保德信金融集團 (PRU) 2015 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the second quarter 2015 earnings teleconference.

(Operator Instructions)

As a reminder, today's conference call is being recorded. I'll now turn the conference over to Mr. Mark Finkelstein. Please go ahead.

Thank you, Cynthia. Good morning, and thank you for joining our call. Representing Prudential in today's call are John Strangfeld, CEO; Mark Grier, Vice Chairman; Charlie Lowrey, Head of International Businesses; Steve Pelletier, Head of Domestic Businesses; Rob Falzon, Chief Financial Officer; and Rob Axel, Controller and Principal Accounting Officer. We will start with prepared comments by John, Mark, and Rob, and then we will answer questions.

Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from projections we make today. In addition, this presentation may include references to non- GAAP measures.

For reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the section titled forward-looking statements and Non-GAAP measure of our earnings Press Release which can be found on our website at www.investor.prudential.com.

John? I will hand it over to you.

Thank you, Mark. Good morning, everyone and thank you for joining us. Prudential reported strong second-quarter results driven by solid fundamentals across our businesses. We achieved operating earnings per share of $2.62 after adjusting for market-driven and discrete items, representing a 4% increase over prior year earnings.

This quarter's ROE is in excess of 15%. As we continue to outperform our longer-term target of 13% to 14%. Our operating results reflect solid, core growth fundamentals across many of our businesses, and favorable underwriting margins, which more than offset the headwinds presented by continuing low interest rates and adverse currency impacts.

Net income for the quarter was modestly above operating earnings, and I would also highlight that during the quarter we completed our annual review of actuarial assumptions. And this had a relatively benign impact on current quarter results. Mark and Rob will walk through the specifics of our key drivers, results, and capital position. I will provide some high-level observations.

To start, we are pleased with the court growth drivers across our enterprise. Retirement and Asset Management both had $6 billion of positive net flows. Retirement benefited from pension risk transfer cases that closed in the quarter and Asset Management continues to attract assets based on its strong investment performance and proven capabilities.

Our Individual Life insurance business produced 26% sales growth over the prior year. This was accomplished while achieving appropriate returns and meeting product diversification targets. We also completed our integration of the Hartford Life acquisition.

With targeted run rate annual savings of $90 million achieved, and integration costs a little better, meaning lower, than our expectations. And, we had solid sales results in our international business, producing overall sales growth of 6% over the prior year with increases in both our Life Planner and Gibraltar businesses. I would highlight that Life Planner constant currency insurance revenue growth was a solid 9% over the prior year.

Our annuities business continues to show stable sales results as we have carefully managed pricing and product features. But importantly, our product and risk diversification effort is showing success. Only about one third of our total annuity sales this quarter include equity focus living benefit guarantees where we retain the exposure. And over time this should help lower the volatility in our annuities business.

We also benefited this quarter from strong underwriting margins in several of our businesses including our life insurance and retirement businesses which produced underwriting results better than our average expectations. And our group insurance business continues to benefit from pricing and underwriting actions in our disability block.

Overall, as we look at our businesses and our opportunities for measured growth, we remain confident that we will continue to produce strong earnings that will generate substantial, deployable capital that can be used to support outsized organic and inorganic growth initiatives and returns of capital to shareholders through dividends and buybacks all while maintaining a strong balance sheet. Recall that we believe our business model generate cash flow equal to about 60% of operating earnings over time.

Now, DOL. As most of you are aware, we followed a comment letter on July 21 with the Department of Labor in response to proposed regulations that effectively redefined who will be considered a fiduciary in transactions that involve certain plans, plan participants, and IRAs. In that letter, we requested clarification on certain provisions within the proposed regulation as well as made suggestions for modifications to ensure that the consumer access to important retirement products is not impeded.

And while we embrace effective regulation, like others we are concerned about unintended consequences that could result from these proposed regulations. Having said that, we benefit from a diversified business model. By geography, by product, and by distribution channel. And so while the process is still very much in flux, we remain confident that we will successfully navigate whatever the ultimate outcome may be.

Otherwise, we continue to work with our Federal Reserve supervisor and international regulatory bodies on capital frameworks, and remain encouraged with the dialogue in developing capital standards that reflect the unique attributes of insurance.

With that, I'll hand it over to Mark.

Thanks, John. Good morning, good afternoon or good evening. Thank you for joining our earnings call this morning. I'll take you through our results and then out turn it over to Rob Falzon who will cover our capital and liquidity picture.

I'll start with an overview of our financial results for the quarter shown on slide 2. On a reported basis common stock earnings-per-share amounted to $2.91 for the second quarter based on an after-tax adjusted operating income. This compares to EPS of $2.49 a year ago. After adjusting for market-driven and discrete items in both the current quarter and the year ago quarter, EPS was up 4% amounting to $2.62 compared to $2.51 a year ago.

Looking across our businesses, there are some highlights of this comparison. I'll mention four key items. First, higher fees reflecting growth in average account values in our annuities business and greater assets under Management in our Asset Management business. Second, improved claims and reserve experience in our US insurance businesses.

Third, a greater contribution from pension risk transfer case experience which continue to be more favorable than our average expectation. And fourth, in international insurance, continued growth on a constant currency basis in our Life Planner operation.

