保德信金融集團 (PRU) 2017 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Prudential Quarterly Earnings Call Fourth Quarter 2017. (Operator Instructions) As a reminder, today's conference is being recorded. I would now like to turn the conference over to your host, Mr. Mark Finkelstein. Please go ahead.

Thank you, Shannon. 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 at 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. 2017 was a strong year for Prudential. We exceeded our earnings objectives for the year and are showing solid momentum across our businesses.

I will provide some higher level observations on results for the fourth quarter and full year, the underlying fundamental trends in our businesses and capital deployment. And I will then hand it over to Mark and Rob to go through the specifics.

Fourth quarter operating earnings, excluding market-driven and discrete items of $2.68 per share, exceeded the prior year of $2.43 per share. The increase reflects business growth and higher PGIM incentive fees, partially offset by lower underwriting margins and an increase in expenses. Recall that the fourth quarter results typically include elevated expenses, which we estimate to be approximately $0.25 per share for the current quarter.

Turning to full year results. Operating earnings, excluding market-driven and discrete items, were $11.31 a share for 2017, well above the prior year of $9.65 per share. This also exceeded the top end of the guidance range we established in December of 2016. Similarly, the operating return on equity of nearly 14% for the year was above our 12% to 13% near- to intermediate-term objective. While full year results benefited from favorable markets and investment results as well as other items that can fluctuate, we are pleased with the core growth and underlying margins in our businesses overall.

I would also highlight that adjusted book value per share increased 12% over the prior year-end. While this includes a benefit from the Tax Cuts and Jobs Act, which Mark will discuss in more detail, adjusted book value per share increased a solid 8%, excluding this benefit. So overall, it was a very good year on almost all measures. While our base case for 2018 does not assume that we will produce the same return on equity that we did in 2017, the underlying themes around the quality of our businesses and consistency in execution should enable us to continue to produce returns exceeding industry averages and generate significant free cash flow while also enabling us to continue to invest in our businesses for future growth.

I will now touch on some of those themes in discussing the performance of our businesses. I'll start with our Retirement business, which continues to perform exceptionally well. Core growth remains robust with nearly $9 billion of positive net flows during 2017, which contributed to 11% year-over-year account value growth. Likewise, underwriting margins in the business continue to exceed our expectations, particularly in our flagship pension risk transfer business. Our success in this business is a direct reflection of the differentiated capabilities that we deliver, and we continue to see Retirement as a source of long-term growth going forward.

In Investment Management, we achieved another important milestone as 2017 marks the 15th consecutive year of positive net flows from institutional clients and 13th consecutive year from retail clients. Over the last 5 years, unaffiliated third-party assets under management have grown annually at above 10%, including 15% in 2017. We continue to benefit from our multi-manager model, strong investment performance across strategies and positive outcomes from our recent initiatives. And while there are many challenges facing active investment managers, which we're not immune to, we continue to generate strong growth in assets under management and stable overall fee rates, leading to favorable financial results and a positive outlook.

We are also seeing strong performance out of our Individual Annuities business. Although industry-wide sales have been under pressure, we've taken thoughtful steps to manage the business more efficiently and effectively, and this has resulted in higher margins, increased amounts of free cash flow and reduced capital volatility. Over the last 2 years, we've generated deployable capital in excess of $3 billion from the Individual Annuities business, including over $1 billion in 2017.

In Group Insurance, we're pleased with the performance of the business following the pricing and underwriting actions we took several years ago. The benefits ratio for 2017 was at the low end of our targeted range, with solid underwriting results in both Group Life and disability. In Individual Life, while results in 2017 were below what we had anticipated due to adverse mortality and actions taken as part of our annual review of assumptions, this is a well-underwritten business, and we continue to actively manage the composition of sales as the environment evolves.

And turning to our international operations. We continue to deliver steady core growth and solid earnings and returns, including an ROE of 17% for 2017. We're particularly pleased at how our Japanese business adapted to price changes on yen products in early 2017 through increased sales of foreign currency-denominated products. Notably, U.S. dollar products grew 16% in 2017 and comprised over 60% of Japan's sales for the year. Looking forward, we expect our differentiated distribution model to continue to deliver stable growth at attractive margins despite some notable headwinds that we and others face in Japan. And we continue to be optimistic that newer markets like Brazil will have a more meaningful impact on results over the next several years.

I will now turn to capital deployment. We returned about $635 million to shareholders in the fourth quarter. This brings our full year shareholder returns to $2.6 billion, about equally split between dividends and share repurchases. We generate considerable free cash flow from our businesses, which we now estimate to be about 65% of earnings over time. As a result of the higher earnings level, along with the increased share of earnings that are deployable, we have increased the amount of capital we are returning to our shareholders. In that regard, we're pleased that the yesterday our board authorized a 20% increase in our quarterly dividend. This follows a similar increase in our 2018 share repurchase authorization announced in December. We continue to put a high priority on capital generation and return to shareholders, and we do so while continuing to invest in our businesses and maintaining a strong balance sheet.

