保德信金融集團 (PRU) 2017 Q3 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, sir.

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.

Thank you, Mark. Good morning, everyone, and thank you for joining us.

I will begin by saying that we're very pleased with the quarter. We reported record adjusted operating earnings per share that were driven by strong fundamental trends and solid momentum across our businesses. I will provide some high-level observations on the quarter and then comment on business fundamentals, capital deployment and other key topics of interest. And following that, I'll hand it over to Mark and Rob to cover the specifics.

Third quarter adjusted operating income, excluding market-driven and discrete items, of $2.94 per share was well above the prior year of $2.51 per share. The annualized ROE for the quarter was over 14%, exceeding our near- to intermediate-term objective of 12% to 13%. In addition, adjusted book value per share increased 6% over the third quarter of 2016, which is after paying $2.95 per share in dividend.

At a high level, results in the quarter benefited from strong margins and good growth across a number of our businesses. We reported record assets under management and account values in our Asset Management, Retirement and Individual Annuities businesses. And while results of the quarter benefited from items that are inherently variable, the earnings power of our businesses continues to trend higher.

I'll now briefly touch on some fundamental trends in our businesses, starting with our domestic businesses. We reported record adjusted operating earnings in our asset management business, driven by strong net flows, market appreciation and stable average fee rates. Importantly, we are seeing the benefits of AUM growth translating directly to strong growth in our core earnings, even while we continue to invest in distribution and product initiatives.

Unaffiliated third-party net flows were robust at $6 billion in the quarter, and we reported record total AUM of $1.1 trillion. This includes nearly $600 billion of unaffiliated third-party AUM. While results for the quarter benefited from some items that will vary, we continue to be very pleased with the core growth in AUM and earnings from asset management.

Retirement had a solid quarter, reporting good earnings and net flows. I would highlight that after several quarters of strong outperformance in this segment, which included particularly favorable pension risk transfer case experience, the third quarter returned to a more normal level of earnings that was broadly in line with our expectations.

We set a new record for account values in both our full service and institutional retirement businesses. While we are clearly benefiting from market appreciation, we have also generated strong net flows, including $7 billion of positive net flows this quarter. This reflects a number of good wins in both our defined contribution and pension risk transfer businesses.

We also reported record core results in our Individual Annuities business. Return on assets of 128 basis points continues to benefit from enhancements to our risk management strategy and growth in our account values. As we mentioned last quarter, we do expect our return on assets to moderate from the particularly strong levels currently, but we nonetheless continue to be pleased with the earnings, cash generation and reduced volatility from Annuities. In the meantime, we are focused on a number of product and distribution initiatives. And while we continue to face near-term sales challenges, we remain optimistic on the longer-term prospects for Annuities as the need for retirement income products is only increasing.

Our U.S. protection businesses showed solid results. Group Insurance continues to produce strong underwriting margins, generating a benefit ratio that again was more favorable than our expected range. We are also pleased to see the improved performance in our Individual Life Insurance business, which benefited from favorable mortality experience in the quarter.

Turning to our international businesses. We produced good overall results that were broadly in line with our expectations. Our Life Planner and Gibraltar businesses continue to show stable core growth and good underwriting margins. Not surprisingly, sales were down 11% compared to a-year-ago quarter. This is largely due to the repricing of yen-based products in Japan, which we believe accelerated sales to the first half of the year. Despite these pressures, we did produce strong growth in our U.S. dollar products in Japan, which were up 15% over the prior year. And for the first time, more than half of our Japan sales in both Life Planner and Gibraltar were from U.S. dollar products.

Shifting to capital deployment. We returned approximately $640 million of capital to shareholders in the quarter, about equally split between dividends and buybacks. This brings our total capital returned to our shareholders since 2011 to approximately $14 billion.

We continue to have a robust capital position and a business model that generates considerable free cash flow. This provides flexibility to return healthy amounts of capital to shareholders, execute strategic M&A and continue to invest in our businesses for the long-term growth.

And finally, I want to make a couple of observations on key topics of interest. I'll start with the recent report issued by the U.S. Treasury that addresses the administration's core principles for financial regulation in respect of asset managers and insurers.

While this report does not produce any explicit change to existing laws or regulations, it contains a number of recommendations that align closely with Prudential's policy positions. In particular, we were pleased with the recommendations that systemic risk evaluation should be more activities-based than entity-focused, and there should be greater coordination between the various regulatory bodies. We continue to believe that we do not meet the criteria of a non-bank, systemically important financial institution and are encouraged by the recent direction of Treasury and the Financial Stability Oversight Council.

On potential tax reform. We support effective tax policy that promotes growth and investment by corporations and greater financial flexibility for individuals to enable them to save more for retirement. While we wouldn't want to speculate on what the final legislation will look like, we are well positioned to absorb the near-term capital impacts that could arise. And we believe, more broadly, that a lower corporate tax rate should be a net long-term positive.

