PRUDENTIAL FINANCIAL, INC.
TABLE OF CONTENTS
Page
Overview 54
Outlook 54
Industry Trends 56
Impact of a Low Interest Rate Environment 56
Results of Operations
59
Consolidated Results of Operations
59
Segment Results of Operations
60
Segment Measures
62
Impact of Foreign Currency Exchange Rates
63
Accounting Policies & Pronouncements
66
Application of Critical Accounting Estimates
66
Adoption of New Accounting Pronouncements
76
Results of Operations by Segment 77PGIM 77U.S. Businesses 81 Retirement 82Group Insurance 83 Individual Annuities 85 Individual Life 90 Assurance IQ 92 International Businesses 93 Corporate and Other 96 Divested and Run-off Businesses 97 Closed Block Division 98 Income Taxes 99
Experience-Rated Contractholder Liabilities, Assets Supporting Experience-Rated Contractholder Liabilities and Other Related Investments
99
Valuation of Assets and Liabilities
101
General Account Investments
103
Liquidity and Capital Resources 124
Ratings 138
Contractual Obligations 140
Off-Balance Sheet Arrangements 141
Risk Management 141
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Certain of the statements included in this section constitute forward-looking statements within the meaning of theU.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are made based on management's current expectations and beliefs concerning future developments and their potential effects uponPrudential Financial, Inc. and its subsidiaries.Prudential Financial, Inc.'s actual results may differ, possibly materially, from expectations or estimates reflected in such forward-looking statements. Certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements can be found in the "Risk Factors" and "Forward-Looking Statements" sections herein. Pursuant to the FAST Act Modernization and Simplification of Regulation S-K, discussions related to the results of operations for the year endedDecember 31, 2018 in comparison to the year endedDecember 31, 2017 have been omitted. For such omitted discussions, refer to Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") included in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2018 . Overview Our principal operations are comprised ofPGIM (our global investment management business), ourU.S. Businesses (consisting of ourU.S. Workplace Solutions,U.S. Individual Solutions, and Assurance IQ divisions), our International Businesses, the Closed Block division, and our Corporate and Other operations. TheU.S. Workplace Solutions division consists of ourRetirement and Group Insurance businesses, theU.S. Individual Solutions division consists of our Individual Annuities and Individual Life businesses, and the Assurance IQ division consists of our Assurance IQ business. InOctober 2019 , we completed the acquisition ofAssurance IQ, Inc. ("Assurance IQ"), a leading consumer solutions platform that offers a range of solutions that help meet consumers' financial needs (see Note 1 to the Consolidated Financial Statements for additional information). 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. Our Corporate and Other operations include corporate items and initiatives that are not allocated to business segments and businesses that have been or will be divested or placed in run-off, excluding the Closed Block division. See "Business" for a description of our sources of revenue and details on how our profitability is impacted. In addition, our profitability is impacted by our ability to effectively deploy capital, utilize our tax capacity and manage expenses. Management expects that results in 2020 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"), 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. The Assurance IQ acquisition accelerates our ability to sell solutions across a broad socio-economic spectrum. We aim to expand our addressable market, build deeper and longer-lasting relationships with customers and clients, and make a meaningful difference in the financial wellness of their lives. 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 announced programs we have launched 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. Over the next several years, we will also see significant expense efficiencies resulting from these investments. During 2019, we incurred significant implementation costs related to these programs, which reflected an acceleration of spending that the Company announced inDecember 2019 that brought forward a portion of the expected implementation costs and is also expected to drive faster realization of projected margin improvement. Implementation costs were approximately$365 million in the fourth quarter of 2019, and approximately$400 million for the full year 2019, including a charge related to the Company's Voluntary Separation Program offered to certain eligibleU.S. -based employees. The voluntary separation program excluded senior executives and employees in certain roles (including employees in ourPGIM investment businesses). The employment end dates for the employees that applied to participate in the program and whose applications were accepted by management are expected to occur between February and September of 2020.
Outlook
We feel confident about our prospects for the future supported by our integrated
and complementary businesses. Specific outlook considerations for each of our
businesses include the following:
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•
maintaining strong investment performance while leveraging the scale of
its approximately
distinctive multi-manager model. In addition to providing solutions for
its third-party clients,
Businesses with a competitive advantage through its investment expertise
across a broad array of asset classes.
investments to further diversify its product offerings, expand its global
investment and distribution footprint, selectively acquire new investment
capabilities (see "-Results of Operations by Segment" below for
information on our strategic acquisitions), and further strengthen
external recognition as a leading global asset manager. These
capabilities will enable
needs and, in turn, to generate flows across multiple asset classes,
client segments and geographies. Underpinning our growth strategy is our
ability to continue to deliver robust investment performance, and to
attract and retain high-caliber investment talent. While we areexperiencing fee pressures in some strategies, our average fee yield has
remained relatively flat due to new flows coming into higher fee yielding
strategies within fixed income, equities and alternatives such as real
estate and private fixed income, and because of our diverse business
profile.
• U.S. Businesses:
U.S. Workplace Solutions. In our Retirement business, we continue to provide
products that respond to the needs of plan sponsors to manage risk and control
their benefit costs, while ensuring we maintain appropriate pricing and return
expectations under changing market conditions. We expect to continue to be a
market leader in pension risk transfer because of our differentiated
capabilities and demonstrated execution in this business. We expect, however,
that growth will not be linear given the episodic nature of larger cases. In
addition, while we foresee continuation of the spread and fee compression that
we have been experiencing in our full-service business, we believe these are
manageable headwinds and we have experienced strong deposits and sales in recent
years. In our Group Insurance business, we are focused on expanding our Premier
market segment and affinity relations, while maintaining a leadership position
in the National segment. Our continued pricing discipline has resulted in
improvements to our benefits ratio. In both Retirement and Group Insurance , we
believe our integrated solutions for helping to improve the financial wellness
of individuals at the workplace differentiates us in the market and helps us
build deeper customer relationships. Over time, this should result in
accelerated revenue growth.
