Prudential Financial: Declining Interest Rates Resulted in Lower Excess Capital Than Expected
February 5, 2015 by Fran Matso Lysiak, senior associate editor, BestWeek: fran.lysiak@ambest.com
NEWARK, N.J. – Prudential Financial Inc. executives said declining interest rates impacted its excess capital position after equity analysts questioned why it was $1.5 billion lower than the $3.5 billion the company estimated in December.
During the fourth-quarter earnings conference call, a few equity analysts questioned areas such as Prudential’s debt, balance sheet or excess capital.
John Nadel, an equity analyst with Sterne Agee, titled a research note as: “How Do You Lose $1.5b of Excess Capital in Two Months?”
“This is the key question for the conference call, even beyond the weaker level of earnings in 4Q14,” Nadel wrote. “In December, [Prudential] estimated its pro forma ‘on balance sheet capital capacity’ post the closed block transaction would end 2014 at $3.5 billion.”
Chief Financial Officer Robert Falzon said Prudential manages a portion of its variable annuity interest rate risk through a broader capital protection framework, which includes an underhedge position.
“As interest rates declined, a negative impact on the underhedge triggered a change in the required capital causing a funding need that we satisfied with holding company resources,” Falzon said. Also, the decline in interest rates through the quarter caused a higher statutory provision based on year-end asset adequacy testing.
Mark Grier, vice chairman of Prudential, noted that in the annuities business, the decline in interest rates and less favorable performance of separate account funds relative to our expectations, caused Prudential to strengthen reserves and adjust deferred policy acquisition costs for guaranteed minimum death and income benefits, resulting in a charge of 10 cents a share.
As Prudential mentioned in its earnings guidance call in December, “we’ve implemented a new reporting structure in Japan that will largely mitigate the impact of these currency exchange rate changes on net income or loss beginning with the first quarter 2015 reporting,” Grier said.
Total debt in the company has been coming down “as we have intended,” Grier said. “However, lower interest rates have resulted in the increase in the amount of debt that we characterize as capital.”
Also, Prudential’s stated capital capacity of $2 billion reflects the impact of repaying about $2 billion in debt, “which we haven’t done,” Grier said. “In the past, we would not have earmarked a portion of capital to repay debt,” he said. Compared to how Prudential would have portrayed capital capacity in the past, “our current number would be about $4 billion,” he said.
“We believe that this is a responsible way to describe capital capacity, understanding that any capital statements necessarily are influenced by underlying assumptions,” Grier said, who added Prudential’s hedges on the yen of $2.4 billion aren’t reflected in its capital numbers “and represents a substantial offset to other market-driven effects.”
Falzon said while statutory results for 2014 are not yet final, Prudential estimates that RBC for Prudential Insurance as of year-end 2014 will be above 400%, consistent with the estimate the company provided in December. This year-end RBC position reflects a $2 billion dividend from Prudential Insurance to the parent company in December, Falzon said.
As to Prudential’s overall capital position, the company calculates it on-balance sheet capital capacity by comparing the statutory capital position of Prudential Insurance to its 400% RBC ratio target, and then add capital capacity held at the parent company and other subsidiaries, Falzon said.
At year-end 2014, Prudential estimates its available on balance sheet capital capacity at $2 billion, with the vast majority considered readily deployable based on how the company has defined that figure in the past, Falzon said. Capital capacity is net of capital the company anticipates using to pay down debt, calibrated to arrive at its long-term targeted leverage ratio of 25%.
Absent this assumption, Prudential’s total capital capacity would be about $4 billion, Falzon said. Prudential’s on-balance sheet capital capacity is lower than the estimate for the year and 2014 that it provided in its 2015 guidance call in December. “The variance is mainly due to the decline in interest rates that occurred in the fourth quarter,” Falzon said.
The company expects to be able to fund its “known or anticipated capital commitments” with the capital it expects to generate in its ongoing businesses, said Falzon.
Prudential Financial’s fourth-quarter 2014 net loss widened to $1.2 billion (Best’s News Service, Feb. 4, 2015). The final quarter of last year included a charge of $1.59 billion from a foreign currency exchange rate remeasurement, Prudential said.
This capital includes generating deployable capital equal to about 60% of its operating earning over time, and other positive items, including settlements to PFI in 2015 on the $2.4 billion fair value of its Japan capital hedge, Falzon said.
Grier said the GAAP net loss reflected the impact of a $2.4 billion pretax loss from foreign currency exchange rate remeasurement, driven by the weakening of the Japanese yen. This impact “largely offset” by corresponding adjustments to asset values that are included in accumulated other comprehensive income, which is outside of net income or loss, Grier said.
The second-largest U.S. life insurer swung to a profit for the full year. Prudential posted net income in 2014 of $1.5 billion, compared with a net loss of $713 million in 2013. “We are very comfortable with our financial strength, capital position and our capital plans,” Grier said.
Total revenues for the year jumped to $49.64 billion from $45.28 billion.
On the afternoon of Feb. 5, Prudential Financial’s (NYSE: PRU) stock was trading at $75.32 a share, down 5.72% from the previous close.
Prudential Insurance Company of America currently has a Best’s Financial Strength Rating of A+ (Superior)
