Q3 2019 Earnings Call
Ladies and gentlemen, thank you for standing by welcome to the potential quarterly earnings call.
At this time all lines are in the West and only mode. Later, we'll conduct a question and answer session instructions will be given to you at that time.
If you need assistance during the call today Press Star and then zero and an operator will assist you offline and as a reminder, today's conference call is being recorded.
I'd now like turn the top until were to Mr., Dan I read out. Please go ahead.
Thank you Cynthia good morning, and thank you for joining all recall representing credential on today's call, our Charlie Lowrey, Chairman and CEO , Bob Dallas, and Vice Chairman, Steve Pelletier head of U.S. businesses, along with a these Sullivan our next set of U.S. businesses.
Pfiester sort of international businesses.
Ken Tangi, Chief Financial Officer, and bought back so controller and principal accounting officer, well start with prepared remarks by Charlie Robyn Ken and then we will take your questions.
Today's presentation May include forward looking statement, it's possible that actual results may differ materially from the predictions we make today.
This presentation may include references to non-GAAP measure it for a reconciliation of such measures to the comparable GAAP measures under discussion of doctors that could cause actual results to differ materially from those into forward looking statement.
FEIBA slide titled forward, looking statements and non-GAAP measures in the appendix to today's presentation, which can be found on our website at Investor day credential Dot com.
Oh handed over to Charlie.
Thank you Dan Good morning, everyone and thank you for joining us today on this call.
Yesterday, we reported third quarter earnings per share of $3.22. We also reported a year to date or are we up 13%.
I'll begin by discussing our progress in executing our financial wellness strategy.
We are committed to delivering a broader set of financial wellness solutions to more people in new ways, leveraging our scale across multiple distribution channels and drawing on our expertise, including product development and asset management.
During the quarter, we took steps to expand our digital distribution capabilities through the announced acquisition of assurance I Q.
Fee based and capital light growth engine.
Assurances, a leading direct to consumer platform for financial wellness solutions that enables us to serve a different demographic segment, including the Macedon middle markets.
Overtime, we believe we can expand these capabilities internationally.
The insurance acquisition, which closed in October also provides attractive financial benefits and significant upside potential.
Assurance shares our purpose of solving the financial challenges of changing world, which is at the core of who we are in that same I'm pleased to note that fortune. His name credential to its prestigious change the world list for a second consecutive year.
We also made progress in the quarter towards our margin expansion goals by evolving and transforming the way we do business across the organization.
Along these lines, we launched a voluntary separation program in October for segments of our U.S. workforce.
These efforts are intended to better position us to meet the needs of our customers, while driving greater speed and efficiency.
Finally, we continue to advance our efforts to reduce the impact of market fluctuations in and transparency to our quarterly financial performance as a result, beginning in the fourth quarter, our corporate and other results will be less affected by changes in the equity market and our own stock price.
Looking ahead, we're taking a very disciplined approach to pricing to help offset the impact of rates on new business profitability.
Which will have an obvious effect on some of our sales.
We are encouraged by our progress and are moving quickly and with conviction to implement the plans. We have set forward to deliver meaningful solutions and long term value to our customers and shareholders with that I'll turn it over to Rob for a closer look at our business performance for the quarter from Thank you Charlie I'll provide an update on how we were executing.
On our strategy to leverage our multichannel distribution product and asset management expertise scale does liver financial opportunity to go wider demographic within our U.S. financial wellness PGM and international businesses.
As shown on slide four U.S. fragile wellness currently represents our workplace and individual solutions Division.
Produced a diversified source of earnings from fees investment spread and underwriting income.
Beginning in the fourth quarter will also include fee based earnings from your assurance business earnings, which are not correlated to equity markets interest rates for credit.
We continue to execute our strategy to expand our addressable market.
Our financial wellness proposition is resonating with our workplace customers and with employees with those customers driving higher participation rates and the employer benefit programs and increased engagement with our advice platform.
The number of people who have activated our digital financial wellness platform has increased to 9 million as of September thirtyth.
This platform provides a digital thing you have to address a variety of needs, including education on financial wellness topics and assessment of financial health.
We're also growing individual relationships and expect to provide additional solutions to the employees or workplace customers as well as other retail customers.
One way we deliver these solutions is through link like Prudential, which is a highly interactive personalized online resource enables people to create a path toward achieving their financial goals.
Earlier this year, we began to deploy link on our workplace platform and we have already made it available to roughly 2.3 billion people.
We are on track to meet our goal of 2.5 million people by the end of the year.
Notably with the October closing up our acquisition of assurance, we have significantly expanded our addressable market with approximately 19 million individuals or actively seeking insurance solutions.
Short answer is direct to consumer platform at the end to end engagement model, which includes over 3000 agents.
I was asked to serve more people along the socio economic spectrum.
This platform will enable us to expand our range available solutions are workplace customers by adding third party provided health and property and casualty insurance as well as Medicare coverage.
We're also making progress streamlining our operations to increase agility, well driving efficiencies and enhancing the customer experience. We're on track to achieve 50 million in run rate margin expansion.
End of 2019 and expect this to increase to 500 million by the end of 2022.
This is being accomplished through a number of programs that we have underway.
And the current quarter, we incurred about 20 million of inflammation implementation costs to support these programs.