•
focused on helping its customers meet their investment and retirement
needs. We remain focused on offering a broad range of solutions that
enable us to realize appropriate returns for the current environment and
provide a strong value proposition for our customers. As we execute on
our product diversification strategy, we expect a natural reduction in
average fee rates due to the maturation of the existing block and due to
sales of newer products which generally have lower rate structures. Our
Individual Life business is continuing to execute on its product
diversification strategy in order to maintain a diversified product mix
and an attractive risk profile. We continue to deepen relationships with
distribution partners while developing a more customer-oriented
experience. As we grow our business, we are remaining disciplined in ourpricing. In the longer term, we believe our ability to provide additional
solutions to the employees of our Workplace Solutions businesses and to
other retail customers should increase revenues in our Individual
Solutions businesses. We also expect to offer Individual Solutions
products on the Assurance IQ platform over time.
• Assurance IQ. In
IQ. Launched in 2016, Assurance IQ leverages data science and technology
to distribute third-party life, health, Medicare and property and
casualty products directly to retail shoppers primarily through its
digital and independent agent channels. We expect that the acquisition of
Assurance IQ will enhance the growth of our
cost synergies. We also believe that Assurance IQ has the potential to
enhance the growth of our International Businesses over time. See Note 1
to the Consolidated Financial Statements for additional information aboutthe acquisition, including the purchase consideration. See "Business" for
a description of the business and "Risk Factors" for a description of the
risks associated with the acquisition.
• International Businesses. Our International Businesses includes ourworld-class Japanese life insurance operation as well as other operations
in select markets. We continue to concentrate on deepening our presence
in
select high-growth markets. We continue to focus on protection solutions
and we innovate as clients' needs evolve. The returns on our death
protection products are largely driven by mortality margins which
mitigates the exposure of results to the current low interest rate
environment. Over the last few years, our sales mix in
to
in the near-term. We are also focused on achieving scale in select growth
markets outside of
may seek to deploy capital in support of our strategy or to exit an
operation if it is determined that it no longer aligns with our broader
strategy. We continue to invest in our businesses and assess acquisition
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opportunities to build scale, complement our businesses, and support our long-term growth aspirations. For additional information on our strategic acquisitions and dispositions, see "-Results of Operations by Segment" below.
Industry Trends
Our
Financial and Economic Environment.
U.S. Businesses - As discussed further under "Impact of a Low Interest Rate Environment" below, interest rates in theU.S. remain lower than historical levels, which may continue to negatively impact our portfolio income yields and our net investment spread results among other factors. In addition, we are subject to financial impacts associated with movements in equity markets and the evolution of the credit cycle as discussed in "Segment Results of Operations" where applicable and more broadly in "Risk Factors". International Businesses - Our International Businesses' operations, especially inJapan , continue to operate in a low interest rate environment. Although the local market inJapan has operated in a low interest rate environment for years, as discussed under "Impact of a Low Interest Rate Environment" below, the current reinvestment yields for certain blocks of business are now generally lower than the current portfolio yields supporting these blocks of business, which may negatively impact our net investment spread results. The continued level of interest rates in theU.S. , along with their relation to interest rates inJapan , may impact the relative attractiveness ofU.S. dollar-denominated products compared to yen-denominated products inJapan . In addition, we are subject to financial impacts associated with movements in foreign currency rates, particularly the Japanese yen. Fluctuations in the value of the yen can impact the relative attractiveness to customers of both yen-denominated and non-yen denominated products. In addition, we are subject to financial impacts associated with movements in equity markets and the evolution of the credit cycle as discussed in "Segment Results of Operations" where applicable and more broadly in "Risk Factors". Demographics.U.S. Businesses - Customer demographics continue to evolve and new opportunities present themselves in different consumer segments such as the millennial and multicultural markets. Consumer expectations and preferences are changing. We believe existing customers and potential customers are increasingly looking for cost-effective solutions that they can easily understand and access through technology-enabled devices. At the same time, income protection, wealth accumulation and the needs of retiring baby boomers are continuing to shape the insurance industry. A persistent retirement security gap exists in terms of both savings and protection. Despite the ongoing phenomenon of the risk and responsibility of retirement savings shifting from employers to employees, employers are becoming increasingly focused on the financial wellness of the individuals they employ. International Businesses -Japan has an aging population as well as a large pool of household assets invested in low-yielding deposit and savings vehicles. The aging ofJapan's population, along with strains on government pension programs, have led to a growing demand for insurance products with a significant savings element to meet savings and retirement needs as the population prepares for retirement. We are seeing a similar shift to retirement-oriented products across other Asian markets, includingKorea andTaiwan , each of which also has an aging population.
Regulatory Environment. See "Business-Regulation" for a discussion of regulatory developments that may impact the Company and the associated risks.
Competitive Environment. See "Business-" for a discussion of the competitive environment and the basis on which we compete in each of our segments.
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;
• insurance reserve levels, market experience true-ups and amortization
of both deferred policy acquisition costs ("DAC") and value of
business acquired ("VOBA");
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• 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".
See below for discussions related to the current interest rate environments in our two largest markets, theU.S. andJapan ; the composition of our insurance liabilities and policyholder account balances; and the hypothetical impacts to our investment results if these interest rate environments are sustained.
Interest rates in theU.S. have experienced a sustained period of historically low levels. While market conditions and events make uncertain the timing, amount and impact of any monetary policy decisions by theFederal 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 rise, our reinvestment yield may exceed the overall portfolio yield resulting in a favorable impact to earnings. Conversely, if interest rates were to decline, our reinvestment yield may be below our overall portfolio yield, resulting in an unfavorable impact to earnings. For the general account supporting ourU.S. Individual Solutions division,U.S. Workplace Solutions division and our Corporate and Other 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 2021. The portion of the general account attributable to these operations has approximately$222 billion of such assets (based on net carrying value) as ofDecember 31, 2019 . The average portfolio yield for fixed maturity securities and commercial mortgage loans is approximately 4.2%, as ofDecember 31, 2019 . Included in the$222 billion of fixed maturity securities and commercial mortgage loans are approximately$146 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$146 billion , approximately 58% 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 ourU.S. Operations excluding the Closed Block Division, by type, for the date indicated: As ofDecember 31, 2019 (in billions) Long-duration insurance products with fixed and guaranteed terms $
136
Contracts with adjustable crediting rates subject to guaranteed minimums
58
Participating contracts where investment income risk ultimately accrues to contractholders 15 Total $ 209 The$136 billion above 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$58 billion above relates to contracts with crediting rates that may be adjusted over the life of the contract, subject to guaranteed minimums. Although we may have the ability to lower crediting rates for those contracts above guaranteed minimums, our willingness to do so may be limited by competitive pressures. The following table sets forth the related account values by range of guaranteed minimum crediting rates and the related range of the difference, in basis points ("bps"), between rates being credited to contractholders as ofDecember 31, 2019 , and the respective guaranteed minimums. 57
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Account Values with Adjustable Crediting Rates Subject to Guaranteed Minimums:
Greater than
1-49 50-99 100-150 150
At bps above bps above bps above bps above
guaranteed guaranteed guaranteed guaranteed guaranteed
minimum minimum minimum minimum minimum Total
($ in billions)
Range of Guaranteed Minimum
Crediting Rates:
Less than 1.00% $ 0.7 $ 1.2 $ 0.5 $ 0.1 $ 0.0 $ 2.5
1.00% - 1.99% 1.0 4.0 11.2 2.4 1.0 19.6
2.00% - 2.99% 1.2 0.9 0.5 2.7 1.1 6.4
3.00% - 4.00% 26.3 2.0 0.1 0.2 0.0 28.6
Greater than 4.00% 0.9 0.0 0.0 0.0 0.0 0.9
Total(1) $ 30.1 $ 8.1 $ 12.3 $ 5.4 $ 2.1 $ 58.0
Percentage of total 52 % 14 % 21 % 9 % 4 % 100 %
__________
(1) Includes approximately
market value adjustment if the invested amount is not held to maturity.