To sum up, we're quite pleased with 2017 results. We exceeded our earnings objectives for the year and continue to show good growth and margin fundamentals across our businesses. We're also excited about the longer-term investments we're making, including those that will enable us to connect with customers with greater agility and over time accelerate our growth rate. The recent realignment of our domestic business organizational structure will help facilitate these initiatives. While items like deposit impact to earnings from the Tax Act will provide a near-term boost, our focus is, and always has been, on delivering long-term growth and shareholder value, and we remain confident that the combination of our superior business mix and track record of innovation and execution will enable us to do just that.

So with that, I'd like to hand it over to Mark.

Thanks, John. Good morning, good afternoon or good evening. 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'll start on Slide 2. After-tax adjusted operating income amounted to $2.69 per share for the quarter compared to $2.46 a year ago. After adjusting for market-driven and discrete items of $0.01 per share, EPS amounted to $2.68 for the quarter, up from $2.43 a year ago. Core performance of our businesses overall was solid in the quarter, with results benefiting from higher fees in our Annuities and Investment Management businesses and continued business growth in International Insurance on a constant-currency basis, partially offset by higher expenses. In addition, other related revenues in our Investment Management business of $92 million in the quarter were $70 million higher than the year ago quarter as a result of higher incentive fees and stronger strategic investing results. Together, these items had a net favorable impact of approximately $0.27 per share on the comparison of results to a year ago. Current quarter results also reflect a net benefit from certain items that varied from our average expectations. This includes non-coupon investment returns and prepayment income, which were about $90 million above our average expectations in the quarter. This was offset by the impact of less favorable underwriting results relative to expectations in our Individual Life and Retirement businesses and other retirement -- and other refinements that amounted to $45 million. The net effect of these items resulted in a benefit of about $0.07 per share. In thinking about our earnings pattern, I would also note that we estimate current quarter expenses for items such as technology and business development, advertising, annual policyholder communications and other variable costs were about $165 million or $0.25 per share, above our quarterly average for the year, consistent with the historical pattern we mentioned when we discussed our third quarter results.

On a GAAP basis, we reported net income of $3.8 billion for the current quarter or $8.61 per share. GAAP net income in the current quarter was about $2.6 billion higher than our after-tax adjusted operating income and included a $2.9 billion or $6.64 per share estimated tax benefit related to the enactment of the Tax Cuts and Job Act -- Jobs Act and about $600 million of pretax net realized investment losses.

Turning to Slide 3. I'll address the financial impacts of the Tax Act. The current quarter tax benefit of $2.9 billion from the enactment of the Tax Cuts and Jobs Act includes 2 key components: a $3.4 billion benefit from the remeasurement of net deferred tax liabilities arising from a lower U.S. corporate tax rate and the adoption of a territorial tax system and a onetime tax expense of about $500 million from the deemed repatriation of unremitted taxable earnings of foreign subsidiaries as part of the transition to the territorial tax system. In addition, the $2.9 billion net tax benefit increased GAAP book value per common share as of December 31, 2017, by $6.59. This compares to an increase in adjusted book value of $2.74 per common share. The difference relates to an adjustment for deferred taxes that were originally established through accumulated other comprehensive income primarily related to the deferred tax impact of unrealized gains and losses. Looking forward, we now expect the 2018 effective tax rate on adjusted operating income to be approximately 22% as compared to our 26% expectation provided in December in connection with our 2018 financial outlook. The reduction is primarily due to applying a lower tax rate to our U.S. business earnings.

Moving to Slide 4. I'll cover the market driven and discrete items for the quarter, which had a relatively small impact on results. These items include a benefit from our quarterly market and experienced unlockings in the annuity business, driven mainly by the performance of equities in customer accounts, partially offset by costs incurred in Corporate and Other related to a debt exchange transaction which we completed in December.

Moving on to Slide 5, which shows the items affecting pretax net income that are not included in adjusted operating income. Our current quarter GAAP net income includes pretax net realized investment losses of $581 million and divested business results and other items outside of adjusted operating income amounting to a net pretax gain of $26 million. Of note, the loss of $500 million from risk management activities was driven by currency hedges as the U.S. dollar weakened compared to certain other currencies and losses on other derivatives used in risk mitigation. Product related embedded derivatives and associated hedging had a negative impact of $332 million, largely driven by the noneconomic impact of applying tighter credit spreads in the calculation of our nonperformance risk related to the Annuities' living benefits. The $338 million gain from the general investment portfolio and related activities was driven by equity and fixed income security-related gains in our international operations.

Slide 6 shows financial highlights for the year. Earnings per share for 2017, based on after-tax adjusted operating income, amounted to $11.31 after adjusting for market driven and discrete items, which implies an ROE of 13.9%. The full year earnings per share increased by 17% from 2016, driven by strong underlying performance across our businesses and tailwinds from equity markets and non-coupon investment returns. Also, as I noted earlier, our adjusted book value per share as of December 31, 2017, of $88.28 includes a $2.74 benefit from the impact of the Tax Act.

[Audio Gap]

business results. I'll start on Slide 7. Let me first highlight that effective this quarter, our business segments are organized consistent with the new U.S. business structure we announced in July. The new organizational structure retains our existing segments but realigns them under new divisions.

