Prudential Financial, Inc. (NYSE:PRU) Q4 2022 Earnings Call Transcript

Prudential Financial, Inc. (NYSE:PRU) Q4 2022 Earnings Call Transcript February 8, 2023

Operator: Ladies and gentlemen, thank you for standing by, and welcome to Prudential’s Quarterly Earnings Conference Call. At this time, all participants have been placed in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. As a reminder, today’s call is being recorded. I will now turn the call over to Mr. Bob McLaughlin. Please, go ahead.

Bob McLaughlin: Good morning, and thank you for joining our call. Representing Prudential on today’s call are Charlie Lowrey, Chairman and CEO; Rob Falzon, Vice Chairman; Andy Sullivan, Head of International Businesses; PGIM , our Global Investment Manager, Caroline Feeney, Head of US Businesses, Ken Tanji, Chief Financial Officer and Rob Axel, Controller and Principal Accounting Officer. We will start with prepared comments by Charlie, Rob, and Ken, and then we will take your questions. Today’s presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions that 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 the discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled Forward-Looking Statements and Non-GAAP Measures in the appendix to today’s presentation and the quarterly financial supplement, both of which can be found on our website at investor.prudential.com.

And now, I’ll turn it over to Charlie.

Charlie Lowrey: Thank you, Bob. And thanks to everyone for joining us today. As we look back on 2022. I am proud of the progress we’ve made executing against our strategic priorities. During the year. We continue to transform our business to be less market sensitive and better positioned to deliver sustainable long-term growth. We exceeded our $750 million cost savings target one year ahead of schedule, and our rock solid balance sheet provided the financial strength to navigate the evolving macro economic environment. I’ll provide an update on each of these areas, beginning with our business transformation. Turning to slide three, during 2022 we reduced the overall market sensitivity of our business by completing the sales of the full service retirement business and the pay lock block as well as the run off of traditional variable annuities.

We simultaneously continue to invest in the long-term sustainable growth of our business through programmatic acquisitions, and partnerships in emerging markets. In Africa, we acquired a minority interest in Alex Forbes, a leading provider of financial advice, retirement, investment, and wealth management in South Africa. We also continue to grow our third-party distribution network in Latin America, particularly in Brazil, where third-party distribution now accounts for about 50% of sales and complements our strong Life Planner channel. Additionally, we advanced our vision to be a global leader in expanding access to investing insurance and retirement security. For example, we completed the second largest pension risk transfer transaction in US market history with IBM and close several major longevity risk transactions, including the $8 billion transaction we completed in the fourth quarter with the Barclays Bank, UK retirement fund.

These transactions underscore our leadership in these markets, as well as the strength of our interconnected business model. Our IBM, PRT transaction provided PGIM with more than $8 billion in additional assets under management, and is a good example of how we leverage synergies across our businesses. We see a strong pipeline of opportunities in these markets in the year ahead. We continue to expand our product offerings to meet the increasing customer needs for financial solutions. For example, building on the success of our FlexGuard annuity products, we introduced during the fourth quarter FlexGuard Life, an indexed variable universal life product. In PGIM, we expanded our private loan capabilities through PGIM private capital, including our direct lending capabilities.

This broad proprietary origination platform provides our insurance businesses and our institutional clients with unique investment opportunities and is another example of our self-reinforcing business model. We also invested in enhanced customer experiences that blend human touch with advanced technology. In Brazil for example, we expanded our digital sales application to expedite same-day policy delivery and processing with greater automation. In addition, as we administrator for the IBM PRT transaction, we introduced new technology capabilities to expedite the onboarding experience for 100,000 IBM pensioners. And as part of our continued efforts to refine customer experience, we implemented a company-wide initiative to better understand the evolving needs of all our customers around the globe.

And in turn, deliver the most effective products and solutions to meet their needs. Moving to slide 4, we achieved $820 million of annual run rate cost savings, exceeding our target of $750 million one year ahead of schedule. We reach this milestone by streamlining and automating the way in which we operate, while improving the customer and employee experience. We leverage new systems and technologies to enhance our digital underwriting, claims and fund processing capabilities, improving efficiency, while reducing customer wait times. For example, for many of our Individual Life customers, we reduce the underwriting time from 22 days to 22 seconds. Our Group Insurance claims processing is now three times faster, and fund verification to process new annuity sales now takes two to three days, down from two to three weeks.