The remaining$15 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. Assuming a hypothetical scenario where the average 10-yearU.S. Treasury rate is 1.85% (which is reasonably consistent with recent rates) for the period fromJanuary 1, 2020 throughDecember 31, 2020 (and credit spreads remain unchanged from levels as ofDecember 31, 2019 ), 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$40 million and$60 million for the period fromJanuary 1, 2020 throughDecember 31, 2020 . 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. Closed Block Division Substantially all of the$60 billion of general account assets in the Closed Block division support obligations and liabilities relating to the Closed Block policies only. See Note 15 to the Consolidated Financial Statements for further 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 regularly examine
our product offerings and their profitability. As a result, we have repriced
certain products, adjusted commissions for certain products and have
discontinued sales of 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
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of
The following table sets forth the insurance liabilities and policyholder
account balances of our Japanese operations, by type, for the date indicated:
As of
December 31, 2019
(in billions)
Insurance products with fixed and guaranteed terms $ 127
Contracts with a market value adjustment if invested amount is not held to maturity
26
Contracts with adjustable crediting rates subject to guaranteed minimums 11 Total $ 164 Of the$127 billion above,$126 billion is 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$26 billion related to contracts that impose a market value adjustment if the invested amount is not held to maturity and$11 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. Assuming a hypothetical scenario where the average 30-year Japanese Government Bond yield is 0.40% and the 10-yearU.S. Treasury rate is 1.85% (which is reasonably consistent with recent rates) for the period fromJanuary 1, 2020 throughDecember 31, 2020 (and credit spreads remain unchanged from levels as ofDecember 31, 2019 ), 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$40 million and$60 million for the period fromJanuary 1, 2020 throughDecember 31, 2020 . Results of Operations
Consolidated Results of Operations
The following table summarizes net income (loss) for the periods presented.
Year ended December 31,
2019 2018 2017
(in millions)
Revenues $ 64,807 $ 62,992 $ 59,689
Benefits and expenses 59,722 58,158 53,202
Income (loss) before income taxes and equity in
earnings of operating joint ventures 5,085 4,834 6,487
Income tax expense (benefit) 947 822 (1,438 ) Income (loss) before equity in earnings of operating joint ventures
4,138 4,012 7,925 Equity in earnings of operating joint ventures, net of taxes
100 76 49
Net income (loss) 4,238 4,088 7,974
Less: Income attributable to noncontrolling interests 52 14 111
Net income (loss) attributable to Prudential
Financial, Inc. $ 4,186 $ 4,074 $ 7,863 2019 to 2018 Annual Comparison. The
•
reserves as well as DAC and other costs, reflecting the impact of our
annual reviews and update of assumptions and other refinements. This
excludes the impact associated with the variable annuity hedging program
discussed below (see "-Results of Operations by Segment-U.S.
Businesses-U.S. Individual Solutions Division-Individual Annuities" for
additional information);
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•
(losses) from equity securities recorded within "Other income (loss)" for
PFI excluding our Divested and Run-off Businesses; and
• $642 million net favorable variance, on a pre-tax basis, primarily fromincome in the current period from our Divested and Run-off Businesses
compared to a loss in the prior period, excluding the impact of our annual
reviews and update of assumptions and other refinements, as discussed
above.
Partially offsetting these increases in "Net income (loss) attributable to
•
gains and losses for PFI excluding our Divested and Run-off Businesses,
and excluding the impact of the hedging program associated with certain
variable annuities discussed below (see "-General Account Investments" for
additional information);
•
net impact from changes in the value of our embedded derivatives and
related hedge positions associated with certain variable annuities (see
"-Results of Operations by Segment-U.S. Businesses-U.S. Individual
Solutions Division-Individual Annuities-Variable Annuity Risks and Risk
Mitigants" for additional information);
•
experience updates; and
•
due to the impact of tax reform and certain other tax matters on the
prior year period (see Note 16 to the Consolidated Financial Statements
for additional information).
Segment Results of Operations
We analyze the performance of our segments and Corporate and Other operations
using a measure of segment profitability called adjusted operating income. See
"-Segment Measures" for a discussion of adjusted operating income and its use as
a measure of segment operating performance.
Shown below are the adjusted operating income contributions of each segment and
Corporate and Other operations for the periods indicated and a reconciliation of
this segment measure of performance to "Income (loss) before income taxes and
equity in earnings of operating joint ventures" as presented in our Consolidated
Statements of Operations.
