have committed to proprietary investing. It's down under $1 billion and that's cut roughly in half from its peak.

And I would just say to you that the driver here is a combination of things that in the commercial real estate market, the way in which the performance manifests itself is that you have initially weakness in asset values and subsequent weakness in mortgage portfolios as the asset value impact on equity begins to make its way into the performance and the delinquency and what have you of the mortgage portfolios.

So the underlying cause at the moment and since the beginning of the year has been primarily the real estate market and it will continue to be the real estate market, but the mix is going to shift a little bit and more of it will be the mortgage side of it going forward.

Okay, that's great. Thank you.

Tom Gallagher, Credit Suisse.

Just first a follow-up for Bernard. So if I understood you correctly, you have two impacts here. One is the mark-to-market of the decline in value of real estate. The second is the -- I guess the losses you would experience on the loans, which I presume mean you are putting up loan loss reserves for senior loans that you have there. And if that's right, are we likely to see similar sized drags do you think for the next several quarters on the loan side? Because I presume you've caught up on the mark-to-market stuff. That's my first question.

Well, we're trying to catch up on the mark-to-market stuff, but some of this is not -- is indirect in the sense that you have accrued incentive fees at risk for claw back, so it's not necessarily linear. You can't necessarily get to a point where it turns around until the market itself begins to turn around. We are not there just yet.

Having said that, yes, I do think that the mix here -- and just to clarify, the $900 million is what we have outside of the interim loan portfolio of $1.8 billion -- but the mix of where those losses will come from is probably going to increasingly be driven by the recognition of problems in the mortgage loan world over the next 18 months.

You know, I could let Rich speak to this if we need to, but we are not in a position to reserve what we think the ultimate losses will be in the mortgage portfolio. We have to reserve -- increase reserves as the experience actually arises. And while we've taken our view of the ultimate loss into account in our stress testing and other forward looks, we are in terms of current period recognition constrained as to what we can recognize until the problems actually arise in the mortgage portfolio.

One more quick follow-up on that, if I may. As we think about this $1.9 billion loan book, is it at all related to what you are doing in the general account in terms of the senior loans? I presume this is somewhat lower quality, a bit more speculative, but is that at all connected? Should we view this as an early indication of what we might see in the CRE loan book at Prudential Insurance Company?

No, if the general account had had appetite for lending of this kind, it would be in the general account. This is deliberately a more aggressive loan portfolio than we use to support the liabilities that the general account is supporting.

The principal difference is while we are not all the way to the place where the banks are, we are not doing construction lending and we are certainly not doing speculative lending, we are doing in effect redevelopment lending on established properties that are going through some kind of repositioning.

And so the loan loss and the risk of loss is higher here than what we've experienced in the -- or expect to experience for that matter in the general account portfolio.

Okay, thanks, and then just one last question, just general I guess maybe even for John. Has the big jump in variable annuity sales concern you at all? That may sound a bit counterintuitive, but the reason I ask is when I see as dramatic an increase in sales and net flows for a product like variable annuities, I guess I wonder why are we seeing such a dramatic change? And is that indicative of the fact that maybe your products are more aggressive or is that something you've looked into? How overall should we be thinking about that?

I think, Tom, let me ask Bernard to elaborate on this. I think a lot of this has to do with the fact that we reached product retooling well before the rest of the market has and we are quite comfortable with where we are at.

Yes, let me try to explain why we are feeling comfortable with what we sell, which is in a notable contrast I think to a lot of our competitors in this space.

The auto rebalancing feature that Mark referred to earlier that we package with the living benefits transfers -- takes a lot of the risk of offering this guarantee out of the product and we wind up with what we think is a very attractive risk reward ratio. It is something which for -- where we remain the only significant player offering this kind of product in the annuity space. There was more channel resistance to this product than there is now and as the auto rebalancing has demonstrated its virtues, I think we found it easier to add new distributors. We don't have final numbers yet, but we think our market share is now 12% to 13% instead of 8%.

And I think the fact that some competitors are pulling back because they don't have similar risk/reward products and that there is in general an example here of the kind of flight to quality we've talked about generally in the domestic markets. It's a combination of all those things, a superior product, a good corporate sponsor, and weakened competition.

Tom, another way to phrase it also is were this on the basis of the old book, we would have concerns about this. On the basis of the new book, which we have been writing for closing in on two years, we're very comfortable with the risk profile.

Understood, thanks.

Dan Johnson, Citadel.