I will discuss the comparative results for each segment excluding the market driven and discrete items I mentioned previously. Annuities earnings were $525 million for the quarter, up by $103 million from a year ago. The increase was driven -- was primarily driven by a greater contribution from policy charges and fee income, reflecting a 7% increase in our variable annuity average separate account values and lower risk management costs, driven by favorable markets and hedging results and the ongoing benefit from our second quarter update of actuarial assumptions. Partially offsetting this increase was a lower contribution from net investment spread results primarily due to the impact of lower reinvestment yields. Returns on non-coupon investments and prepayment fees were approximately $10 million above our average expectations in both the current quarter and the year ago quarter. Annuities return on assets, or ROA, of 125 basis points is down modestly from last quarter's record level. As we mentioned during our financial outlook call, a portion of the elevated ROA compared to last year is sustainable, including the impact of the annual actuarial assumption updates. And therefore, we expect to exceed our long-term ROA target of about 115 basis points in the short to medium term. However, over time, we expect higher risk management costs and lower average fee rates to cause our ROA to migrate to the long-term target level.

Slide 8 presents our annuity sales. Total annuity sales in the quarter of $1.6 billion are slightly below the year ago, but $300 million higher than last quarter. The sequential quarter increase was driven by higher HDI sales as a result of our repricing actions in October. Although account values of $165 billion set a new record driven by market appreciation, we continue to experience net outflows due to lower-than-historical sales levels and higher withdrawals.

Turning to Slide 9. Individual Life earnings were $98 million for the quarter compared to $138 million a year ago. The decrease primarily reflects unfavorable claims experience and the adverse ongoing impact of the second quarter 2017 annual review and update of actuarial assumptions and other refinements. The net contribution to current quarter results from claims experience, inclusive of reinsurance, associated reserve updates and amortization, was approximately $25 million less favorable than our average expectations compared to approximately $15 million more favorable than our average expectations in the year ago quarter. We experienced a higher-than-expected level of large claim activity in the current quarter. Partially offsetting this decrease was the absence of updates to other reserve balances and related items, which negatively impacted the year ago quarter by $25 million, and this year, a greater contribution from net investment spread results. Earnings for the current quarter included income from non-coupon investments and prepayment fees, about $5 million above our average expectations.

Turning to Slide 10. Individual Life sales, based on annualized new business premiums of $183 million, were consistent with the year ago quarter. Lower Guaranteed Universal Life sales were offset by higher sales across the other products, reflecting our product diversification strategy and specific distribution and product actions we have taken as well as an increase in large case variable life placements in the quarter.

Turning to Slide 11. Retirement earnings were $291 million for the quarter compared to $298 million a year ago. The decrease reflects less favorable case experience and higher expenses, partially offset by a greater contribution from net investment spread results. Current quarter case experience was about $10 million less favorable than our average expectations compared to about $10 million more favorable than average expectations a year ago. The greater contribution to net investment spread results included current quarter returns on non-coupon investments and prepayment fees, which were about $50 million above our average expectations, compared to returns about $30 million above expectations a year ago, partially offset by continued spread compression.

Turning to Slide 12. Total Retirement gross deposits and sales were $17.1 billion for the current quarter compared to $8.9 billion a year ago. This increase was driven by gross sales of Institutional Investment products in the current quarter, which amounted to $10.3 billion, including roughly $4 billion of longevity reinsurance transactions, $3.3 billion of funded pension risk transfer cases and $3 billion of stable value wraps. Total retirement account values were a record at $429.1 billion, up 11% from a year earlier. This increase includes the benefit from market appreciation as well as about $8.9 billion of positive net flows over the past year, split about evenly between Full Service and Institutional Investment products. I would highlight that the institutional net flows included about $6 billion of new funded pension risk transfer cases, which more than offset our runoff of the in-force business.

Turning to Slide 13. Group Insurance earnings were $22 million for the quarter compared to $43 million a year ago. The decrease reflects higher expenses, including the impact of nonlinear items such as premium taxes, and less favorable Group Life underwriting results, partially offset by a higher contribution from net investment spread results. Included in the current quarter, underwriting result was approximately $10 million of unfavorable reserve and premium refinements. In addition, current quarter net investment spread results included returns on non-coupon investments and prepayment fees, which were approximately $10 million above our average expectations in comparison to returns approximately $5 million above our average expectations in the year-ago quarter.

Turning to Slide 14. Investment Management earnings were $306 million for the quarter compared to $224 million a year ago. The increase in earnings was driven by a $70 million greater contribution from other related revenues as a result of higher incentive fees and stronger strategic investing results. The earnings contribution of other related revenues is inherently variable since it reflects changing valuations and the timing of transactions and amounted to $92 million in the current quarter, about $60 million above the average of the trailing 12 quarters. In addition, higher asset management fees, net of related expenses, reflect a 7% increase in average assets under management, driven by fixed income net inflows and equity market appreciation. The Investment Management business reported $1.4 billion of net positive unaffiliated third-party flows in the quarter, excluding money market activity. Net retail inflows of $1.5 billion, driven by fixed income strategies, were slightly offset by institutional net outflows driven by equities. For the year, we produced $15.7 billion of positive unaffiliated third-party net flows, another strong year for our growing Investment Management business.