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Year ended December 31,
2019 2018 2017
(in millions)
Adjusted operating income before income taxes by
segment:
PGIM $ 998 $ 959 $ 979
U.S. Businesses:
U.S. Workplace Solutions division:
Retirement 1,301 1,049 1,244
Group Insurance 285 229 253
Total U.S. Workplace Solutions division 1,586 1,278 1,497
U.S. Individual Solutions division:
Individual Annuities 1,843 1,925 2,198
Individual Life 87 223 (191 )
Total U.S. Individual Solutions division 1,930 2,148 2,007
Assurance IQ division:
Assurance IQ (9 ) 0 0
Total Assurance IQ division(1) (9 ) 0 0
Total U.S. Businesses 3,507 3,426 3,504
International Businesses 3,359 3,266 3,198
Corporate and Other (1,766 ) (1,283 ) (1,437 ) Total segment adjusted operating income before income taxes
6,098 6,368 6,244
Reconciling items:
Realized investment gains (losses), net, and related
adjustments(2) (764 ) 466 (417 ) Charges related to realized investment gains (losses), net(3)
(125 ) (316 ) 544
Market experience updates(4) (462 ) 0 0
Divested and Run-off Businesses(5):
Closed Block division 36 (62 ) 45
Other Divested and Run-off Businesses 452 (1,535 ) 38
Other adjustments(6) (47 ) 0 0
Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests(7) (103 ) (87 ) 33 Consolidated income (loss) before income taxes and equity in earnings of operating joint ventures
$ 5,085 $
4,834
__________
(1) Assurance IQ was acquired by the Company in
Consolidated Financial Statements and "-Assurance IQ" for additional
information.
(2) Represents "Realized investment gains (losses), net," and related
adjustments. See "-General Account Investments" and Note 22 to the
Consolidated Financial Statements for additional information. Prior period
amounts have been updated to conform to current period presentation.
(3) Includes charges that represent the impact of realized investment gains
(losses), net, on the amortization of DAC and other costs, and on changes in
reserves. Also includes charges resulting from payments related to market
value adjustment features of certain of our annuity products and the impact
of realized investment gains (losses), net, on the amortization of Unearned
Revenue Reserves ("URR").
(4) Represents the immediate impacts in current period results from changes in
current market conditions on estimates of profitability, which are excluded
from adjusted operating income beginning with the second quarter of 2019. The
Company had historically recognized these impacts in adjusted operating
income. See Note 22 to the Consolidated Financial Statements for additional
information.
(5) Represents the contribution to income (loss) of Divested and Run-off
Businesses that have been or will be sold or exited, including businesses
that have been placed in wind down, but that did not qualify for
"discontinued operations" accounting treatment under U.S. GAAP. See
"-Divested and Run-off Businesses" for additional information.
(6) Represents adjustments not included in the above reconciling items. "Other
adjustments" include certain components of the consideration for the
Assurance IQ acquisition, which are recognized as compensation expense over
the requisite service periods, as well as changes in the fair value of
contingent consideration. See Note 22 to the Consolidated Financial
Statements.
(7) Equity in earnings of operating joint ventures are included in adjusted
operating income but excluded from "Income (loss) before income taxes and
equity in earnings of operating joint ventures" as they are reflected on an
after-tax
of Operations. Earnings attributable to noncontrolling interests are excluded
from adjusted operating income but included in "Income (loss) before income
taxes and equity in earnings of operating joint ventures" as they are
reflected on a
Statements of Operations. Earnings attributable to noncontrolling interests
represent the portion of earnings from consolidated entities that relates to
the equity interests of minority investors.
Segment results for 2019 presented above reflect the following:
PGIM . Results for 2019 increased in comparison to 2018, primarily reflecting higher asset management fees and other related revenues, partially offset by higher expenses. 61
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Retirement. Results for 2019 increased in comparison to 2018, primarily reflecting a favorable comparative net impact from our annual reviews and update of assumptions and other refinements, and higher net investment spread results. This increase was partially offset by higher expenses and less favorable reserve experience.Group Insurance . Results for 2019 increased in comparison to 2018, primarily reflecting more favorable underwriting results, higher net investment spread results and lower expenses, partially offset by an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Individual Annuities. Results for 2019 decreased in comparison to 2018, inclusive of an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Excluding this item, the results decreased primarily driven by lower fee income, net of distribution expenses and other associated costs, and higher expenses, partially offset by higher net investment spread results, and an unfavorable impact from changes in market conditions on the estimates of profitability in the prior period, which beginning with the second quarter of 2019 is excluded from adjusted operating income (see Note 22 to the Consolidated Financial Statements for further information).
Individual Life. Results for 2019 decreased in comparison to 2018, primarily reflecting unfavorable comparative net impacts from our annual reviews and update of assumptions and other refinements.
Assurance IQ. Results for the period fromOctober 10, 2019 ("acquisition date") toDecember 31, 2019 were$(9) million . This reflects the starting period of Assurance IQ's earnings with Prudential and includes net revenues more than offset by operating expenses as well as amortization expenses related to intangible assets recognized as part of purchase accounting (see Note 1 and Note 10 to the Consolidated Financial Statements for additional information). International Businesses. Results for 2019 increased in comparison to 2018, inclusive of favorable net impacts from foreign currency exchange rates and favorable comparative net impacts from our annual reviews and update of assumptions and other refinements. Excluding these items, the results decreased primarily reflecting higher expenses, partially offset by favorable impacts from business growth, more favorable underwriting results, and higher net investment spread results. Corporate and Other. Results for 2019 reflected increased losses in comparison to 2018, driven by higher corporate expenses, including implementation costs for certain programs that are expected to result in margin improvements (see "-Overview" above), higher capital debt interest expense and lower income from our qualified pension plan, partially offset by higher net investment income. Closed Block Division. Results for 2019 increased in comparison to 2018, primarily driven by an increase in net realized investment gains and related activity, higher net investment income, and an increase in net insurance activity including dividends to policyholders, partially offset by an increase on the policyholder dividend obligation.