These benefits were offset by three primary items. One, higher net expenses in several businesses. Two, a lower contribution from net investment results with returns on non-coupon investment below our average expectations in the current quarter. And three, less favorable currency exchange rates in International Insurance. I would also note the decreased corporate income tax rates in Japan drove a lower effective tax rate in the current quarter.

On a GAAP basis, including amounts categorized as realized investment gains or losses, and results from divested businesses, we reported net income of $1.4 billion for the current quarter, modestly above our after-tax adjusted operating income. We've taken some steps to mitigate volatility of our reported net income, in relation to the operating results driven by our business performance, particularly with respect to foreign currency exchange rates remeasurement.

Low value per share excluding accumulated other comprehensive income or AOCI, and after adjusting the numbers to remove the impact of foreign currency exchange rate remeasurement, amounted to $71.09 at the end of the second quarter, up by $6.34 from year-end, after the payment of two quarterly dividends, totaling $1.16 per share. This includes the benefit of the close block restructuring in the first quarter.

Annualized ROE for the first half of the year was 15.6% based on after-tax adjusted operating income, excluding market-driven and discrete items and using book value, excluding AOCI, and the impact of foreign currency remeasurement. This ROE reflects strong underlying business performance bolstered by a net benefit that we would estimate at about 110 basis points from net favorable variances in comparison to our average quarterly expectations in a number of areas.

These include the seasonal revenue pattern in our international businesses, pension risk transfer case experience, returns on non- coupon investments and items that affected corporate and other results in the first quarter. I'll discuss the impact of these run rate items on the current quarter in reviewing our business results. Slide 3 percents the AOI impact of our actions assumption updates.

This years annual review of actuarial assumptions had a net favorable impact of $117 million on pretax adjusted operating income, or $0.17 per share. The most significant items are $68 million benefit in Individual Life to adjust amortization and reserve including impact of our mortality experience update on legacy business. $31 million in annuities mainly driven by more favorable guaranteed minimum income benefit utilization experience, and $28 million in group insurance primarily from more favorable disability claims resolution experience.

As you recall we moved up the annual actuarial review to the second quarter in order to have a refreshed view of our assumption update in place before the start of our year-end forecasting and capital planning cycle. Last year's review completed in the third quarter had a net unfavorable impact of $186 million on pretax adjusted operating income.

Turning to slide 4, the remainder of this quarter's list of market-driven and discrete items included in our results consist of only two items with a net benefit to results of $0.12 per share. In the annuities business, we released reserved for guaranteed minimum death and income benefit and adjusted DACE to reflect market performance and expectations resulting in the benefit of $0.13 per share.

And, in Individual Life we absorbed integration cost of about $0.01 per share, related to the Hartford Life acquisition. The current quarter marks the substantial completion of the Business integration and these costs. Over the two and half years since the acquisition, we have integrated the distribution platforms and product portfolios and achieved our targeted $90 million of annual run rate cost savings with the full impact commencing in the third quarter of this year.

Total integration costs amounted to $110 million or $10 million less than our original expectations. During the year ago quarter market-driven and discrete items produced a net charge of $0.02 per share.

Moving to slide 5, on a GAAP basis our net income of $1.4 billion in the current quarter includes amounts characterized as net realized investment gains of $286 million in divested business results and other items outside of adjusted operating income amounting to a pretax loss of $43 million comprised of the items you see on this slide. Of the larger items, product related embedded derivatives and hedging activity had a positive impact of $510 million as the benefit from increasing interest rates in the quarter was partially offset by the application of credit spreads to our gross GAAP liability proverbial annuity benefits. General portfolio and related activities, mainly in our international operations, resulted in that pretax gains of $405 million.

And, mark-to-market losses on derivatives, including those used to manage asset and liability durations with values that reflect changes in interest rates had a negative impact of $728 million. The current quarter loss from divested businesses of $57 million mainly relates to long-term care. And includes interest rate driven decreases in the market value of derivatives.

Moving to our business results and starting on slide 6, I'll discuss the comparative results excluding the market-driven and discrete items I have mentioned. Slide 6 highlights individual annuities. Annuities results were $423 million for the quarter, up $29 million from a year ago. Slide 7 gives a few of our trend in earnings and return on assets.

Most of our operating earnings in the annuities business come from base contract charges linked to daily account values. The 7% earnings increase exceeded the growth of average account values from a year ago, resulting in a higher return on assets, or ROA, in the current quarter. ROA for the quarter was 105 basis points, up from 101 basis points in the year ago quarter. Lower interest expense and more favorable base amortization factors in the current quarter, contributed to the higher ROA.

Looking back over the five quarter shown on the slide, I would note that ROA tends to vary within a range, depending on the quarterly DAC pattern of expenses and other nonlinear items. Slide 8 covers our annuity sales. Our gross variable annuity sales for the quarter were $2.3 billion compared to $2.7 billion in the year ago quarter.

Our risk diversification strategy has resulted in a dramatic change in the mix of new sales. With just over one third of our new business for the current quarter adding to our net exposure to equity market linked highest daily or HDI living benefit guarantees, compared to 70% in the year ago quarter.