Moving to the International Insurance businesses and turning to Slide 15. Earnings for our Life Planner business were $383 million for the quarter compared to $395 million a year ago. Excluding a $5 million negative impact of foreign currency exchange rates, earnings decreased by $7 million from a year ago. The decrease was driven by higher expenses and less favorable policy benefits experience, partially offset by continued business growth, with constant dollar insurance revenues up by 7% from a year ago. Claims experience in the current quarter was consistent with our average expectation and in the year ago quarter was approximately $15 million more favorable than our average expectation. In addition, the current quarter contribution from net investment spread results included returns on non-coupon investments and prepayment fees, approximately $15 million above our average expectations.

Turning to Slide 16. Gibraltar Life earnings were $394 million for the quarter compared to $360 million a year ago. This increase primarily reflects more favorable policy benefits experience and continued business growth, driven by the increase in U.S.-denominated product sales over the past year.

Turning to Slide 17. International Insurance sales on a constant dollar basis were $644 million for the current quarter, down $69 million or 10% from a year ago. We've experienced similar trends in both Life Planner and Gibraltar operations, where sales decreased by $37 million and $32 million, respectively, compared to the year ago quarter. This decrease primarily reflects lower sales in Japan following elevated sales levels in the first half of the year. Yen-based product sales in Japan decreased by $131 million compared to the prior year due to the elevated level of sales in the first half of this year, which occurred in advance of rate increases that was driven by the lower standard discount rate, which was effective in the second quarter. This was partially offset by an increase in U.S.-dollar-denominated sales in Japan of $66 million, driven by the continued attractiveness of U.S. dollar products in the current environment, which further benefited from the introduction of new U.S. dollar whole life products earlier this year. As a result, 78% of sales in Japan were U.S. dollar denominated in the quarter. Sales outside of Japan were consistent with the year ago quarter as growth in Brazil was offset by modest declines in other markets. On a full year basis, 2017 sales -- 2017 total sales of $3 billion and Japan sales of $2.5 billion were consistent with the prior year. However, with a greater mix of U.S.- dollar-denominated sales.

Turning to Slide 18. The Corporate and Other loss was $451 million for the current quarter compared to a $441 million loss a year ago. The increased loss was driven by higher expenses, including nonlinear items, which can fluctuate, and lower investment income, net of interest costs. Partially offsetting this increase was higher income from our pension plan following our assumption updates at year-end last year. Higher expenses drove the sequential quarter increase in the loss. Of the company's $165 million overall excess of fourth quarter expenses in relation to the quarterly average for the year that I mentioned, about $70 million resides in Corporate and Other.

Before I hand it over to Rob, I'd like to cover one other topic that may be on your mind and thus wanted to address it now. The topic relates to guaranteed group annuities and MetLife's disclosure that it plans to strengthen reserves to address a pool of missing annuitants. We have read MetLife's disclosures, but we don't know the specifics of their situation. In terms of our Retirement business, we take fulfilling our obligations to our customers seriously. Under our policies and procedures, we use internal and external tools and resources to locate customers. We also have policies on the development of our reserve estimates. We're comfortable with our overall reserves and that we're complying with our policies and procedures and meeting our obligations to customers. Given the size and the age of our block of business, there are inevitably some customers we can't locate for a number of reasons, but that number is small. We regularly review, test and enhance the process and -- processes and tools we use to locate customers. And over time, we expect them to continue to evolve. This issue is certainly getting a lot of attention in the market. And ultimately, we could see straight -- see greater standardization of what may currently be divergent practices across the industry.

Now I'll turn it over to Rob.

Thank you, Mark. Now turning to Slide 19. I'm going to provide an update on key balance sheet items and financial measures. 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've 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. We expect that the reduction in the corporate tax rate from 35% to 21% as part of the Tax Act will result in a reduction of statutory deferred tax assets and an increase in certain statutory reserves, which will adversely affect the statutory capital position of our domestic insurance companies for 2017. However, while statutory results are not yet filed, we expect that our Prudential Insurance, PALAC and composite RBC ratios will each continue to be above our current 400% AA target as of year-end, including the estimated impacts from the Tax Act.

In Japan, Prudential of Japan and Gibraltar Life reported strong solvency margins of 893% and 935%, respectively, as of September 30. These solvency margins are comfortably above our targets, and we estimate that they continue to be so as of the end of the year.

Looking at liquidity. Leverage and capital deployment highlights that are on Slide 20. Cash and liquid assets at the parent company amounted to $4.4 billion at the end of the quarter, which was consistent with last quarter. Cash inflows during the quarter supported approximately $635 million of shareholder distributions, which were about evenly split between dividends of $321 million and share repurchases of $313 million and also funded debt maturities and other business operations. Our financial leverage and total leverage ratios as of year-end remained within our targets. And as John noted, we returned $2.6 billion to shareholders during the year through dividends and share repurchases and announced a 20% increase in our quarterly dividend yesterday.

I would also remind investors of 2 items we communicated in our guidance that we expect to have a positive impact on adjusted book value in the first quarter of 2018 of roughly $1 billion. We'll implement the new accounting standard that impacts the treatment of equity investments and which will result in a reclass of net unrealized gains of approximately $900 million from AOCI to retained earnings. In addition, we intend to eliminate the 1-month reporting lag in our Gibraltar operations so that Gibraltar's first quarter results reflect January through March activity. This would not result in an extra month of Gibraltar earnings in our 2018 results, but instead, would essentially result in an adjustment to opening equity.