So to conclude my remarks, we had an excellent quarter and we remain positive on our strategies to produce long-term growth and consistent financial outcomes across our businesses. We continue to invest in initiatives that leverage our differentiated capital, the capabilities to capitalize on powerful market themes, such as the need for retirement readiness. This includes enhancing the ways in which we connect and engage with our customers.

And at the same time, we're generating strong returns and substantial cash flow in our businesses. And this enables us to strike the right balance between investing in growth and returning capital to shareholders through dividends and share repurchases.

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

Thanks, John. Good morning, good afternoon and good evening. Thank you for joining our 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.

And I'm starting on Slide 2. After-tax adjusted operating income amounted to $3.01 per share for the quarter compared to $2.66 a year ago. After adjusting for $0.07 per share of market-driven and discrete items, which I will discuss momentarily, EPS amounted to $2.94 for the quarter, up from $2.51 a year ago, as the core performance of our businesses overall was strong in the quarter.

Looking across our businesses, I'll mention a few highlights of results compared to a year ago. First, fees from our Individual Annuities, Asset Management and Retirement businesses increased by about $140 million, reflecting market appreciation and positive flows. The Annuity business also benefited from the ongoing favorable impacts of our annual assumption updates last quarter and refinements to our risk management strategy which was implemented last year.

Second, a lower loss from Corporate and Other operations, driven by favorable fluctuations in expenses and investment income. And third, continued business growth in our International Insurance business on a constant-currency basis. Together, these items had a net favorable impact of approximately $0.42 per share on the comparison of results to a year ago.

In addition, results in the current quarter benefited from positive variances in comparison to our average expectations or our trend considerations related to favorable claims experience and reserve refinements across businesses, and also to favorable noncoupon investment returns and prepayment income. These were partially offset by higher-than-typical expenses, which collectively contributed about $0.04 per share to earnings. After adjusting for market-driven and discrete items, our EPS of $8.63 for the first 9 months of 2017 implies an ROE of 14.4% on an annualized basis.

In thinking about our earnings pattern, I would note that in recent years, many of our businesses have had higher-than-average expenses in the fourth quarter, including the impact of seasonal items, such as annual policyholder communications and on-boarding, as well as business development, advertising and other variable costs. Looking back over the past 3 years, this pattern has produced expenses, on average, about $125 million to $175 million higher in the fourth quarter than the average quarterly level for the respective year.

On a GAAP basis, including amounts categorized as realized investment gains or losses and results from divested businesses, we reported net income of $2.2 billion for the current quarter or $5.09 per share, about $900 million above our after-tax adjusted operating income. This difference was mainly driven by a positive impact from product derivatives, which I will discuss shortly.

Moving to Slide 3. For the current quarter, market-driven and discrete items consist only of our quarterly market and experience unlockings in the Annuities business. These favorable unlockings were mainly driven by the performance of equities in our customer accounts and resulted in a net benefit of $0.07 per share.

Turning to Slide 4. Our GAAP net income of $2.2 billion in the current quarter includes amounts characterized as pretax net realized investment gains of $1.2 billion and divested business results and other items outside of adjusted operating income amounting to a net pretax gain of $97 million.

Of note, product-related derivatives and hedging had a positive impact of $1 billion, largely driven by applying wider credit spreads in the calculation of our nonperformance risk related to the Annuities' living benefits. The $445 million gain from the general investment portfolio and related activities was driven by equity, security and foreign currency-related gains in our International Insurance operations. The loss of $307 million from other risk management activities was driven by currency hedges as the U.S. dollar weakened compared to certain other currencies.

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 mentioned earlier. Annuities earnings were $529 million for the quarter, a record high and up by $80 million from a year ago. The increase was primarily driven by a greater contribution from policy charges and fee income, reflecting a 4% increase in our variable annuity average separate account values and the ongoing benefit from the annual assumption updates last quarter as well as positive impacts from the refinements in our risk management strategy for product guarantees that we implemented last year.

Record-high return on assets, or ROA, of 128 basis points reflects the strong earnings I just mentioned and is up modestly from last quarter. As we mentioned last quarter, a portion of the elevated ROA is sustainable, including the impact of the prior quarter annual actuarial review. However, we do not expect to be able to maintain this elevated level as a baseline in the future. Notably, we continue to evaluate enhancements to our risk management approach to optimize the balance between earnings, liquidity, capital flexibility and volatility. And to a lesser extent, we do expect future fee levels to be impacted over time by our product diversification strategy and by the aging of our business.