Thanks, just a simple one. Can you remind us as to how much of the Wachovia gain has already been booked? So depending on what the final number is we can figure out the remaining shareholders equity accretion. Thank you.

Yes, this is Rich. There was a gain booked on the options back a year or so ago sitting inside of stockholders equity, but that is not benefiting the RBC ratio. So I think you want to ignore that. And if we use the benchmark of $5 billion, the after-tax gain is somewhere in the tune of $1.7 billion.

$1.7 billion on a GAAP basis, but the whole -- I guess you'd call that $5 billion plus whatever tax offset would go to benefit the RBC, which is where you get your 100 points?

There's already -- remember now, the investment is carried in PICA, so PICA is already enjoying a $2 billion carrying value that is a good asset and was added to surplus. So the incremental add to surplus would be the $1.7 billion plus some incremental tax benefits upon a $5 billion assumption for gross proceeds.

Got it, and that gets you to your 100 --?

That's 100 RBC.

Thank you very much.

Mark Finkelstein, Fox-Pitt, Kelton.

Actually one quick follow-up question on the asset management commercial real estate comments. I'm curious what is the PRU exposure to unfunded commitments? I believe there's a fair amount that are kind of in the fund. I don't know if there is co-investments on those.

And in those scenarios, if there's losses that you assume to occur in the portfolio, do you take those today or does that occur actually when they are funded? Just wondering if this is a relevant discussion.

This is Bernard. We will look for the exact number on the unfunded commitments. But the short answer is that to the question that I assume is on your mind, which is that when we fund a commitment, we are buying in at current market values, not at some historical cost basis that is no longer at the current values.

But if -- this is Rich. If this got trapped inside of the FAS 5 contingent liability and there was -- it was a loss contract per se, we would analyze it for recognizing the loss at that point in time.

Okay, all right, I guess just -- I think in the past you've said that VA CARVM is expected to have little impact. I guess can you just give an update on current thinking on that? And with the equity markets up, should that turn into a benefit? What are the sensitivities if any that you can disclose around that?

We haven't refreshed our calculation to the current markets, but because of the way we held reserves, we didn't take full advantage of lowering -- or lowering down our RBC because of the regulatory regime at the time, so we topped them up, which is why when we implement full VA CARVM, the number is going to be order of magnitude $100 million, $120 million. And maybe come down from there, but we haven't done that calculation. That's the downside.

Yes, that answer is consistent with what we had said as of year-end, and as Rich said, we haven't refreshed that, but that's the downside. It's very small for us.

Okay, just finally one last question. Just looking at the corporate segment and I understand the comments on liquidity and excess liquidity and negative spread. Should we be thinking about this level of loss going forward? Is that what's essentially embedded in guidance? I mean how should we think about the corporate segment for the back half of the year?

It's going to be pretty consistent with what you see except that it doesn't have all -- it's not bearing only interest expense of that $1 billion that we issued in June, so you figure tack on another $35 million, 7% on $1.070 billion, half of that is $35 million. So you're going to have to add that (multiple speakers) right around the two quarters.

And I think with respect to the time horizon you've got in mind, we would say we expect this to more or less look the way it does except for the items Rich mentioned.

Okay, great. Thank you.

Ed Spehar, Bank of America-Merrill Lynch.

Thank you. I wanted to follow up on the liquidity question. Just, Rich, could you tell me -- did you say that you were going to -- your plan was to put $1.5 billion to $2 billion of the cash to work by year-end? Did I hear that?

No.

You didn't say that?

There was some -- let me think about this now. So yes, I was going to bring the cash at the holding company down from the $3.5 billion which was net of CP and the intercompany borrowings and I was going to bring it down from the $3.5 billion to $2 billion and that $1.5 billion would be put into the regulated entities. Yes, Ed, you are correct.

Okay, so if we have no ability to allocate among segments at this point and we were just using corporate as a catchall, wouldn't there be improvement in corporate if that was our catchall from this type of an action?

No, I don't think so. I think I've got -- I've got this $1.5 billion sitting in corporate making -- in cash, making I don't know, 1%. So I'm going to shove that down into the businesses. It's not going to improve corporate. It may improve some of the business earnings modestly.

I guess that's my point. Just as a catchall, from an earnings, overall earnings standpoint, though, there is a 5% let's say incremental investment income pickup as you move this money, no?

There should be, Ed, but that may be filling -- yes, I guess the answer has got to be yes. The simple answer is yes.

Okay and then on the Wachovia, if we did assume the $5 billion number, in terms of the earnings impact we should just -- near term, we should just be thinking about investing -- assuming you sell any shares you get -- you are going to be investing the after-tax proceeds or the cash that you get, correct?

