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PRUDENTIAL FINANCIAL INC – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE OF CONTENTS
Page
Overview 82
COVID-19 83
Regulatory Developments 84
C urrent Market Conditions 84
Impact of Changes in the Interest Rate Environment 84
Results of Operations 87
Consolidated Results of Operations 87
Segment Results of Operations 88
Segment Measures 90
Impact of Foreign Currency Exchange Rates 91
Accounting Policies & Pronouncements 93
Results of Operations by Segment 95
PGIM 95
U.S. Businesses 99
Retirement Strategies 100
Group Insurance 108
Individual Life 110
Assurance IQ 112
International Businesses 112
Corporate and Other 117
Divested and Run-off Businesses 117
Closed Block Division 118
Income Taxes 119
Experience-Rated Contractholder Liabilities, Assets Supporting Experience-Rated
Contractholder Liabilities and Other Related Investments
119
Valuation of Assets and Liabilities 121
General Account Investments 122
Liquidity and Capital Resources 143
Ratings 153
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") addresses the consolidated financial condition of Prudential
Financial, Inc. ("Prudential," "Prudential Financial ," "PFI," or "the Company")
as of September 30, 2022 , compared with December 31, 2021 , and its consolidated
results of operations for the three and nine months ended September 30, 2022 and
2021. You should read the following analysis of our consolidated financial
condition and results of operations in conjunction with the MD&A, the "Risk
Factors" section, and the audited Consolidated Financial Statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2021 ,
as well as the statements under "Forward-Looking Statements," and the Unaudited
Interim Consolidated Financial Statements included elsewhere in this Quarterly
Report on Form 10-Q.
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Table of Contents
OverviewPrudential Financial , a financial services leader with approximately$1.350 trillion of assets under management as ofSeptember 30, 2022 , has operations primarily inthe United States of America ("U.S."),Asia ,Europe andLatin America . Through our subsidiaries and affiliates, we offer a wide array of financial products and services, including life insurance, annuities, retirement solutions, mutual funds and investment management. We offer these products and services to individual and institutional customers through one of the largest distribution networks in the financial services industry. InOctober 2021 , we announced the creation of Retirement Strategies, a newU.S. business that would serve the retirement needs of both our institutional and individual customers by bringing the institutional investment and pension solutions offered through our Retirement business together with the financial solutions and capabilities of our Individual Annuities business. Commencing with the second quarter of 2022, this new structure has been fully operationalized; therefore, the results of our former Retirement segment (now known as the "Institutional Retirement Strategies" operating segment) and our former Individual Annuities segment (now known as the "Individual Retirement Strategies" operating segment) have been aggregated into the Retirement Strategies segment. Prior periods have been updated to conform to this new presentation. Our principal operations consist of PGIM (our global investment management business), ourU.S. Businesses (consisting of ourRetirement Strategies, Group Insurance, Individual Life and Assurance IQ businesses), our International Businesses, the Closed Block division, and our Corporate and Other operations. The Closed Block division is accounted for as a divested business that is reported separately from the Divested and Run-off Businesses that are included in Corporate and Other. Divested and Run-off Businesses consist of businesses that have been, or will be, sold or exited, including businesses that have been placed in wind-down status that do not qualify for "discontinued operations" accounting treatment under generally accepted accounting principles inthe United States of America ("U.S. GAAP"). Our Corporate and Other operations include corporate items and initiatives that are not allocated to business segments as well as the Divested and Run-off Businesses described above. We attribute financing costs to each segment based on the amount of financing used by each segment, excluding financing costs associated with corporate debt, which are reflected in our Corporate and Other operations. The net investment income of each segment includes earnings on the amount of capital that management believes is necessary to support the risks of that segment. Management expects that results will continue to benefit from our differentiated mix of