We also implemented a hybrid work model for our employees that reduced our U.S. real estate footprint by 50%, equating to approximately $50 million in annual run rate savings. And finally, we adopted a continuous improvement mindset that helps us proactively identify and execute on cost savings opportunities that enhanced customer and employee experiences, and continue to improve our competitiveness going forward. Now to slide 5, our rock solid balance sheet and disciplined approach to capital deployment have helped Prudential navigate financial and macro economic challenges for nearly 150 years. And 2022 was no exception. Our financial strength, including our AA ratings is supported by $4.5 billion in highly liquid assets at the end of the fourth quarter, as well as a high quality, well diversified investment portfolio.

We continue to balance investments in the growth of our businesses with returning capital to our shareholders. During the fourth quarter, we returned more than $800 million to shareholders through dividends and share repurchases, for a total of over $7.5 billion since the beginning of 2021. For 2023, our Board has authorized up to $1 billion in share repurchases, as well as a 4% dividend increase beginning in the first quarter. This represents our 15th consecutive annual dividend increase. Looking ahead, our strategic progress, financial strength and self-reinforcing business system, coupled with a higher interest rate environment position as well to be a leader in expanding access to investing, insurance, and retirement for our customers across the globe.

Now, before turning it over to Rob, I’d like to extend a special Thank you to all our employees for their dedication to our customers and our communities. Together, we have made significant progress on our transformation, and are fulfilling our purpose of making lives better, by solving the financial challenges of our changing world. And now, over to Rob, to talk about the fourth quarter financial results, and to provide an update on our business performance.

Rob Falzon: Thank you, Charlie. I’ll provide an overview of our financial results and business performance for our PGIM, US, and International Businesses. I’ll begin on slide six. Pre-tax adjusted operating income was $4.7 billion or $9.46 per share for 2022 and $1.2 billion or $2.42 per share in the fourth quarter. These results reflect lower variable investment and fee income, partially offset by improved mortality as COVID has transitioned to an endemic phase, an increase in spread income due to rising interest rates, and underlying business growth. In addition, full year results include the strengthening of reserves from our annual assumption update and the gain on the sale of the PALAC Legacy variable annuity block. Our GAAP net loss for the quarter was $1.53 per share and included net realized investment losses and related charges and adjustments of $800 million, largely reflecting the impacts of rising interest rates.

This loss also included a $700 million goodwill impairment due to the reduction in the estimated fair value of assurance. While assurance is making good progress in many areas and had a profitable fourth quarter, the impairment reflects lower growth expectations, higher discount rate applied to future applied to future cashflows reflecting macroeconomic conditions, and lower publicly traded peer evaluations. Turning to the operating results from our businesses compared to the year ago quarter. PGIM, our global investment manager reported fees, primarily due to lower assets under management, resulting from higher rates and equity market declines. Results of our US businesses primarily reflected less favorable variable investment income, partially offset by the impact of higher rates on spread income and more favorable underwriting.

The decrease in earnings and our international businesses primarily reflected lower spread income, largely due to less favorable variable investment income and less favorable underwriting including elevated surrenders in Japan through the depreciation of the yen. Turning to slide seven, PGIM, our global investment manager has diversified capabilities in both public and private asset classes across fixed income, equities, and alternatives including real estate and private credit. PGIM’s investment performance remains attractive with more than 79% of assets under management outperforming their benchmarks over the last three, five, and 10 year periods. For 2022, PGIM experienced positive institutional net flows that were more than offset by retail outflows, primarily in fixed income, consistent with industry trends due to the rising rate environment.

In the fourth quarter, PGIM experienced third-party net outflows of $11.7 billion, driven by public fixed income strategies across institutional and retail clients. Institutional net outflows were driven by a few large client redemptions, while retail net outflows reflected the impact of the rising interest rate environment on retail flows across the industry. As the investment engine of Prudential, success and growth of PGIM and of our US and International Insurance and Retirement businesses are mutually reinforcing. PGIM’s asset origination capabilities, investment management expertise and access to institutional and other sources of private capital are a competitive advantage, helping our businesses bring enhanced solutions and create more value for our customers.

