保德信金融集團 (PRU) 2017 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Prudential quarterly earnings call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mark Finkelstein. Please go ahead.

Thank you, Roxanne. Good morning, and thank you for joining our call. Representing Prudential on 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, Principal Accounting Officer. We will start with prepared comments by John, Mark and Rob, and then we will answer your questions.

Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a 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 Measures of our earnings press release, which can be found on our website at www.investor.prudential.com.

And with that, I will hand it over to John.

Good morning, everyone, and thank you for joining us. We had a very good start to the year, reporting strong earnings and showing continued underlying momentum across our businesses. I will provide some higher-level observations on our results for the quarter, the core fundamental drivers in our businesses and capital deployment, and then hand it over to Mark and Rob to go through the specifics.

First quarter operating earnings of $2.76, which excludes a $0.03 benefit from market-driven and discrete items, exceeded the $2.26 we reported in the first quarter of 2016, which, as you will recall, was subject to considerable market headwinds. Our annualized return on equity for this quarter was very good at just over 14%, which is above our near to intermediate ROE target of 12% to 13%.

Results benefited from particularly strong spread income in the quarter, with our returns on non-coupon investments outperforming our longer-term expectations. We also continued to benefit from solid underlying growth in a number of our businesses such as Retirement, asset management and our International businesses.

Our underwriting experience on an overall basis was slightly weaker than our average expectations as we experienced adverse mortality results in our life insurance businesses. However, this was largely offset by favorable experience in our longevity businesses, namely our Retirement segment. First quarter has historically shown some larger swings in underwriting experience at the segment level, but we are pleased to see that the benefit of our mix of mortality and longevity businesses moderates these impacts.

We also recognized higher expenses in the quarter related to a change to our long-term compensation program. This change only affected the timing of expenses during 2017. As a consequence, we reported certain expenses in the first quarter that under former plan provisions, would have been spread throughout 2017. But overall, it was a good, clean quarter without a lot of noise.

Our net income per share of $3.09 was modestly above operating EPS, and we continued to show solid adjusted book value per share growth, up 7% over the first quarter of 2016, which is after paying $2.85 in dividends per share.

I will now touch on some key fundamental trends in our businesses, starting with our domestic businesses. We produced record earnings in our Retirement business. While outsized non-coupon investment results and strong case experience were the notable drivers of the earnings strength, which you will hear more from us on, Retirement also benefited from some other smaller items in the quarter. And so while we would be cautious on extrapolating current quarter adjusted results through the remainder of the year, we are very pleased with the underlying earnings trends of the Retirement business. We are benefiting from solid account value growth and outstanding underwriting results, particularly from our pension risk transfer block.

Asset management had another good quarter, benefiting from positive net flows and stable overall fee rates. Total assets under management of $1.1 trillion, up 7% over the prior year, benefited from $600 million of third-party unaffiliated net flows. Notably, we set a record for unaffiliated third-party assets under management of $543 billion.

Individual Annuities also had very good results, with earnings equal to the record set in the third quarter of 2016 after adjusting for market-driven and discrete items. We are continuing to benefit from strong margins, aided by the actions we took last year to more efficiently manage the living benefit risk and reduce capital volatility.

Not surprisingly, we did see a sizable decline in variable annuity sales over the prior year, which is consistent with the pressures others in the industry have also experienced with the DOL rule uncertainty. Nevertheless, this is an important business for our franchise, and we expect Individual Annuities to be a solid source of earnings and cash flow.

As I mentioned, our Individual Life and Group Insurance protection businesses did experience elevated mortality claims in the quarter, which weighed on our results. In the case of Group Insurance, this was mitigated by favorable Group Disability results. We reported the second lowest disability benefit ratio in 5 years, which continues to reinforce the success of our recent underwriting actions.

Now turning to the international position. I would characterize our international results as solid with few surprises. Foreign currency continues to be a modest headwind, but overall, we are seeing stable core growth and continued steady results. Sales overall were strong, up 8% over the prior year on a constant currency basis. This was driven by a particular strength in our Life Planner channel, which was up 34%.

We did experience a sales surge in advance of a premium rate increase on yen-based products in Japan. But more broadly, we continued to show good growth in our Life Planner account, solid increases in U.S. dollar product sales and overall favorable fundamentals.

Partly offsetting the strength in the Life Planner segment, we experienced lower year-over-year sales at Gibraltar due to declines in the bank channel.

Our adherence to profitability standards and the nature of third-party bank distribution does give rise to the potential for more sales variability. In that regard, we terminated sales of certain yen-based products last year in response to interest rate declines. And I would add that bank channels sales for the industry are also showing pressure.