Shifting to a discussion of third quarter trends and the underlying fundamentals of our businesses I'll start with flows in the U.S. financial wellness.
This quarter, focusing on our retirement and to do with these businesses.
Our retirement business had net outflows of $2.7 billion driven by single large client lapse, our full service business.
As a partially offset by strong sales in the quarter as the market continues to be active including episodic large client activity.
The institutional investments business had net inflows of 600 they.
Including $3.6 billion of longevity risk transfer transactions.
Year to date, we have closed $17 billion of longevity reinsurance transactions and we have a strong pipeline.
This elevated deal activity is driven by our strong competitive positioning and innovation as well as by UK pension funds de risking ahead of Brexit.
Well, we did not close any funding CRT transactions in the third quarter and recent declines and interest rates have impacted the funding levels of these plans a fourth quarter has started well and we have a solid pipeline of pending transactions.
Our annuities business experienced $1.1 billion of net outflows driven by our bite normal countless roles as well as by elevated lapses certain contracts move out of the surrender period.
We expect this elevated level of lapses to persist through 2020 .
This was partially offset by an increase in sales, including the impact of watching to approve secure fixed indexed annuity last year and expanding into the IMO channel this quarter.
However, we expect the current low interest rate environment to continue to pressure sales.
Turning to slide five.
Our strategy and teach him our asset management business is to combine our multi manager model with global distribution and affiliated flows grow and higher value added strategies that serves investors globally.
Can you give us a top 10 global asset manager with $1.3 billion of assets under management. It ranks as the fifth largest investor in fixed income and the third largest investor and alternative investments with significant real estate and private investment platforms.
As the investment engine or Prudential it benefits from a symbiotic relationship with our U.S. financial wellness and international insurance businesses.
Pgms asset origination capabilities and investment management expertise provides a competitive advantage, helping our businesses to bring enhanced solutions and more value to our customers, both retail and institutional <unk>.
And our businesses in turn provide a differentiated source of growth for PJM affiliated ATM flows that complements its successful third party track record of performance and growth.
We generated $800 million of net third party flows during the third quarter.
Our third party that retail flows were $3 billion.
Strong investment performance at our growing yes, and use its platforms and record mutual fund sales delivered solid fixed income flows partially offset by equity outflows.
And our third party institutional outflows were $2.2 billion, mainly driven by a single institutional fixed income client withdrawal of $2.9 billion due to manager consolidation.
We serve many of the worlds largest institutional investors and as a result experience large idiosyncratic inflows and outflows from time to time.
Our asset management fees benefited from record assets under management due to market appreciation and continued robust fixed income flows.
Strong investment performance and expertise across a broad range of asset classes has allowed us to continue to attract close into higher return strategies.
Approximately 80% or more assets under management have outperformed their benchmarks over the last three five and 10 year periods.
We continue to broadening globalize, our products and capabilities by developing and launching private and alternative investments and expanding in retail and international markets.
Our multi manager model strong track record of private originations and demonstrated investment performance as well as investments, we're making it our distribution capabilities will position us to generate positive flows overtime and to grow earnings even absent the wells Fargo fee arrangement, which ends this year.
Turning to slide six.
Our international business includes our World Class Japanese life insurance operation, where we have a differentiated business model with unique distribution as well as other operations and high growth markets like Brazil.
Our life planner strategy is to grow our high quality distribution with a focus on needs based sales in emerging markets. We looked at combined potential strengths with local expertise to serve customers in dog in a non traditional way.
Life planner sales, which were about half of the total international sales in the current quarter increased by 8% compared to the year ago quarter. This was driven by record life planner count and higher U.S. dollar sales in Japan as well as by continued growth in our Brazil operations.
Sales for Gibraltar, which represents the other half of international were 11% lower than a year ago.
This primarily reflects lower single pay U.S. dollar fixed annuity sales in our life consultant channel.
As we continued to focus on recurring pay protection products. In addition, the recent declining unless interest rates resulted in lower crediting rates, which also affected sales of U.S. dollar denominated products.
We also experienced lower production at our independent agency channel and lower Bank channel sales due to continued to heightened competitive conditions.
We'll continue to innovate new products and consider pricing actions, while focusing on maintaining our target level of profitability.
Sales overtime.
In summary in order to generate profitable growth and attractive returns, we're expanding our distribution or product solutions, leveraging our asset management expertise.
Focused on engaging more deeply with our customers.
With that I'll hand, it over to Kevin Thanks, Rob I'll begin on slide seven which provides additional insight into our fourth quarter earnings relative to our third quarter results. We began with our third quarter pre tax adjusted operating income, which was $1.7 billion and resulted in earnings per share of $3, a 22 cents on an app.
Your tax basis, then we adjust for the following items first we adjust a variable investment income to a normalized level, which is worth $65 million second the fourth quarter will include seasonal expenses and implementation costs related to the acceleration our financial wellness strategy. We expect this will lower result.
In the fourth quarter by approximately 280 million, resulting in an expected loss in the corporate and other segment of $475 million to $500 million inclusive of the cost over financial wellness initiatives.
There will also be additional costs in the fourth quarter related to the voluntary separation program that Charlie mentioned. This is all part of this $600 million to $700 million of the implementation costs to accelerate our financial wellness strategy as we discussed on Investor day.
