保德信金融集團 (PRU) 2009 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Prudential third-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. Good morning, or I guess I should say good morning, good afternoon, good evening depending upon where you are or where you are listening to us. Thank you for joining us. 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 third quarter of 2009, 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 contract holder liabilities resulting from changes in related asset values. The comparable GAAP presentation and a reconciliation between the two for the third quarter are set out in our earnings press release on our website. Additional historical information relating to the Company's financial performance is also located on our website.

Okay, our speakers today are John Strangfeld, CEO; Rich Carbone, Chief Financial Officer; and Mark Grier, Vice Chairman. After our formal remarks, we will welcome your questions and in the Q&A, John and Rich and Mark will be joined by Bernard Winograd, the CEO of our domestic businesses; Ed Baird, the CEO of our international businesses; and Peter Sayre, our Controller. John?

Thank you, Eric and good morning -- or good morning or afternoon, everyone. Thank you for joining us. As Eric mentioned, I will kick things off with some high-level comments and then Rich and Mark will walk you through the quarter in detail.

Let me start very macro. Amidst all of the drama and mayhem of the financial crisis, the Prudential management team has kept two thematics top of mind. One is an expectation, the second is an aspiration. The expectation is for ourselves to weather the storm better than most and we believe we have. The aspiration has been to gain ground. We have done that as well. In fact, it is not an aspiration; it is a reality as evidenced by quarterly results in each sequential quarter, but most visible in Q3.

Our ability to achieve both our expectation and our aspiration is a product of the quality of our businesses, the skill and cohesiveness of our management team and the confidence our customers place in our brands and our financial strength. We are not declaring victory, but we do think that with the benefit of hindsight, we have struck the right balance between taking short-term actions to reduce risk while maintaining our long-term strategic trajectory.

Furthermore, we have not simply hunkered down; we have been focused on being well-positioned to benefit from the flight to quality, both in new business and in talent. As we pull through the other side of this crisis, we look to make the most of it. I would characterize our mindset as confident, but not cocky.

Now, moving more specifically to the third quarter, our results show solid underlying performance and also reflect better market conditions. Our businesses with relatively modest exposure to US financial markets, namely individual and group insurance, retirement and international insurance, showed few ill effects from recent dislocations in the environment. These businesses are as strong and well-positioned as they have ever been. In fact, we believe they are benefiting from a strengthened competitive position as we emerge from the recent environment.

At the same time, those businesses that are more sensitive to market conditions, annuities and asset management, are fundamentally sound and are positioned to benefit from improving market conditions. Meanwhile, each is demonstrating excellent commercial momentum. Annuities is enjoying record variable annuity sales and flows and asset management is recording strong flows from both institutional and retail investors.

Our businesses serve different markets and they are affected by different risks. And because of these differences, they have not and will not perform equally well in all periods, but, and this is a key point, they are all good businesses. That is they have quality business models, they serve attractive markets, they are well led and they are highly competitive in their markets. We believe our portfolio of businesses will produce superior returns over time, as well as superior consistency of results relative to those of our US life peers.

Our sales and our flows demonstrate that we are gaining ground in the marketplace. They are solid virtually across the board in the third quarter and year-to-date and reflect, we believe, the attractiveness of our products and our ability to stand behind them. We believe that the financial market volatility of the recent past has strengthened the appeal of our value proposition to clients.

As Rich will review for you, we have significantly enhanced our financial flexibility this year through our management of capital and liquidity. We have made a strong company stronger and we view our financial strength as an enabler to pursue exceptional organic growth opportunities as you have seen. And we have ample resources to continue to pursue these opportunities. And at the same time, we believe we have fortified ourselves against the risk of another adverse environment.

This brings me to earnings guidance for the full year. Considering current financial market conditions, including equity market levels, interest rates and credit spreads, as well as our results for the first nine months of the year, we believe that Prudential Financial will achieve common stock earnings per share for 2009 in the range of $5.40 to $5.60 based on after-tax adjusted operating income of the financial services businesses. It should be clear, this expectation assumes a stable equity market over the remainder of the year from today's level.

To sum up, our businesses are solid and market conditions are improving. Our sales and flows show that we are gaining ground. Our financial strength and flexibility allows us to pursue exceptional opportunities and our management team is confident. Now Rich and Mark will walk you through the details and then we will welcome your questions. Rich?

Thanks, John and good morning, everyone. As you have seen from yesterday's release, we reported common stock earnings per share of $1.59 for the third quarter and that is up 56% from the $1.02 that we reported in the year-ago quarter. And that is based, of course, on adjusted operating income for the financial services business.

Let me start with some high-level comments on the current quarter. We are benefiting from good performance in our major businesses, both in adjusted operating income results and in flows -- and sales and net flows, continued improvement in the financial markets by driving recovery of account values, which contribute to favorable unlocking adjustments, as well as base earnings for several of our businesses. But please, keep in mind that most of our earnings are in businesses that are not market-sensitive and they have turned in record to very strong results for the quarter.

On the other hand, the cost of holding excess liquidity, which is showing up as a negative spread, mostly in corporate and other, was a drag on our results for the quarter. In addition, we expanded the hedging program in our annuity business to help protect our capital from adverse swings in the financial markets. We include the changes in market value of derivatives we use in this hedging program in adjusted operating income. This partially offset the benefit of rising equity markets.

Our earnings per share for the current quarter also reflected dilution of about $0.14 from the 37 million shares we issued in June. Operating results of some of our businesses are affected by discrete items, including the impact of our annual reviews of experience and actuarial assumptions that we typically complete for our insurance and retirement businesses in the third quarter and I will go through the major items now.