Moving to capital deployment. We returned $640 million to shareholders in the quarter, which was about equally split between dividends and share repurchases. We have a robust capital position and generate considerable free cash flow. This puts us in a good position to continue to invest in our businesses for long-term growth while also returning large amounts of capital to our shareholders.

And finally, before handing it over to Mark, I would conclude by observing that there's obviously a fair amount of uncertainty in the broader environment around topics like tax return -- tax reform, regulation, the direction of interest rates and policies that affect the macroeconomic landscape. While we don't know how all of this will play out, we remain highly active in our advocacy efforts to make sure that our ability to deliver strong customer value, while also producing strong shareholder value, remains intact.

Additionally, we benefit from our superior mix of businesses and diverse sources of earnings, supported by a strong capital position that positions us well to deliver differentiated returns and a high level of free cash flow. And further, this combination puts us in an optimal position to capitalize on opportunities and succeed across a wide variety of outcomes and circumstances.

And with that, I'll turn it over to Mark. Mark?

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

I'm starting on Slide 2. After-tax adjusted operating income amounted to $2.79 per share for the quarter compared to $2.18 a year ago. After adjusting for $0.03 per share of market-driven and discrete items, EPS amounted to $2.76 for this quarter, up from $2.26 a year ago and implying an ROE of 14.1% on an annualized basis.

Core performance of our businesses was strong in the quarter, with earnings from asset-based fees and asset management, Annuities and Retirement about $100 million higher than a year ago, driven by market appreciation and positive flows. In addition, results benefited from continued business growth in International Insurance on a constant currency basis as well as greater spread margins, partially offset by higher expenses.

As John mentioned earlier, current quarter results also benefited from a few notable or inherently variable items. Non-coupon investment returns and prepayment income were about $125 million above our average expectations in the current quarter. We experienced modestly unfavorable net underwriting results as compared to our average expectations. This reflects adverse mortality experience in our life insurance business, which was mostly offset by favorable case experience in our Retirement business. These items, together, had a net benefit of about $0.15 per share in the current quarter.

In addition, current quarter expenses reflect the impact of modification to certain provisions within our long-term compensation program, where a minor change in retiree service requirements triggered a change in the timing of expense recognition. This resulted in expense of approximately $80 million or $0.12 per share, which would previously have been recognized in subsequent quarters of 2017.

While the plan modification only affects the timing of when certain expenses are recognized in a given year, it is a permanent change, and therefore, will affect the pattern of expenses in future years as well.

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, about $100 million above our after-tax adjusted operating income.

Moving to Slide 3. For the current quarter, market-driven and discrete items consist only of our quarterly market and experience on [lockings] in the annuity business, driven mainly by the performance of equities in our customer accounts, which resulted in a net benefit of $0.03 per share.

Turning to Slide 4. Our GAAP net income of $1.4 billion in the current quarter includes amounts characterized as pretax net realized investment gains of $38 million and divested business results and other items outside of adjusted operating income amounting to a net pretax gain of $72 million. The current quarter net realized investment gains were driven by pretax gains in our International Insurance investment portfolio, partially offset by losses from other risk management derivatives, including currency hedges as the yen strengthened modestly during the quarter.

Moving to our business results and starting on Slide 5. I'll discuss the comparative results excluding the market-driven and discrete items that I have mentioned. Annuities earnings were $449 million for the quarter, up by $68 million from a year ago. The increase was driven by a greater contribution from policy charges and fee income, primarily a result of an 8% increase in our variable annuity average account values as well as the continued benefit from our refinement in risk management strategy for product guarantees, which we implemented in 2016.

Also contributing to the growth in earnings was more favorable net investment results, including current quarter earnings from non-coupon investments and prepayment fees, about $15 million above our average expectations.

The increase in return on assets, or ROA, from a year ago to 114 basis points includes the benefit of changes in our risk management strategy for product guarantees as well as more favorable investment results. Quarterly ROA can vary from a baseline, and the current quarter and the third quarter of 2016 both benefited from items that were stronger than what we would expect as a base case.

Slide 6 presents our annuity sales. Total gross sales of $1.4 billion in the quarter are down by $600 million from a year ago. This trend in gross sales reflects the actions we have taken to reprice our PDI product as well as the broader industry sales pressures seen, we believe, in response to the anticipation of the DOL fiduciary rule.

Turning to Slide 7. Retirement earnings were $397 million for the quarter, up by $178 million from a year ago. This increase was driven by a greater contribution from net investment results, more favorable case experience and higher fee income. The contribution from net investment results was up $135 million from a year ago.

Current quarter earnings from non-coupon investments and prepayment fees were about $65 million above our average expectations compared to a contribution about $40 million below expectations a year ago. Higher spread-based account values also contributed to the stronger net investment results.

Current quarter case experience was about $50 million more favorable than our average expectations, primarily from our pension risk transfer business, which continues to perform very well.