Third there are other considerations that we expect result will increase results by approximately $25 million on a net basis in the fourth quarter and fourth we anticipate a $10 million reduction in the quarterly net investment income from portfolio reinvestment assuming reinvestment rates.
Our held flat with the third quarter.
Absent a change in interest rates the two cents per share for one quarter would compound to 30 cents per share over the five quarter period ending December 2020.
This assumes a 7% annual turnover on $370 billion fixed income portfolio with new money yields 65 basis points below disposition yields on average.
Combined this gets us to a baseline of $2.50 per share for the fourth quarter before including the impact of future share repurchases business growth in market impacts.
This baseline includes a few items that puts it below our typical earnings level first we have seasonal expenses in the fourth quarter. We expect those expenses to be similar to prior years about $125 million to $175 million.
Second we expect about $95 million, a financial wellness implementation costs in the fourth quarter and third we expect $55 million of higher typical expenses higher than typical expenses in life planner.
These three items total about 58 cents per share and explain the elevated level expense expected in the fourth quarter baseline.
Well, we have provided these items to consider there maybe other factors that affect fourth quarter earnings per share.
A few additional items to note first we issued 5.5 million shares in the fourth quarter for the insurance acquisition.
Second as Charlie mentioned in his remarks, we have taken further action to reduce fluctuation of quarterly earnings by reducing the impact of movement credentials stock in the equity in the equity markets on long term and deferred compensation expenses also on slide 17, we have provided updated information regarding seasonally.
Adams by business.
We hope that you continue to find our new disclosures, including our baseline earnings per share information helpful. In understanding the earnings power of our businesses. We've indicated over the past few years, we're considering alternatives to how we approach guidance with the new disclosure now in place and provided on a regular basis, we have decided not.
To provide annual EPS guidance or host outlook call in December we believe our enhanced disclosures and processes provide insightful information on a more frequent basis.
Turning to slide eight.
I'll provide an update on capital deployment liquidity and leverage.
We feel very good about the overall strength of our capital position, we returned $1.4 billion shareholders. During the current quarter through dividends and share repurchases our share repurchase authorization for the remainder of the year is $500 million as of September thirtyth and over the last five years, we've increased our dividend per share by Sir.
16% per year on average.
Our current quarterly dividend of one dollar represents a 4% yield on our adjusted book value.
We also continue to maintain a rock solid balance sheet, our regulatory capital ratios continued to be above our double the financial strength target levels in our financial leverage ratio remains better than our target.
Our cash and liquid assets at the parent company was $6.2 billion at the end of the quarter and that was above our top end of our $3 billion to $5 billion liquidity target range as shown on the slide we've provided a pro forma of the highly liquid asset balances that reflects the amount that funded the acquisition of assurance in early October .
Sure and brings the balance within our target range.
We will look to continue to invest in the growth of our businesses assess acquisition opportunities to build scale or gain capabilities and return capital to shareholders.
Turning to slide nine and in summary, we are accelerating our strategy and positioning our business is to deliver long term growth. We remain on track to achieve $50 million in run rate margin expansion by the end of 2019 and $500 million by the end of 2022, we've generated.
A record high adjusted book value per share and continued to generate strong cash flows that support consistent growth in dividends and other distributions to shareholders and we maintain a robust capital and liquidity position with financial flexibility now I'll turn it over the operator for questions.
Thank you and ladies and gentlemen, if you wish to ask a question. Please press star followed by one on your Touchtone phone.
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We'll go to line up Alec Scott with Goldman Sachs. Your line is open.
Hey, good morning.
So first question I had is on variable annuities and I guess, we're seeing the ROI way it really starting to come down.
Just wanted to see if you get dimension for us what's impacting that as it is it sort of the spread your ranking on the on the riders.
Is it just the fee levels coming down and yes.
I think previously you talked about 115 narrowing 16 bips through so we're we're already below that I mean should we expect a significantly lower long term.
Trendable level at this point.
Yeah, Hey, this is discount take that.
First our variable annuity business continues to be very profitable and that's although it's a bit lower it still has a high ROI and a strong ROI. We know we've mentioned in the past that we'd expect the our way to trend over overtime as policies, both move into lower feed years, and as we continue to diversify our product mix.
Solutions with less equity markets sensitivity, so that that continues to play out.
While the ROI as a general generally a good benchmark for profitability. It will adjust when markets move can significantly and interest rates have declined pretty significantly in 2019 down by about a over 100 basis points year to date, so why the decline in rigs.
Increases the account value it affects earnings by the combination of higher benefit ratios and and higher DAC amortization. So despite the decline in rates that again the business continues to be very profitable.
And generated quarterly cash cash flow, we still like to profitability, albeit at a lower our away.
Got it Okay and then my follow up question, So I guess more broadly on expenses.
Some acceleration in life planner.
Little bit more next quarter, you've got the digital expenses going on but I guess, you've also got assurance, our Q coming on which I think there were some synergies with some other things you're doing on digital capabilities. So just just wondering if you could provide more.
Detailed thoughts on how much you'd be looking to span to get over the next year or so.
And what kind of.
Offset there as from insurance coming online.
And if and therefore have any more like baby accelerations like there wasn't life planner for other segments like once you get past, what your whatever you're focusing on life planner.
Let me just this is Charlie let me start in and then others others can join in so we said, we we've insurance that there would be.
