PRUDENTIAL FINANCIAL INC – 10-Q – MANAGEMENT REPORT ON THE FINANCIAL POSITION AND OPERATING RESULTS
TABLE OF CONTENTS Page Overview 80 COVID-19 80 Impact of a Low Interest Rate Environment 82 Results of Operations 85 Consolidated Results of Operations 85 Segment Results of Operations 86 Segment Measures 88 Impact of Foreign Currency Exchange Rates 89 Accounting Policies & Pronouncements 92 Results of Operations by Segment 93 PGIM 93
U.S.Businesses 98 Retirement 99 Group Insurance100 Individual Annuities 102 Individual Life 108 Assurance IQ 110 International Businesses 110 Corporate and Other 116 Divested and Run-off Businesses 116 Closed Block Division 117 Income Taxes 119
Experience-rated policyholder liabilities, experience-rated support assets
Liabilities of policyholders and other related investments
119 Valuation of Assets and Liabilities 121 General Account Investments 123 Liquidity and Capital Resources 143 Ratings 154 Off-Balance Sheet Arrangements 155 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, 2021, compared with December 31, 2020, and its consolidated results of operations for the three and nine months ended September 30, 2021and 2020. 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, 2020, 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. 79
Prudential Financial, a financial services leader with approximately $1.727 trillionof assets under management as of September 30, 2021, has operations primarily in the United States of America("U.S."), Asia, Europeand Latin America. Through our subsidiaries and affiliates, we offer a wide array of financial products and services, including life insurance, annuities, retirement-related services, 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. Our principal operations consist of PGIM (our global investment management business), our U.S.Businesses (consisting of our Retirement, Group Insurance, Individual Annuities, 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 in the 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. In October 2021, we announced the creation of Retirement Strategies, a new U.S.business that will serve the retirement needs of both individual and institutional customers. This business will bring the financial solutions and capabilities of our Individual Annuities business together with the institutional investment and pension solutions offered through our Retirement business. During the fourth quarter of 2021, the new leadership team is being assembled and will be making decisions around the business's operating structure. When this new structure is finalized and operational, the presentation of our segment results may be modified to conform to this new structure. 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. While challenges exist in the form of a low interest rate environment (see "Impact of a Low Interest Rate Environment" below), fee compression in certain of our businesses and other market factors, we expect that our businesses will produce appropriate returns for the current market environment. 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 will result in multi-year investments in technology, systems and employee reskilling, as well as severance and related charges, which we expect will result in significant expense efficiencies over the next several years. For the three and nine months ended September 30, 2021, the Company estimates that the impact to results from these programs was a benefit of $146 millionand $388 million, respectively, and, as of September 30, 2021, we continue to remain on track to accumulate approximately $750 millionof annual run-rate cost savings by the end of 2023.
Since the first quarter of 2020, the novel coronavirus ("COVID-19") has created extreme stress and disruption in the global economy and financial markets and has elevated mortality and morbidity experience for the global population. The COVID-19 pandemic continues to impact our results of operations in the current period and is expected to continue to impact our results of operations in future periods. The COVID-19 pandemic has moved in localized waves, with its impact worsening and then improving in different locations at different times in a repetitive but unpredictable pattern. During the third quarter of 2021, the mortality impacts to our businesses from COVID-19 increased compared to the second quarter. 80 -------------------------------------------------------------------------------- Table of Contents 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: The risk of hospitalization and death from COVID-19 and its variants to date has been greatly reduced as several vaccines are now widely available in the U.S.The vaccine rollout continues (with approximately 80% of the U.S.adult population receiving at least one dose) and other therapeutics are available now, or soon will be. Nevertheless, transmission of the virus persists and in certain geographies remains high. Although the pandemic worsened in the U.S.during the third quarter of 2021, with deaths peaking in mid-September, the Company has seen impacts begin to moderate and the trend of the pandemic's impacts on our U.S.Businesses may continue to improve as population immunity from vaccination or prior infection increases and treatment options for COVID-19 patients expand.
Specific considerations on the outlook for some of our
Retirement. Given that many of the products in our institutional investment products business assume longevity risk, elevated levels of mortality resulting from COVID-19 may continue to contribute to a higher level of underwriting gains; however, high vaccination rates among pensioners in both the
U.S.and the U.K.suggest that mortality rates will continue to normalize toward pre-pandemic mortality levels. The pandemic may also impact sales volumes. Group Insurance. We expect COVID-19 to continue to contribute to elevated levels of mortality resulting in increased life insurance claims in the near-term. In addition, we expect elevated unemployment to drive increased disability claims in this business. The pandemic may also impact sales volumes and the utilization of workplace benefits. Individual Life. We expect COVID-19 to continue to contribute to elevated levels of mortality, resulting in increased life insurance claims in the near-term. The pandemic may also impact sales volumes.