Turning to Slide 8. Total Retirement gross deposits and sales were $10.8 billion for the current quarter compared to $8.7 billion a year ago. The increase was driven by higher Institutional Investment product sales in the current quarter, including 2 longevity reinsurance cases totaling about $2 billion and a modest increase in stable value wrap sales.

Total Retirement account values were a record $396 billion, up 6% from a year earlier. This includes the benefit for market appreciation as well as $5 billion of positive net flows over the past year. The modest net outflows in the quarter reflect the episodic nature of the large case business inherent in both Full Service and Institutional Investment products as well as the impact of the normal runoff of group annuity and longevity reinsurance cases. In addition, there was an increase in participant withdrawals due to market activity.

Turning to Slide 9. Asset management earnings were $196 million for the quarter compared to $165 million a year ago. The increase was driven by higher asset management fees and a greater contribution from other related revenues, partially offset by higher expenses. The increase in asset management fees reflected greater fees from growth in fixed income assets under management and the benefit of a fee rate restructuring in real estate in the third quarter of last year.

The current quarter included about $25 million of expense related to modifications of certain provisions within our long-term compensation program, which I mentioned earlier. Asset management reported about $600 million of net unaffiliated third-party flows in the quarter, excluding money market activity, driven by another quarter of strong fixed income flows.

Turning to Slide 10. Individual Life earnings were $118 million for the quarter compared to $120 million a year ago. Higher expenses and adverse claims experience were partially offset by a greater contribution from net investment results. Earnings for the current quarter reflected claims experience that was about $50 million below our average expectations compared to claims experience about $35 million below expectations a year ago. We do not adjust our average quarterly expectations for seasonal variances. However, it is not uncommon for us to experience adverse mortality in the first quarter.

The higher contribution from net investment results included income from non-coupon investments and prepayment fees, about $15 million above our average expectations in comparison to realized -- to results of about $10 million below our average expectation a year ago.

Turning to Slide 11. Individual Life sales, based on annualized new business premiums, were essentially unchanged from a year ago and down about $37 million from the seasonally strong fourth quarter. The sequential quarter decrease came mainly from guaranteed and other Universal Life, including tax and estate planning sales that tend to peak in the fourth quarter. The prior quarter also reflected accelerated purchases in advance of price increases and face amount limits we implemented for our guaranteed Universal Life products.

Moving to Slide 12. Group Insurance earnings were $34 million for the quarter, up by $8 million from a year ago. The increase came mainly from a greater contribution from net investment results, partially offset by less favorable underwriting results and higher expenses. Current quarter earnings included income from non-coupon investments and prepayment fees that were about $15 million more favorable than our average expectations compared to about $10 million below average expectations a year ago.

The current quarter total benefits ratio was at the midpoint of our long-term targeted range of 87% to 91%, reflecting less favorable Group Life experience, offset by favorable Group Disability experience.

Turning to Slide 13. Most of our Group Insurance sales occurred in the first quarter, reflecting calendar year effective dates. Current quarter sales, based on annualized new business premiums of $301 million, were solid and slightly lower than the year-ago quarter. The decrease was driven primarily by the absence of a large life case sale in the year-ago quarter, partially offset by growth in disability sales.

Moving to International Insurance and turning to Slide 14. Earnings for our Life Planner business were $408 million for the quarter compared to $410 million a year ago. Excluding a $13 million negative impact of foreign currency exchange rates, earnings increased by $11 million from a year ago. Current quarter results benefited from continued business growth, with constant dollar insurance revenues up 7% from a year ago, partially offset by less favorable policy benefits experience with claims experience about $15 million less favorable than our average expectations. A concentration of annual mode premium revenues in our Life Planner business results in an earnings pattern that favors the first quarter. We estimate that this benefited current quarter results by about $25 million in relation to the quarterly average.

Turning to Slide 15. Gibraltar Life earnings were $391 million for the quarter compared to $369 million a year ago. Excluding a $2 million negative impact from foreign currency exchange rates, earnings increased by $24 million from a year ago. Current quarter results benefited from business growth, including a full quarter contribution from our investment in AFP Habitat in Chile, which was acquired in March of last year.

In addition, results reflect the greater contribution from net investment results, partially offset by less favorable policy benefit experience. The contribution from net investment results included returns on non-coupon investments and prepayment fees modestly above our average expectations compared to about $20 million below average expectations a year ago. Mortality experience in the quarter was about $10 million less favorable than our average expectations compared to slightly more favorable than average expectations a year ago.