There would be a certain amount of expense synergies I think we said 25 to 50 million next year, and then and additional after that so you can expect those to come in over time those are separate and distinct from some of the other expenditures.
That we're making or some of the other savings were seeing in the margin improvements.
And then the other area for the quarter was was international where we did see.
The shift of some expenses and a higher level expenses in the quarter.
And so that really one time are you going through any kind of process, where you might be assessing needs for other.
Other segments that are outside of the digital initiative Thats in corporate.
Hi, Alex This is a this is Scott I think Darren gave some guidance on what will be recurring and nonrecurring, but there's a couple of big things going on.
First of all to the specific waters.
As I mentioned before we see evolving regulatory oversight and we're trying to put the infrastructure in place to continue to be it industry best practices and some of that's rolling out actually not just in Japan, but around the world.
As I mentioned at Investor Day, We also have been following some of the technology upgrades in the digital upgrades that occurred in the U.S., we kind of follow what worked well and we're rolling.
Some of those out across the board and then this quarter, we actually had some additional litigation and other reserves.
And finally, some things we're doing on not process improvement and automation. So you know I would say it really falls into those those two big buckets, we were playing a bit of catch up on a on the.
Improving regulatory best practices and then we had some significant initiative rollouts that we were we were doing in international what I would say lag the U.S. by about a year, where most of the way through that and so I think if you look at the if you look at the adjustments we have a call it.
55 million an accelerated.
I just noticed.
Spending in the fourth quarter that will disappear as we hit our run rate going into 2020, I think we would say that's that's largely our new baseline.
Got it that's very helpful. Thank you.
And I'll just add the quarter keep in mind corporate was lower and there was sort of pieces. There we had a lower long term.
Compensation expense related to the change in our share price.
That as we mentioned will will no longer occur going forward as we've we've modified our our long term compensation program to no longer need to.
I have that stock price flowing through our expense.
And then corporate expenses were also little bit lower so if you looked at corporate and internationally. They were there were somewhat offsetting.
Thanks.
Thank you.
Next question comes nine up Erik bass with Autonomous Research Your line is open.
Hi, Thank you so you've talked about the outlook for EPS in the fourth quarter, but it sounds like that includes a number of one off expenses. In addition to the normal seasonal impacts so it's not.
So real reflection of your earnings power. Therefore can you help us think about a more reasonable earnings baseline for 2020 and is it really adding back the 54 cents of items, so thinking if something in kind of below $3 range before buybacks and growth.
Yes, Hi, Eric it's Ken Theres actually a number of ways that you can think about this and look at this so I'll first I'll start with the the baseline that we gave at the end of the second quarter going into third quarter, which was about $3. So that was sort of where we thought in the middle of the year our earnings power was.
The third quarter results came in at $3.22 and.
That was a little bit above that because we had a favorable variable investment income and favorable underwriting expense across our businesses and.
And as I mentioned in our last comments expenses kinda offset between corporate and other international. So if you adjust that you've got to a number that was a little better than than three $3 now in the fourth quarter baseline.
Do you have.
A number of items like I said in my in my opening remarks that make it a little bit below our typical earnings level.
First is our seasonal expenses.
That.
And unique going on this year typical to what we see in the fourth quarter.
We have the financial wellness implementation costs again, very consistent with what we articulated at Investor Day, and and then third we have.
The expectation of little higher expenses in our international businesses. If you put those items all together.
Yes, and you adjusted for that you'd you'd be back at a earnings level, a little bit over $3. So I think that's a that's the way we're thinking about.
Our earnings power over those Timeframes.
It gets Rob let me just sort of pick up on that sort of looking ahead to offset that baseline.
I'm Ken mentioned in his commentary that we do have interest rate sensitivity going forward and we've given some guidance on that so that's sort of updated and will be a headwind.
As contrary to what would otherwise have while underlying business growth and then obviously very significant increase we haven't growth as result of capital deployment from from shares.
The other piece to think about with interest rates is that will have lower sales that are that come out of that and in a lower interest rate environment as well or at least that's that's what we're anticipating.
Recognizing all that we are being very proactive youre managing sales through product pricing design and mix.
Switching costs.
So that includes implementing the previously announced financial wellness initiatives that.
That Ken covered as well and we've been actively deploying capital for growth that was evidenced very clearly in the assurance I do acquisition.
Which is not sensitive to to rates or equity markets.
But also the things that we've done in PJM.
Its investment capabilities and its distribution capabilities and the other global technology and distribution initiatives that we have all of which we think will contribute to the fundamental growth and then obviously as I mentioned that share repurchases. So deploying capital for growth all that we believe gives us the ability.
In caught and.
In combination with what's happening on international in terms of our continued ability to grow the in force.
Gives us confidence that we can.
Can you to show a differentiated level or we can show going forward a differentiated level of of growth.
And our OE.
These beating the industry in light of the sort of the macro headwinds that debt that we outlined.
Thank you that's helpful detail.
May be going on the interest rate comment it seems like your interest rate sensitivity is increased versus the 30 cents impact for 100 basis point move that you gave on last year's outlook call. Just hoping you give a little bit more color on why that's the case, yeah sure I'll cover that the.
Again, a year ago, when we issued guidance interest rates, where we're in a different zone and our guidance a year ago assumed 2019 would have interest rates above 3% to use the tenure U.S treasury as a as a benchmark.