In our annuity business, we had the benefit of about $0.30 per share from the release of a portion of our reserves for guaranteed minimum debt and income benefits and we had a benefit of about $0.04 per share from the positive unlocking of DAC. This reduced amortization of deferred policy acquisition costs.

Going the other way, the capital program I just mentioned had a negative impact of about $0.23 per share on results for the annuity business. Now this is separate from our living benefit hedge. The impact of hedging breakage from our variable annuity living benefits, including the adjustment for our own nonperformance risk, was not significant during the current quarter.

Our individual life insurance business benefited $0.17 from the reduction in net amortization of DAC and related costs due to the completion of the annual review of actuarial assumptions and the recovery of account values in the third quarter. Individual life also benefited another $0.05 per share from compensation received based on the multiyear profitability from sales of certain third-party products.

Our retirement business had a net charge of about $0.01 per share from completion of its annual review and in our international business, Gibraltar Life, had income of about $0.02 per share from initial policy surrenders to the Yamato Life business we acquired in May. In total, all the items I just mentioned had a net favorable impact of about $0.34 per share on our earnings per share for the third quarter.

Now let's move on to the GAAP results for the financial services business. We reported net income of $1.1 billion, or $2.35 per share for the third quarter. This compares to a net loss of $118 million or $0.25 per share in the third quarter of 2008. GAAP pretax results for this quarter include amounts characterized as net realized investment losses of $235 million. This loss reflects $360 million of impairments and credit losses, including $292 million from impairments and credit losses on fixed maturities and $62 million from impairments on equity securities.

The $292 million of impairments in credit losses from fixed maturities includes roughly $25 million from sales of credit-impaired securities, $150 million of fixed income credit losses on subprime ABS and $120 million spread across public and private corporate holdings and other asset-backed securities. The $62 million of equity impairments came mainly from declines in value reaching the 12-month mark and identification of securities that we intend to sell, primarily Japanese equities that were in unrealized loss positions. The impairments, excuse me. The impairments in credit losses in the quarter were partially offset by favorable mark-to-market on externally managed European securities.

Now I will give you an update on where we stand in capital and liquidity. We began the year with a very strong capital position, which we significantly enhanced over the past nine months. During the third quarter, we issued $600 million of three-year notes at 3.6% and $900 million of six-year notes at 4.8%. These rates were near five-year lows. We saw this as an opportunity to replace some short-term borrowings at very attractive levels.

In September, we issued a $500 million exchangeable surplus note out of Prudential Insurance to Nippon Life. This note, which counts as statutory surplus for financial insurance, has a 10-year maturity and an interest coupon of 5.4% and can be exchanged commencing five years after issue for Prudential Financial common stock at a conversion price of $98.78 per share.

Together with the $1.4 billion of common stock and the $1 billion in public long-term debt we issued in June, we have raised more than $4 billion of long-term debt and equity over the first nine months of 2009. We are continuing to manage our insurance companies at levels consistent with what we believe to be AA standards.

The 15% increase in the S&P index for the third quarter following the 15% increase in the second quarter reversed the portion of the capital erosion that we experienced last year in the early part of 2009 and when equity markets fell in the first part at the end of 2008 and the early part of 2009.

Credit migration and impairments have always been considered in our capital forecast and remain consistent with our original expectations. The surplus note issued during the third quarter has displaced other capital management options for Prudential Insurance that we might have considered under certain circumstances.

If we were reporting RBC for Prudential Insurance at September 30, we believe it we would be comfortably above 400. Keep in mind that this is hypothetical since RBC is an annual calculation and we have not done a bottoms-up analysis as of September 30.

Other than the surplus notes, none of the proceeds from the securities we issued this year were utilized at Prudential Insurance to bolster its RBC. In addition, the estimate of RBC for year-end and for the quarter 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 tax attributes.

Our Japanese insurance companies, Prudential of Japan and Gibraltar Life, each reported solvency for the most recent fiscal year, solvency margins for their most recent fiscal year, March 31, 2009. That was comfortably above their benchmarks for a AA rating. These high return businesses continue to generate capital and we are confident that the solvency margins have been maintained or improved through the end of September.

Our capital position provides for both business growth and a buffer to manage our insurance company's capital under stressed conditions in the equity and credit markets. That said, with the economy and the financial markets continuing to face challenges and the level of impairments and credit migration over the remainder of the credit cycle still uncertain, we continue to believe that it is ill-advised to quantify a measure of access or available capital.

Now to liquidity. As noted earlier, we have retained a substantial portion of the proceeds of our debt and equity issuances at the parent company invested in cash equivalents. This contributes to a strong liquidity position, but also creates a bit of a negative spread for now. At September 30, we had $4.2 billion of cash and short-term investments at the parent company, PFI. If we remove outstanding commercial paper and short-term intercompany borrowings, we have net cash on hand of $3.4 billion. The $3.4 billion net cash position is essentially unchanged from $3.5 billion at the end of the second quarter.

About $1.2 billion of the proceeds from our $1.5 billion parent company debt issuances during the third quarter were used to replace commercial paper financings in several of our businesses where we felt longer-term debt was a more appropriate financing source. Commercial paper borrowings at the end of the third quarter were about $200 million in PFI and about $700 million in Prudential Funding, the financing arm of Prudential Insurance. These borrowings are not material or essential to our business needs. This compares to $1.2 billion of commercial paper at PFI and $4.4 billion of commercial paper at Prudential Funding as of last year-end. We have no significant debt maturities at PFI until 2011.