Turning to Slide 16. International Insurance sales on a constant dollar basis were $825 million for the current quarter, up by $61 million or 8% from a year ago. This includes a 6% increase in Japan, driven by higher Life Planner sales, partially offset by lower bank channel sales in Gibraltar. Life Planner sales in Japan were up 41% from a year ago, reflecting an elevated level of sales in advance of repricing actions associated with the standard discount rate changes on yen-based products effective April 1. Also contributing to the sales increase was an 8% increase in the Life Planner count in Japan, driven by sales manager appointments and higher retention.

Gibraltar sales were down by 14% from a year ago, driven by a decline in bank channel sales. This includes the effects of terminating sales of single-premium yen-based products in 2016, increased competition, as well as the impacts of an industry-wide decline in bank channel sales. About half of our sales in Japan in the quarter were from U.S. dollar products. This percentage is down sequentially from 60% in the fourth quarter, reflecting the higher yen-based sales in Life Planner in advance of premium rate changes as well as lower bank channel sales, which primarily consist of U.S. dollar products.

We continue to benefit from our long-standing competitive advantages in distribution of U.S. dollar products in Japan, emphasizing recurring premium death protection products with returns mainly based on mortality and expense margins. Sales outside Japan are up 18% from a year ago, driven by continued growth in Brazil and increased sales in Korea.

Turning to Slide 17. The Corporate and Other loss was $352 million for the current quarter compared to a $312 million loss a year ago. The increased loss was driven mainly by higher expenses. The current quarter included an expense of about $25 million related to modifications of certain provisions within our long-term compensation plan, as I mentioned earlier, and higher compensation expenses that are linked to equity returns, including our share price.

Going the other way, results reflect lower interest expense from our paydowns of debt last year, a higher contribution from net investment income and higher income from our pension plan following our assumption update at year-end.

Now I'll turn it over to Rob.

Thanks, Mark. I'm going to provide a brief update on the key balance sheet items and financial measures, starting on Slide 18. Following the recapture of our living benefit risks and the refinements we made to our risk management strategies in 2016, most of the contract risks and supporting capital for Annuities reside in our PALAC statutory entity. Therefore, we view the RBC ratios at Prudential Insurance, or PICA, and PALAC as well as the composite RBC shown here, to be important measures of our financial strength.

Having said that, recall that we manage our annuity risks using an economic framework that includes holding total assets to a CTE 97 level with the ability to maintain that level through modern stresses. As a consequence, over time, we may see some variability in the excess of PALAC's RBC over our target ratio.

At December 31, 2016, the PICA, PALAC and composite ratios were 457%, 867% and 527%, respectively, and we estimate that they continue to be well above our target at the end of the first quarter.

In Japan, Prudential of Japan and Gibraltar Life reported strong solvency margin ratios of 841% and 967%, respectively, as of December 31. These solvency margin ratios are comfortably above our targets, and we estimate that they continue to be so at the end of the first quarter.

Looking at the liquidity, leverage and capital deployment highlights on Slide 19. Cash and highly liquid assets at the parent company amounted to $4 billion at the end of the quarter. The decline of about $600 million from year-end was primarily driven by our shareholder distributions exceeding capital inflows from the businesses in the first quarter. I would highlight that distributions received from the businesses are not uniform across all quarters. Recall that the parent company received $1 billion of distribution from PALAC in the fourth quarter of 2016 and historically has received a significant dividend from PICA in the second quarter.

During the first quarter, we returned about $640 million to shareholders, including $327 million of dividends and $312 million of share repurchases under the $1.25 billion authorization for the year.

And finally, our financial and total leverage ratios declined modestly from year-end and remained within our targets as of the end of the first quarter.

Now I'll turn it back over to John.

Thank you, Mark. Thank you, Rob. Let's open it up to questions.

(Operator Instructions) Our first question comes from the line of Ryan Krueger, KBW.

I had a question on the Life Planner count. I guess, the 8% increase in Japan was pretty significant. Can you give a little bit more color on the dynamic there and as well as your expectations going forward?

Sure, Ryan. It's Charlie. You're right in your observation that it is a new record count for POJ. And it really has to do with a couple of things, actually. One is our concentration on sales managers and creating more sales managers. And obviously, when you do that, you -- they then go out and recruit more Life Planners. And sales managers were up about 8% year-over-year. But there's another initiative that we started last year, which I think is pretty interesting and pretty exciting, and that is that we put a team together to try and attract more women to become Life Planners. And last year, we actually hired 82 women LPs in 2016, which represented about 13% of all recruits. Now those are really the 2 main reasons why I think Life Planners have increased, and there has been, I think, a higher level of increase than we've seen in the past. So I think in general, the long-term average for POJ has been about 2% to 4%, and we're -- we've been a little hotter than that in the past few quarters. But I think as you think about it going forward, probably 2% to 4% is the right number.