Segment Measures
Adjusted Operating Income. In managing our business, we analyze our segments' operating performance using "adjusted operating income." Adjusted operating income does not equate to "Income (loss) before income taxes and equity in earnings of operating joint ventures" or "Net income (loss)" as determined in accordance withU.S. GAAP, but is the measure of segment profit or loss we use to evaluate segment performance and allocate resources, and consistent with authoritative guidance, is our measure of segment performance. The adjustments to derive adjusted operating income are important to an understanding of our overall results of operations. Adjusted operating income is not a substitute for income determined in accordance withU.S. GAAP, and our definition of adjusted operating income may differ from that used by other companies. However, we believe that the presentation of adjusted operating income as we measure it for management purposes enhances the understanding of our results of operations by highlighting the results from ongoing operations and the underlying profitability of our businesses. See Note 22 to the Consolidated Financial Statements for further information on the presentation of segment results and our definition of adjusted operating income. Annualized New Business Premiums. In managing ourIndividual Life, Group Insurance and International Businesses, we analyze annualized new business premiums, which do not correspond to revenues underU.S. GAAP. Annualized new business premiums measure the current sales performance of the business, while revenues primarily reflect the renewal persistency of policies written in prior years and net investment income, in addition to current sales. Annualized new business premiums include 10% of first year premiums or deposits from single pay products. No other adjustments are made for limited pay contracts. 62
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The amount of annualized new business premiums for any given period can be significantly impacted by several factors, including but not limited to: addition of new products, discontinuation of existing products, changes in credited interest rates for certain products and other product modifications, changes in premium rates, changes in tax laws, changes in regulations or changes in the competitive environment. Sales volume may increase or decrease prior to certain of these changes becoming effective, and then fluctuate in the other direction following such changes. Assets Under Management. In managing ourPGIM business, we analyze assets under management (which do not correspond directly toU.S. GAAP assets) because the principal source of revenues is fees based on assets under management. Assets under management represent the fair market value or account value of assets which we manage directly for institutional clients, retail clients, and for our general account, as well as assets invested in our products that are managed by third-party managers. Account Values. In managing our Individual Annuities and Retirement businesses, we analyze account values, which do not correspond toU.S. GAAP assets. Net sales (redemptions) in our Individual Annuities business and net additions (withdrawals) in our Retirement business do not correspond to revenues underU.S. GAAP, but are used as a relevant measure of business activity.
Impact of Foreign Currency Exchange Rates
Foreign currency exchange rate movements and related hedging strategies
As aU.S. -based company with significant business operations outside theU.S. , particularly inJapan , we are subject to foreign currency exchange rate movements that could impact ourU.S. dollar ("USD")-equivalent earnings and shareholder return on equity. Our USD-equivalent earnings could be materially affected by currency fluctuations from period to period, even if earnings on a local currency basis are relatively constant. Our USD-equivalent equity is impacted as the value of our investment in international operations may also fluctuate based on changes in foreign currency exchange rates. We seek to mitigate these impacts through various hedging strategies, including the use of derivative contracts and by holding USD-denominated assets in certain of our foreign subsidiaries. In order to reduce earnings volatility from foreign currency exchange rate movements, we enter into forward currency derivative contracts to effectively fix the currency exchange rates for a portion of our prospective non-USD-denominated earnings streams. This forward currency hedging program is primarily associated with our insurance operations inJapan andKorea . In order to reduce equity volatility from foreign currency exchange rate movements, we primarily utilize a yen hedging strategy that calibrates the hedge level to preserve the relative contribution of our yen-based business to the Company's overall return on equity on a leverage neutral basis. We implement this hedging strategy utilizing a variety of instruments, including USD-denominated assets, foreign currency derivative contracts, and dual currency and synthetic dual currency investments held locally in our Japanese insurance subsidiaries. The total hedge level may vary based on our periodic assessment of the relative contribution of our yen-based business to the Company's overall return on equity. The table below presents the aggregate amount of instruments that serve to hedge the impact of foreign currency exchange movements on our USD-equivalent shareholder return on equity from our Japanese insurance subsidiaries as of the dates indicated. December 31, 2019 2018 (in billions) Foreign currency hedging instruments: Hedging USD-equivalent earnings: Forward currency contracts (notional amount outstanding)$ 0.6 $ 1.3 Hedging USD-equivalent equity: USD-denominated assets held in yen-based entities(1) 13.1
13.5
Dual currency and synthetic dual currency investments(2) 0.6
0.6
Total USD-equivalent equity foreign currency hedging instruments 13.7
14.1
Total foreign currency hedges $ 14.3 $ 15.4
__________(1) Includes USD-denominated fixed maturities at amortized cost plus any related
accrued investment income, as well as USD notional amount of foreign currency
derivative contracts outstanding. Note this amount represents only those USD
assets serving to hedge the impact of foreign currency volatility on equity.
Separate from this program, our Japanese operations also have
and
USD-denominated assets supporting USD-denominated liabilities related to
USD-denominated products.
(2) Dual currency and synthetic dual currency investments are held by our
yen-based entities in the form of fixed maturities and loans with a
yen-denominated principal component and USD-denominated interest income. The
amounts shown represent the present value of future USD-denominated cash
flows.
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The USD-denominated investments that hedge the impact of foreign currency exchange rate movements on USD-equivalent earnings and shareholder return on equity from our Japanese insurance operations are reported within yen-based entities and, as a result, foreign currency exchange rate movements will impact their value reported within our yen-based Japanese insurance entities. We seek to mitigate the risk that future unfavorable foreign currency exchange rate movements will decrease the value of these USD-denominated investments reported within our yen-based Japanese insurance entities, and therefore negatively impact their equity and regulatory solvency margins, by having our Japanese insurance operations enter into currency hedging transactions. Those hedges are with a subsidiary ofPrudential Financial . These hedging strategies have the economic effect of moving the change in value of these USD-denominated investments due to foreign currency exchange rate movements from our Japanese yen-based entities to our USD-based entities. These USD-denominated investments also pay a coupon which is generally higher than what a similar yen-denominated investment would pay. The incremental impact of this higher yield on our USD-denominated investments, as well as our dual currency and synthetic dual currency investments, will vary over time, and is dependent on the duration of the underlying investments as well as interest rate environments in both theU.S. andJapan at the time of the investments.