Lastly, given the continued market uncertainties, our current intent is to maintain a current position, cash position, at PFI representing 18 to 24 months of cash requirements, including maturities, or about $1.5 billion to $2 billion. We will reassess this policy as the long-term effects of the market downturn are better understood. Now Mark will comment on the investment portfolio for our financial services business and review our business results for the quarter. Mark?

Thanks, Rich and John. Hello, everyone. Thanks for joining us today. I am going to start off with comments on the investment portfolio. The narrowing of credit spreads that began earlier this year has continued through the third quarter, driving substantial recovery of values in our investment portfolio. While the market values of many classes of assets have fluctuated due to volatile financial market conditions and we may not have seen the last of this volatility, 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.

I will start with our fixed maturity portfolio. The continued narrowing of credit spreads, coupled with a modest decrease in base interest rates during the quarter, has returned our general account fixed maturity portfolio to a net unrealized gain position, roughly $1 billion, for the first time since a year ago. Gross unrealized losses on fixed maturities in our general account stood at $4.8 billion at the end of the third quarter. This represents a recovery of $3 billion from the second quarter and $6.5 billion from last year-end.

Roughly $1.5 billion of total gross unrealized losses at the end of the third quarter relate to subprime holdings. This compares to $2.1 billion at the end of the second quarter. Total subprime holdings were roughly $4.5 billion at the end of the third quarter based on amortized costs. This represents a decrease of over $400 million from the second quarter, reflecting just under $300 million to of paydowns during the quarter and the $150 million of impairments that Rich mentioned.

At September 30, the general account fixed maturity portfolio included $7.8 billion of commercial mortgage-backed securities at amortized cost. 93% of these holdings have AAA ratings. Super senior AAA securities with 30% subordination represent roughly 80% of our holdings. Based on amortized costs, non-investment-grade securities comprised about 8% of the $131 billion fixed maturity portfolio at the end of the quarter. This is up from about 7% at last year-end, mainly as a result of rating agency downgrades on a portion of our subprime holdings earlier in the year.

This is a high-quality fixed maturity portfolio. As Rich mentioned, total impairments and credit losses for the quarter were under $300 million, including about $150 million for subprime ABS. The remainder includes write-downs to market value for securities we intend to sell and we estimate that about half represents true credit losses.

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 September 30, the average loan-to-value ratio for our commercial mortgage holdings is 65% and the average debt service coverage ratio is 1.8 times. Delinquencies are light, amounting to less than 1% of holdings.

Now I will cover our business results for the quarter, starting with the US businesses. Our annuity business reported adjusted operating income of $166 million for the third quarter compared to a loss of $307 million a year ago. Results for the current quarter reflect several discrete items, including our annual unlocking of actuarial assumptions.

We released a portion of our reserves for guaranteed minimum death and income benefits, contributing $185 million to current quarter results. This benefit to earnings is mainly driven by the equity market uptick in the quarter and also reflects the annual update of our actuarial assumptions, including mortality and lapses.

Together with a market-driven release of these reserves in the second quarter, we have recovered about three quarters of the GAAP reserve increases we recorded since a year ago, 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 net release of over $800 million of statutory reserves for our annuity guarantees over the past two quarters, including about $350 million in the third quarter with a corresponding restoration of the decrease of 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 $26 million, reflecting market performance and the update of our actuarial assumption.

Under the reversion to mean approach we use to evaluate DAC and reserves, we set expected future returns for a look-forward period, currently four years so that expected returns in combination with historical returns will average out to a long-term assumption. However, we capped expected equity returns for the look-forward period. Meaning that we will not assume returns greater than a maximum level. In connection with our annual review of assumptions, we reduced the assumed return for overall account values from 10.5% to 9.7%.

As Rich mentioned, we recently expanded the hedging program in our annuity business to help protect our capital from adverse swings in the financial markets, primarily equity market exposure. Mark-to-market on the derivatives we are using in this capital hedge program, essentially driven by the uptick in the equity markets, had a negative impact of $140 million on current quarter results.

The items I mentioned sum up to a net favorable impact of $71 million on current quarter results. The impact of breakage between changes in the value of our living benefit guarantees and the related hedging instruments was not significant in the current quarter, amounting to a net charge of $9 million after related amortization of DAC. This compares to a net charge of $37 million a year ago. Results for the year-ago quarter also included a $418 million negative effect from unfavorable unlocking and market-driven true-ups.

Stripping out the unlockings and true-ups, the mark-to-market from the capital hedge program and hedging breakage on our living benefit guarantees from the comparison, annuity results were down $44 million from a year ago, reflecting an increase in the portion of fees we are reserving for guaranteed benefits and the non-capitalized portion of commissions associated with the increase in sales.

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 family of benefits, over 60% of our account values with living benefits at September 30 are now subject to auto-rebalancing, reducing our risk profile and limiting our exposure to fluctuations in the cost of hedging.

With about 85% of our current quarter variable annuity sales, including the HD living benefit, we are continuing to migrate out book of business toward auto-rebalancing products. With the improving financial markets, about $5.5 billion of account values that had been rebalanced to fixed income investments during the market downturn returned to client selected investments over the past two quarters.

Our gross variable annuity sales for the quarter reached a record high of $5.8 billion compared to $2.5 billion a year ago. This marks our second consecutive quarter of record-breaking sales. Our highest daily or HD living benefit guarantees, coupled with our auto-rebalancing feature that protects account values in market downturns, has provided us with a substantial competitive advantage in the variable annuity market.