As we discussed on our Investor Day, effective on April 1 we entered into an agreement with union Hamilton to reinsure our approximately 50% of our HDI 3.0 optional living benefit risk on new business for this year and 2016, up to a maximum of $5 billion. This agreement will effectively convert about half of our sales with the HDI rider to sales without optional living benefits.

During the current quarter we reinsured the living benefit rider risk with about $550 million of the $1.4 billion of total HDI sales. In addition, we sold approximately $600 million of our Prudential Defined Income product which directs the clients investments to a fixed income fund that we match. And, sales include about $350 million of products without a living benefit guarantee. Overall, only about one third of our variable annuity sales in the quarter include living benefit riders with equity market exposure that we are retaining.

Slide 9 highlights the Retirement business. Earnings for the Retirement business amounted to $237 million for the current quarter, down by $49 million from $286 million a year ago. The decrease was driven by $55 million lower contribution from net investment results. Current quarter returns from non-coupon investments were about $20 million below our average expectations. While the contribution to results from the year ago quarter was about $10 million above our average expectations.

Fixed income returns were also lower in the current quarter as the impact of lower earned rates on our institutional and full-service product portfolios more than offset the benefit of growth in our pension funded risk transfer business. The lower contribution for net investment results was primarily offset by a greater contribution from case experience on pension risk transfer business which was about $25 million above our average quarterly expectation.

Turning to slide 10, total Retirement gross deposits and sales were $14.2 billion for the current quarter compared to $6.6 billion a year ago. Standalone institutional gross sales were just over $9 billion in the first quarter compared about $2 billion a year ago.

Current quarter sales reflected the closing of four significant pension risk transfer transactions totaling about $7 billion, including roughly $5.5 billion of unfunded longevity reinsurance, as well as a $1.4 billion stable value wrap sale to existing Group Life insurance client. Full-service growth sales and deposits, shown in the dark blue bars, were $5 billion for the quarter, up from $4.5 billion a year ago.

As we have commented in the past, sales in both full-service and institutional Retirement products can fluctuate meaningfully on a quarterly basis. Total Retirement account values amounted to $373 billion at the end of the quarter, up by $42 billion or 13% from a year earlier, reflecting net flows of about $35 billion, largely driven by longevity reinsurance and funded pension risk transfer business, together with favorable market performance.

Slide 11 highlights the Asset Management business. The Asset Management business reported adjusted operating income of $196 million for the current quarter, compared to $200 million a year ago. While most of the segment's results come from Asset Management fees, the decrease in earnings from a year ago was driven by and $9 million lower contribution from incentive, transaction, strategic investing, and commercial mortgage activities.

This contribution, which amounted to $24 million for the current quarter, is inherently variable since it reflects changing valuation and the timing of transactions. Asset Management fees were $540 million for the current quarter, up by 7% from a year ago. Largely tracking a 6% increase in unaffiliated third-party institutional and retail assets under Management, which totaled $471 billion at the end of the quarter.

Net inflows over the past year amounted to $14 billion, including $6.4 billion in the current quarter which was largely driven by institutional fixed income mandates. The benefit of higher Asset Management fees was largely offset by higher expenses. The higher level of expenses in the current quarter includes variable compensation reflecting performance including our $3 billion increase in unaffiliated third-party asset under Management net flows compared to year ago, investments we are making to build teams and infrastructure to expand our product, and distribution capabilities and higher upfront commissions associated with the $2 billion increase in gross retail inflows for the quarter.

Slide 12 highlights our US Individual Life business. Individual Life earnings were $177 million for the current quarter, up by $11 million from a year ago. The increase in earnings was driven by more favorable claims experience in the current quarter, including reserve updates, mortality and related amortization. The contribution to current quarter results was about $30 million more favorable than our average expectation.

This compares to a contribution from claims experience about $15 million more favorable than our average expectations a year ago on the same basis. The benefit to current quarter results for a more favorable claims experience was partly offset by a lower contribution from investment results and higher expenses, including distribution cost driven by increased sales.

Slide 13 shows Individual Life sales based on annualized new business premiums, which amounted to $130 million for the current quarter, up by $27 million from a year ago. The higher level of sales reflects selective repricing to improve our competitive position where we saw opportunities to build business with appropriate returns. Together with expanding distribution and product enhancements over the past year.

The increase of $19 million in Universal life sales was universal life sales was mainly driven by greater sales and selected age bands where we made pricing changes earlier this year to bring our rates more in line with the market. Term insurance sales in the gray bars are up $6 million from a year ago with a continuing benefit from pricing changes we made last August. We also saw an increase in variable life sales driven partly by product enhancements.

Slide 14 highlights the group insurance business. Group insurance earnings amounted to $47 million in the current quarter, essentially unchanged from a year ago. Benefits from continued improvement in Group Disability claims experience and more favorable Group Life underwriting results were largely offset by higher expenses at a lower contribution from investment results.

Slide 15 presents the trend of our group insurance benefit ratios. After adjusting for the impact of the actuary overviews in the current quarter, and in the third quarter of last year. In Group Disability, favorable claims experience, mainly driven by resolutions of existing claims, produced an improvement of about 8 percentage points in the benefit ratio from the year ago quarter.