Slide 6 presents our annuity sales. Total gross sales of $1.3 billion in the quarter are down by $800 million from a year ago and $200 million from the prior quarter. This trend in gross sales reflects the actions we have taken to reprice our PDI product consistent with our diversification strategy as well as broader industry sales pressures, including the continued impact of the Department of Labor Fiduciary Rules.

Turning to Slide 7. Retirement earnings were $248 million for the quarter, down by $25 million from a year ago. The decrease was driven by a lower contribution from net investment spread results, partially offset by more favorable case experience and higher full service fee income.

The contribution from net investment results was down about $60 million from a year ago. Current quarter earnings from noncoupon investments and prepayment fees were about $5 million below our average expectations compared to a contribution about $55 million above expectations a year ago. The impact of a 4% increase in average spread-based account values was largely offset by continued spread compression.

Current quarter case experience was consistent with our average expectations compared to about $20 million less favorable than expectations a year ago.

Turning to Slide 8. Total retirement gross deposits and sales were $16 billion for the current quarter compared to $12.3 billion a year ago. The current quarter sales included a $5.7 billion full service defined contribution plan sale, a $2.2 billion longevity reinsurance case and several funded pension risk transfer cases totaling $1.6 billion. These transactions contributed to net flows in the current quarter of $7.3 billion. Total retirement account values were a record at $415.8 billion, up by 8% from a year earlier. This increase includes the benefit from market appreciation as well as about $4.2 billion of positive net flows over the past year.

Turning to Slide 9. Asset Management earnings were a record-high $259 million for the quarter compared to $191 million a year ago. The increase was primarily driven by higher asset management fees, reflecting the 6% growth in average assets under management. The increase in earnings also reflects a $13 million higher contribution from other related revenues, which amounted to $29 million in the current quarter, driven by strong strategic investing results. In addition, results benefited from a particularly strong contribution from commercial mortgage agency loan originations, which was $12 million higher than the year-ago quarter as well as recent averages.

Asset management reported $6 billion of net unaffiliated third-party flows in the quarter, excluding money market activity, with contributions from the institutional and retail business each driven by strong income flow -- strong fixed income flows, partially offset by equity outflows. On a year-to-date basis, we have produced $14.3 billion of unaffiliated third-party net flows.

Turning to Slide 10. Individual Life earnings were $150 million for the quarter compared to $111 million a year ago. The increase primarily reflects favorable mortality experience, which was about $10 million more favorable than our average expectations in the current quarter compared to about $30 million less favorable than our average expectation in the year-ago quarter.

In addition, current quarter results include the benefit of reserve refinements and lower-than-typical expenses, which together, amounted to about $15 million, while the year-ago quarter included charges for reserve refinements and higher-than-typical legal costs which amounted to $20 million. These increases were partially offset by the unfavorable ongoing impact of the second quarter 2017 annual review and update of actuarial assumptions and other refinement.

Turning to Slide 11. Individual Life sales, based on annualized new business premiums, were essentially consistent with the year-ago quarter. Lower Guaranteed Universal Life sales were offset by higher sales across the other products, reflecting specific distribution and product actions we have taken.

Turning to Slide 12. Group Insurance earnings were $61 million for the quarter compared to $62 million a year ago. More favorable underwriting results were offset by higher expenses and a lower contribution from net investment spread results as returns on noncoupon investments and prepayment fees were about $10 million above our average expectations in the year-ago quarter.

The Group Insurance benefits ratio was below the low end of our targeted range of 87% to 91%, reflecting favorable group life and disability results. The contribution to current quarter results from underwriting experience, net of a related adjustment to deferred acquisition cost, was about $10 million more favorable than the low end of our expected range.

Moving to International Insurance and turning to Slide 13. Earnings for our Life Planner business were $373 million for the quarter compared to $391 million a year ago. Excluding a $5 million negative impact of foreign currency exchange rate, earnings decreased by $13 million from a year ago. The decrease was driven by higher expenses, partially offset by continued business growth, with constant dollar insurance revenues up by 7% from a year ago.

Current quarter results included about $40 million of higher-than-typical net expenses, including updates to legal reserves. Claims experience in the current quarter and the year-ago quarter was about $10 million more favorable than our average expectations. In addition, returns on noncoupon investments and prepayment fees were about $10 million above our average expectations in comparison to returns only slightly above our average expectations in the year-ago quarter.

Turning to Slide 14. Gibraltar Life earnings were $426 million for the quarter compared to $389 million a year ago. Excluding a $1 million positive impact from foreign currency exchange rates, earnings increased by $36 million from a year ago. This increase reflects lower expenses, including the absence of higher-than-typical cost associated with employee benefit plans and office relocations incurred in the year-ago quarter and more favorable policy benefits experienced and continued business growth.