Our insurance and retirement businesses, in turn, provide a source of growth for PGIM through affiliated flows that totaled $13 billion during 2022 as well as unique access to insurance liabilities. In addition, we continue to grow our alternatives business, which has assets in excess of $230 billion across private credit and real estate equity and debt and benefits from our global scale and market leading positions. Notably, PGIM’s private businesses deployed nearly $43 billion of gross capital in 2022. Turning to slide 8. Our US Businesses produced diversified earnings from fees, net investments spread and underwriting income and benefit from our complimentary mix of longevity and mortality businesses. We continue to shift towards higher growth and less market sensitive products and markets, enhance our customer experience while reducing costs by amplifying the use of capabilities and self-service tools and further expand our addressable markets.

Retirement Strategies achieved robust sales in fourth quarter and full year 2022 across its institutional and individual lines of business. Our Institutional Retirement business has market leading capabilities with full year sales of almost $32 billion driving record account values at the end of the year. This includes being selected for a 50% participation in a $16 billion pension risk transfer transaction and our fourth largest international reinsurance transaction of $8 billion in the fourth quarter. In Individual Retirement, product pivots have resulted in continued strong sales of more simplified solutions like FlexGuard and FlexGuard income, representing over $12 billion of sales since inception, as well as increased fixed annuity sales.

Our Individual Life sales were consistent through the year and reflect our earlier product pivot strategy, with variable life products representing approximately 70% of sales for the year. And our Group Insurance benefits ratio has improved during the year from lower COVID mortality. Turning to slide 9. Our International Businesses include our Japanese life insurance companies, where we have a differentiated multi-channel distribution model as well as other businesses aimed at expanding our presence in high growth emerging markets. In Japan, we are focused on providing high quality service and expanding our geographic coverage and product offerings. Our needs-based approach and protection product focus continue to provide important value to our customers as we expand our product offerings to meet their evolving needs.

In emerging markets, we are focused on creating a carefully selected portfolio of businesses and regions where customer’s needs are growing, where there are compelling opportunities to build market leading businesses and where the Prudential enterprise can add value. Our International Businesses experienced their highest sales since the third quarter of 2020, including record sales in Brazil. Compared to the prior year quarter, Gibraltar sales were up 20% mainly driven by the life consultant channel primarily from higher US dollar sales. Life Planner sales were also up 17%, driven by continued momentum in Brazil’s third-party distribution channel, as well as higher sales in Japan. As we look ahead, we’re well-positioned across our businesses to be a global leader in expanding access to investing, insurance and retirement security.

We continue to focus on investing in growth businesses in markets, delivering industry leading customer experiences, and creating the next generation of financial solutions to better serve the diverse needs of a broad range of customers. And with that, I’ll now hand it over to Ken.

Ken Tanji: Thanks, Rob. I’ll begin on slide 10, which provides insight into earnings for the first quarter of 2023 relative to our fourth quarter results. As noted, pre-tax adjusted operating income in the fourth quarter was $1.2 billion and resulted in earnings per share of $2.42 on an after tax basis. To get a sense of how our first quarter results might develop, we suggest adjustments for the following items. First, variable investment income was below expectations in the fourth quarter by $125 million. Next, we adjust underwriting experience by net $60 million, as we normalize for fourth quarter experience and expect seasonality in the first quarter. And last, we expect other items to increase adjusted operating income by $91 million, primarily due to seasonally elevated expenses in the fourth quarter.

These items combined get us to a baseline of $3.01 per share for the first quarter. I’ll note that if you exclude items specific to the first quarter, earnings per share would be $3.07. The key takeaway is that, our underlying earnings power has improved due to the business growth and the benefit of higher interest rates. While we have provided these items to consider, please note that there may be other factors that affect earnings per share in the first quarter. As we as we look forward, we have included other considerations for 2023 in the appendix. Turning to slide 11. I’ll now provide an update on the adoption of the new accounting standard for long duration insurance contracts which went into effect on January 1. The new standard applies to our GAAP financial statements and will have no direct effect on our statutory financial statements, cash flows or dividend capacity.