Okay. Great. And then related question was just, I guess, how much of the sales in Japan in Life Planner this quarter would you characterize as more accelerated ahead of the discount rate reductions versus other products that weren't or aren't going to be impacted?

So POJ sales were up, as was stated earlier, about 41%. And part of that is the fire sale or the accelerated sale in front of the standard discount rate change. But I think part of it also has to do with product mix, and it also has to do with the first quarter. So let me go through that. The first quarter is obviously POJ's highest quarter, and that's because of some of the annualized premiums that come in, and it's also the end of the qualification period for Life Planners. So there's -- POJ always has a strong first quarter. But I think the other reason is you're seeing a shift to U.S. dollar product. So what was so interesting, I think, about this quarter is while there was increased activity from the Life Planners as they went out and talked to their clients about potentially purchasing insurance product ahead of the standard rate change and the premium increases, they did that for yen product, but they actually sold proportionally more dollar product. So dollar sales were up 50%, whereas Japanese yen product sales were only up 38%. So in total, dollar sales were 31% as opposed to 29% a year ago. So I think there was some increase, obviously, that can be attributed to the fire sale. But it's -- the first quarter's always a good quarter for POJ. So I don't have an exact percentage. But if you look back a couple of years, you'll see there is always a slight peak in the first quarter, and then it goes down in the second quarter. I think that would be accelerated this time around because you've probably taken some of the second quarter sales that would have occurred in the second quarter and accelerated them to the first quarter.

Our next question comes from the line of Jimmy Bhullar, JPMorgan.

So I had a question, first, on just the drivers behind weak sales in Gibraltar. I think they were down around 14%. And then relatedly, you'd mentioned increased competition in Japan when speaking about Gibraltar. So wondering if you could just give us details on which product lines or specific channels you're seeing that in.

Sure. The weak sales in Gibraltar are really entirely attributed to the bank channel. So let me start with that, and then I'll come back to the other question. But the full story to explain the bank channel trend really consists of a few contributing factors. First and foremost, as John mentioned, we've always viewed the bank channel as a complementary distribution channel where we're committed to growing profitably. So sales will vary, and we saw that some -- a few years ago as well. But as such, following the negative interest rate play or policy in early 2016, we took very swift action to suspend sales of all yen-based single-pay products. And the absence of those single-pay sales this quarter represented roughly 1/3 of the year-over-year decline. So it was a tough comparison year-over-year. Secondly, we're seeing our competitors begin to offer more easily sold recurring pay products, primarily yen denominated, which has had an impact on the sales in the first quarter. And this is because we primarily sell one yen-based-denominated recurring premium product in the bank channel, which is a whole life product that sold for estate planning purposes and consequently requires more time and explanation to be sold. We can do that because of the seconded LPs we have there. And so it's a more sophisticated type of sale. And while we understand that our competitors' recurring pay products, the yen products were popular ahead of repricing, we continue to main our discipline around product, profitability and pricing. As an example, we suspended further sales of any 3- or 5-pay recurring premium whole life product after April 1 because much of that becomes an advanced pay, that becomes a single-premium product with the advance pay option. And then thirdly, there has been some decline in sales as a result of certain banks enforcing tighter control over the sales process in connection with essentially a fiduciary duty standard. And this really exerts itself in the form of banks not enforcing month-end sales targets. And so I think you've seen all bank sales across the industry decline slightly. So as a result of this, our bank sales declined by about 32%, but the mix of sales we did also continues to migrate to non-yen sales. So just as I said in the previous question with POJ, U.S. dollar product sales increased this quarter to 83% from 68% a year ago and total non-yen sales, which includes Aussie dollar and U.S. dollar, increased 90% from 75% a year ago. And this is consistent with what I'd call our kind of simple philosophy, and that is we'd rather sell less more profitable product than more less profitable product. And as a result, we feel pretty good about the results in the bank channel this quarter.

Okay. That's helpful detail. And you note -- I noticed there was a decline in the Life Planner count outside of Japan. I think down about 2% or so from last year. Can you give us some details on which markets drove that?

Yes. They're -- overall, Life Planner count went up. Outside of Japan, it went down slightly. But what we've done is raised -- we have raised recruiting standards and validation requirements in a number of countries in order to make sure that we're hiring the right people. And so that was particularly in Korea and Taiwan where we did that. And the result was that fewer Life Planners were able to stay on essentially. And we've hired a few less as the recruiting standards have increased. So that is -- that's the case of really protecting the quality of the franchise, if you will, and you'll see us do that in all the countries as we continue to raise the bar as we go through. But Brazil still has very good Life Planner account growth, and that counteracted some of the decrease in the other countries.

Our next question comes from the line of Humphrey Lee, Dowling & Partners.