Claims experience in the current quarter and the year-ago quarter was about $10 million more favorable than our average expectations. The current quarter net investment spread results included returns on noncoupon investments and prepayment fees slightly above our average expectations.

Before leaving International results, I will note that we have substantially completed the hedging of our expected yen earnings for 2018, and our hedging rate for next year is expected to be JPY 111 per U.S. dollar. That compares to JPY 112 this year.

Turning to Slide 15. International Insurance sales on a constant basis -- on a constant-dollar basis, were $671 million for the current quarter, down by $87 million or 11% from a year ago. On a year-to-date basis, 2017 sales were 3% above the first 9 months of the prior year. We have experienced similar trends in both Life Planner and Gibraltar operations, where sales decreased by $36 million and $51 million, respectively, largely driven by lower sales in Japan.

In total, yen-based product sales in Japan decreased by $131 million from the prior year. As current quarter sales were lower due to the elevated level of sales in the first half of this year in advance of rate increases, which are driven by the lowering of the standard discount rate effective last quarter. This was partially offset by an increase in U.S. dollar sales in Japan of $56 million, driven by the increased attractiveness of U.S. dollar products in the current environment as well as the introduction of a U.S. dollar whole life product with nursing care benefits last quarter. As a consequence, the vast majority of sales in Japan were U.S. dollar-denominated. Sales outside of Japan were consistent with last year as growth in Brazil was offset by modest declines in other markets.

Turning to Slide 16. The corporate and other loss was $310 million for the current quarter compared to a $413 million loss a year ago. The main drivers of the variance are: Lower expenses, including lower cost for employee benefit and compensation plans with obligations that are remeasured each quarter based on equity markets or on our company's share price, as well as other corporate expenses which can fluctuate; a greater contribution from investment income, net of interest cost, including higher income on equity method investments and highly liquid assets as well as lower interest expense; and finally, higher income from our pension plan following our assumption update at year-end last year.

Now I'll turn it over to Rob.

Thank you, Mark. I'm going to provide a brief update on key balance sheet items and financial measures, starting on Slide 17.

Following the recapture of our living benefit risks and the refinements we made to our risk management strategies in 2016, 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, as we have highlighted previously, 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 moderate 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 well above our target. And we estimate that they continue to be well above our target at the end of the third quarter.

In Japan, Prudential of Japan and Gibraltar Life reported strong solvency margin ratios of 844% and 902%, respectively, as of June 30. These solvency margin ratios are comfortably above our targets, and we estimate that they continue to be so at the end of the third quarter.

Looking at the liquidity, leverage and capital deployment highlights on Slide 18. Highly liquid assets at the parent company amounted to $4.4 billion at the end of the quarter, an increase of around $700 million from June 30. This increase is driven by the $750 million hybrid debt issuance in the current quarter. While we continue to evaluate uses of capital, we have higher-cost hybrid securities totaling about $600 million that are callable in 2018, and we took advantage of an opportune time in the market to issue new hybrid securities.

As noted by John, during the quarter, we turned about $640 million to shareholders, including $324 million of dividends and $312 million of share repurchases under the $1.25 billion authorization for the year.

And finally, our financial leverage and total leverage ratios were within our targets as of the end of the third quarter.

Now I'll turn it back over to John.

Thank you, Rob. Thank you, Mark. We'd like to now open it up to questions.

(Operator Instructions) And our first question comes from the line of Erik Bass from Autonomous.

In Annuities, you've commented that you see material upside to your long-term ROA targets, near term, and we certainly saw that this quarter. Can you just help us think about how that ROA normalizes over time if markets perform in line with your expectations? Is this something that happened over a few quarters? Or could the outperformance last longer than that?

Erik, this is Steve Pelletier. I'll touch upon your question and maybe I'll hand it over to Rob for further comments. Obviously, we're very pleased with the performance of the business. It generated strong earnings, strong ROA, and strong cash flows. The elevated ROA reflects a number of factors, in particular: Favorable equity market conditions; the strong performance by the funds on our platform; and in particular, continued favorability in the emergence of our risk management framework. And all of that contributed to a marginal increase to ROA compared to the previous quarter -- largely stable with the previous quarter. We believe some of this lift is sustainable, but we aren't expecting to maintain that full increase in ROA going forward. In particular, we're always looking at ways of managing our risk to create the best economic outcomes across scenarios and optimizing trade-offs between increased ROAs and the ability to further decrease volatility and increase our flexibility with respect to distributable earnings and capital. Our guidance as to how we think about the ROAs in this business are unchanged from last quarter when we said that we see the long-term sustainable ROA in that 110 to 115 basis points range over the long run, still with meaningful upside in the near term. In terms of some of the particular aspects you queried about in terms of how that ROA normalizes over a period, I'll ask Rob to expand further.