Impact of intercompany foreign currency exchange rate arrangements on segment results of operations
The financial results of our International Businesses andPGIM reflect the impact of intercompany arrangements with our Corporate and Other operations pursuant to which certain of these segments' non-USD-denominated earnings are translated at fixed currency exchange rates. The financial results of our Retirement segment reflected the impact of an intercompany foreign currency exchange arrangement with our Corporate and Other operations in 2017 prior to its termination effectiveJanuary 1, 2018 . This foreign currency exchange risk is now managed within our Retirement segment using a strategy that may include external hedges. Results of our Corporate and Other operations include any differences between the translation adjustments recorded by the segments at the fixed currency exchange rate versus the actual average rate during the period. In addition, specific to our International Businesses segment where we hedge certain currencies, the results of our Corporate and Other operations also include the impact of any gains or losses recorded from the forward currency contracts that settled during the period, which include the impact of any over or under hedging of actual earnings that differ from projected earnings. For International Businesses, the fixed currency exchange rates are generally determined in connection with a foreign currency income hedging program designed to mitigate the impact of exchange rate changes on the segment's USD-equivalent earnings. Pursuant to this program, our Corporate and Other operations execute forward currency contracts with third parties to sell the net exposure of projected earnings for certain currencies in exchange for USD at specified exchange rates. The maturities of these contracts correspond with the future periods (typically on a three-year rolling basis) in which the identified non-USD-denominated earnings are expected to be generated. In establishing the level of non-USD-denominated earnings that will be hedged through this program, we exclude the anticipated level of USD-denominated earnings that will be generated by USD-denominated products and investments. For the year endedDecember 31, 2019 , approximately 12% of the segment's earnings were yen-based and, as ofDecember 31, 2019 , we have hedged 100%, 72% and 28% of expected yen-based earnings for 2020, 2021 and 2022, respectively. To the extent currently unhedged, our International Businesses' future expected USD-equivalent of yen-based earnings will be impacted by yen exchange rate movements. As a result of these arrangements, our International Businesses segment's results for 2019, 2018 and 2017 reflect the impact of translating yen-denominated earnings at fixed currency exchange rates of 105, 111, and112 yen per USD, respectively, and Korean won-denominated earnings at fixed currency exchange rates of 1,110, 1,150, and1,130 Korean won per USD, respectively. We expect our 2020 results to reflect the impact of translating yen-denominated earnings at a fixed currency exchange rate of104 yen per USD and Korean won-denominated earnings at a fixed currency exchange rate of1,090 won per USD. Since determination of the fixed currency exchange rates for a given year is impacted by changes in foreign currency exchange rates over time, the segment's future earnings will ultimately be impacted by these changes in exchange rates. ForPGIM and certain other currencies within our International Businesses, the fixed currency exchange rates for the current year are predetermined during the third quarter of the prior year using forward currency exchange rates. The table below presents, for the periods indicated, the increase (decrease) to revenues and adjusted operating income for the International Businesses,PGIM and Retirement segments and for Corporate and Other operations, reflecting the impact of these intercompany arrangements. 64
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Year ended December 31,
2019 2018 2017
(in millions)
Segment impacts of intercompany arrangements:
International Businesses $ 49 $ 10 $ 3
PGIM 6 0 0
Retirement(1) 0 0 2
Impact of intercompany arrangements(2) 55 10 5
Corporate and Other:
Impact of intercompany arrangements(2) (55 ) (10 ) (5 )
Settlement gains (losses) on forward currency contracts(3) 67 (13 ) (16 )
Net benefit (detriment) to Corporate and Other 12 (23 ) (21 )
Net impact on consolidated revenues and adjusted operating
income $ 67 $ (13 ) $ (16 )
__________
(1) Effective
and Other operations and Retirement was terminated and this risk is now
managed within our Retirement segment using a strategy that may include
external hedges.
(2) Represents the difference between non-USD-denominated earnings translated on
the basis of weighted average monthly currency exchange rates versus fixed
currency exchange rates determined in connection with the foreign currency
income hedging program.
(3) As of
currency contracts within our Corporate and Other operations were
billion,
insurance operations.
Impact of products denominated in non-local currencies on
While our international insurance operations offer products denominated in local
currency, several also offer products denominated in non-local currencies, most
notably our Japanese operations, which offer USD- and Australian dollar
("AUD")-denominated products. The non-local currency-denominated insurance
liabilities related to these products are supported by investments denominated
in corresponding currencies, including a significant portion designated as
available-for-sale. While the impact from foreign currency exchange rate
movements on these non-local currency-denominated assets and liabilities is
economically matched, differences in the accounting for changes in the value of
these assets and liabilities due to changes in foreign currency exchange rate
movements have historically resulted in volatility in U.S. GAAP earnings.
In 2015 we implemented a structure in Gibraltar Life's operations that
disaggregated the USD- and AUD-denominated businesses into separate divisions,
each with its own functional currency that aligns with the underlying products
and investments. The result of this alignment was to reduce differences in the
accounting for changes in the value of these assets and liabilities that arise
due to changes in foreign currency exchange rate movements. For the USD- and
AUD-denominated assets that were transferred under this structure, the net
cumulative unrealized investment gains associated with foreign exchange
remeasurement that were recorded in "Accumulated other comprehensive income
(loss)" ("AOCI") totaled $2.7 billion and $3.2 billion as of December 31, 2019
and 2018, respectively, and will be recognized in earnings within "Realized
investment gains (losses), net" over time as these assets mature or are sold.
Absent the sale of any of these assets prior to their stated maturity,
approximately 14% of the $2.7 billion balance as of December 31, 2019 will be
recognized in 2020, approximately 12% will be recognized in 2021, and the
remaining balance will be recognized from 2022 through 2051.
Highly inflationary economy in
Our insurance operations inArgentina , Prudential ofArgentina ("POA"), have historically utilized the Argentine peso as the functional currency given it is the currency of the primary economic environment in which the entity operates. During 2018,Argentina experienced a cumulative inflation rate that exceeded 100% over a 3-year period. As a result,Argentina's economy was deemed to be highly inflationary resulting in reporting changes effectiveJuly 1, 2018 . UnderU.S. GAAP, the financial statements of a foreign entity in a highly inflationary economy are to be remeasured as if its functional currency (formerly the Argentine peso) is the reporting currency of its parent reporting entity (the USD) on a prospective basis. While this changed how the results of POA are remeasured and/or translated into USD, the impact to our financial statements was not material nor is it expected to be material in future periods given the relative size of our POA operations. It should also be noted that due to the macroeconomic environment inArgentina , substantially all of POA's balance sheet consists of USD-denominated product liabilities supported by USD-denominated assets. As a result, this accounting change serves to reduce the remeasurement impact reflected in net income given that the functional currency and currency in which the assets and liabilities are denominated will be more closely aligned. 65
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Accounting Policies & PronouncementsApplication of Critical Accounting Estimates
The preparation of financial statements in conformity withU.S. GAAP requires the application of accounting policies that often involve a significant degree of judgment. Management, on an ongoing basis, reviews estimates and assumptions used in the preparation of financial statements. If management determines that modifications in assumptions and estimates are appropriate given current facts and circumstances, the Company's results of operations and financial position as reported in the Consolidated Financial Statements could change significantly.