We estimate that as of September 30, 2022, GAAP equity will increase by approximately $15 billion comprised of two components. Accumulated other comprehensive income, or AOCI, will increase by approximately $17 billion, primarily due to remeasurement of long duration liabilities with higher discount rates in our Japan business. Retained earnings will be reduced by approximately $2 billion, reflecting the reclassification of non-performance risk gains from retained earnings AOCI and other changes in reserves. Also of note, GAAP equity will continue to exclude certain unrealized insurance margins from products subject to LDTI. As of September 30, 2022, the estimated after-tax unrealized insurance margins related to those products are approximately $50 billion, primarily in our Japan business.

These margins are an important factor in determining financial strength and assessing profitability. And finally, we do not expect significant impacts from LDTI on our total underlying earnings power, as impacts across our businesses will largely offset. Turning to slide 12. Our capital position continues to support our AA financial strength rating. Our cash and liquid assets were $4.5 billion, at the high end of our liquidity target range. We have substantial off-balance sheet resources, including contingent capital and liquidity facilities. We remain thoughtful in our capital deployment, balancing the preservation of financial strength, investment in our businesses and shareholder distributions. Turning to slide 13 and in summary. We are transforming our businesses for sustainable growth.

We exceeded our targeted cost savings one year ahead of plan and will maintain our discipline and continuous improvement mindset going forward. We continue to navigate the current macro environment with the financial strength of our rock solid balance sheet. Now, I’ll turn it to the operator for your questions.

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. Our first question today is coming from Erik Bass from Autonomous Research. Your line is now live.

Erik Bass: Hi. Thank you. Just hoping you could talk a bit more about how you’re viewing excess capital. If we look at the pieces you provide, the pike RBC ratio is below the 400% level where it’s run historically, I think the SMR ratio looks in line and Holdco liquidity is within your target range, but at the low end, if we adjust for the planned debt call that you talked about on the last call. So if this suggests a little excess capital, but are there other pieces or sources that we should be considering?

Ken Tanji: Yeah. Hey, Erik, it’s Ken. Overall, we do feel good about our overall capital picture in multiple parts, as you suggest, but I thought it might be helpful to give a little bit of an overall context for our capital management. We’ve had a very well-established and consistent approach. And we’ve served us very well particularly last year as we look to shift our business to be less market-sensitive and grow, while also maintaining financial strength and the flexibility. We closed the sales of our full service business and the PALAC variable annuity block last year that released capital at attractive terms. And we also deployed capital to the second largest PRT transaction with IBM. We also, as we mentioned and discussed on our last call, absorbed the capital impact of the assumption update in our life insurance business and the non-economic impact of higher rates on staffed capital.

Again, that was expected. It’s manageable, and we’ve appropriately addressed those capital implications. When you put that all together, we ended 2022 in a solid capital position. Our RBC ratios were above our AA objectives and our target there is to be above 3.75%. Our Japan solvency margin ratios are above their AA objectives. We have an HLA balance of $4.5 billion at the Holdco. And as you mentioned, that’s at the high end of our target range. And we have a healthy outlook for our businesses with sustained profitability and free cash flow, so that led our Board to authorize $1 billion of share repurchases for next year €“ or this year, actually, 2023, and that’s reflective of our capital position as we end 2022. That also considers the free cash flow outlook for our businesses and our opportunities to deploy capital and also the macro environment, whether that’s a potential for another recession or other stress events.

So again, when we put that all together, we feel good that we’re consistent with our AA objectives. We have a level of flexibility, and that’s what our board considered when they issued where they authorized $1 billion in share repurchases for this year and increased our dividend 4%, which, again, is the 15th straight year of dividend increases. So hopefully, I gave you a much broader answer there, but I hope that’s helpful context.

Erik Bass: Yes. Thank you. And then my second question was just hoping you could provide a bit more color on the company’s sensitivity to short-term interest rates, which it seems like has been a big uplift, particularly in the individual retirement business. Hoping to get a little bit of the sensitivity there. And then just wondering if it were to reverse and the Fed were to cut interest rates would then you see kind of the earnings pattern for individual retirement move back lower?