Through the first nine months of 2021, we continued to see an elevated level of claims due to COVID-19, with the most material impacts in
Braziland Japan; however, expenses to support our captive agents have decreased significantly compared to 2020. Japandeclared a series of COVID-19 driven states of emergency in 2021 across various prefectures, but lifted these restrictions in September. We continue to see signs of improvement based on the global increase in vaccination rates and decreased levels of mortality in all key markets; however, as the global pandemic continues to evolve, any further implementation or tightening of COVID-19 restrictions is possible and, depending on the specific circumstances and geographies impacted, could adversely impact our sales prospects for a period of time. 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 2021. •Investment Portfolio. While the economy continues to re-open and recover from the impacts of COVID-19, there could still be periods of volatility. The market expectations for credit migration and related losses continue to decrease. The sectors most impacted by the pandemic, including energy, consumer cyclical and retail related investments, have started to recover but may lag the general economic improvement. In certain instances, the Company may agree to modify an investment to provide forbearance, which grants borrowers additional time to make payments. As of September 30, 2021, approximately 1.6% of total invested assets, including those held for sale, were modified to allow for limited forbearance. Under the terms of forbearance, the borrower is allowed to defer a portion of current year principal and/or interest payments for a short period (e.g., 6 months). These deferrals accrue additional interest and do not have a material impact on our investment value.
• Sales and Flows. See “- Segment Operating Results” for a discussion of sales.
and flows in each of our segments.
•Underwriting Results. Through the first nine months of 2021, we estimate that COVID-19 had a net negative impact on our underwriting results reflecting unfavorable mortality impacts in our
Group Insurance, Individual Life and International businesses, partially offset by favorable mortality impacts in our Retirement business. For the fourth 81 -------------------------------------------------------------------------------- Table of Contents quarter of 2021, the Company expects underwriting results to be adversely impacted by approximately $185 millionin our U.S.Businesses, predominantly in our Group Insurancebusiness, and approximately $20 millionin our International Businesses; however, the ultimate impact on our underwriting results will depend on factors such as: 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). Our risk management framework incorporates severe to very severe stresses across equities, interest rates, credit migration and defaults, currencies and pandemics. This framework includes a specific "pandemic and sell-off" scenario with a mortality calamity (1.5 extra insured 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 our business than our current understanding of COVID-19 mortality. 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 of September 30, 2021, 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 impact of COVID-19 has been moderated by the balance between our mortality exposure (such as in our Individual Life and Group Insurancebusinesses) and our offsetting longevity exposure (such as in our Retirement business). •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 ended December 31, 2020. •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. We believe all of our businesses can sustain remote work and social distancing for an indefinite period 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.
Impact of a low interest rate environment
As a global financial services company, market interest rates are a key driver of our results of operations and financial condition. Changes in interest rates can affect our results of operations and/or our financial condition in several ways, including favorable or adverse impacts to: •investment-related activity, including: investment income returns, net interest margins, net investment spread results, new money rates, mortgage loan prepayments and bond redemptions; •hedging costs and other risk mitigation activities; •insurance reserve levels, market experience true-ups and amortization of both deferred policy acquisition costs ("DAC") and value of business acquired ("VOBA"); •customer account values, including their impact on fee income; •fair value of, and possible impairments on, intangible assets such as goodwill; •product offerings, design features, crediting rates and sales mix; and •policyholder behavior, including surrender or withdrawal activity.
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 discussions related to the current interest rate environments in our two largest markets, the
U.S.and Japan; the composition of our insurance liabilities and policyholder account balances; and the hypothetical impacts to our investment related results if these interest rate environments are sustained. 82
Interest rates in the
U.S.have experienced a sustained period of historically low levels with certain benchmarks reaching significant lows. While market conditions and events make uncertain the timing, amount and impact of any monetary policy decisions by the Federal Reserve, changes in interest rates may impact our reinvestment yields, primarily for our investments in fixed maturity securities and commercial mortgage loans. As interest rates decline, our reinvestment yield may be below our overall portfolio yield, resulting in an unfavorable impact to earnings. Conversely, as interest rates rise, our reinvestment yield may exceed the overall portfolio yield resulting in a favorable impact to earnings. For the general account supporting our U.S.Businesses and our Corporate and Other operations, we estimate annual principal payments and prepayments that we would be required to reinvest to be approximately 7.0% of the fixed maturity security and commercial mortgage loan portfolios through 2022. The portion of the general account attributable to these operations has approximately $240 billionof such assets (based on net carrying value and including assets classified as "held-for-sale") as of September 30, 2021. The average portfolio yield for fixed maturity securities and commercial mortgage loans is approximately 3.8% as of September 30, 2021. Included in the $240 billionof fixed maturity securities and commercial mortgage loans are approximately $177 billionthat are subject to call or redemption features at the issuer's option and have a weighted average interest rate of approximately 4%. Of this $177 billion, approximately 51% contain provisions for prepayment premiums. If we reinvest scheduled payments or prepayments (not subject to a prepayment fee) at rates below the current portfolio yield, including in some cases at rates below those guaranteed under our insurance contracts, future operating results will be impacted to the extent we do not, or are unable to, reduce crediting rates on in-force blocks of business, or effectively utilize other asset/liability management strategies described below, in order to maintain current net interest margins. The following table sets forth the insurance liabilities and policyholder account balances of our U.S.operations excluding the Closed Block Division, by type, for the date indicated: As of September 30, 2021 (in billions) Long-duration insurance products with fixed and guaranteed terms $ 153
Adjustable credit rate contracts subject to guaranteed minimums
61 Participating contracts where investment income risk ultimately accrues to contractholders 14 Total $ 228 The
$153 billionabove relates to long-duration products such as group annuities, structured settlements and other insurance products that have fixed and guaranteed terms, for which underlying assets may have to be reinvested at interest rates that are lower than portfolio rates. We seek to mitigate the impact of a prolonged low interest rate environment on these contracts through asset/liability management, as discussed further below. The $61 billionabove relates to contracts with crediting rates that may be adjusted over the life of the contract, subject to guaranteed minimums. Although we may have the ability to lower crediting rates for those contracts above guaranteed minimums, our willingness to do so may be limited by competitive pressures. The following table sets forth the related account values by range of guaranteed minimum crediting rates and the related range of the difference, in basis points ("bps"), between rates being credited to contractholders as of September 30, 2021, and the respective guaranteed minimums. 83
Account Values with
Adjustable credit rates subject to guaranteed minimums:
Greater than 1-49 50-99 100-150 150 At bps above bps above bps above bps above guaranteed guaranteed guaranteed guaranteed guaranteed minimum minimum minimum minimum minimum Total ($ in billions) Range of Guaranteed Minimum Crediting Rates: Less than 1.00%
$ 1.1 $ 1.1 $ 0.1 $ 0.0 $ 0.0 $ 2.31.00% - 1.99% 5.6 12.1 1.9 1.7 1.4 22.7 2.00% - 2.99% 1.3 1.1 0.5 2.4 1.6 6.9 3.00% - 4.00% 26.0 2.1 0.2 0.3 0.0 28.6 Greater than 4.00% 0.9 0.0 0.0 0.0 0.0 0.9 Total(1) $ 34.9 $ 16.4 $ 2.7 $ 4.4 $ 3.0 $ 61.4Percentage of total 57 % 27 % 4 % 7 % 5 % 100 % __________
(1) Includes approx.
value adjustment if the amount invested is not held to maturity.
$14 billionof 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. Assuming a hypothetical scenario where the average 10-year U.S. Treasuryrate is 1.50% (which is reasonably consistent with recent rates) for the period from October 1, 2021through September 30, 2022(and credit spreads remain unchanged from average levels experienced during the third quarter 2021), we estimate that the unfavorable impact to net investment income of reinvesting activities, including scheduled maturities and estimated prepayments of fixed maturities and commercial mortgage and other loans (excluding assets supporting participating contracts), would be between $50 millionand $80 millionfor the period from October 1, 2021through September 30, 2022. In order to mitigate the unfavorable impact that a low interest rate environment has on our net interest margins, 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. Closed Block Division Substantially all of the $58 billionof 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.
International insurance operations
While our international insurance operations have experienced a low interest rate environment for many years, the current reinvestment yields for certain blocks of business in our international insurance operations are generally lower than the current portfolio yield supporting these blocks of business. 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. Our international insurance operations employ a proactive asset/liability management program in order to mitigate, to the extent possible, the unfavorable impact that the current interest rate environment has on our net interest margins. 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. Additionally, our diverse product portfolio in terms of currency mix and premium payment structure allows us to further mitigate the negative impact from this low interest rate environment. 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 84 -------------------------------------------------------------------------------- Table of Contents other products that do not meet our profit expectations. The impact of these actions and the introduction of certain new products has resulted in an increase in sales of
U.S.dollar-denominated products relative to products denominated in other currencies. For additional information on sales within our international insurance operations, see "-International Businesses-Sales Results," below. 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, 2021 (in billions) Insurance products with fixed and guaranteed terms $ 140
Contracts with market value adjustment if the amount invested is not held
Adjustable credit rate contracts subject to guaranteed minimums
11 Total $ 176 The
$140 billionis 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 $25 billionrelated to contracts that impose a market value adjustment if the invested amount is not held to maturity and $11 billionrelated 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. Assuming a hypothetical scenario where the average 30-year Japanese Government Bond yield is 0.65% and the 10-year U.S. Treasuryrate is 1.50% (which is reasonably consistent with recent rates) for the period from October 1, 2021through September 30, 2022(and credit spreads remain unchanged from average levels experienced during the third quarter 2021), we estimate that the unfavorable impact to net investment income of reinvesting activities, including scheduled maturities and estimated prepayments of fixed maturities and commercial mortgage and other loans (excluding assets supporting participating contracts), would be between $20 millionand $40 millionfor the period from October 1, 2021through September 30, 2022.