Yes.

And what is that number if we said it was $5 billion that you get? What does that mean in terms of after-tax cash to you?

Think of $1.7 billion. I'm sorry, that's the [cane]. Think of $3.7 billion.

So $3.7 billion to invest. There's no earnings impact from anything related to this in your numbers today, correct?

Very small.

Okay, thank you very much.

Jimmy Bhullar, JPMorgan.

I had a couple of questions on items that have been discussed before, but first on variable annuities, on the auto rebalancing, obviously it's a positive when the markets decline. But it does limit upside in the rising market. So I just wanted to get an idea on whether you expect to see an uptick in withdrawals or just are you getting any pushback from agents about that as the markets have been recovering?

Then secondly on commercial real estate, the losses have obviously been modest thus far and if Bernard could just address on what your view is for commercial real estate on whether the losses are reflective of just improved fundamentals or is it expected that the losses would be low just given the lag versus the normal credit cycle?

Jimmy, the VA question, we have not -- we are still as you can tell by the difference between gross and net flows in the VA business, we are still not seeing the level of redemptions that we used to see historically in this business. We used to get maybe a 10% run rate redemptions. It looks like it has stabilized at about 8% at this point. Until the market gets quite a bit higher, it's hard to believe that that ratio is likely to change.

Have you gotten pushback from people on the fact that their account values might not have gone up as much, especially if they bought around the bottom of the market?

Well, there aren't that many people who bought at the bottom of the market, but the short answer to your question is no, we haven't because they tend to compare where they are compared to where they could have been And they are feeling very good about this. I mean the general client experience of people who are the beneficiaries of our auto rebalancing guarantees is that it has done for them exactly what they were told it would do, which it has limited their exposure on the downside and they willingly gave up and understood they were giving up upside in order to get that.

And that is what they want and that is what they're getting. So no, we have not had pushback on that point.

With regard to commercial real estate, I'm not sure I fully understood your question. As I said earlier, we do anticipate that losses in the mortgage portfolio are going to be high over the next 18 months. And the fact that there are very few delinquencies at all at this point in the general account portfolio should not be taken as an indication that there won't be losses.

That's basically what I was asking. Thank you.

Eric Berg, Barclays Capital.

Thanks for extending the call. I actually just have one question which is also a follow-up on the real estate. Since you said, Bernard, that you expect losses in the general account and the mortgage portfolio to be high, I think that's what you said, is it correct to conclude from that that you are expecting really dramatic reductions in commercial real estate values? Because I just think arithmetically it has to be the case that the only way you would have a loss given your reasonably low loan to value ratio -- I don't remember the exact number is if you had really -- is if you were anticipating 30%, 40% declines in property prices. Am I thinking about how you are thinking about the future, the real estate business correctly? Thank you.

Eric, what we tell our clients is that we expect a peak to trough decline in real estate values, I should say our equity clients, equity real estate clients. We expect a peak to trough decline in commercial real estate values of 45% and that we think 30% has occurred already, which means it's about 20% more from here.

And just one quick one, do you expect -- you know, some insurers have said, well, we expect that sort of magnitude of decline, but not for us because we are much better. What --?

We may be talking about apples and oranges. Let's just be clear about this. That's a decline in equity values. What that translates into in terms of losses in the commercial real estate portfolio is a totally different matter. I would say to you that we have an expectation that losses in our commercial real estate portfolio or mortgage portfolio, excuse me, are going to accelerate over the next 18 months. But I don't want you to read into that that we think they're going to be unusually high by historical standards. In fact, we think our mortgage portfolio is much better positioned going into this downcycle than it was, say, in the last downcycle, where our exposure to the office sector where most of losses occurred was 40% and is now only 20%.

So we're feeling very good about the relative performance of our commercial loan portfolio compared to our peer group, but we are not feeling good about the way in which those losses will be recognized. As to whether it was -- excuse me -- we're feeling like the next 18 months will be worse than the last six and the fact that there have been very little in the way of delinquencies so far should not be taken as an indication there won't be losses.

So just to be absolutely clear about this, Bernard, because as you pointed out it is easy to get it wrong. When you say that you are expecting the equity value a peak to trough drop of 35%, 40%, 45%, do you mean owners, a decline in the value of owner's equity in their buildings, or do you mean a decline in the value of the buildings? Those are two very different things.

The latter, we are talking about the decline in the value of the buildings.

Thanks very much.

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