Thanks, Steve. So Erik, I think about it sort of in 2 buckets. The first is a group of things that, on the margin, have the ROA elevated that we think will reduce over time. And that would be we've got some positive hedge breakage that we don't forecast to be sort of normal over a long period of time. We are seeing both spread compression and fee compression in the business as a result of, on the fee side at least, the book maturing and the diversification strategy that we've had for our products. So on the margin, those things will play out over a longer period of time, in response to your question. The other driver -- or the larger driver is the change in hedge tactics going forward that Steve alluded to. So recall, we manage the VA block to a CTE 97, and we have -- and as I stated in my remarks, we hold at that level such that we can sustain it through a level of cyclical stress. We've previously indicated that within that risk management construct, we're continually evaluating our hedge tactics and we try to optimize the mix of derivatives and cash instruments that we use. We're looking at balancing cash flow and earnings against liquidity, ensuring flexibility and looking to reduce volatility where we can. Given the runup in the markets and the benefit we're seeing from our assumption updates, we see this as a good opportunity to revisit those hedge tactics in order to further decrease the interim volatility, increase flexibility, particularly with respect to distributable earnings. We actually began implementing this in the third quarter of '17, though the costs were not so material that you actually saw it come through and impact the ROA. And we're going to continue to adjust it through the rest of 2017 and '18. The remainder, as I mentioned before, the other drivers are things that will affect ROA over a longer period of time than that. So I think it's fair to say that we expect the ROA will continue to be above that long-term expectation in the near to intermediate term, but will migrate over to -- closer to it in the course of '17 and '18. And then over a longer period of time, more in line with that long-term objective.

That's helpful. And Rob, in your comments, you mentioned a couple of times kind of the balance on cash flow generation. I was just hoping you could comment on your free cash flow target of 60% over time. And I realize it may be something you want to address on the outlook call, but just based on your comments about the improved contribution from Annuities, should we think about that 60% range having moved higher?

So it's a good question, Erik. I think both from our annuities business, and frankly, from our other businesses, we're seeing across, a strong generation of cash flow and capital. And recall that we had actually increased our free cash flow guidance from 50% to 60% back when we gave guidance in 2015. So since that point in time, both our visibility and our confidence in our cash flow generation have both risen. Having said that, at this point in time, we're not changing our guidance. And it is something that we'll revisit, and as appropriate, we'll talk about in December when we visit on guidance.

Our next question is from the line of Suneet Kamath, Citi.

Just wanted to go to the asset management business. If I just look at your slide and adjust for some of the nontrendable items, it seems like the fee -- the core fee business is up pretty dramatically, especially relative to AUM. So I'm just trying to get a sense of what's driving that, what I'd call, operating leverage. And do you think it's sustainable going forward?

Suneet, this is Steve. I'll address that question. I think just kind of work through the sequence. We're seeing very strong flows across a number of asset classes, but particularly in fixed income, both public and private fixed income. We're seeing the ability to sustain our average fee level across the entire platform, and that's a pretty distinctive outcome in the active asset management business. We've been able to do that by attracting particularly strong flows into some higher fee-yielding strategies. A lot of those flows come into businesses that are already at scale, in particular, a lot of the flows have come in to our fixed income business, where the scale economies are particularly attractive. Obviously, some degree of market friendliness has helped to some extent. But you put all that together, and what you see is margin expansion and a very attractive bottom line result in the asset management business. It's good to see this emerge, but it's not necessarily a surprise to us. In the past few years, we've been investing in this business. We've been investing in order to expand our distribution capabilities and to expand our product set and further extend our bench strength in our investment platforms. All of that has played out over time. Last year, we started to see the flows come from this -- from these investments. Now those flows are continuing and the flows are translating into earnings. So I think what we're seeing is the logical consequence of the investments we've made and the achievement of the objectives of those investments.

Got it. Okay. And then just switching over to international and noting the strong U.S. dollar sales growth. We're also hearing that from other companies. So are you seeing incremental competition in terms of pricing in international on the foreign currency products?

Yes, it's Charlie. I'll take that. So we haven't seen much competition in the LP or LC channels nor in the IA channel, per se, partly because of the nature of what we sell, which is death protection. Don't forget that 60% or 2/3 of what we sell is sort of pure death protection, and partly due to the way in which we sell it, which is needs-based selling through the LPs and the LCs. But we have seen some increased competition in the bank channel. Most of the competition we've seen, actually, has been in the recurring premium yen product, (technical difficulty) raised prices and others have held the line. So we've seen a fall there. But interestingly, we haven't seen as much competition yet for the recurring premium U.S. dollar product. In terms of single premium product, we sell virtually no single premium yen product anymore in any channel. We eliminated those last year. And on the single premium U.S. dollar annuity product, we've seen some additional competition. And realistically, we'd expect to see more in the future as others enter the market. But to put this into perspective, the single premium U.S. dollar product we sold in the third quarter was less than 5% of our total bank sales or about $8 million, so this isn't a particularly big number. But that's where our differential -- or differentiated distribution strategy really comes into play, with the [Cond and] LPs in the bank channel and a dedicated wholesaler distribution strategy in the IA channel, which will become even more important and a more important distinguishing factor as we go forward. So short answer, we've seen some increased competition on the U.S. dollar side, but not as much as we might have expected.