market-leading businesses that complement each other to provide competitive advantages, earnings diversification and capital benefits from a balanced risk profile. We believe we are well-positioned to tap into market opportunities to meet the evolving needs of individual customers, workplace clients, and society at large. Our mix of high-quality protection, retirement and investment management businesses enables us to offer solutions that cover a broad range of financial needs and to engage with our clients through multiple channels, including the ability to sell solutions across a broad socio-economic spectrum through Assurance IQ's digital platform. We aim to expand our addressable market, build deeper and longer-lasting relationships with customers and clients, and meaningfully improve their financial wellness. In order to further increase our competitive advantage, we are working to enhance the experience of our customers and the capabilities of our businesses, which we expect will also help us realize improved margins. In 2019, we launched programs in pursuit of these objectives that have resulted and will continue to result in multi-year investments in technology, systems and employee reskilling, as well as severance and related charges. For the three and nine months endedSeptember 30, 2022 , we incurred approximately$39 million and$102 million of costs, respectively, in connection with these programs. We expect these programs will generate significant expense efficiencies over several years that will mitigate the impact from increases in other expenses due to inflation and business growth initiatives. For the three months and nine months endedSeptember 30, 2022 , the Company estimates that these programs generated cost savings of approximately$182 million and$526 million , respectively, and, as ofSeptember 30, 2022 , we have exceeded$750 million of annual run-rate cost savings, more than one year ahead of our targeted date. 82 -------------------------------------------------------------------------------- Table of Contents COVID-19
Since the first quarter of 2020, the COVID-19 pandemic has caused extreme stress
and disruption in the global economy and financial markets and elevated
mortality and morbidity for the global population. The COVID-19 pandemic
impacted our results of operations in the current period and is expected to
impact our results of operations in future periods.
The Company has taken several measures to manage the impacts of this crisis. The actual and expected impacts of these events and other items are included in the following update: •Outlook.U.S. Businesses:
Specific outlook considerations for certain of our
following:
Retirement Strategies. As many of the products in our Institutional Retirement
Strategies business assume longevity risk, elevated levels of mortality
resulting from COVID-19 may contribute to higher levels of underwriting gains.
Group Insurance . COVID-19 may contribute to elevated levels of mortality, which would result in increased life insurance claims. In addition, we continue to monitor the potential impact of the pandemic on our disability business, overall sales volumes, and the utilization of our workplace benefit offerings.
Individual Life. COVID-19 may contribute to elevated levels of mortality,
resulting in increased life insurance claims.
International Businesses:
Our Japanese operations have experienced an elevated level of COVID-19 claims through the first nine months of 2022 due to the continued spread of the virus, including a significant increase in incidence in the third quarter. Most of these claims relate to regulatory guidance that extends hospitalization benefits for at-home recoveries from COVID-19; however, a recent industry-wide revision, effective in late September, now limits these benefits to only certain high-risk individuals. Additionally, we continued to experience modest disruptions to sales and agent recruiting inJapan . The situation remains fluid and COVID-19 might impact future claims, sales and recruiting. We believe our needs-based selling and death protection focus are even more valuable to consumers based on the global experience of COVID-19 and will help support the continued long-term growth of our businesses. •Results of Operations. See "-Results of Operations" and "-Results of Operations by Segment" for a discussion of results for the third quarter and the first nine months of 2022. •Investment Portfolio. Credit migration and defaults were low in 2021 and have remained limited in 2022. We continue to monitor our portfolio for potential credit issues and opportunities as part of our overall portfolio and risk management process.
•Sales and Flows. See "-Segment Results of Operations" for a discussion of sales
and flows in each of our segments.