The following sections discuss the accounting policies applied in preparing our financial statements that management believes are most dependent on the application of estimates and assumptions and require management's most difficult, subjective, or complex judgments.
Insurance Assets
Deferred Policy Acquisition Costs and Deferred Sales Inducements
We capitalize costs that are directly related to the acquisition or renewal of
insurance and annuity contracts. These costs primarily include commissions, as
well as costs of policy issuance and underwriting and certain other expenses
that are directly related to successfully negotiated contracts. We have also
deferred costs associated with sales inducements related to our variable and
fixed annuity contracts primarily within our Individual Annuities segment. Sales
inducements are amounts that are credited to the policyholders' account balances
mainly as an inducement to purchase the contract. For additional information
about sales inducements, see Note 13 to the Consolidated Financial Statements.
We generally amortize DAC and deferred sales inducements ("DSI") over the
expected lives of the contracts, based on our estimates of the level and timing
of gross premiums, gross profits, or gross margins, depending on the type of
contract. As described in more detail below, in calculating DAC and DSI
amortization, we are required to make assumptions about investment returns,
mortality, persistency, and other items that impact our estimates of the level
and timing of gross margins, gross profits, or gross premiums. We also
periodically evaluate the recoverability of our DAC and DSI. For certain
contracts, this evaluation is performed as part of our premium deficiency
testing, as discussed further below in "-Insurance Liabilities-Future Policy
Benefits." As of December 31, 2019 , DAC and DSI for PFI excluding the Closed
Block division were $19.7 billion and $0.9 billion , respectively, and DAC in our
Closed Block division was $235 million .
Amortization methodologies
Gross Premiums. DAC associated with the non-participating term life policies of our Individual Life segment and the whole life, term life, endowment and health policies of our International Businesses segment is primarily amortized in proportion to gross premiums. Gross premiums are defined as the premiums charged to a policyholder for an insurance contract. Gross Profits. DAC and DSI associated with the variable and universal life policies of our Individual Life and International Businesses segments and the variable and fixed annuity contracts of our Individual Annuities and International Businesses segments are generally amortized over the expected lives of these policies in proportion to total gross profits. Total gross profits include both actual gross profits and estimates of gross profits for future periods. Gross profits are defined as: i) amounts assessed for mortality, contract administration, surrender charges, and other assessments plus amounts earned from investment of policyholder balances, less ii) benefits in excess of policyholder balances, costs incurred for contract administration, the net cost of reinsurance for certain businesses, interest credited to policyholder balances and other credits. If significant negative gross profits are expected in any periods, the amount of insurance in force is generally substituted as the base for computing amortization.U.S. GAAP gross profits and amortization rates also include the impacts of the embedded derivatives associated with certain of the optional living benefit features of our variable annuity contracts, and index-linked crediting features of indexed universal life and fixed indexed annuity contracts and related hedging activities. For additional information on the significant inputs to the valuation models for these embedded derivatives including capital market assumptions and actuarially determined assumptions, see below "-Insurance Liabilities-Future Policy Benefits." In calculating amortization expense, we estimate the amounts of gross profits that will be included in ourU.S. GAAP results and in adjusted operating income, and utilize these estimates to calculate distinct amortization rates and expense amounts. We also regularly evaluate and adjust the related DAC and DSI balances with a corresponding charge or credit to current period earnings for the impact of actual gross profits and changes in our projections of estimated future gross profits on our DAC and DSI amortization rates. Adjustments to the DAC and DSI balances include the impact to our estimate of total gross profits of the annual review of assumptions, our quarterly adjustments for current period experience, and our quarterly adjustments for market performance. Each of these adjustments is further discussed below in "-Annual assumptions review and quarterly adjustments." 66
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Gross Margins. DAC associated with the traditional participating products of our Closed Block is amortized over the expected lives of these contracts in proportion to total gross margins. Total gross margins are defined as: i) amounts received from premiums, earned from investment of policyholder balances and other assessments, less ii) benefits paid, costs for contract administration, changes in the net level premium reserve for death and endowment benefits, annual policyholder dividends and other credits. We evaluate our estimates of future gross margins and adjust the related DAC balance with a corresponding charge or credit to current period earnings for the effects of actual gross margins and changes in our expected future gross margins. DAC adjustments for these participating products generally have not created significant volatility in our results of operations since many of the factors that affect gross margins are also included in the determination of our dividends to these policyholders and, during most years, the Closed Block has recognized a cumulative policyholder dividend obligation expense in "Policyholders' dividends," for the excess of actual cumulative earnings over expected cumulative earnings as determined at the time of demutualization. However, if actual cumulative earnings fall below expected cumulative earnings in future periods, thereby eliminating the cumulative policyholder dividend obligation expense, changes in gross margins and DAC amortization would result in a net impact to the Closed Block results of operations. As ofDecember 31, 2019 , the excess of actual cumulative earnings over the expected cumulative earnings was$2,816 million . The amortization methodologies for products not discussed above primarily relate to less significant DAC and DSI balances associated with products in ourGroup Insurance and Retirement segments, which comprised approximately 2% of the Company's total DAC and DSI balances as ofDecember 31, 2019 .