We're at rate levels that are now over 100 or 100 basis points below that.
Well I should and when we gave that guidance last year, we mentioned that our sensitivity to a 100 basis points decline would be.
30 cents per share and Thats kind of what we've experienced as we've gone through the year and that's what we've experienced in in our financial results as well so the impact that we've experienced in 2019 is very consistent with what we provided those sensitivities again a year ago.
But for me here the rates are at a lower start point and we also have more U.S. dollar business in Japan, we have more business that crediting rate minimums. So there is and it's not linear as well and and was we do have a greater impact and you also have to consider.
There's an impact on the present value of claims at a at a lower discount rate. So those are the reasons that it's well have more interest rate sensitivity now and it all has to do with a lower rate environment.
Got it thank you.
Thank you.
Our next question comes from line up for me to come up with Citi. Your line is open.
Thanks, just a follow up on that Ken just as we think about this rate pressure potentially compounding.
Over time, you know the two cents eventually becoming.
Well much bigger number.
Right well move up isn't that's going to pretty much offset some of the margin expansion that you are targeting is associated with the financial wellness initiative.
Yeah the.
Interest rate impact you know again, assuming rates don't change does does build over time of eventually it does dissipate as the portfolio more more fully turns over.
And this is exactly the experience that we had if you go back a number of years as we shifted from the then rate environment to what was the the more recent rate environment. Now, we're we're going through that again, so that that phenomena is not new.
It's it's how it plays out.
So I think it will it will work its way through and multiple and multiples.
Leaves as as you go out, but again dissipates eventually over time as the as the portfolio turns over so they just call out India and the deck. It's robin in the deck that we provided we gave you the sort of this sensitivity of rates based on what's the delta between our our third quarter new money rates.
And and the and the yield on the Omniab portfolio that'd be turning over on a go forward basis. That's about 65 basis points. So these are the where we are today you know if rates modestly rise to something thats sort of in the mid twos not not very different from where we were just a little while ago. This phenomena begins to to wear off.
Got it Okay and then just on the decision to not hosted and outlook call I guess for next year. It typically it would be on that call that we would get a sense of how you're thinking about capital return for the upcoming year and.
Our view or an outlook on year end 18 reserve so.
Not having that call just wondering if you could provide some commentary on how you're thinking about that two thing.
At this point.
Yeah. So first I'll start with 80, a given lower rates, we would have a.
Rising asset adequacy testing reserves.
But we do have derivative interest rate derivative hedges that would have gains as well talk to offset that so we still feel very good about the RBC level of our Oh Prudential insurance company of America.
In terms of our our capital returns that's a decision that the board will make.
In December .
And and we'll get that information.
Well once the board makes that decision and and does its authorization.
You know our free cash flow profile has been very consistent and our capital management.
Approach has also been very consistent so for now you can you can factor that into your thinking.
Okay. Thanks.
Thank you.
Our next question comes from the line Uptime Gallagher with Evercore ISI. Your line is open.
Good morning.
We can just just going through the this slide that discusses the corporate loss.
If I take the 475 billion.
For the for the four to guide and then I strip out the 150 million sort of the midpoint of higher seasonal.
For Q expenses in the 95 million of onetime restructuring expenses that gets me to a corporate loss of about 230 million.
Thank you.
The guidance you guys have provided.
Has been over 300 million a quarter as more of a normalized corporate loss I just want to know.
Are you implying that you would expect the corporate wants to be lower on a on a go forward basis or is there is a little over 300 million still a decent quarterly loss.
Expectation, yes, Tom the one thing I think that I think you have a little bit off there is the 150 of seasonal doesn't all occur and corporate and other only about half of that does so I think if you. If you would you make that consideration.
You are more in line with where our core corporate and other run rate has been okay. Thanks for that clarification D. The other the other question I had is on the just a follow up on capital return cash flow the.
I think it based on.
I understand you know there's been some GAAP earnings pressure here, but can you talk about.
How cash flow.
Visibility is playing out as you head into 2020 would you still expect a similar call it 65% conversion ratio.
Or will that be changing based on where interest rates aren't both Japan and the U.S.
Yes, Tom the our cash flow engines are still very much intact. So.
First for the the businesses that have been providing quarterly dividends.
PJM and and our annuities business you know as you can see those have been very consistent in regular and paid quarterly.
And Japan paid a dividend.
This quarter in the third quarter, as well and we'll be filing for a dividend.
From pica in the fourth quarter, so yes rates will decrease.
Segment income and have some modest impact as we talked about with our sensitivities, but in general our cash flow picture is quite strong and quite consistent.
Gotcha, and then just one final follow up if I could the market related experience.
Adjustment factor, which was I take around a negative 300 million to net income this quarter was that a just a onetime adjustment [noise] outside of the actuarial review to reflect macro or can you just provide some color on that thanks, Yeah sure no that wasn't a onetime adjustments so that.
Adjustment occurs to update our discount rates related to our best domestic best estimates of insurance liabilities and the amortization of.
Deferred acquisition costs.
And that it.
Lead to.
A charge for the quarter, having said that we had other gains as.
As well and if you looked at.
GAAP net income it was actually above operating income. So overall, our GAAP profile was a was pretty in line with our operating profile.
Okay. Thanks.
Thank you. Our next question comes from the line John Nadel with yes.
And it's open.
Good morning, everybody.