In August, we introduced the next generation of our living benefit product feature called HD 6 Plus. As implied by the name, this feature offers a 6% annual rollup for protected value rather than the previous product's 7% and a higher, but still competitive, fee structure. While it is reasonable to assume that a portion of our third-quarter sales reflected purchases of the earlier product in anticipation of the introduction of the new one, HD 6 Plus continues to offer the differentiated value proposition that has driven our success in the marketplace. And initial indications are that it is being well-received by clients and their advisers. Net variable annuity sales were also very strong in the quarter amounting to $4.4 billion.

The retirement segment reported adjusted operating income of $119 million for the current quarter compared to $133 million a year ago. Current quarter results reflected a charge of $8 million from updating of DAC and other amortization items based on our annual review while results for the year-ago quarter benefited by $12 million from net refinements, including the impact of a similar annual review.

Stripping these items out of the comparison, results for the retirement business were up $6 million from a year ago as higher investment spreads were partly offset by less favorable case experience on traditional pension business and offset partially by lower fees.

Current quarter full-service gross sales and deposits were $4.8 billion, including a $1 billion major case win where we will provide record-keeping and consulting services through the Mullin unit we acquired late last year. Large case sales emerge after lengthy bid processes and 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 96% and this was our eighth consecutive quarter of positive net flows.

The asset management segment reported adjusted operating income of $29 million for the current quarter compared to a loss of $8 million a year ago. The improvement in results reflected a reduction in losses from investment results associated with proprietary investing activity, amounting to about $20 million in the current quarter and about $100 million a year ago. The year-ago losses came mainly from investments in fixed income and equity funds we manage, which we later redeemed while the current year loss came mainly from real estate fund investments.

The reduction in proprietary investing losses was partly offset by unfavorable results from commercial mortgage operations, including declines in the value of interim loans we hold in the asset management portfolio and by lower performance-based fees, mainly related to institutional real estate funds.

Adjusted operating income from our individual life insurance business was $243 million for the current quarter compared to $238 million a year ago. Third-quarter results benefited from three discrete items. The DAC unlocking, which mainly came from refinements of our assumptions for interest spreads on general account business and updating our actuarial assumptions to give effect to mortality experience over a five-year period contributed $55 million.

In addition, third-quarter results benefited from a reduction in net amortization of deferred policy acquisition costs and other items that was driven by favorable separate account performance. We estimate that this market-driven benefit had a favorable impact of about $50 million in comparison to the year-ago quarter.

And compensation we received based on multiyear profitability of third-party products distributed by our agents contributed another $30 million. Due to the renegotiation of the distribution arrangements, opportunities for similar compensation will be limited going forward.

Results for the year-ago period included a $79 million benefit from a favorable unlocking and $53 million from compensation related to our distribution of third-party products. Stripping these items from the comparison, results for individual life were essentially unchanged from a year ago.

Sales amounted to $86 million in the current quarter compared to $82 million a year ago. The increase was driven by strong performance in our universal and term life products, especially in our third-party distribution channels. Our sales benefited from market opportunities due to the retrenchment of some carriers and from competitive positioning following our repricing of universal life insurance products in August of 2008.

We commenced implementing price increases for universal life and term insurance in April and May of 2009 and we have announced further price increases for both lines effective this fall. We believe our products will remain competitive given the trends we are seeing in the market.

The group insurance business reported adjusted operating income of $64 million in the current quarter compared to $101 million a year ago. Results for the year-ago quarter benefited by $13 million from group visibility reserve refinements based on an annual review. The current year's annual review had no significant impact on our results.

Stripping the annual reviews out of the comparison, results were down $24 million from a year ago, reflecting less favorable group life and disability claims experience in the current quarter. Excluding the reserve requirements of reserve refinements, benefit ratios for the first nine months are essentially consistent with the year-ago period in both lines. Sales for the quarter were $110 million compared to $117 million a year ago.

Turning to our international businesses. Within our international insurance segment, Gibraltar Life adjusted operating income was $190 million in the current quarter compared to $167 million a year ago. Current quarter results include income of $25 million from the Yamato Life business we acquired in May of this year. We were selected by the Japanese regulators to acquire and restructure Yamato following its bankruptcy and significant surrender charges were imposed with regulatory approval as part of the restructuring. Consistent with our overall expectations, surrenders were concentrated during the initial period following the restructuring and we estimate that these early surrenders contributed about $15 million to current quarter results.

Sales from Gibraltar Life based on annualized premiums in constant dollars were $140 million in the current quarter, up 25% from $112 million a year ago. Bank channel sales were $38 million in the current quarter, up from $15 million a year ago. The increase was driven almost entirely by sales of life insurance protection products that we began to distribute through banks last year. Sales from the life advisor channel, our proprietary channel, were up $5 million, or 5% from a year ago.

Our Life Planner business, the international insurance operations other than Gibraltar Life, reported adjusted operating income of $310 million for the current quarter, up $17 million from a year ago. The increase tracked continued business growth. Sales from our Life Planner operations, based on annualized premiums in constant dollars, were $205 million in the current quarter, up $27 million from $178 million a year ago.

The increase was driven primarily by strong sales of our variable life and retirement income products in Korea and Taiwan, reflecting improving economic conditions in those markets, as well as sales in advance of a repricing. Sales in Japan were up $4 million from a year ago.

International insurance sales on an all-in basis, including life planners, life advisors and the bank channel, amounted to $345 million for the third quarter, up 19% from a year ago, benefiting from expanding distribution and our strong value propositions that meet protection needs.

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 $13 million for the current quarter compared to $37 million a year ago. Results for the current quarter included mark-to-market income of $14 million on securities related to trading exchange memberships. The remainder of the decline came from less favorable results from our global commodities operation.

Corporate and other operations reported a loss of $201 million for the current quarter compared to a $38 million loss a year ago. Our results are bearing the cost of our management of liquidity and capital as we face continued uncertainties in the economy and financial markets. These costs primarily take the form of negative spread and higher interest expense on capital debt within corporate and other results.