While the benefit from the actions we've taken, including pricing adjustments and enhancements to our claims Management process, is now evident over several quarters and we recognize the history of improvements and long-term disability claims resolutions in our assumption update, we continue to expect the claims experience will fluctuate from one quarter two another. The Group Life benefits ratio was near the favorable end of our expected range and improved from a year ago, including a benefit from fewer new claims.

Moving to International Insurance, slide 16 highlights our Life Planner operations. Earnings for our Life Planner business were $392 million for the quarter up $10 million from a year ago, excluding a $12 million negative impact of foreign currency exchange rates which reflect our hedging of yen income at JPY91 this year versus JPY82 a year earlier. Earnings are up by $22 million or 6%.

Results benefited from continued business growth with insurance revenues including premiums, policy charges, and fees up by 9% from a year ago on a constant dollar basis. The benefit to results from continued business growth was partly offset by higher expenses including technology costs, and slightly less favorable mortality experience in the current quarter.

Slide 17 highlights Gibraltar Life and other operations. Earnings for Gibraltar Life were $471 million for the current quarter compared to $502 million a year ago. Excluding a negative impact of $26 million on the comparison from foreign currency exchange rates, results were essentially unchanged from a year ago.

Higher net expenses in the current quarter, largely driven by a benefit from fixed asset sales a year ago, more than offset the greater current quarter contribution of about $20 million from investment results. The benefit to current quarter results from non-coupon investments and mortgage prepayment income was about $30 million above our average expectation.

Slide 18 shows the quarterly pattern of earnings for our International Insurance businesses over the past seven quarters. Looking at the trend, you can see the seasonality pattern that favors the first half of the year, which results from a concentration of annual [mode] premium revenues for our Life Planner operations in the first quarter and for Gibraltar Life in the second quarter. We would estimate that this benefited current quarter earnings for Gibraltar Life by about $40 million in relation to a quarterly average.

Turning to slide 19, International Insurance sales on a constant dollar basis were $777 million for the current quarter, up by $45 million or 6% from a year earlier. Sales by our Life Planners in Japan, shown in the dark blue bars, were $183 million in the current quarter, up $12 million or 7% from a year ago.

The increase reflected a 5% greater life planner cap partly driven by our appointment additional sales managers earlier in the year and higher agent productivity, as measured by the number of policies sold per agent, per month. At a product level, the increase came mainly from greater sales of term insurance.

Life Planner sales outside of Japan were up $14 million from a year ago mainly driven by an increase in Brazil, where we've also grown Life Planner account meaningfully. Gibraltar's Life Consultant sales, shown in the light blue bars, amounted to $204 million in the current quarter, down by $16 million from a year ago. This decrease was driven by lower fixed annuity sales as our reductions of crediting rates we offer a new business which are continually updated to reflect market interest rates, made these products relatively less attractive than other investment-focused alternatives in the market.

Our fixed annuities have been popular among retiring teachers, many of whom are clients of our life consultants. For investment of life lump-sum payouts upon Retirement, in the second quarter of the year. Sales through the bank channel, shown in the gray bars, amounted to $191 million in the quarter of $30 million or 19% from a year ago.

The increase was mainly driven by greater sales of US dollar denominated whole life insurance, reflecting broadening distribution among our Japanese bank relationships. Sales through independent agents, shown in the green bars, amounted to $81 million in the current quarter. The $5 million increase from a year ago was driven by greater sales of Retirement products.

Slide 20 shows the results of corporate and other operations. Corporate and other operations reported a loss of $305 million for the current quarter, compared to a $341 million loss a year ago. The reduction in the loss came mainly from lower expenses in the current quarter. Expenses in corporate and other are inherently variable, and current quarter costs for items including deferred compensation programs and employee benefit plans were below recent averages, accounting for about half of the reduction in loss.

An additional benefit from investment income on remaining assets that were formally associated with our close block business, and initially transferred to corporate and other, when we completed the restructuring of that business at the beginning of this year, was largely offset the higher interest expense.

Now, I'll turn it over to Rob.

Thanks, Mark. I'll now provide an update on some key items under the heading of financial strength and flexibility. Starting on slide 21. We continue to manage our insurance companies to levels of capital that we believe are consistent with AA standards.

For Prudential Insurance, we managed to a 400% RBC ratio. As of year-end, Prudential Insurance reported in RBC ratio of 498%, with total adjusted capital of $15 billion. While we don't perform a quarterly bottoms up RBC calculation, we estimate that our June 30 RBC ratio remains well above our 400% target, after giving effect the results for the first half of the year, including a $2 billion dividend to the Parent Company in May, following the completion of our close block restructure.

In Japan, Prudential Japan and Gibraltar Life reported strong solid margins of 844% and 882%, respectively, as of March 31. There fiscal year ends. These solvency margins are comfortably above our targets.

Looking at our overall capital position on slide 22, we calculate our on balance sheet capital capacity by comparison the statutory capital position the potential trends to our 400% RBC ratio target. And then add capital capacity held in Japan and other operations and at the Parent Company. As of year-end, we estimated are available on balance sheet capital capacity at approximately $2 billion on a net basis.