Maybe a question for Rob for Airport 10.
It it sounds like.
It sounds like this is more macro driven and maybe you can correct me if I'm wrong, but it sounds like your expectations are that.
You know sort of given in particular sustained low rate.
You know some insurance products are simply less.
Attractive to customers and as a result.
So your expectation is that sales.
In such an environment would be somewhat pressured it may be down.
Hi.
First question is do I have that right or is there something else to that story and then the second or related question is.
Should we expect.
That.
At least in the short term as a result of that environment.
Your free cash flow could actually be better and maybe we ought to consider potentially at least.
Some incremental.
Capital deployment or capital return to shareholders.
Yes, John This is Charlie let me start and then some others will jump into it let me just start.
Philosophically about sales so the answer is as interest rates.
Decrease absolutely sales will may well decrease as we changed pricing.
And as certain products become.
So much less profitable for us and we've always talked about is sustained level of profitability overtime and so what we have to calibrate between is.
Making sure that our products meet our hurdle rates on the one hand into sustaining distribution on the other hand, and we're always calibrating between that but we will we have already and will continue to raise pricing lower crediting rates do whatever it takes in order to.
Maintain a level of profitability that makes sense for the company and shareholders and at the same time look at what a minimum level of.
Of sales would be in order to maintain what is a world class distribution system as we go forward that's what we're toggling.
And that's why we're toggling on those two issues and you will you will see that as we go through but we have already raised pricing and taken multiple <unk> pricing actions, both domestically and internationally John It's it's Steve maybe all amplify Charlie's comments and get a little bit more specific on what I think is.
A primary example of it which is in the in the annuities business recently with the decline in interest rates.
We have been active been making product changes that reduce the level of product benefits and and effectively increased pricing.
That relates to over the past a couple of months.
Reducing payout rates by by 40 to 45 points or in some of <unk> in our products.
By reducing the roll up rate on HD I'd buy by 50 basis points. This is something that we do as Charlie mentioned in the normal course of business in order to manage the business for sustainable profitable growth well, certainly looking to maintain relevance with distribution partners and the competitive value proposition for customers.
We've seen some competitors take some actions, but frankly, we've made more changes than most.
As a result, it's possible that we could see our sales trajectory decline in the near term and we see simply see that as an outcome of how we manage the business and I would mention as that's how we've managed the business for an extended period of time, if you look over a multiyear period in the.
Annuities business, we've certainly been active in the marketplace threw out but we've been significantly more active.
During periods, where capital market conditions were more supportive of product features and add issue returns and we've been relatively less active.
In periods, where capital market conditions were not so supportive of that over an extended period of time, a that is built the enforced block in that business that has the characteristics characteristics Board made the 10 mentioned earlier of strong profitability, a robust returns and solid cash flow.
Yeah I listened.
I appreciate the then need to balance right maintenance for maintaining distribution.
Versus profitability of sales and.
I was just wondering if there is if if if if you'd expect that sales would be down sufficiently.
Such that you know, maybe it hasn't and near term or a short term impact on free cash flow, but we can take that offline.
John I concur that real quickly then sales come down yes nationally you would expect that cash flow would improve because we're not we don't need to hold capital associated with new business. So that the direction is is as you described thank you and Ken I've got one quick housekeeping one and this is in light of really.
Our outlook for 2020 call, but any reason why your tax rate.
Given the business mix et cetera should be any should be meaningfully different next year than it is this year.
No I think our tax rate has been very consistent.
Thank you.
Thank you.
Our next question comes from the line of Humphrey Lee with Dowling and partners. Your line is open.
And money and thanks for taking my questions I'm looking at PJM the fee rate seems to be a little more pressure this quarter, especially in retail in general account assets. I was just wondering if you can talk about just kind of Oh, youre overall fee rate expectation in the near term and especially the fees of the assets that have left and versus that those who.
Well they came in.
I'm sorry, it's Steve I'll take your question.
Well, Rob called out a specific fixed income a institutional outflows this quarter, but general story throughout 2019 has been a pretty strong inflows into fixed income and some other asset classes and pressure on equity flows a negative flows in the equity space.
Really a experience across the industry as I would say the active to passive the the past active to passive headwinds picked up again this year, given the relative a fee rates across asset classes.
That ER that migration.
Of of assets.
From an asset mix from from equities to fixed income.
Has that the impact that you a that you noted on our average fee levels now I should emphasize we've been able to significant significantly mitigate that.
By drawing a lot of our flows in including our fixed income flows into specific strategy strategies that have a a solid fee levels, but nonetheless, the cumulative impact is as you as you pointed out I wouldn't say, though that this gradual migration of.
Assets.
From equity the fixed income of asset mix from equity to fixed income, especially fueled by fixed income appreciation in recent quarters doing due to the declining interest rate environment, well that might be a source of pressure on fees. It's also highly supportive of margin in the business a fixed and we have scale economies.
Throughout our asset management complex.
But the fixed income businesses, where those scale economies are our most attractive and flows.
Increasing contribution of fixed income to our asset mix will be supportive of margin expansion in the business.
Got it appreciate that color just for clarification on the expenses in international I think in response to Ali's question earlier, you talked about the 55 million in a full quota in terms of the elevated expenses kind of where you think would drop off but I think from last quarter's call you talked about.