•Underwriting. Throughout the pandemic, COVID-19 had a significant net negative impact on our underwriting results, reflecting unfavorable mortality and morbidity impacts in ourGroup Insurance , Individual Life and International businesses, partially offset by favorable mortality impacts in the Institutional portion of our Retirement Strategies business. Beginning with the third quarter of 2022, the Company has embedded COVID-19 considerations within its best estimate assumptions of future expected mortality impacts for its applicable businesses. The ultimate impact on our underwriting results, however, will continue to depend on various factors including: an insured's age; geographic concentration; insured versus uninsured populations among the fatalities; the transmissibility and virulence of the virus, including the potential for further mutation; and the ongoing acceptance and efficacy of the vaccines and other therapeutics. •Risk Management. Prudential has a robust risk management framework that seeks to ensure we can fulfill our customer, regulatory, and other stakeholder obligations under a range of stress scenarios by maintaining the appropriate balance between the Company's resources and risks. We evaluate the Company's exposure to stress under four lenses (economic, STAT, GAAP, and liquidity). 83 -------------------------------------------------------------------------------- Table of Contents Our risk management framework incorporates severe to very severe stresses across equities, interest rates, credit migration and defaults, currencies and mortality. This framework includes a specific "pandemic and sell-off" scenario with a mortality calamity (1.5 extra deaths per 1,000 lives in the first year) based on a modern-day interpretation of the 1918 Spanish Flu experience that is aligned with most regulatory frameworks. The stress scenario assumes an even distribution of increased mortality across the population, which is more adversely impactful to the Company than our current understanding of COVID-19 mortality, which is skewed toward older ages. As the COVID-19 pandemic continues to unfold, we continue to update our analysis and take management actions in response to this specific event. As ofSeptember 30, 2022 , the COVID-19 pandemic has not reached the most severe levels of financial impacts included in the Company's stress testing. In addition, the net mortality impact of COVID-19 has been moderated by the balance between our mortality exposure (such as in ourIndividual Life and Group Insurance businesses) and our offsetting longevity exposure (such as in our Institutional Retirement Strategies business), and is influenced by the age distribution ofU.S. COVID-19 mortality. The future evolution of the virus, among other factors, could cause the actual course of the pandemic to differ from our current expectations. •Risk Factors. The COVID-19 pandemic has adversely impacted our results of operations, financial position, investment portfolio, new business opportunities and operations, and these impacts are expected to continue. For additional information on the risks to our business posed by the COVID-19 pandemic, see "Risk Factors" included in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 . •Business Continuity. Throughout the COVID-19 pandemic, we have been executing our business continuity protocols to ensure our employees are safe and able to serve our customers. This included effectively transitioning the vast majority of our employees to remote work arrangements. InMarch 2022 , our offices were reopened to employees and most of our workforce has adopted a hybrid work arrangement. We believe all of our businesses can sustain long-term hybrid or fully remote work arrangements while ensuring that critical business operations are sustained. In addition, we are managing COVID-19 related impacts on third-party provided services, and do not anticipate significant interruption in critical operations.
Regulatory Developments
Inflation Reduction Act. OnAugust 16, 2022 ,President Biden signed into law the Inflation Reduction Act of 2022 (the "Inflation Reduction Act"). Among other provisions, the Inflation Reduction Act imposes (1) a 15% book-income alternative minimum tax on corporations with average applicable financial statement income over$1 billion for any three-year period ending with 2022 or later; and (2) a 1% excise tax on the fair market value of stock that is repurchased by publicly tradedU.S. corporations or their specified affiliates. Both provisions are effective in taxable years beginning afterDecember 31, 2022 . The impact of the book-income alternative minimum tax, if any, will vary from year to year based on the relationship of our GAAP income to our taxable income. Current Market Conditions Geopolitical risk, rapidly rising interest rates and significant equity market declines, as we have seen this year, among other factors, adversely impact our liquidity and capital positions, cash flows, results of operations, and financial position. The statutory capital of certain of our insurance subsidiaries will also be negatively affected by increased reserve requirements due to our annual update of actuarial assumptions and other refinements, particularly in our Individual Life business, and may be negatively affected by asymmetrical and non-economic statutory accounting impacts from rising rates. As we navigate through the current environment, we may take actions consistent with our risk and capital frameworks, as necessary, to preserve our liquidity and capital positions. Such actions may include, among other things, accessing off-balance sheet resources and/or suspending our share repurchase program.
Impact of Changes in the Interest Rate Environment
As a global financial services company, market interest rates are a key driver
of our liquidity and capital positions, cash flows, results of operations and
financial position. Changes in interest rates can affect these in several ways,
including favorable or adverse impacts to:
•investment-related activity, including: investment income returns, net
investment spread results, new money rates, mortgage loan prepayments and bond
redemptions;
•the valuation of fixed income investments and derivative instruments;
•collateral posting requirements, hedging costs and other risk mitigation
activities;
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Table of Contents
•customer account values and assets under management, including their impacts on
fee-related income;
•insurance reserve levels, market experience true-ups and amortization of both
deferred policy acquisition costs ("DAC") and value of business acquired
("VOBA");
•policyholder behavior, including surrender or withdrawal activity;
•product offerings, design features, crediting rates and sales mix; and
•the fair value of, and possible impairments on, intangible assets such as
goodwill.