This represented about $4 billion of gross capital capacity, less $2 billion earmarked to reduce capital debt, to arrive at our long-term targeted financial leverage ratio of 25%. Net capital capacity on the same basis increased over $2.5 billion at the end of the first quarter.

During the second quarter, our estimated on balance sheet capital capacity increased to over $3 billion. The current quarter increase was mainly driven by capital generated by our businesses and changes in interest rates, which had a modest positive net impact on our capital position. These increases to capital capacity more than offset about $500 million of distributions including $250 million each from share repurchases and our $0.58 per share quarterly dividend.

As I mentioned, during the quarter, Prudential Insurance paid a $2 billion dividend to PFI, the Holding Company. As a result of that dividend, as well as other sources of capital generated, we're able to reclassify about $2 billion from capital debt to operating debt as this debt is no longer supporting capital needs within our businesses.

As our outstanding debt matures, all else equal, funds will be available at the Holding Company to reduce overall borrowings. As a result, our financial leverage ratio is now below our targeted level of 25% and there is no adjustment to earmark a portion of our capital capacity for reduction of capital debt to arrive at this target.

Our overall level of borrowings is essentially unchanged from year-end and our total leverage ratio is down modestly, reflecting the increase in our equity. The fair value of the Japan equity hedge after subtracting the remaining unsettled amount that we locked in during the first quarter, and already included in capital capacity, was about $2.2 billion at June 30.

Turning to the cash position of the Parent Company, cash and short-term investments net outstanding commercial paper amounted to about $5.6 billion as of June 30. The cash in excess of our targeted $1.3 billion liquidity cushion is available to repay maturing operating debt, to fund operating needs, and to redeploy over time for strategic and capital management purposes.

Now, I'll turn it back over to John.

Thank you, Rob, thank you, Mark and we now like to open it up to questions.

Thank you.

(Operator Instructions)

Erik Bass, Citigroup.

Hi, thank you. I was hoping you could provide a little bit more detail around the drivers of the $500 million in improvement in excess capital? Particularly the capital generated by the Business? And maybe touch on any amounts from the settlements of the capital hedge that contributed to that?

Erik, it's Rob, happy to do so. As I said, the capital that we generated this quarter was primarily from business earnings and there was a modest benefit from interest rates. The math is relatively straightforward, if you think about the guidance that we've given before. If you look at our after-tax operating income, you net from that the buybacks and dividends that we provided during the course of the quarter and the rule of thumb that we use for business growth that has the amount of capital that needs to be put back into our business to finance our growth, you come up with a number that's pretty close to the $500 million that we generated. So it comes primarily from that earnings that are generated at the Business level. The capital hedge, I presume in that case you're referring to the FX equity hedge, actually did not have a material impact in this quarter. If you recall in the first quarter, we accelerated some of the -- locked in, I should say, some of the gains associated with that. So that included most of what we otherwise would have realized during the course of this quarter.

Thank you, that's helpful. And given the volatility that we've seen in the excess capital over the past three quarters, can you talk about how comfortable you are in redeploying this capital? And does the volatility at all limit your deployment options in terms of how you would think about using that capital?

I think, Erik, the way I would respond to that is, we had -- the volatility was limited to a single quarter as opposed to volatility that you've seen on a consistent basis, first. Secondly as we look at the capital capacity I think our inclination and philosophy for redeployment has not changed. We look at holding a prudent amount of it and to ensure that we retain and maintain a strong balance sheet and we otherwise would to redeployed the capital either to finance growth, organically or inorganically, and to keep a balanced distribution back to our shareholders as well.

Thanks. And a final question, given the recovery in the excess capital position and the uptick that we've seen in interest rates, have you given any consideration to either reducing or eliminating the rate under hedge?

We look at our interest -- that particular under hedge is looked at in the context of our overall interest sensitivity across the enterprise. At this point we're comfortable with where we stand on that position. I think as we've said before we have a positive convexity toward interest rates, meaning that as rates rise we will benefit. We will benefit more than we would suffer should rates decline and we like that position at this point in the cycle.

This is Mark. Let me just remind you that you need to take a broader view of that. That narrow product under hedge does go the other way from some other things in our income statement and particularly in my remarks I commented on nearly $800 million of negative mark-to-market on basically duration hedging derivatives. And so you've got to think more generally about what goes the other way and how that's netted off before you start thinking about specifically the under hedge as a standalone either view on rates or influence on our overall balance sheet.

Got it. Thank you for the comments.

Seth Weiss, Bank of America.

Hi, good morning. To follow up on the theme of capital, if we look at the Parent Company cash and short-term investment, the $5.6 billion, I believe this is the highest it's been in about 2 1/2 years. I understand access capacity -- you think about holistically in terms of Holdco and statutory entities, but given the higher Parent Company cash position, should we think about that as any type of short-term opportunity to deploy or other near-term timing needs of cash that we should consider?

Seth, I would point to the comment I made in my opening remarks about our leverage position and specifically I would note that if you look forward to maturing operating debt that we've got during the course of this year, we have about $2 billion worth of debt that matures in the second half of the year. We're sitting on a substantial amount as you noted, cash at the Holding Company, and we would expect to be able to pair those things off during the course of the year.