Now I'll turn it back over to John.

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

(Operator Instructions) Our first question is from the line of Ryan Krueger with KBW.

Following the impacts of tax reform and the varying impacts to both cash taxes and GAAP effective tax rates, do you still feel comfortable with the 65% free cash flow conversion guidance?

Ryan, it's Rob. Yes. We're comfortable that, again on average over time, the 65% ratio is -- of free cash flow is something that the businesses will continue to produce. If we look at the impact of tax reform, we expect cash taxes to actually be lower on a -- over the course of the next few years, primarily from not incurring U.S. taxes on repatriations from Japan and the utilization of accelerated tax credits on our U.S. taxes. So we expect most of the near-term increase in after-tax AOI resulting from tax reform to actually translate into free cash flow, even including the amortization of the onetime total tax that we mentioned of about $0.5 billion. Longer time, there are more -- there -- longer term, there are more variables that come into play, but we generally expect reform to be neutral or a positive to future years' cash -- cash flow. And so we remained with our guidance around the 65% free cash flow ratio.

And then related question on the, I believe, it was the outlook call, you stated that you expect the PICA RBC ratio to remain above 400, even if the NAIC changes the denominator factors. Is that still the case as well?

Yes, it is. So what you saw is 2 of the biggest pieces related to that came through as of year-end. So that was the reduction in the DTAs and the increasing of reserves primarily around AAT reserves that would -- that get adjusted on a -- as a result of the lower taxes. So those are both baked into the numbers that we'll produce as of year-end and while we haven't published those yet, and therefore, we don't want to be overly specific, we're comfortable that, that number is going to come out ahead of our -- or above our 400% target for AA as we're currently labeling that. The remaining piece that's a potential -- would represent about half of the 100-basis point decline in RBC that we had given for the totality of the impact of tax reform, when and how that actually manifests itself is still unknown, but we've assumed that a recalibration of the metrics without any adjustments going from 35 down to 21, without that -- the impact of that would -- with something where we would still be able to maintain our 400% RBC using our available cash -- our available capital capacity. Some of that capital capacity exists within our on balance sheet, off balance sheet and earnings that we obviously generate during the course of the year as well.

The next question is from the line of Erik Bass with Autonomous.

Sticking on the topic of taxes. As you look across your U.S. businesses, how do you see tax reform affecting competitive dynamics in pricing?

Erik, this is Steve. Let me address your question. And I'll just start by saying that, as you know, we regularly review our product pricing and update key assumptions as appropriate. And there are a number of factors that we consider as part of that, tax impact being just one of them. I think the most meaningful impact from the tax reform will likely not really be derived in regard to new product sales, but rather simply from applying lower tax rates for the results of our in-force business. For products that do, where our at-issue returns do benefit from the tax reform, I think it'd be reasonable to expect that some portion of the benefits realized from that will be competed away over time. However, we see this happening over time and at varying rates of speed in our varying businesses, depending upon the competitive landscape in each of those businesses. And throughout this, our primary focus will continue to be in ensuring that we price our products for sustainable profitable growth. In terms of the lowering of tax rates and does that impact the value proposition that we offer to customers? We don't believe so. We believe that, even at lower tax rates, our insurance solutions continue to offer a strong value proposition and help to meet our customers' financial needs.

And I guess, post-tax reform, we've also seen a number of large corporates that've announced contributions to their pension plan. And when we combine that with rising interest rates and higher PBGC fees, are you seeing an increase in interest in PRT transactions, particularly amongst jumbo plan sponsors?

Yes, Erik. We do see a very, very healthy pipeline at the start of the year, and it's for the reasons that you mentioned. Ability to transact is bolstered by increasing funding levels, and that's driven by both an uptick in rates and the contributions that you mentioned. A significant number of plan sponsors have made contributions in 2017 to their plans, and they have until September to do so, and to take advantage of the lower 2017 tax rates. So ability to transact is very strong, and propensity to transact continues to be bolstered by the factors that we've mentioned before on these calls, such as rising PBGC premiums, increasing awareness of the longevity risk and that increasing awareness being reinforced by new mortality tables. So all of those factors around both ability and propensity to transact really make for a healthy pipeline here at the early stages of the year.

And the next question is from the line of Suneet Kamath with Citi.

I wanted to start with the VA business, in particular on the hedging program. Just given a lot of the volatility that we've seen just in the past week, particularly related to volatility-related products, do you have any exposure to those products? Or can you talk about what you've just seen in your hedging program just recently?