See "-Current Market Conditions" above, for how rapidly rising interest rates,
among other factors, adversely impact the Company's financial results.
For more information on interest rate risks, see "Risk Factors-Market Risk"
included in our Annual Report on Form 10-K for the year ended
See below for a discussion of the current interest rate environment and its
impact to net investment spread in our
the composition of their insurance liabilities and policyholder account
balances.
While interest rates in the
historically low levels in recent years, rates have increased throughout 2022
and our average reinvestment yield is generally now exceeding our current
average portfolio yield.
In order to manage the impacts that changes in interest rates have on our net investment spread, we employ a proactive asset/liability management program, which includes strategic asset allocation and hedging strategies within a disciplined risk management framework. These strategies seek to match the characteristics of our products, and to closely approximate the interest rate sensitivity of the assets with the estimated interest rate sensitivity of the product liabilities. Our asset/liability management program also helps manage duration gaps, currency and other risks between assets and liabilities through the use of derivatives. We adjust this dynamic process as products change, as customer behavior changes and as changes in the market environment occur. As a result, our asset/liability management process has permitted us to manage the interest rate risk associated with our products through several market cycles. Our interest rate exposure is also mitigated by our business mix, which includes lines of business for which fee-based and insurance underwriting earnings play a more prominent role in product profitability. We also regularly examine our product offerings and their profitability. As a result, we may reprice certain products and discontinue sales of other products that do not meet our profit expectations. The portion of the general account supporting ourU.S. Businesses and our Corporate and Other operations has approximately$169 billion of fixed maturity securities and commercial mortgage loans (based on net carrying value) as ofSeptember 30, 2022 , with an average portfolio yield of approximately 4.1%. For the portion of the general account attributable to these operations, we estimate annual principal payments and prepayments that we would be required to reinvest to be approximately 6.4% of the fixed maturity security and commercial mortgage loan portfolios through 2023. Included in the$169 billion of fixed maturity securities and commercial mortgage loans are approximately$133 billion that are subject to call or redemption features at the issuer's option and have a weighted average interest rate of approximately 4%. Of this$133 billion , approximately 54% contain provisions for prepayment premiums. Future operating results will be impacted by (i) the reinvestment of scheduled payments or prepayments (not subject to a prepayment fee) at different rates compared to the current portfolio yield, including in some cases at rates below those guaranteed under our insurance contracts, and (ii) our utilization of other asset/liability management strategies, as described above, in order to maintain favorable net investment spread. The following table sets forth the insurance liabilities and policyholder account balances of ourU.S. operations excluding the Closed Block Division, by type, for the date indicated: As of September 30, 2022 (in billions) Long-duration insurance products with fixed and guaranteed terms $ 146
Contracts with adjustable crediting rates subject to guaranteed minimums
36
Participating contracts where investment income risk ultimately accrues to
contractholders 2
Total $ 184
85
-------------------------------------------------------------------------------- Table of Contents The$146 billion above relates to long-duration products such as group annuities, structured settlements and other insurance products that have fixed and guaranteed terms. We seek to manage the impact of changes in interest rates on these contracts through asset/liability management, as discussed above. The$36 billion above relates to contracts with crediting rates that may be adjusted over the life of the contract, subject to guaranteed minimums. Although we may have the ability to lower crediting rates for those contracts above guaranteed minimums, our willingness to do so may be limited by competitive pressures. The following table sets forth the related account values by range of guaranteed minimum crediting rates and the related range of the difference, in basis points ("bps"), between rates being credited to contractholders as ofSeptember 30, 2022 , and the respective guaranteed minimums. Account Values with
Adjustable Crediting Rates Subject to Guaranteed Minimums:
Greater than
1-49 50-99 100-150 150
At bps above bps above bps above bps above
guaranteed guaranteed guaranteed guaranteed guaranteed
minimum minimum minimum minimum minimum Total
($ in billions)
Range of Guaranteed Minimum
Crediting Rates:
Less than 1.00% $ 1.0 $ 0.8 $ 0.1 $ 0.0 $ 0.0 $ 1.9
1.00% - 1.99% 1.3 0.1 0.0 0.8 2.5 4.7
2.00% - 2.99% 1.1 0.0 1.6 1.5 2.9 7.1
3.00% - 4.00% 18.8 0.0 1.8 0.5 0.1 21.2
Greater than 4.00% 0.8 0.0 0.0 0.0 0.0 0.8
Total(1) $ 23.0 $ 0.9 $ 3.5 $ 2.8 $ 5.5 $ 35.7
Percentage of total 64 % 3 % 10 % 8 % 15 % 100 %
__________
(1)Includes approximately
market value adjustment if the invested amount is not held to maturity.