Okay, so is there no plan to roll those debts?

We have a lot of liquidity sitting at the Holding Company and we don't -- we would not, based on our current position, think that we would want to add to that liquidity by effectively rolling over our existing debt rather than look at the opportunity to just repay that as it becomes due in its natural course.

Okay, great, thanks. And if I could just follow up one in the Retirement segment. I think we've seen positive case experience in the pension close outs for several quarters or a couple years now. Perhaps you could just comment, maybe give a little bit more granularity on where that positive case experience is coming from and if that's something that -- I know you're not guiding to anything sustainable there, you're pretty specific calling that out in both the releases and in earnings calls here, maybe just explain why that should normalize lower?

Seth, this is Steve. I'll comment on that. I'm not going to attribute the positive case experience to any particular transactions or any particular part of the book. I will say that we call it out because we recognize that these are liabilities with longer average duration, about 9 to 10 years on the funded side as we spoke about, and about 8 to 12 years on the longevity side. We're not about to take the positive case experience and bake it into our expectations, however I will say that as you pointed out, the consistent positive case experience does serve to bolster our already high confidence that we've priced this business appropriately and assessed the risks accurately.

Okay. Maybe just a follow-up in terms of the kind of risk characteristics of this. Is this something that will have quarterly volatility like a Group or Life that we're a little bit more accustomed to, and that it's just been several quarters of good luck or is there maybe just a better trend here that we could think about?

Well I wouldn't necessarily call it good luck, I'd call again reflecting strong underwriting of the Business. But again this would be something that we wouldn't expect to see the same type of number emerging from this every single quarter.

Okay, thank you.

Tom Gallagher, Credit Suisse.

Thanks. The first question I had is Rob, when you take the 60% ratio of free cash flow versus GAAP earnings that you all have put out there, and then you compare it to the results you had for the last few quarters, I get something closer to 90%. So my question is, I don't know if that would be precisely the way you would calculate it -- but I think directionally that's right, where is that, we'll call it above average or above expectations, capital generation? Where is that coming from right now? Is that something going on within the Arizona VA captive? Is that broadly related to interest rates? Can you just expand upon how you're over-earning from a cash flow generation standpoint right now?

Tom, without benefiting from exactly how you're doing your calculations, I'd note a couple things that have positively benefited our cash flow ratio. The most significant of which would be the Closed Block transaction. So as a result of that restructuring that we've talked about before, there's been a substantial freeing up of cash from the Closed Block business up to the Parent Holding Company and we've see the benefits of that in our cash flow and hence that may be skewing the numbers that you're looking at. And again, then depending on the time frame that you're looking at, if you look at the positive convexity I mentioned that we have to interest rates -- as interest rates have increased from their lows, we have benefited from that and that frees up capital in a way that you don't see coming necessarily from earnings but outside of earnings. And then, I'm sorry, the one other point is the benefit from the yen hedge, so that's outside of our AOI number but winds up as we monetize that we're able to get the cash from that, and you've seen that, we talked about that in the course of the first and second quarters. That yen has contributed to cash that has been available and is sitting at the Holding Company. The total of that on an after-tax basis in the first quarter, we mentioned, was several hundred million dollars and what was not material in the second quarter we benefited from that in the cash position.

Okay and just a follow-up. The Closed Block transaction in terms of how much that moved the needle to your overall enterprise view of leverage and excess capital was how much?

The dividend this year was $2 billion from PICA, about $1.25 billion of that was associated with Closed Block. You can do the math and figure out the attribution of that to our decline in the capital ratio. The decline in the financial ratio really came about by virtue of three things. That was the first. The second was we issued $1 billion of hybrids and 25% of that hybrid goes toward equity attribution, and so that helps on the leverage ratio. And the third was just a growth of our earnings during the course of the quarter that increased the denominator.

Okay, thanks and just one last follow-up. So I guess to get back on the question of interest rate sensitivity, overall capital position, would you guys be willing to provide sensitivities to this number which is now $3 billion in terms of balance sheet capital capacity? How much sensitivity is there if we were to see -- say around year-end this year, a decline in interest rates to either a 2% level on the ten-year treasury or 1.5%? Is that something you could help frame for us? That's one of the main questions that I still get from people as to one of the concerns that they have.

We have not provided direct sensitivities of capital to interest rates, Tom. I think what we did say on Investor Day, is that we've run stresses. I think what we ran was a 50 basis point decline, 50 to 100 basis point decline in our levels of interest rates and looked at what that would do to our capital capacity. And the result of that was a relatively modest impact to our capital capacity and just a slight elevation to our leverage ratio. So I would say that we feel reasonably comfortable that our capital capacity is sustainable in a declining interest rate environment.

Okay, thanks.

Suneet Kamath, UBS.

Good morning. I want to start with Retirement if I could. If I go back to the Investor Day, you showed a helpful slide that shows the profit emergence of PRT versus longevity transactions over time. So my question is what is the relative size of those two businesses? I'm not sure what's the right way to do it in terms of reserves or capital or earnings, but can you give us some sense of, given the deals that you've announced to date, the relative sizes of those two businesses?