Sure, Suneet. It's Rob. So first of all, big picture, this is a good story, and it's consistent with the prior messaging that we've been giving around the increased stability and predictability around our Annuities business. So let me break it down into pieces. Let me talk first about the last part of your question, which is the hedge performance during the course of the quarter. So we do -- we include volatility in our hedging. We don't hedge the VIX directly, but we have options and other things. And they -- and so volatility is expressed through that. Our actual breakage month-to-date for February was only around $45 million. Now I remind you, that's on a liability that's in excess of $9 billion. And so that's consistent with the kind of hedging efficiency that -- and effectiveness that we've been seeing in prior quarters and prior years. If you look back at the fourth quarter, the way in which we look at our effectiveness, we're at 90% or above in terms of our hedge effectiveness. So the second piece then in terms of volatility. So obviously, there are multiple pieces of volatility that you want to think about. If there is a direct increase in hedge cost when volatility increases within a period, and to the extent that volatility gives rise to breakage, you have that indirect cost as well. Now those costs are subject to the fact that: one, as I noted, we hedge it. Two, recall that we have our auto rebalance feature, and that allows us, as -- when volatility is typically associated with declining markets, we're rebalancing out of equities and into fixed income, and so our exposure to that is declining as markets increase in volatility and decline. In terms of the broader than impact of vol on our earnings, the long-term cost of our hedging is included in our AOI. That's the [AT] factor that we set upfront when we look at our fees, and we anticipate how much of that is going to flow into AOI as opposed to what's needed in order to settle out the liability. The period costs in any given period, the plus or the minus, is part of how we define breakage net period. So if volatility goes up and the cost of our hedging goes up, that's going to be defined in our breakage. And then to the extent that we have any efficiencies, that will be in there as well. That gets amortized into our AOI via changes in our benefit ratios. And to date, that's actually been a positive number, and it's contributed modestly to the elevated ROAs that we've been reporting. And so as part of our guidance, I'll remind you that what we did is we said that we were expecting that 100 -- mid-125-ish ROA would migrate down over time as we took the opportunity of high -- of relatively high equity markets and high profitability coming out of the business to recalibrate how we go about hedging our annuities book. An increase in the use of derivatives and hedges as we did that. And so we undertook that, that was fully in place by the end of the fourth quarter. And therefore, we further benefited from the fact that we had, in addition to our product hedges, a capital hedge overlay on top of that against equity market volatility. And all of that's consistent with what we've been messaging in the last 4 quarters around expect a slight decline in ROA. And the exchange for that is going to be less volatility in our earnings and our cash flow, which we think is a good trade, particularly given the elevated levels of both markets and our profitability. Final piece to that, equity markets, obviously, it follows up when equities markets are down. The -- that -- all things being considered, we would rather equity markets were up. That enhances the profitability of not only the Annuities business but our other businesses as well. That -- any equity market declines are ultimately reflected in our earnings through unlocking of the K-factor in our benefit ratios. But recall a couple of things. One is there's a mean reversion assumption in there, and that mutes the impact of it. And because of the hedging that we do, both the product hedge and the capital hedge that I described before, we significantly offset the impact of decline in equity markets. And that's what we've been talking about again over the last few quarters. We're using the higher level of earnings to reduce that volatility and then shore up our earnings and our cash flow or reduce the volatility around that. So we do better in a rising equity market, but we're well protected in downturns. And expect a muted earnings impact from what we saw -- the likes of what we saw in February from the combination of volatility and directions in markets.

Okay. That's helpful. The other follow-up I had was related to the auto rebalance. So the trend has been falling equity markets and rising interest rates. And as you pointed out, I think the algorithm would shift funds into fixed income option. What happens if we sustain this type of environment, i.e., equity markets continue to drop and interest rates rise? Doesn't that auto rebalance end up working against account value growth at some point?

So to the extent the auto rebalance leaves people within the -- within -- more skewed toward bonds than equities, they stay in that position until a point at which the equity markets rise and the auto rebalance begins to work in the other direction. So if you have an environment where equity markets remain relatively flat, they'll be in the fixed income instruments. Obviously, the duration of that fixed income fund is sort of it's -- sort of a midrange duration. I remember, specifically, 5, 6 years, something like that. So as interest rates rise, as they're in that over time, they'll get higher yields out of that. As the yield in the -- on the assets in that fund increase. Now if equity markets further decline, obviously, they're going to be protected from that because we'll continue to auto rebalance out of equities and into fixed income. And so they'll eventually hit a floor where further equity market declines will be -- they'll be fully insulated from those kind of movements. Steve, I don't know if you want to elaborate on that.

Yes, I'll just add a couple of ones, Rob. First of all, just remember that the fixed income vehicle is a corporate bond fund, and so spreads come into play as well. But also, just a more fundamental point that we've consistently emphasized. The auto rebalancing program is not an account value optimizer. That's not what it's about. It's about the support of our risk profile over an extended period of time and making sure that we're able to responsibly offer the benefit that we do in our product design. So that's really the underlying and fundamental purpose that we very much discuss with our customers about the auto rebalancing program. It's not meant to optimize account values.

And the next question is from the line of Alex Scott with Goldman Sachs.

First question, just on the Investment Management business and some of the incentive and transaction fees or the strategic things you mentioned. Can you discuss the timing of those? And if you have any kind of visibility that they will remain elevated for some period here in 2018?

Alex, it's Steve. I'll address your question. First of all, incentive and performance fees often do have some seasonality. It's not unusual to see them emerge in the fourth quarter if we've earned them. In terms of what happened this quarter, we saw those elevated incentive fees actually across multiple asset classes. We saw it in fixed income, both public and private. We saw it in real estate, and we saw it in our equity businesses as well. Over time, we have been drawing increasing flows to strategies that do carry incentive fees, and that's particularly true in our fixed income businesses. So it would not be unusual to see a growth in these strategies over time and possibly emergence of greater incentive fees in our earnings patterns over time.