The remaining$2 billion of insurance liabilities and policyholder account balances in these operations relates to participating contracts for which the investment income risk is expected to ultimately accrue to contractholders. The crediting rates for these contracts are periodically adjusted based on the return earned on the related assets.
Closed Block Division
Substantially all of the$48 billion of general account assets in the Closed Block division support obligations and liabilities relating to the Closed Block policies only. See Note 7 to the Unaudited Interim Consolidated Financial Statements for additional information on the Closed Block.
Japanese Operations
Japan has experienced a low interest rate environment for many years and, in recent years, the Bank of Japan's monetary policy has resulted in even lower and, at times, negative yields for certain tenors of government bonds. In order to manage, to the extent possible, the impact that the current interest rate environment has on our net investment spread, our Japanese operations employ a proactive asset/liability management program. In conjunction with this program, we have not purchased negative yielding assets to support the portfolio and we continue to purchase long-term bonds with tenors of 30 years or greater. We also regularly examine our product offerings and their profitability. As a result, we may reprice certain products, adjust commissions for certain products and discontinue sales of other products that do not meet our profit expectations. Additionally, our diverse product portfolio in terms of currency mix and premium payment structure allows us to further manage any impacts from changes in the interest rate environment. Our Japanese operations have continued to invest inU.S. dollar-denominated assets supporting ourU.S. product portfolio, which has now driven average reinvestment rates to exceed current average portfolio rates. For additional information on sales within these operations, see "-International Businesses-Sales Results," below. The portion of the general account supporting our Japanese operations has approximately$148 billion of fixed maturity securities and commercial mortgage loans (based on net carrying value) as ofSeptember 30, 2022 , with an average portfolio yield of approximately 3.5%. For the portion of the general account attributable to these operations, we estimate annual 86 -------------------------------------------------------------------------------- Table of Contents principal payments and prepayments that we would be required to reinvest to be approximately 5% of the fixed maturity security and commercial mortgage loan portfolios through 2023. Included in the$148 billion of fixed maturity securities and commercial mortgage loans are approximately$17 billion that are subject to call or redemption features at the issuer's option and have a weighted average interest rate of approximately 4%. Of this$17 billion , approximately 7% contain provisions for prepayment premiums. Future operating results will be impacted by (i) the reinvestment of scheduled payments or prepayments (not subject to a prepayment fee) at different rates compared to the current portfolio yield, including in some cases at rates below those guaranteed under our insurance contracts, and (ii) our utilization of other asset/liability management strategies, as described above, in order to maintain favorable net investment spread. The following table sets forth the insurance liabilities and policyholder account balances of our Japanese operations, by type, for the date indicated: As of September 30, 2022 (in billions) Insurance products with fixed and guaranteed terms $ 123
Contracts with a market value adjustment if invested amount is not held to
maturity
24
Contracts with adjustable crediting rates subject to guaranteed minimums
9 Total $ 156 The$123 billion is primarily comprised of long-duration insurance products that have fixed and guaranteed terms for which underlying assets may have to be reinvested at interest rates that are lower than current portfolio yields. The remaining insurance liabilities and policyholder account balances include$24 billion related to contracts that impose a market value adjustment if the invested amount is not held to maturity and$9 billion related to contracts with crediting rates that may be adjusted over the life of the contract, subject to guaranteed minimums. Most of the current crediting rates on these contracts, however, are at or near contractual minimums. Although we have the ability in some cases to lower crediting rates for those contracts that are above guaranteed minimum crediting rates, the majority of this business has interest crediting rates that are determined by formula.
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