Suneet, this is Steve. I'll speak to the business that we've done in this quarter. As Mark mentioned in his comments we had about $7 billion in sales in the quarter, of which about $1.5 billion was funded business and the remainder was in several different longevity transactions. In terms of the overall size of the book, we're looking for that data now and can provide it to you in due course.

Okay, great. And I guess my follow-up question is, just a follow-up to Seth's on the $2 billion of debt that's maturing that you're going to repay. I haven't done the math on what the financial -- implications are for the financial leverage ratio if you repay that debt but, just based on where you sit today, it would seem that you're going to be well below your 25% target that you use when you access excess capital capacity. So just wondering what the thought is there? Are we going to at some point see a reduction in that target from 25% to something lower? Or how should we think about that?

The debt reduction would actually be in the total leverage ratio, would not affect our financial leverage ratio. So, we've already recharacterized the debt that's to be repaid from Financial to Operating, so the $2 billion that's coming up will further -- will then repay Operating debts. So our total financial ratio will decline from around 44% to around 42%. But there would be no impact on the reported financial ratio.

Okay so you're still going to travel around that 25% target that you've talked about?

That's our targeted number and while we may bump above or below it depending on any given quarter and particular situation or opportunity that we're looking at, our intent is to have it hover around that number, yes.

Okay, thanks.

Let me just follow up on your question. If you look on page 18 of the QFS, we do break out total account values for longevity reinsurance and Group Annuities and other products so you'll see those numbers there.

Okay but is all that Group Annuities stuff PRT or are there other pieces in there?

There are some other products, like a Legacy PRT in there.

Okay, I'll follow-up later.

But you do see the longevity which is essentially the UK longevity block that we've added over the last couple years.

Okay, thanks.

Jimmy Bhullar, JPMorgan.

Hi I had a few questions. First on the [SFA] business, you've had positive flows now I think for three straight quarters so and this quarter was especially good so in the past your outlook for the business and your view on market trends hasn't been that positive. Wondering if that's changed recently?

And then on Group Benefits margins in both Group Life and Disability, seems like they're unusually good. Not sure if it was an aberration or it's the result of pricing actions that you've taken. And is this somewhat of a sustainable level in margin into the second half or would you expect margins to compress from these levels?

Jimmy, this is Steve. I'll address both your questions. We think the full-service flows that we've seen reflecting investments made in the business to be -- to lower our unit costs and manage our unit costs more effectively. And to improve our persistency and our sales pipeline. So we think that the, like I said, the sales we've seen reflect our enhancement of our competitive position. By the same token, we still view this as a highly competitive business and one in which sales and flows will be fairly chunky over time. This quarter sales did not reflect any particularly large jumbo cases on either the sales or on the withdrawal side but, for example in, it's been publicly announced, in July, we closed the State of Connecticut business which was over $4 billion. So, we still view this as something that we'll, like I said, have its ups and downs and that we see as a highly competitive business in which we're going to maintain our pricing discipline.

On Group Benefits ratios, I'd segment it out into Life and Disability. In Life we think the guidance we've given of the target range for the benefit ratio between 88% and 92% still holds. This was a good quarter at the lower end of that range, but still within the range. On Disability, we've given a similar range of 88% to 92%. Quite frankly, I do think that range is rather stale as we see our successful efforts in remediation of the existing book. And as we in particular see our successful efforts in improving are Claims Management capabilities. We think there's the potential for, as things settle down in our remediation of this business, for revising that target ratio over time. I don't have a different type of figure for you yet, but I would expect that as we take a look at that, we'll come up with something that is in between the 88% to 92% range at the high end and where we are today at the low end.

Okay. And then for Mark, on the Department of the fiduciary standards, how much of an impact you expect the standards, if they are approved in final form, similar to how the preliminary guidance was, how much of an impact would you see on your business and what are the specific product lines that you think will be the most affected?

That's actually a question for Steve.

Jimmy, I'll respond to that. I think some people have been asked on their calls do they see the DOL impact as a net negative or a net positive? We see it as a net negative on the marketplace that we serve. We see the risk of individuals having restricted access to advice and certain types of solutions, in particular around guaranteed Retirement Income Solutions. Just to give you a little bit of a flavor, the regulation itself is certainly voluminous and so is the industry commentary that has been made in response to the regulation. I think it's far too early to anticipate exactly what changes will ultimately be enacted and to give you an estimate of the impact of those changes. I can say that in our own comments, we highlighted a few different areas that really need clarification or outright amendment. I'll highlight a couple of those. Like many in the industry, we believe that the fiduciary definition in the regulation as drafted is too broad, encompassing activities such as traditional marketing that we're really never viewed as or intended to be fiduciary in nature.

We also share concerns expressed by many others that the best interest contract exemption, as it's written and as it could be interpreted, would be highly problematic and could entail higher compliance burdens and costs and potentially higher legal exposures for industry participants. And we also highlighted where the DOL really needs to clarify and sharpen the distinction between education and advice. For us in Prudential, as I highlighted on our last earnings call, we do believe that our market position, our mix of businesses and the strength of our franchise will help us to adapt to any regulatory framework that emerges. We think that there are some aspects of our particular business model that benefit us in this regard. For example, most of our DC record-keeping businesses is with cases with over 100 participants already and that's relatively less impacted in this regulation. The investment platform supporting both our Retirement and our Annuities businesses already operate on very much of an open architecture basis and our own agency force Prudential advisor sells a range of proprietary and non-proprietary products. So we think we're relatively well-positioned to deal with an emerging regulatory framework. However, we still do view this, as I say, as something that has the potential for unintended negative consequences on the marketplace and the clients that we serve.