And Gibraltar you wish that some high expenses to kind of up to continue throughout 2020, and then especially given it seems like you brought it was a little lighter expenses in the third quarter. My guess is should we still expect elevated expenses in international throughout 2020, and then kind of coming off after that.
How should we think about I in general.
Hi, I'm sorry. This is Scott I'll take that the 55 really related to the to the life planner business and as you pointed out we had a we actually had a.
Overshot on what we thought our expenses might be in into brought through this quarter.
We do still expect in Gibraltar, a modest level of elevated expenses I think where we guided you last quarter that that would continue to about mid year.
The the really sizable amount. So that were were picked up in 2019. So I'd say those are relatively de minimis and I think in the in the guidance on expenses that were given on the overnight we've captured that bleed and.
And I would say, it's not really very significant in Gibraltar.
Got it thank you.
Thank you Hi next question will come from the line up do you mean dealer would take P. Morgan Your line is open.
Hi, I'm. So first a question for again on the interest rate impact.
I'm, assuming that us if you don't if rates do not change than that at least for the next to one or two or three years bump bonds at a much faster rate than your normal learnings draw. It so it becomes a bigger and bigger had to end.
In a 2021 horses, what do you have outlined before potentially the next 12 months right.
Yes, I think you should think of it as as a for you know the we said 30 cents for five quarters call. It 28 cents for floor and that sort of the the annual annual drag.
But then beyond that it should be a considerably higher than that 28 cents in the next four quarters just at the base that it's building up correct Yep Yep, that's the way the math works.
And I'm overtime, it dissipates, yeah, but that's a few years out as you'd on the portfolio over us it assuming no change in rates again, right. That's right that's right.
And then on your Japan sales at Prudential of Japan, You said there was a tax law change you wouldn't do it term product should we assume that at least in the near term that sales will remain muted or <unk>.
And if you could just give us color on what drove the became a weakness that there's something besides that.
That drove the these sales this quarter and just some idea on I'm sort of trends in that market and what's your expectations are for sales.
Jimmy This is Scott I'll, let me take that a couple of ways. One the corporate tax law change did in fact impact everybody in industry, but it touched us in both P.O.J.
And in the life planner business I'm in a so there was the the natural National tax authority was reviewing the the rules and there was a four or five month period, where you didn't know what they were going to look like and then an implementation period after that.
In the case of a in the case of P.O.J. I would say the effect was a more modest because of the clientele being business owners in high net worth and and some of the products that are coming back.
There will continue to sell some of the new corporate products, but more importantly, the life planner growth across.
Our channel has been strong.
You know really a really across a across the board so that that's favorable.
I would say in the case, you know engine for alter its its really a a more significant challenge we've been seeing more competitive you. We had the the corporate product. We've also continued to see pretty intense competition.
In the bank a you know in the bank channel market.
And we've also imposed some pricing discipline, where weve favored kind of recurring premium mortality based products versus some of the more income oriented products as rates came down. So when you combine those three effects I would say in the case of Gibraltar. The issues are more challenging in the case of P.O.J. and.
Life planner generally they're more transitory in nature.
Okay, and then just lastly, any comments on what's going on in bed till the end market just with all the political instability and.
The potential for pension reform at some point.
Yeah, a couple of comments our business a there with a with habitat actually has performed very very well.
A year to date.
And Ah, we actually had very very favorable NK performance based on the underlying markets. A this quarter that being said a I would say we've been in touch.
You know fairly frequently with what's going on there and I wouldn't really downplay what's going on there. It's a you know it's it's relatively a serious I think the people they're concerned about the the unrest that being said one of the one of the responses.
And one of the request if you will the demands that are out there and the the factors impacting insecurity relates to people being nervous about old age retirement, and so there's there's actually proposals to materially increase a the deposits and call. It the generosity of some of the systems, we may or.
Or may not benefit that much from that because sometimes when they increased the deposits. They don't allow fees on them and what have you, but in general I would say I think it's a it's a serious situation down there that being said, we're we're actually quite well positioned and we're in a space in the market where the demand.
So those that are feeling disadvantaged are looking for government actions that would be a supportive of our sector.
And also don't forget way below it we have the lowest fees.
And some of the best investment performance in the business and therefore, weve, even the pension sector, we're very well positioned as well.
Okay. Thank you.
Thank you I next question will come from the line up Barney with Sandler O'neill. Your line is open.
Thanks, and another life insurer had a large write down on the quarter on private equity position can you walk us through how many different private equity or venture capital positions you have average investment size and largest on carrying value. Please [noise].
John It's Rob in our if you look at our alternatives portfolio a couple things to note. One is it's extraordinarily well diversified there were in excess of.
2000 underlying companies invested through somewhere around 300 funds.
That portfolio. So while we do not have any particular concentration to the extent that we have direct investments in companies.
In that portfolio, which come about as as as they do and he's kind of strategies by Coinvestment rights.
They are primarily if not exclusively.
In private equity Navient venture capital.
Therefore tend to have significantly less volatility and any of those in underlying investments are relatively small. So we obviously in the context of our alternatives portfolio. We have out another performance. That's a reflection of markets and overall segment performance, we tend to have a little less of it of the.
Cradic performance as a result, a single investments were not entirely immune from it.
But but nothing to particularly call out there well well diversified.
And and relatively conservatively position.