Our next question is from the line of Ryan Krueger, KBW.

In regards to your strategy to reduce -- further reduce variable annuity volatility, I guess once that gets implemented, should we think about that as having any potential impact to your view of capital deployment? In other words, if your confidence increases around downside risk, could you potentially deploy more of your existing on-balance-sheet capital?

Ryan, it's Rob. So I wouldn't think of it that way because we're holding capital to a CTE 97, and that is not changing by virtue of what we're talking about with regard to tactics. I would think about it more around confidence levels around distributable cash flow. So given with the -- why all -- why mix -- differentiating the mix between derivatives and cash instances that we use, what we can do is reduce the volatility in earnings in any given scenario. And by virtue of doing that, we enhance the ability to take that earnings, translate it into free cash flow and distribute it out of the business. So I think it's really more targeted about interim -- toward interim volatility and distributable cash flow and really leaves capital unaffected.

Understood. And then can you give us any sense of the potential quantification of the reduction in the admitted deferred tax asset on the U.S. statutory basis from potential tax reform?

So if it's okay, Ryan, actually, let me try to bring that up a level and talk maybe a little bit more broadly about tax reform as opposed to isolating one particular aspect of it because you really need to think about it sort of across the spectrum of ways in which it could affect our capital position. First, 2 points before I dig into that. Let me reiterate what John said upfront, which is longer term, lower corporate tax rates, all things being equal, are positive for us and for businesses. And so we think we look at the opportunity for tax reduction as being something that's going to be beneficial. And two, most of our focus on this is frankly going to be on the implications to product and wanting to ensure that consumers are still have the proper motivations and incentives to continue to save for retirement. With regard to the capital piece of it, we have run a whole series of analyses on this. And I guess what I would say is just to sort of provide a conclusion on it for you, Ryan, is that under all those analyses, our insurance companies would continue to be capitalized at AA levels, our leverage would remain within our targets, our liquidity would remain well above our minimums and we would expect no disruption to our shareholder distribution plans. So DTA, in terms of your specific question, is entirely factored into that. One other thing I'd just sort of throw out. While we did that analysis and look at that in the context of existing constructs and metrics around what a AA means, I would note that while the -- while there's the possibility that through tax reform, there could be a negative impact to capital ratios and the way that they're calculated, you also have to remember that for insurers, we have a significant margin in our reserves, and then that margin in reserves, in our case in any event, is well in excess of the equity that we have -- the capital that we have within the business. And so the benefit to the margins and reserves on a after-tax basis will well exceed any detriment that occurs to our capital by virtue of a higher tax rate. And therefore, while we did all of our analysis, assuming that there's not going to be any changes in metrics, you would have to consider that, that benefit to the strengthening of, effectively, our after-tax reserves is something that would be considered into what would ultimately be deemed sort of the appropriate solvency ratios, posttax reform.

Our next question is from Tom Gallagher, Evercore.

First question on regulatory. The -- so AIG was recently de-designated. And John, I heard your comments about the Treasury report on insurers. I guess just specifically, would you expect Prudential to be able to pursue a path to also bring your designation to a vote? Can you talk a little bit about how that process might work?

Yes, Tom. It's Mark. I've been saying, I guess, over a couple of calls now, that we anticipate that at some point, we would no longer be designated as a SIFI and that there are several ways to get there. One which is probably somewhat remote would be Dodd-Frank reform in Congress. But another choice would be pursuing a variety of administrative channels, reflecting some of the implications of the thoughts reflected in the Treasury report on insurance. Keep in mind, there's also a report coming out on FSOC that will address the designation process. So there will be another round of thinking about that, and so that will also be part of how we'll consider the steps that we take going forward. But I would say the tone of things with respect to the administrative side is at least favorable to the consideration of activities-based approaches as opposed to entity designations. And so that's how we're thinking about it as well and we'll be considering those as we possibly move forward. One thing to add is that we also have legal options. And so if things are not unfolding in a positive direction with respect to administrative processes, we also have the option to go to court. So there are a number of different ways in which this can happen. We're encouraged by the points that are made in Treasury's report. We're looking forward to what comes out about FSOC. And we'll take it from there.