Okay, thank you.

Eric Berg, RBC Capital Markets.

Thanks very much. I would like to start by talking about the Retirement business. Just eyeballing the set of column charts on the right on slide 10, I'll let you get to that. It looks like the business, the real growth in the business is on the longevity reinsurance side as opposed to the funded side. Is that right? And if so, why are clients gravitating towards that option?

Eric, this is Steve. I think we've seen growth on both fronts. I think that naturally speaking, the longevity reinsurance business, being reinsurance activities at its core, tends to be in higher tickets, higher transaction sizes. But as we've spoken about before both in terms of earnings attribution and in terms of capital attribution, the funded business has higher earnings per dollar of account value and higher capital attribution.

In terms of the solutions and what kind of marketplace is developing more rapidly, I would say the UK longevity reinsurance industry has been established for several years now. There's a regular stream of transactions in the marketplace in what has become a relatively well-established business. The pension risk transfer business on the funded basis in the US tends to be more episodic in nature. We still view the business has having developed very nicely over the past couple of years but particularly in the large case market in which we tend to do most of our business, that's naturally going to be episodic in nature.

The longevity reinsurance transactions are more attractive to clients in the UK for structural and cost reasons. In the US we've actually done much better on the fully funded. It's not that clients choose one of the other, you're kind of thing two different places here.

The longevity reinsurance business really has not yet emerged in the US.

Before turning to a question about annuity I just want to ask one quick one further about Retirement. Just to make sure I understand what exactly we mean by case experience here being favorable? Is the idea plainly and simply that debts of plan participants are happening at a greater rate than you priced for, so you're [CC-ing] payments to annuitants sooner than you priced for? Is that what you mean by favorable case experience?

That's primarily it, Eric. There's also an impact from investment experience as well.

One last question regarding the annuity business and I'll be wrapped up. One of the things I noticed in your supplement is that despite what has now been a multi- quarter effort to de-risk the annuity business, the relationship between the two sets of account values, those with higher risk and those with less risk, whether they are reinsured or don't have equity risk, hasn't really changed. That's what at least I'm taking away from the supplement. Is that right? And if so, why hasn't this ratio changed?

Well, Eric, I think on that front, this is Steve again, it's just more a matter of the math. We have a very large enforce book and we have been embarked on this product diversification effort for basically two years now. We've had I think remarkable success in altering our sales pattern over those two years as Mark highlighted in his business commentary. But, the plain mathematical fact of the matter is that it will take time for that altered sales pattern to have a significant impact on the nature of the enforce.

Very good. I'm all set. Thanks very much.

Cynthia, we'll take one more question please.

Michael Kovac, Goldman Sachs.

Great, thanks for taking my question. Just wondering on the assumption review this quarter if you could walk us through in a little more detail relative to last year, what some of the underlying changes that you made were and specifically thinking about long-term and shorter-term interest rate assumptions embedded in some of your products?

Michael, it's Rob, I'll try to tackle that. First, let me answer the latter part of it. We actually brought down our long-term reversion rate both in the US and Japan by 25 basis points. And that had a negative impact on our assumption update for the year. Offsetting that were positive drivers that we had, and if I had to sort of summarize them across the businesses, it would be that Mortality was a positive impact both in our Life and Corporate and Other business. The annuity utilization rate, specifically on an our GMIB product, was a positive impact, and then we had a positive impact from long-term Disability termination rates. If you look at the AOI impact of that, I think as Mark highlighted, that was a positive of that $117 million, but importantly on a GAAP net income basis it was also a positive of about $60 million. And so it would have less of a positive impact on a GAAP basis (inaudible) a positive outcome there as well. Does that answer your question without getting into specifics on any individual business? We're happy to do so if you're looking for more detail.

I can follow up on the individual businesses. I was looking at it at the rate level. And then one more question on the Annuities business. Thinking about a run rate for this, you call that some of the one-time items, but is scale really driving this to a more reasonable, maybe [$425 million] run rate on a quarterly basis? And so that's part one on the Annuities. And second, when you think about sales going forward with now the reinsurance in place, do you expect to be able to accelerate the pace of sales in this business going forward?

Michael, it's Steve, I'll tackle that. In regard to how we deal with run rate for the business, I guide you to my comments that I made earlier about ROA. We're pleased with the progress on that front but we still view this as a business where the sustainable ROA over time will be in the low 100s basis points ranging up to 105 basis points. In regards to reinsurance, we view that as a risk management initiative and tool. We do not see it as something that we intend to use to lever up our HDI sales. That's not how we view it all. We continue to price our HDI product without regard to the reinsurance contract for example, and conduct ourselves in the market accordingly. So I really emphasize the reinsurance arrangement is purely a risk management tool, one of several at our disposal.

Great, thanks.

Thank you.

(Operator Instructions)

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.

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