As a result, interest expense net of investment income produced about half of the negative swing in corporate and other results compared to a year ago. Higher expenses, including mark-to-market on deferred compensation liabilities, drove most of the remaining increase in the loss.

And briefly on the Closed Block business, results of the Closed Block business are associated with our Class B stock. The Closed Block business reported a net loss of $8 million for the current quarter compared to a net loss of $58 million a year ago. The reduced loss reflects a lower charge in the current quarter for dividends paid or accrued to policyholders, including the impact of a reduction in the dividend scale that we had implemented for 2009. We measure results for the Closed Block business only based on GAAP.

To sum up, our businesses are performing very well. Improving financial market conditions are contributing to our results and recovery of account values is strengthening our earnings power going forward. Our value propositions have become more compelling as clients are more aware of their financial risks and more motivated to look to a strong partner to help manage these risks.

We have enhanced our competitive position coming out of the recent market downturn and are continuing to register solid sales and good product flows virtually across the board. We remain comfortable with the risk profile of our investment portfolio. We have excellent liquidity and a strong capital position and we have bolstered our financial strength and flexibility, enhancing our buffer against further market dislocation and increasing our resources to pursue business growth opportunities. Thank you for your interest in Prudential and now we look forward to hearing your questions.

(Operator Instructions). Suneet Kamath, Sanford Bernstein.

Thanks and good morning. I had a question about the variable annuity business and the changes in the product that you have talked about. What I am wondering is how have the changes that you have made changed the return profile of that product, particularly given different market scenarios as you run them through in terms of the new versus the old? Thanks.

I think Bernard Winograd will take that.

Good morning. I think the overall theme here is that we are watching the evolution of this market with the benefit of being the low-cost provider of living benefit guarantees at the moment. And the reason for that is that embedded in the auto-rebalancing design, which, by definition, gives us less to hedge than the people we are competing with and because hedging has become, in the past year, the most expensive, newly expensive part of the product offering, we wind up -- we find ourselves in the enviable position of having a cost advantage.

The way we have chosen to take advantage of that gets to the answer to your question, which is we are taking marketshare, but also raising prices to remain competitive. And what we have done in the design or in the changes between HD 7 and HD 6 is, as we indicated before, taking down the rollup rate from 7 to 6, raising the fee from 75 to 85 basis points and making some other changes that all have the effect of giving us more revenue for what we sell and leaving us with a benefit that is still highly competitive in the marketplace.

So our -- what we have also observed overall is that, because of the cost advantage, we have been able to do all that and see the expected return evolve upwards as the marketplace has evolved, which means that currently our expectation for the margins or the return on equity involved in supporting HD 6 are in the high teens, which is up a bit from the mid-teens kind of expectation we had for HD 7 before.

That is helpful and I am assuming that the high and mid-teens, the number is assuming sort of a stable equity market environment. I guess my question was really around what happens if we go back to something that we saw over the past 18 months or so? How low could those returns go or what would be the ROE differential between the new product and the old product? Thanks.

I think it is safe to say that returns will compress, but less than the returns will compress from competitive products in the marketplace. Again, because of the auto-rebalancing, we will have lesser drops in asset values in that kind of scenario going forward. We are, at this point, at 41% of total book and over 65% of the living benefit book now in the auto-rebalanced format as a result of the sales that we have driven. And as a consequence, the portfolio as a whole would be more resistant to a downturn than the old one was.

We are roughly at 95% of what our peak AUM was back in the third quarter of '07 in the annuity business, but with a very different risk profile. Probably the best way to think about that is that the auto-rebalancing products, despite their increasing share of the portfolio, still now represent only about 9% of the net, of the at-risk, netted risk on the death benefit for example. And so there is a very different profile we would expect going forward.

Thanks. Just one quick follow-up on the auto-rebalance. When things are in the fixed income portion, I am assuming that is bond funds, and you run your market stresses, I mean I'm going to go ahead and assume that you are stressing the bond piece also because [really] bond funds can lose money just like equity funds. Is that correct?

We are and we are doing a stochastic model of that that reflects the distribution of the risks, if you will, of correlation changes in the tail of that as well.

Great. Thank you. Thank you very much.

Nigel Dally, Morgan Stanley.

Great, thanks and good morning, everyone. First, could we get an update on the outlook for asset management? Continue to have losses on proprietary investments and commercial mortgage loans, which continue to dampen the results. From your perspective, where are we in this cycle? Is it reasonable to believe that losses should dissipate from here or do you continue to see challenges in commercial real estate remaining a headwind as we look to 2010?

Then the second question I had was on acquisition opportunities. Recently, we got news that AIG is no longer planning on disposing of certain assets that I think many of us thought would be a good strategic fit for you. So just be interested in your views. Are you still seeing an attractive pipeline of potential consolidation opportunities or has it become more difficult to find opportunities that would be a strong strategic fit at this point? Thanks.

So Nigel, Bernard will take part A and -- this is John -- and I will take part B.

Let me try to separate the market and the losses questions that you asked with regard to commercial real estate. We have been expecting, for some time now, that the losses that the market would be down 45% or so from peak to trough and we are down about 35% as of the end of the third quarter. So we clearly have some distance to go yet, but there is a limit to how much further down we think it can go. And we clearly have also the lion's share of that behind us at this point. From the market's point of view, 2010 should be a better year in terms of the marketplace in general than 2009.