Great and my follow up most of them been answered, but are you seeing any signs of early activity in flu season. It seems like everyone here as sick earlier.
[laughter].
John This is Steve I'll answer your question I think I don't know about a above the.
Immediately present, a state of the flu season, but I I think that you know we did see.
In this quarter, our our life mortality in the individual life business I have some have some experience that was a counter to what we normally see as a as the as the seasonal trends normally the third quarter is a tends to be a positive Victor.
Variance.
In the in life mortality it didn't play out that way this quarter, we saw the unfavorable experience in this quarter in blocks that have really generally trended quite favorably over time.
And as a result, we believe this quarter's results is more of a random fluctuation rather than indicative of any underlying issues or trends I would say also in relation to the third quarter mortality experience being.
Different from normal seasonal patterns in life, we saw exact the those similar phenomenon play out in the retirement business a business that normally has in the third quarter less favorable reserve experience.
And in this quarter because of a a similar mortality trends the business was able to realize outsized reserve gains again kind of pushing away from the normal seasonal patterns and I think this speaks to our complimentary business mix working out as we but as we intend to too and as we've designed it there.
Great. Thank you very much.
Thank you.
Oh.
Our next question will come from the line never leave Greenspan with Wells Fargo.
Your line is open.
Thanks, Good morning, My first question.
Hey, Nice you guys aren't.
Seeing an outlook on anymore, but I guess on their way that you can give I have a kind of baseline as well or maybe where you come in on you know what in your I'll lead bank in 2020 till we get a sense.
If that somewhere eight following base beyond Ken I guess, you know thinking about how many items you called out in the slides as well as fight the higher corporate expenses that you know do occur every fourth quarter.
Yeah sure I'll, just sort of echo some of the things that Rob mentioned earlier and I sort of described how you can think about whether whether the baseline that we described coming out of the second quarter or or our results for the third quarter adjusted for the things that were a bit favorable or or the four.
Fourth quarter baseline we provided.
Adjusted for the elevated level of expenses, all kind of gets you to.
EPS number that's you know a little bit better than the three Bucks and then you know our businesses are growing.
We articulated or some of our growth thoughts at Investor day.
And and now we do have a lower interest rate environments, so that that eats into that a little bit as as we described and given sensitivities to but then on top of that we have the margin improvement that we have underway, which again, we've articulated and ER and gave it measures for as well.
The impact of assurance like you acquisition, which we expect to be accretive in 2020. So I think those are all the the components.
That we think about as we look to 2020 and would encourage you to think about for yourself Lisa Let me just sort of jump in on the or are we portion of your question.
First I'd note that in the a in the third quarter, we had our we have an excess of 13%.
While we had headwinds associated with equity markets. We did have positive impacts and so she had been associated with interest rates, we had positive impacts.
With the with the movement and equity markets and because if you think about a little better than three dollar quarterly baseline number that that can triangulate around.
That would still represented our OE that would be about 13% and so when we provided our outlook of about 12% to 14% or are we it was obviously in an environment where interest rates were much higher.
But the expectation was that absent those interest rates, we would be in the in the midpoint of that 13% does the midpoint. Good till 2014 was more should have a a baseline expectation as opposed to the high end of our range with the headwind interest rate to put a little bit of pressure on that but I think that the the a that he steam.
As we made with regard to that range of 12 to 14.
Not change materially by virtue of the.
Anything thats occurred since the point in time, where we've when we when gave out that guidance absent that the recalibration for interest rates.
Okay. Thanks, and then in terms of insurance that deal is now Paul is.
Is there anything in terms of modeling that you want to point out in terms of seasonality on as we put that into our models I believe I think they really sad English more weighted towards fourth quarter, just anything that stands out as we think about getting that into 2020 on a quarterly basis.
Yeah sure at least this is Andy I'll take your question and thank you for the question.
Hey, there will be seasonal variability quarter to quarter and right now a good portion of the revenue is driven by the Medicare advantage product and the individual under age 65 product that are really driven by the open enrollment periods in the fourth quarter. So when you think about earnings pattern with the current mix of business that we.
I have with assurance and prior to ASCO executing line, adding additional products to the platform.
The fourth quarter will will likely be our heaviest from but the revenue and earnings perspective.
But keep in mind again this is a.
A young company in a growing company and we didn't expect it to be material to the fourth quarter.
And we feel good about the progress we're making a in the outlook for 2020, and 2021 and maybe just to two to add ons. Obviously in this fourth quarter, well experienced transaction transaction financing costs.
Also the CCAR results are going to be net of the amortization of the intangible assets that are that went on the books. So.
Okay. Thank you very much.
Thank you and bring that back to turn it back over to probably Larry for any closing comment.
Thank you.
So as you heard we're committed to delivering on our purpose of providing financial opportunity to more people and we look forward to keeping you updated on our progress in the months ahead, well before ramping up I'd like to take a moment to recognize Steve Pelletier.
Who is retiring next month following an extraordinary 27 year career at the company. Thank you Steve for your many contributions to Prudential throughout your career and for those of you who are not in the room here, but on the telephone I wish you can see his green, we choose from year to year.
As he participates in his last earnings call and with that I'd like to thank you again for joining us today, and we look forward to more conversations in the future. Thank you.
Thank you then ladies and gentlemen. This does concludes today's conference call. Thank you for attending you may now disconnect.