Just looking at asset management's profitability, it looks continue to improve even when I account for the asset -- the AUM growth, there seems to be some margin expansion going on there. Can you maybe talk about at a high level in terms of what you see as the earnings power for asset management? And then also, maybe comment on the expenses, excluding the long-term compensation charge in the quarter.

Humphrey, it's Steve. I will address your question by mentioning a couple of points. First of all, in terms of average fee levels, we've been able to maintain those even we've seen equity market -- equity outflows, but we've seen substantial inflows in fixed income, in real estate, in our origination businesses, our private debt and mortgage origination businesses, all of which are relatively -- especially certain parts of fixed income where we've been able to attract flows, are relatively higher fee levels. In fact, in real estate, we were able to raise the fees, as we mentioned last year, on our existing asset base, and that's been attractive. Second, kind of taking the next part of the equation in computing margin, a lot of our flows has been into our fixed income business. And that is a business where the scale economies of our platform are exceptionally attractive. So all of that really relates to being able to sustain our fee levels even in the face of pricing pressures across the industry. We're not immune to those pressures, but we've been able to attract flows into categories that have solid fee levels and the margins inherent in our scale economies. In regard to the expenses, we do continue to see expense growth in the business, but that's by design. We're investing in this business significantly. We've been investing both in terms of expanding our investment capabilities and in terms of our distribution platforms. And as you'd expect, those investments are starting to pay off. It kind of stands to reason that the distribution investments start to pay off first. And a lot of our flows that we've seen, particularly in fixed income, has come from international markets, in particular, Japan, and that's directly attributable to the investments we've made in our global institutional distribution platform.

So maybe a question for Charlie. Looking at the -- in the life insurance business in Japan, there's definitely a discussion about mortality table change that would affect the pricing. Can you talk about what that may potentially impact Gibraltar or Life Planners kind of top line and kind of a sales growth outlook?

Sure. Humphrey, let me take that sort of generally. And the -- as you said, the new Japan statutory mortality table has been released as an exposure draft. It's expected to go into effect for new business issued after April 1, 2018, at least that's what they're saying at this point. And as expected, life mortality rates are lower than the prior 2007 table. And while this will put some downward pressure on profitability of protection products, there are mitigating options such as revisions to expense loading and other things and also lower statutory mortality rates result in lower cash values and statutory reserves, reducing the statutory strain associated with new business. So with the mortality tables, there are going to be ups and downs, and we'll just have to wait and see how it plays out. But the good news is we still have some time, so we'll wait and see. But we think we'll be able to deal with it.

Our next question comes from the line of John Nadel, Credit Suisse.

First question, more of a strategic question for you, John. I'm curious about your appetite, if at all, for group insurance acquisitions. I ask because while you're a sized player, Prudential is a sized player in that market, it's clearly not a significant contributor to your overall earnings. And so I'm curious whether you'd have an appetite to make the Group Insurance business bigger contributor via M&A if the opportunity was available.

Yes. So John, let me start with a bigger-picture response just how we're thinking about M&A in general or opportunities in general and then M&A more particularly, and then I'll turn it over to Steve to speak more specifically about group. When we think about opportunities, actually, our starting point is around organic because organic's cheaper, it's less intrusive, and it's also able to be more custom tailored to the specific needs that we're seeing in terms of our customer set. So we continue to think this is a really good time for a strong brand, strong capital position and the leadership team with the skills to both evolve the business in a natural organic way, but also to innovate. And when you look at our track record of converting those kind of opportunities into realities, it's one that inspires confidence in our ability to continue to do that looking forward. Now when we think about M&A, it's more of a nice to do, not have to do, meaning you've heard me say that before, meaning it's not critical to strategic positioning and we're not depending on it to achieve our financial objectives. But nevertheless, it can play an important role in our long-term success. So in the recent past, that been things like Habitat just in the last 12 months or so. Habitat pension business, the Deutsche Bank Investment Management businesses in India, a step up of our ownership in our India Life insurance business or most recently, the Group Insurance business acquisition from Itaú in Brazil. So they're -- those are not necessarily high profile in each individual case, but in aggregate, they're meaningful and strategically, they're important in terms of our long-term positioning. Now that's sort of the construct around both the opportunities in general, the role of organic and generally how we're thinking about M&A. Let me turn it over to Steve to speak more specifically to your question on group.

Thank you, John. John, I'd address the group perspective as follows. We're certainly aware of and alert to opportunities that may appear from time to time in the space. We are certainly a -- have stronger capabilities to be an acquirer then we did, say, a few years ago due to the investments we've made in our business platform and the way we strengthened the business platform. And we have an interest to grow. We see the group business as an attractive one, both in its own right and as a highly effective client acquisition model for relationships that we can deepen and individualize across our businesses. At the same time, I'd pick up on some of the themes that John just mentioned. We have good momentum in organic growth in the business, and we're mindful of continuing that. And that's really what our priority is. And I'd also say that the -- some other things that have taken place in the group market recently have done so at fairly full valuations, shall we say. And so while we're alert to other opportunities that appear, we're going to be disciplined and measured in the way we approach our own valuation of those opportunities.