Got you. And then just a follow-up question is on -- I know in the first half of the year, there were net contributions into the Japanese subs. Would you expect -- did that reverse in 3Q? And would you expect kind of normal cash flows out of Japan during the back half of the year?

Tom, it's Rob. So Japan goes into the same basket that I -- when I commented on seeing strong cash flow and distributable cash flow coming across our businesses when I spoke to Annuities. But Japan would be included in that as well. Year-to-date, we have repatriated out of Japan around $900 million. Recognize that we typically repatriate from Japan in the second half of the year, so you see a concentration of that coming in the latter half. The form in which we repatriate, we have a variety of tools for doing that. Obviously given the potential for tax reform, we're being sensitive and sensible about how we go about doing that. And so you won't necessarily seeing that coming through in a dividend line in the sources and uses, it comes through other mechanisms that we employ. And -- but we can and will use dividends as things become more clear on the tax front. The -- and you made a comment about contributions into Japan in the earlier part of the year. I would -- sort of just for clarity on that. The contributions into our international business at the earlier part of the year were largely driven by the joint venture investments and acquisitions that we've been doing. So the vast majority of that has been funding things we've done, for instance, in Africa, in Brazil and in Indonesia. So that wasn't really capital consumption by Japan itself, but rather our growth initiatives internationally.

Got it. And Rob, the $900 million. Is that a net number? Or that's just a gross number of the amount? That's the repatriation you took out, and that there might -- does the $400 million, which I'd hear you on what that was being used for, were there other offsetting beyond the $400 million? Were there other offsetting payments down? Or is that a net $900 million number out?

The $900 million is a gross number, Tom. But when you net out -- when you take the acquisition activity out, the amount that would then get netted down from that is a less consequential amount. You're dealing with something that's probably a couple hundred million dollars. And remember, the biggest driver to that would be we have our equity hedge settlements for the -- that this year, that's been $140 million, $150 million, actually going towards Japan. Now remember that that's temporal because that's a reflection of higher earnings that we get on a post-translation basis. But that would be part of -- the other part that would be sort of netted from the $900 million.

The next question is from the line of Humphrey Lee, Dowling & Partners.

In terms of asset management, flows definitely have been very strong, especially on the institutional side. I was just wondering if you have seen anything different in terms of where do your clients are coming from? And then also maybe if you can comment a little bit on the pipeline in the coming quarter.

Humphrey, it's Steve. I'll address your question. We have seen growth in flows from international clients. Again, that's been a part -- that's been the objective of a lot of our investments in the business over the past couple of years. A big part of that was building out our institutional relationship management efforts on a global basis. So we have seen an increasing portion of flows coming from international markets. And we still see a robust picture, the types of strategies that we're offering and the engagement that we have with clients continues to bode well for the success of the business. Bear in mind that this is a business that has had 14 consecutive years of positive net flows from institutional clients.

Understood. And then I believe you got -- recently have the -- got the approval for some active ETF strategies. And maybe, can you talk about your appetite in terms of -- entering into some of these active ETFs or qualitative ETFs?

Right. I would address that as well. I would say, Humphrey, that first of all, you used absolutely the right term, active ETFs, and I would emphasize that. Broadly speaking, we see the passive ETF space as being thoroughly spoken for. As it relates to our consideration around active ETFs, I think it's important to emphasize that this is -- if we do something here, it would not be venturing into a brand-new effort. ETFs are about smart beta capabilities. Active ETFs are about smart beta capabilities, enhanced indexing. Those are value propositions that we already have today and that we already advance into the market today primarily through our QMA business. So any decision that we finally take in regard to the active ETF space would simply be a new vehicle by which we're delivering existing strategies and existing capabilities into the marketplace.

Our next question comes from the line of Alex Scott, Goldman Sachs.

Just a quick one on pension risk transfer. I think there was some accounting changes that were going into effect in 4Q related to company's ability to -- maybe it was capitalize some of the pension cost. And I was wondering if you're expecting to see a more robust pipeline from that in this space and if you would potentially look at bigger transactions or if you sort of have a capped appetite at this point.

Alex, it's Steve. I'll address your question. Generally speaking, we see -- continue to see a very robust pipeline. I'll kind of elevate the question and just discuss the pipeline overall. You heard Mark speak to our 3Q results in the business. I'd also point out that it's in the public domain, since the end of the third quarter, we've also written an additional funded $1.3 billion case with International Paper. We were very, very happy to see that. And what we see in the pipeline is both a strong propensity to transact and strong ability to transact. Rates are going up -- or rates have gone up, that reduces the liability and increases funding level and increases ability of plan sponsors to transact. At the same time, there's no broad expectation among plan sponsors that rates are due to spike upward further, so they have a strong propensity to transact at today's levels. PBGC premiums continue to be an issue that many plan sponsors are seeking to address. One dynamic that we continue to see play out in the market is even, very large plan sponsors looking to bring maybe slices of their liability to the market, those slices being comprised of liabilities that are large in headcount but with small benefits per participant. And again, in doing so, they're looking to eliminate administrative costs and reduce the per capita portion of PBGC premiums. That's a dynamic we've seen as underpinning several of the pieces of business that we've written this year and in the third quarter. So overall, we see the pipeline as being very strong, and we see the receptivity to the strength of our value proposition as being very promising.