The way that manifests itself in our reported results is a little bit mediated by the accounting principles that don't allow us to recognize losses until they actually appear in a debt portfolio and we are marking to market in the equity portfolio. The equity portfolio marked-to-market means that it is done on an appraisal basis, so there's a little bit of a lag, but we would expect that equity, the equity environment would be better in 2010 than in 2009, which is not to say good, but better.

And with regard to the mortgage market, the more equity-like mortgages that we have -- that is the interim loan portfolio for example -- we will have -- we hope to have -- we do not yet know whether this will happen because it is constrained by the actual events that are beyond our control -- but we would hope to have ourselves in a position by the end of 2009 where the reserves that remain to be taken will be less in 2010 than 2009.

And finally, with regard to the high-quality mortgages that are the staple of the general account, there is still very little indication that our portfolio is going to face any meaningful, any substantial losses, but whatever we have will probably materialize late in the cycle.

Now taking the second part of your question, Nigel, this is John, going through your question about M&A pipeline outlook, let me hit that in a broader sense and then a little more specific the pipeline without obviously referring to any specific set of circumstances.

Our historical characterization of M&A being like to do versus have to do still holds and there is really two reasons for that. One is the one we have always used in the past and the second -- or most recently used in the past -- and the second is one new observation. That is for now the last three years or so, we found ourselves not being in a position of having subscale businesses that needed M&A to make them upscale. In fact, these businesses are now each individually performing very well.

The second is that some of the marketshare progress that we are seeing in several lines of our business is of a scale and nature that you would normally associate with M&A without all the execution risk. So as a consequence of that, the opportunity costs in a sense of doing something is higher than it would be in more normal times.

Obviously, there is a prospect for things in motion and it is harder to define the specifics. If you do look at the supply side of divestitures over the next 36 months, both what is visible and what is likely, it is very extensive and some of it may be potentially attractive. And we think we are better positioned than most as a counterparty if there is a trade sale because of our size, our scope, our scale, our management depth and our financial strength.

Having said that, activities and specific outcomes are very hard to predict. So our view on this is there could be some interesting opportunities there; yet we are going to be patient, careful, thoughtful and disciplined and recognizing that there is a long-term pipeline involved here in terms of activity levels, not just current events. So that is how I would characterize M&A.

That's great. Thank you.

Tom Gallagher, Credit Suisse.

Good morning, a few questions. First for Rich, can you talk a bit about the excess liquidity drag? So if I understand correctly, you essentially termed out your short-term into longer-term debt. If you have that much excess liquidity, why bother doing that? Why not just repurchase it instead of taking the negative spread? That is question number one.

The second question is related to the comment about credit and statutory surplus and the comment that you didn't inject anything into the sub. Wasn't it a $500 billion surplus note that you issued to Nippon sort of a backdoor capital injection or am I not reading that correctly? Thanks.

Let me take the second question first. I think in my remarks I said other than the $500 million Nippon note. None of the proceeds that were raised by PFI were injected into PICA. So I thought I was clear that indeed the surplus note is issued at PICA's level. So that PICA did benefit I guess about 25 RBC points from the Nippon note.

But to be fair and make sure everybody knows, earlier in the year, when we brought up some retail notes out of PICA, PICA did book a gain of $300 million on the those retail notes that were paid back to PFI. So to complete the picture, PICA benefited from the $500 million in surplus notes that it issued to Nippon and then it benefited from a gain of $300 million as we extracted the retail notes. But no proceeds have been downstreamed to PICA from any of our issuances.

Got it. Okay.

Okay. Now on your second question -- oh, sorry -- on your first question that I reversed the order of. Let me talk about liquidity from the holding company's perspective. Okay, it is our intent to maintain -- and I said this in my opening remarks -- to maintain a liquidity cushion and I am differentiating between a cushion and excess. So a cushion is something that we are going to hold onto for the foreseeable future and that is about 18 months to 24 months of cash at the holding company that the holding company needs in the next 18 to 24 months, including maturities.

We have got more than that on the balance sheet today. We will deploy that piece over time into our assets that will eliminate a piece of that negative spread. So the capital that was available, the debt was available out there in the markets at very attractive rates. We brought them on the balance sheet. Some is going to be maintained in the liquidity cushion and some will be invested over the course of 2010 at rates that will eliminate a portion of the negative spread.

Okay, thanks. And then just one follow-up. On the variable annuity side and hedging, can you just comment on -- I believe you're hedging some of your capital now. Can you comment on what the structure of it is and how large it is? And then are you still naked on the GMDB or should we think about at least part of that being hedged now?

Well, to answer the second -- this is Mark -- the second part of it first. The hedge that we have discussed today should be considered to cover exposures to capital in the annuity business and some of those exposures may arise from fluctuations in GMDB reserves. So you can think of that relationship, but you want to think of it on a fairly general level. But the short economic answer to your question is probably yes.

With respect to what we have done, it is a derivative-based short and the impact of this on earnings in this quarter was $140 million. So I think you can probably do some work and scale it if you want to think about how much the market moved relative to the $140 million that we printed.

Okay, fair enough. Thanks.

Andrew Kligerman, UBS Securities.

Great, good morning. Just Rich, on that excess liquidity or just liquidity in general, can you clarify what it is that 18 to 24 month cushion you want to have there? And then in general, what is that liquidity level at the holding company? I believe you mentioned some numbers earlier, but I want to make sure I have them right.

Sure. What we are covering is fixed charge coverages, mostly interest.

No, no. I got that. I just want to know the exact numbers.

Oh, it is $1.5 billion. $1.5 billion is where we are targeting today is the amount that we are thinking of holding at the holding company -- we are holding at the holding company.

Do you have that amount and you are targeting that amount?

We have more than that amount and the amount above that amount is the piece that we will release and invest longer term over time.