Very much appreciate that last comment, especially. And then I have a follow-up for Mark on the regulatory side. Any insight yet, Mark, into what's likely to come out of the review of FSOCs designation process, especially as it relates to SIFI insurance companies. And if ultimately your SIFI destination was rescinded, how does that impact your global -- your G-SIB designation? Is that automatically rescinded as well since you're not deemed systemic by your home regulator? How does that work?

Right. On the current outlook, we've expressed optimism about the general tone of the discussion in Washington around regulation and more specifically around SIFI designation. And I think it's challenging to predict specific outcomes, but we continue to believe that as time passes and as either processes or specific designations are reviewed, we expect that ultimately, we may not wind up as a SIFI. Exactly how we get there, I'm not quite sure. So it's work in process. It's an uncertain environment, but we think the tone of things is moving in the right direction in terms of the regulatory burden and the consideration of non-bank SIFIs in particular. With respect to G-SIB designation, the two don't go hand in hand. And being -- having our domestic designation rescinded would not result in necessarily the removal of the G-SIB designation. That comes from the FSB, the Financial Stability Board, and there have been circumstances where there are differences between being domestically significant and internationally significant. So that's not in the cards. Those things won't necessarily move together. Having said that, though, remember that there is no mechanism currently to directly implement any standards as it relates to our G-SIB designation. Right now, we depend on -- or that process would depend on Federal Reserve supervision. As New Jersey plays a role as a group supervisor, we'll see how they deal with the international aspects of questions and issues related to supervision. So that's out there as a channel or mechanism for enforcing G-SIB standards, but I'd say we're not quite there yet.

Understood. So New Jersey could play the Federal Reserve role potentially?

Yes, they are currently a group supervisor of ours.

The next question then comes from the line of Suneet Kamath, Citi.

Wanted to start on Slide 6 of your earnings deck on the annuity business. If I look at the mix of Annuities, HDI retained by PRU, that percentage of your total has gone up year-over-year. And I guess, 2 questions related to that. Is one of the impacts that, that reinsurance arrangement is now expired? And then second, is another reason just DOL and the fact that advisers are now more focused on living benefit type of products?

This is Steve. I'll address your question as follows. I think that in terms of the change of mix, you're looking at a couple of different things. First of all, yes, the reinsurance arrangement with Union Hamilton did expire. They informed us and other counter-parties that they've reached capacity for this line of business. And I think that another contributing factor is the decline in PDI sales that Mark referenced in his opening comments. The PDI is sensitive to pricing changes. As we've discussed before, we have a kind of unique capability across the industry to reprice monthly from new sales in several of our product lines, including PDI. Twice last year in the face of a very low interest rate environment, we took down the PDI benefit and we saw impacted sales in the fourth quarter and in the first quarter. So that was a driver of what you're pointing to. I will mention, though, that we did take the benefit back up in February. Market conditions and higher interest rates permitted us to do that while still writing business at target returns. So we have seen a pickup in PDI sales momentum over the last month of the quarter.

Okay. And then maybe just shifting to Retirement and specifically, PRT. Has there been any change in either the, I'll call it, the supply or capacity to do PRT transactions by the industry or demand on the part of plan sponsors to execute such a transaction given kind of where we are with interest rates?

Yes, first off, in terms of the competitive environment, there are several competitors in this space. Some of them are sharpening their appetites, so we see capacity at a minimum holding steady, if not increasing. So that's been the case for some time now, and that trend continues. In regard to the pipeline, we see a very robust pipeline. The rate environment is kind of in a sweet spot right now in that regard. There's been a pickup in rates from last year, and that's improved plan funding levels, and so that certainly strengthens the ability of plan sponsors to transact. At the same time, though, most plan sponsors don't seem to anticipate near-term rapid further increases in rates, so their propensity to transact still remains strong. And of course, there are other contributing factors to that propensity to transact like rising PBGC premiums and heightened awareness of longevity risk. So the business will remain episodic, but we see the pipeline as being very solid.

And with that increase in supply by insurance companies, is there -- is that creating any pricing pressures in terms of these competitive dynamics?