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

First, I just had a follow-up to Mark's comments on the SIFI designation. It doesn't seem like you've been constrained in a major way by the designation. But would losing the SIFI label affect your approach to capital or just your overall business strategy?

I would repeat what we've been saying for a long time, which is that we are not hoarding or jettisoning capital in anticipation of SIFI capital rules. And in fact, we think we do the right things around aligning capital and risk and resources and business strategies. So that's a long way of saying the answer is no. We would not anticipate changes with respect to the way in which we're managing capital as a result of the rescission of our designation, and we would also not expect any impact on the businesses. Keep in mind that we run with a very high measure of financial discipline, including economics, GAAP accounting and statutory accounting. And we've often said that we can meet higher standards, that's not a problem for us. And so we're very much in sync with the appropriate regulatory views on solvency and risk and capital and capital adequacy. So we've been comfortable as a supervised entity. The burden for us has more been in the arena of reporting and preparing for exams and those sorts of things as opposed to substantive consequences for the business. But again, not because it isn't on the radar screen, but because we think we're in good shape there.

Ann could you give us a rough number on how much you're spending on SIFI-related reporting or SIFI-related activities that might obviously go away once -- if you are indeed undesignated?

Jimmy, it's Rob. So we spent about $135 million last year, about $88 million year-to-date and about $31 million in the third quarter. I would think about that as roughly in 3 buckets, Jimmy. One is there's about 1/3 of it that, if we were to be de-designated, would go away very rapidly. There's about 1/3 of it which will go away over a period of time as we're finishing out projects that we began that tend to be technology-related. And so those things get completed and they will burn off of their own volition in course of 1 year to 2, 2.5 years. And then the remaining 1/3 are costs that we think we actually will continue to incur because recall that while we may not be group supervised by the Fed, we will continue to be group supervised by New Jersey and we continue to deal with developments that are occurring on the international front. And so there's a level of spending that we expect -- spending and investment that we continue to expect that would be ongoing over a longer time.

Okay. And if I could ask one more of Charlie. In Gibraltar, your life consultant count was down sequentially. And wondering if that's because of changes in recruiting or productivity standards and whether that has an impact on expected sales in the business over the next year.

Sure. Happy to answer that. So you're -- both your comment and your observation are correct. So life count decreased by about life consultant count decreased by about 5% year-over-year. And the decrease was due to a couple of things. One is an adherence to more stringent validation requirements, as we talked about last time, and also a more stringent recruiting processes. And this really has a double effect, right? Because on the one hand, you got more terminations from more stringent validation requirements that are being enforced. And on the other hand, you're recruiting slightly less people because you've raised the bar. You have higher recruiting standards, so you have less recruits. And it's tough to do this because when you elect to do this, you enter kind of a J-curve, if you will. And so we think we'll hit the bottom of the J-curve sometime next year. The life consultant count has been decreasing and will probably decrease for a little while longer. But that's exactly what we did in this business twice before. We did it when we acquired Kyoei originally. We did it when we acquired Star and Edison. And it's what's we've done in Korea, Taiwan, Italy and Poland over the past 18 months, which is, as we said, sort of go back to the basics of increasing the quality in the field. So I would kind of label this as periodic business as usual, meaning that periodically, we look at our requirements and we're continually raising the bar as we go forward. So that's kind of the situation where we are.

Roxanne, we have time for one more question.

And that question comes from the line of John Barnridge, Sandler O'Neill.

How is PRU approaching implementation of MiFID II? And could that actually lead to cost saves? And will it be implemented globally in your asset management business?

John, this is Steve. We've been planning and preparing for MiFID II requirements for some time. We intend to be in full compliance, obviously, by the effective date, at the beginning of 2018. Just as a point of background, we have 2 MiFID firms in the EU that will be subject to the regulations. Our MiFID firms currently do not intend to pass research cost onto clients. We have significant experienced internal research groups, and we don't expect any of the -- any material impact from the research cost that we would absorb. As we think about the implications of MiFID II beyond the EU, we do see the potential that the new requirements for MiFID firms relating to research cost may have an impact on how research is distributed and paid for more broadly. And we're simply continuing to monitor the landscape and how the industry is evolving in this area.

Ladies and gentlemen, that concludes our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.