Right. And the amount -- and what is above that right now?

We are at $3.4 billion now as we measure it and that excludes our commercial paper outstanding, as well as the intercompany facility that Rich mentioned.

Right, and that would have been in the (multiple speakers)?

The difference between $3.4 billion and $1.5 billion is the number you that you are looking for.

Got it. Perfect. And then just one more clarification. Mark, derivative-based short, can you just give me a little clarity around that one? What is it exactly that caused the $140 million loss? This is a new program, right, this is something different than what you have done in the past. What exactly is this derivative-based short?

The answer is yes, this is new. It is something that was done during the quarter, reflecting a view on our part that we wanted more protection for statutory capital in market fluctuations. What I mean by derivative short is that it is a total return swap, and we would be paying the return on the market. So when the market goes up, we pay more money and when the market goes down, we pay less money. And that is how we benefit inversely from the market moves.

Got it. Okay, and then the really important question that I have is I took a look at -- I was very upbeat about this quarter. I took a look at the $5.40 to $5.60 guidance last night -- that is part one -- and I got a number of $1 as your guidance, the midpoint of your guidance for next year. Now if you took all the unusuals out, you know, Rich had mentioned I think $0.34 of unusuals; you get $1.25 normalized. And it is that $1.25 with some growth factors meshed in that would get you to something north of an 11% ROE.

But if you're looking at $1 of earnings next year based on this new guidance, it is very concerning because then you are looking at an ROE maybe of 9%, maybe less. And in talking with Neil Stern last night trying to get a little color about what might be in that guidance, I would still sense that $1.25 is a more normal number.

So that gets me to the question, what do you -- what is your ROE goal looking into '10 and beyond? And is that dollar -- the second part of it is, is that $1 the run rate that we should be thinking about as we look to '10?

Andrew, this is John. Let me start with that and then ask Mark to speak to it as well. While you may think the guidance is a little light as it relates to the fourth quarter -- and I would say it is maybe only a little -- you should not infer that we see or anticipate any weakness in our fundamental momentum. The earnings do fluctuate quarter to quarter, and we are giving you a reasonable view of the impact of some seasonality and some other known items that will show up in the fourth quarter, none of which is individually very large nor problematic. So the message on our business remains very, very positive.

Yes, let me extend some of your points a little bit. But first of all, you should not be extrapolating this fourth-quarter expectation into 2010. You ought to be thinking about it in the contest of exactly what John just said. And if you are thinking about the emerging ROE of the Company, you should be thinking about the performance of our businesses that are not sensitive to the markets and how well they are doing and where they might go.

You should be thinking about the market sensitive businesses and how they are recovering as the market improves. You should be thinking about the excess liquidity that Rich talked about and the capital cushion. And you should be thinking about the redeployment of proceeds from the settlement of Wells Fargo. Those will be the drivers of the ROE of the Company going forward.

We will go into this in more detail on Investor Day, but I want to steer you away from extrapolating the inference of fourth-quarter numbers into 2010 or beyond. In this guidance, we are essentially giving guidance for one quarter just because of where we are in the calendar. And that means of necessity, we are going to include seasonal influences and we are going to include the consideration of things that we know.

We also in this guidance have made a more conservative assumption about the market, namely that it is flat, than we would make as we look out over longer periods of time. So again, I would caution you about extrapolating the fourth-quarter number that you have inferred from our guidance. And again, as I said, we are sort of in a box here giving one-quarter guidance, but we are by no means giving 2010 guidance and we will talk about that more in detail on Investor Day.

Yes, and just quickly to follow up on that comment you just made, Mark, about flat market. Usually, I think you're assuming something close to 3% equity appreciation per quarter, right? And if I am right, then what kind of a negative DAC impact might that have on the quarter? You know, that is an interesting data point.

Andrew, the 3% is the DAC assumption. The market assumption that we typically make is 8% a year.

So maybe 2% a quarter, but that could have maybe a -- I mean would that have a negative impact in the fourth quarter if the market did end flat with where it was as of yesterday when you reported?

Yes, it would. If we don't have market appreciation that keeps up with what we have anticipated, then we will have a drag from that.

And that is what you are assuming then, based on what you just said before. You are assuming some drag, right?

Yes. So again, the very short-term nature of this number makes it different from the emerging outlook for ROE that I think you are trying to focus on, and that would be one element of that equation.

You know what, Rich, it's very helpful, and I think too many people are just extrapolating that number in what was just -- what I think was a phenomenal quarter. So thanks very much for that insight.

Well, we would share your view that we had a very good quarter and we would caution you about extrapolating that inferred number for the fourth quarter. That is not what is going on around here.

Thanks.

Ed Spehar, Bank of America.

Thank you, just two questions. I guess the first, Mark, when you suggest the drag from excess liquidity being about half of the negative variance year-over-year in corporate and other, I think that is about $80 million negative in the quarter or about $320 million on an annual basis.

So that would suggest, I guess, we could do some math that maybe you look at $6 billion plus as the number of potential redeployment. So I guess what I am wondering, if my math is even close, that forgetting about the holding company it seems like there is a few billion dollars that you could invest at the subs, and I'm wondering how quickly do you think you will do that? And then I have one follow-up.

I am going to let Rich answer that.

Ed, I am not tracking all of your numbers, particularly the $6 billion. Eric talked before about we are going to hold a cushion of $1.5 billion, and we have $3.4 billion now. Some of that $3.4 billion is going to be used to pay fixed charges between now and the end of the year. So we are going to have about $1 billion coming out of the corporate account to reinvest at long-term rates, and that will eliminate a part of the negative spread.