The business is a price competitive one. And at the same time, though, our focus in the midsized to large cases really continues to work for us. It's an area where -- while it would certainly need to be price competitive, we see that the competition takes place across a number of dimensions, including strength of the value proposition, including our certainty of close and our very effective process for shepherding a transaction to closing. Large case market also gives us a very robust information and census data that enables us to fully deploy our underwriting skills. And in particular, the large case market also involves assets in kind rather than being a cash market as the smaller end of the market is. Those assets in kind and our ability to take those over and redeploy them really plays to our asset management skills. So for all of those reasons, while we're not absent from the -- from all spectrums of the market, we, relatively speaking, write less in the small end that is all about price competition and write more in the larger segments of the market where some of these value-added dimensions can come into play.

Our next question is from the line of Tom Gallagher, Evercore.

Hey, Charlie, I just wanted to circle back on Japan. So I get your comments on the changes in pricing on some of the yen products. But you've had very good momentum for your U.S. dollar and Aussie dollar products for a while here. Can you provide a little perspective on what's been happening there? What are -- are those high-margin products well above yen? Are those -- what is competition like in that end of the market? A little more -- and do you think you can sustain pretty good sales momentum and for the foreign currency products?

Yes. So let me make a couple of comments in general, and then I'll come back to kind of competition. So looking at our Japan business, much of what we sell, in fact, 2/3 of what we sell is protection. And so we are in a segment of the market right off the top that many other people, either aren't in or kind of shy away from. And that's because of the strength of our distribution model. So 2/3 of our business or 3/4 of our business comes from what I'd call our [tied-agency] system. And only about 1/3 comes from third-party distribution. So we're able to sell protection products because of the sophistication of our Life Planners and life plan consultants. The second point I'd make is that most of our product, over 90% of our product is recurring premium product. So -- and the rest is almost all Fixed Annuities or Annuities that reprice every 2 weeks. So again, we sell a more sophisticated product. And then on top of that, we're able to sell U.S. dollar product. And that's really, I think, one of the competitive advantages that you see that we've had and we continue to have as we shift our business mix to U.S. dollar product, which is by -- I will say by definition, but it's not by definition, but is more profitable than yen product. So yen product, we're selling, it's within our target range. Quite frankly, before the repricing, it was probably at the lower end of our target range. But the dollar product is at the high end of our target range. And we look at the business mix of all that together, and it's -- that is what produces the momentum and the profitability of our franchise. Now in terms of competition, we haven't seen much competition in our captive channels for U.S. dollar product nor in the IA channel. It's partly because of the nature of what we sell, which I said was death protection, and it's partly due to the way that we sell it needs-based selling through the sophistication of our Life Planners and life plan consultants. We have seen some increased competition in the bank channel, but frankly, not as much as we might have expected. But -- so there is some there, but we have seen -- we haven't seen as much as we might have thought we would. So again, I think we're in a fairly reasonable place in terms of the momentum we have and the way in which we're conducting our business.

And so the foreign currency products you're selling are mainly protection? I would have thought a lot of that would have been driven by the spread on interest rates and more of -- more for the investment orientation of the product.

No, again, if you think 2/3 of what we sell is protection product, that's the basis of our franchise. And so there is some investment component in some of the product. But most of it, you think about the amount of mortality and expense margin that we have from our protection products, we rely much more on that than we do on spread margin.

Okay. And then just my final question. Just curious, I think you've been asked this before just on economic solvency in Japan and whether you guys would provide an estimate of what that ratio would be for you or just some perspective on the way you view your solvency under SMR and then more under some sort of economic framework and whether it gets better or worse when you think about change -- ultimate change and where the regulatory environment may go.

It's Rob. Let me try to take a stab at that. So as you're alluding to, the JFSA is working on developing a more economically sensitive to solvency regime to either evolve or complement the SR and regime that's currently in place. It's important this is a long-term project, Tom, development of any replacement is going to be something that's going to be beyond even what the IAS is talking about. So think about it as being beyond the 2020 sort of a timetable. They have conducted field tests. We participated in those, but field tests were modeled after some of the things that were being done by the IAIS. Importantly, what came out of those field tests we think that the lesson that came out of that for the JFSA was that it pointed to the inherent flaws in some of the constructs that are being floated, particularly as it applies to life companies and life companies that are selling long-duration life products like the Japanese insurers. So when you see the composite ratios that were released from that, it sort of indicates it didn't work very well for the Japanese companies and that's wasn't a surprise to us. And I think it was helpful in terms of an education process for the regulators. With respect to us, our Japan business is extremely well capitalized. We see this in our existing solvency margin ratios, and we see it in our own internal economic ratios. So we have and always have and will continue to manage our business with an economic lens and hold capital to the higher of whatever is required from either statutory or an economic standpoint. We would expect this to be evident in any appropriate solvency regime that the FSA might develop over the next course -- the next several years. And to answer the question you didn't ask but I'm sure is the intent of your question, we don't expect our capital redeployment in Japan to be anyway affected by the evolution of the solvency margin regime in Japan and have no intent at this point to change our philosophy or distribution targets.

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