And follow-up question on Individual Annuities. The surrenders and withdrawals kind of ticked up a bit more than in previous quarters. Is that a trend that you'd expect to escalate? Are there any things you're doing on the sales front relatedly to maybe offer products that don't require rebalancing or things like that, that you'd expect to help sales and offset some of the outflow?

Alex, again, I'd -- I'll address your questions. It is not at all surprising for us to see elevated lapses and withdrawals in this quarter. I'd mention a couple of things. First of all, just in terms of the market conditions, we expect to see elevated lapses in our -- as interest rates rise. And interest rates rising is usually associated with alternative solutions becoming available that clients may go into. I would also recall that correlation of rising interest rates is built into how we manage our actuarial assumptions in the business and our risk management in the business. So that kind of dynamic relationship between rising interest rates and lapsation is really built into what we do. On a longer-term basis, I'd also recall that as more and more of our in-force business emerges from surrender period, we would expect to see that. In terms of new product design, we just last week launched a fixed index annuity product, and so we see that as offering a fuller suite of product designs to our distribution partners and their clients. And we have other products in the course of this year that we expect to introduce into the marketplace.

The next question comes from the line of Tom Gallagher with Evercore ISI.

Steve, another one for you just on the auto rebalance, highest daily value product. I just want to make sure I understand the dynamics that are happening with it and the way the product works again. So correct me if I'm wrong, but I -- my understanding is the vast majority your portfolio has the highest daily feature. If we equity markets decline over 10%, the auto rebalance kicks in and I think fully moves into fixed income or largely moves into fixed income at down 20%. Is that the way the product works? And just a related question. How do you -- would you have to respond and start altering your hedge program with a pretty big asset reallocation? And what would that do to your ROA in this scenario that the market continues to weaken?

Tom, I'll address your question. The activation of the auto rebalancing program is not based on overall certain level of market decline. Actually, auto rebalancing would, under normal circumstances, kick in well before a 10% market decline. The -- again, to emphasize, the auto rebalancing program is driven by our evaluation of the risk profile in each and every one of our HDI products and then the aggregation of that change in risk profile of all those individual contracts. That's what drives auto rebalancing activity, change in risk profile of each and every contract. As to the asset reallocation topic, maybe I'd ask Rob to comment on that.

Yes, so a couple of things, Tom. First, just to put some numbers on Steve's point. If you -- if we look at what happened in February, so the big movement on the 5th of February, we were down about 4%. It was a little over $0.5 billion transfer in the auto rebalance out of equities into fixed income as a result of that movement. So well before we hit the 10%. But again, put that in the context of a $9 billion overall liability, and you sort of get some sense for how that works. With respect to your return on asset, the implications on the return on assets is sort of -- what I was going through before, Tom, is it actually doesn't -- with that in and of itself would not -- the algorithm, the rebalancing in and of itself is not going to change the ROA that we're getting out of the business. Recall, first, that the fees are charged on the guaranteed value. And so therefore, to the extent that we're in fixed income or otherwise where markets move down, our fees are not diminished by virtue of that. And then secondly, the fact that we actually have less hedging cost, as I just -- just like if we have more hedging cost, we're going to look at that as being periodic, and we have a longer-term view of what the hedging cost would be over the life of the contract. And absent changing that, those -- that interim -- in that particular case, lower hedging cost if we're more in fixed income than equities is something that we're going to amortize in over the life of the contract. So we'd have probably a modest, positive impact in terms of less hedging cost than what we've built in, but not material in any way and not highly volatile either. And I'm sorry. Was there another part to your question, Tom?

No, that was good, Rob. That did it on VA. And then just my follow-up is, just on the topic of long-term care. I know it's something that you all took a charge on several years back, I'm going to say maybe 4 years ago or 5 years ago. Just out of curiosity, do you still have -- after that charge, just based on your experience to date, is there still margin there? Is that something we should be watching out for from a development standpoint 2018, 2019? Can you comment a bit about what you're seeing on underlying trend there?

Yes. So let me share a couple of observations, Tom. First, let me start with the caveat that our book here is a relatively small book. So we've got 215,000 policies, $6 billion in reserves, and you can kind of put that in context of the others in the industry that are much more significantly in this product. A couple of things I'd also mention, just to sort of lay out the nature of our book. We're -- it's -- the more recent vintage book, Tom, so that's when plan designs got more conservative, and about 2/3 of the book is group as opposed to individual. And again, the plan designs are more conservative in the group long-term care policies than they were in the individual. With respect to our assumptions, we look at those every year. So yes, we did the big assumption update in 2012 and had the GAAP loss recognition event. I think that's what you're referring to. But every year, we continue to look at that. And the assumptions that we have in place for that book, we look at both with regard to our own experience and with regard to industry experience. And we are in line, if not generally on the more conservative end of that industry experience that's available to us. Now I'd throw a caveat in there, and that is that our book is relatively nascent, as I mentioned. So it's got about 1 -- a little over 1% of the book is actually in payout at this point in time. And I'd say the same thing of the industry, which is that the experience of people is still evolving and then we all have to watch for how that experience may change, what we've currently seen. So while assumptions may reflect experience to date, that's not to say that experience can't change as more and more of the book goes from the deferred status to active status. And then to get to your very specific question, we have a cushion above our loss recognition -- it's in excess of $0.5 billion, and so we feel pretty comfortable with that level of cushion, with the realization that we'll constantly be updating our assumptions, and we'll look to do that in the second quarter of next year.