Mark mentioned the Wachovia proceeds. They will come in in early next year and that will be added to, and that will be additional monies that we can invest. So I might have a number if you use $5 billion for Wachovia and $1 billion to be squeezed out of the corporate account of $5 billion. There may be some excess liquidity in PICA, but I would rather talk about that on Investor Day when we have a clearer view of the future.

Okay. And then the follow-up, Rich, is on RBC. At the end of the second quarter, you said the same thing that you said at the end of this quarter. And I guess if I combine the benefit from the Nippon notes plus the VA reserve release, I think you had -- just those two items are probably 40 to 45 RBC points. Plus I am assuming you have got some capital benefit from -- I am assuming that the equity portfolio in the Closed Block was up in the quarter.

So when we talk about comfortably above 400, are we comfortably comfortably this quarter versus comfortably last quarter?

We are comfortably above 400 this quarter.

Are we going to get anymore -- (multiple speakers)?

There is a very -- Eric doesn't want me to do the very simple walk.

This is Mark. Our RBC ratios are very strong.

Are we going to get anything more specific, do you think, on Investor Day?

No, not in terms of parsing details of where we are today. We will continue to talk about managing our RBC to the levels that we believe are consistent with our ratings aspirations, and that is factored into our capital planning and stress test picture, but we are in very good shape.

Ed, there is just one point that I want to make sure everybody understands on the Wachovia money. You know we are earning zero on that investment today. So it is the entire $5 billion that gets redeployed at an earnings rate. There's some friction after taxes. We will pay a little tax in there, but that is about it.

Yes, got it. Thanks.

Jimmy Bhullar, JPMorgan.

Hi, thank you. I have a couple of questions. They are both on your international business. The first one is just on Gibraltar; your sales were up 25%, and I think a huge portion of that was just the pickup in the bank channel. I just wanted you to talk about the opportunity you see in the bank channel. And to the extent you can quantify any numbers in terms of distribution agreements you have already and how much you think you can potentially add.

The second question is on the Korean business. Your other Life Planner business outside of Japan had pretty good sales. So I am assuming Prudential -- that was driven primarily by Prudential of Korea. But in the past you have suffered because of aggressive competition in terms of agent retention. Just if you can comment on trends in that market.

Sure, Jimmy. Let me start with the bank channel, and what we are seeing there is the emergence of what could become a very substantial third distribution for us, in addition to POJ and Gibraltar. The bank channel opened up as a result of deregulation that was limited to the annuity businesses first. But starting last year, they were allowed to sell insurance products. And in the first quarter in which we sold, which I think was about five quarters ago, we sold just $1 million, but the big driver of the increase in this quarter was the growth in the sale of pure debt protection insurance. So that grew from virtually $1 million to $23 million in its most recent quarter.

And what is particularly unusual and valuable about it is it is not what you might assume would be single premium insurance, but rather it is recurring premium both for retirement income and for our whole life. As far as where that is going to go, it is hard to say because this is still a very young distribution system. But to your point about the distribution, we have continued to grow that quarter by quarter.

So for example, at the beginning of this year, we had 10 banks within our distribution. We are now up to 19 banks. So that alone should contribute to the growth in the channel beyond what we are already getting from our in force relationships.

As far as Korea, you are right. It appears, at least in the last few quarters, most noticeably in this quarter, that we may have turned a corner in what had been a multiyear cycle of very aggressive poaching by the competitors. As a result, we have seen an increase in the number of Life Planners almost to a new historic level and an increase of over 30% in the sales in Korea.

They have also been more in the debt protection area rather than in the variable annuity area. So across the board, a number of positives. We would attribute this to three or four different things. One is the economy as a whole is starting to bounce back in Korea. Secondly, there has been a marked weakening of the competition. The very competitors who were poaching and limiting our growth in the last few years were really damaged by the downcycle because they were selling a lot of hot products. The market has returned more to traditional debt protection products and that, of course, is our core competency and so we are benefiting from that.

And the final in fairness is that there is some anticipation of rate increase here, as well as somewhat in Taiwan, which also had very substantial growth even a higher percentage than in Korea. So we are getting a little bit of that phenomenon as well. But across the board, a very positive cycle. We will want to wait another quarter or two to see whether this is indeed an enduring secular improvement or to some extent some cyclical benefit coming from the weakening of the competition coinciding with the strengthening of the economy.

Okay. And could you also address just your outlook for growth in Life Planners for Prudential in Japan? You have aspired I think in the past to a high single digit rate. You haven't had that for several quarters and maybe a few years and it doesn't seem reasonable anymore given the size of the agency force. But what is your view on what a more realistic growth target would be for the Life Planner account at POJ?

Yes, let me give you some numbers for Life Planner in general and then we can focus on POJ. Life Planners in general have been growing -- I think this cycle if you adjust for the 4% in total, by putting back the transfers out of POJ that have gone into the bank channel and helped fuel that growth -- that number jumps up to a little over 6%. I think it is 6.2%. That is probably a more realistic number.

Now in POJ, even with the adjustment for the transfers, it is somewhat less than that and I think it has to do with a couple of factors. One you have mentioned, which is the difficulty in continuing that high level of growth in a more mature large-scale organization. But I think somewhere in that range is a realistic number for us to be targeting for POJ.

Thank you.

Ladies and gentlemen, today's conference call will be available for replay after 1:30 p.m. today until midnight, November 12. You may access the AT&T teleconference replay system by dialing 800-475-6701 and entering the access code of 986906. International participants dial 320-365-3844 and those numbers once again 1-800-475-6701 or 320-365-3844 and enter the access code of 986906. That does conclude your conference call for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.