The next question is from the line of Jimmy Bhullar with JPMorgan.

I had a couple of questions. The first one just on the VA business. Your surrenders picked up significantly, and I realize the book is aging, but did it pick up noticeably from the previous quarter? So what drove that? And what's your outlook for just withdrawal rates in general in the VA business? And then secondly, just on international agent counts. So Gibraltar, the agent count, I think, was down a little bit sequentially. Japan Life Planner declined as well. Is that more seasonality? Or is it something else going on? And your outlook for that as well?

Jimmy, it's Steve. I'll answer the first part of your question. As I mentioned, in a rising interest rate environment, we would expect to see withdrawals and lapses in the variable annuities business. Rising interest rates are usually associated with the emergence of alternative solutions. And thus, it would be only natural to see increased lapsation in that -- for that reason. In addition to the emergence from surrender charges, as you mentioned, as a longer-term trend. And again, I just mentioned that we have thoroughly incorporated that correlation into our actuarial and risk management underpinnings for this business. Those -- the assumptions we make call for a dynamic relationship between the interest rate -- between direction of interest rates and lapsation.

Jimmy, it's Charlie. Let me talk about both Life Planners, and then as you mentioned, Life Consultants. So in Life Planners in Japan, they were up 3%. But to your point, you are correct. There is some seasonality with regard to Life Planners. So recall that transfers to sales managers generally happen twice a year in the second quarter and the fourth quarter. And we had a very -- we had a high number of LPs transfer this quarter, resulting in an increase in sales managers year-over-year by 11%. Now that's good because these new sales managers will contribute to future recruitment and continued LP growth, but they do lower the current LP count. We also had a higher number of secondees that were transferred to the bank channel. So there are a lot of ins and outs, especially in the second and fourth quarter. But the long-term average for POJ, and frankly, for Life Planners in general is about 2% to 4%. So if you look over a 5-year period for all of Prudential International Insurance, the LP growth rate in total has been about 2% or so. So slow and steady growth of 2% over the long term is what you should anticipate. Now with the Life Consultant count, that's a bit of a different story. So Life Consultant count decreased by about 6% year-over-year, and this is due to the adherence of more stringent validation and recruiting processes that we put into effect and that we talked about last quarter. And that really has a double effect. The first is that there are more terminations from stringent validation requirements that are being enforced. But also, with higher recruiting standards, you have less recruits. And it's tough to do this because, when you elect to do this, there's a bit of a J curve that -- of sorts. So while we were flat versus prior quarter, we're not yet at the bottom of the J curve. And I think we said last quarter, it'll take really most of this year to get to the bottom. But we think we'll hit the bottom later this year, and it's exactly what we've done in several operations outside of Japan over the past 18 months, including Korea and Taiwan. Going back to the basics and increasing the quality of the field. Now a proof point to what we're doing is the fact that while LC count, the Life Consultant count, decreased by 6%, sales only decreased by 4% in this market. And therefore, what you'd expect to see and what you're seeing especially at first is that, as you take off essentially the bottom of the Life Consultants, if you will, the ones that aren't performing well, you'd expect to see sales go down less than the Life Planner count. And that's exactly what we saw. That won't happen every quarter, but we did expect to see it in the first quarter, and that's what we saw.

And the final question comes from the line of Humphrey Lee with Dowling & Partners.

A question on Investment Management. So the fee rates has been pretty stable to slightly improving. And part of it, I believe, is from the mix shift towards the fixed income. I guess, at a high level, like how much better is your average fee rates for your inflows versus your average fee rates for your outflows?

Humphrey, it's Steve. I'll address your question. We've seen secular pressure on fees in the Investment Management industry overall. And actually, that's been not just in the active space, but also in the passive space. There's been considerable fee compression. In the face of that, we've been able to keep actually pretty stable fees overall in our book. Now in -- to address your question, rather than speak about the fee rate on outflows versus fee rate on inflows, I'd point out we have not been immune in all portions of our platform to fee compression. That's not where our stable fee rate comes from. We've experienced that fee compression in various of our -- various parts of our platform, in particular, in the retail -- in retail portions. However, we have been able to draw flows into higher fee-yielding strategies, and particularly in fixed income, as you mentioned, and in other areas as well, such as real estate. So given the multi-manager model and given our ability to draw flows into a variety of strategies, including ones that yield higher fees, we feel well positioned to compete even in this period of secular pressure on fees.

Got it. And then just a follow-up question to Tom's earlier question on long-term care. So you mentioned there's $6 billion of reserves. Is that GAAP or stat?

That was stat.

Okay. And then would the reserves be kind of similar to the split between the group and the individual side, kind of 1/3, 2/3? Or how should we think about that?

The -- so remember, the size of the book is -- yes, if you look at the 2/3 versus the 1/3, that would be -- probably a pretty good indicator. I don't have the number off the top of my head, Humphrey. But I think it's -- look, we'll have some more follow-up with you specifically, but it would -- I would think about it being roughly that order of magnitude because they're both relatively nascent books.

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