Annual assumptions review and quarterly adjustments
Annually, we perform a comprehensive review of the assumptions used in estimating gross profits for future periods. Over the last several years, the Company's most significant assumption updates resulting in a change to expected future gross profits and the amortization of DAC and DSI have been related to lapse and other contractholder behavior assumptions, mortality, and revisions to expected future rates of returns on investments. These assumptions may also cause potential significant variability in amortization expense in the future. The impact on our results of operations of changes in these assumptions can be offsetting and we are unable to predict their movement or offsetting impact over time. The quarterly adjustments for current period experience referred to above reflect the impact of differences between actual gross profits for a given period and the previously estimated expected gross profits for that period. To the extent each period's actual experience differs from the previous estimate for that period, the assumed level of total gross profits may change. In these cases, we recognize a cumulative adjustment to all previous periods' amortization, also referred to as an experience true-up adjustment. The quarterly adjustments for market performance referred to above reflect the impact of changes to our estimate of total gross profits to reflect actual fund performance and market conditions. A significant portion of gross profits for our variable annuity contracts and, to a lesser degree, our variable life contracts are dependent upon the total rate of return on assets held in separate account investment options. This rate of return influences the fees we earn on variable annuity and variable life contracts, costs we incur associated with the guaranteed minimum death and guaranteed minimum income benefit features related to our variable annuity contracts and expected claims to be paid on variable life contracts, as well as other sources of profit. Returns that are higher than our expectations for a given period produce higher than expected account balances, which increase the future fees we expect to earn on variable annuity and variable life contracts and decrease the future costs we expect to incur associated with the guaranteed minimum death and guaranteed minimum income benefit features related to our variable annuity contracts and expected claims to be paid on variable life contracts. The opposite occurs when returns are lower than our expectations. The changes in future expected gross profits are used to recognize a cumulative adjustment to all prior periods' amortization. The weighted average rate of return assumptions used in developing estimated market returns consider many factors specific to each product type, including asset durations, asset allocations and other factors. With regard to equity market assumptions, the near-term future rate of return assumption used in evaluating DAC and other costs for our domestic variable annuity and domestic and international variable life insurance products is derived using a reversion to the mean approach, a common industry practice. Under this approach, we consider historical equity returns and adjust projected equity returns over an initial future period of five years (the "near-term") so that equity returns converge to the long-term expected rate of return. If the near-term projected future rate of return is greater than our near-term maximum future rate of return of 15.0%, we use our maximum future rate of return. As ofDecember 31, 2019 , our domestic variable annuities and variable life insurance businesses assume an 8.0% long-term equity expected rate of return and a 3.1% near-term mean reversion equity expected rate of return, and our international variable life insurance business assumes a 4.8% long-term equity expected rate of return and a 2.2% near-term mean reversion equity expected rate of return. With regard to interest rate assumptions used in evaluating DAC and DSI, we update the long-term and near-term future rates used to project fixed income returns annually and quarterly, respectively. As a result of our 2019 annual reviews and update 67
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of assumptions and other refinements, we kept our long-term expectation of the 10-yearU.S. Treasury rate and 10-year Japanese Government Bond yields unchanged and continue to grade to rates of 3.75% and 1.30%, respectively, over ten years. As part of our quarterly market experience updates, we update our near-term projections of interest rates to reflect changes in current rates.
Value of Business Acquired
In addition to DAC and DSI, we also recognize an asset for VOBA. VOBA is an intangible asset which represents an adjustment to the stated value of acquired in-force insurance contract liabilities to present them at fair value, determined as of the acquisition date. VOBA is amortized over the expected life of the acquired contracts using the same methodology and assumptions used to amortize DAC and DSI (see "-Deferred Policy Acquisition Costs and Deferred Sales Inducements" above for additional information). VOBA is also subject to recoverability testing. As ofDecember 31, 2019 , VOBA was$1.1 billion , and included$0.8 billion related to the acquisition from American International Group ("AIG") ofAIG Star Life Insurance Co., Ltd ,AIG Edison Life Insurance Company ,AIG Financial Assurance Japan K.K. and AIG Edison Service Co., Ltd. (collectively, the "Star and Edison Businesses") in 2011. The remaining$0.3 billion primarily relates to previously-acquired traditional life, deferred annuity, defined contribution and defined benefit businesses. The VOBA associated with the in-force contracts of the Star and Edison Businesses is less sensitive to assumption changes, as the majority is amortized in proportion to gross premiums which are more predictably stable compared to gross profits.
Insurance Liabilities
Future Policy Benefits
Future Policy Benefit Reserves, including Unpaid Claims and Claim Adjustment Expenses
We establish reserves for future policy benefits to, or on behalf of,
policyholders using methodologies prescribed by
• For most long-duration contracts, we utilize a net premium valuation
methodology in measuring the liability for future policy benefits. Under
this methodology, a liability for future policy benefits is accrued whenpremium revenue is recognized. The liability, which represents the present
value of future benefits to be paid to or on behalf of policyholders and
related expenses less the present value of future net premiums (portion of
the gross premium required to provide for all benefits and expenses), is
estimated using methods that include assumptions applicable at the time
the insurance contracts are made with provisions for the risk of adverse
deviation, as appropriate. Original assumptions continue to be used in
subsequent accounting periods to determine changes in the liability forfuture policy benefits (often referred to as the "lock-in concept") unless
a premium deficiency exists. The result of the net premium valuation
methodology is that the liability at any point in time represents an
accumulation of the portion of premiums received to date expected to beneeded to fund future benefits (i.e., net premiums received to date), less
any benefits and expenses already paid. The liability does not necessarily
reflect the full policyholder obligation the Company expects to pay at the
conclusion of the contract since a portion of that obligation would be
funded by net premiums received in the future and would be recognized in
the liability at that time. We perform premium deficiency tests using best
estimate assumptions as of the testing date without provisions for adverse
deviation. If the liabilities determined based on these best estimate
assumptions are greater than the net reserves (i.e., GAAP reserves net of
any DAC, DSI or VOBA asset), the existing net reserves are adjusted by
first reducing these assets by the amount of the deficiency or to zero
through a charge to current period earnings. If the deficiency is more
than these asset balances for insurance contracts, we then increase the
net reserves by the excess, again through a charge to current periodearnings. If a premium deficiency is recognized, the assumptions as of the
premium deficiency test date are locked-in and used in subsequent
valuations and the net reserves continue to be subject to premium
deficiency testing. In addition, for limited-payment contracts, future
policy benefit reserves also include a deferred profit liability
representing gross premiums received in excess of net premiums. The
deferred profits are generally recognized in revenue in a constant
relationship with insurance in force or with the amount of expected future
benefit payments.
• For certain contract features, such as those related to guaranteed minimum
death benefits ("GMDB"), guaranteed minimum income benefits ("GMIB") and
no-lapse guarantees, a liability is established when associated
assessments (which include all policy charges including charges for
administration, mortality, expense, surrender, and other, regardless of
how characterized) are recognized. This liability is established usingcurrent best estimate assumptions and is based on the ratio of the present
value of total expected excess payments (e.g., payments in excess of
account value) over the life of the contract divided by the present value
of total expected assessments (i.e., benefit ratio). The liability equals
the current benefit ratio multiplied by cumulative assessments recognized
to date, plus interest, less cumulative excess payments to date. The
result of the benefit ratio method is that the liability at any point in
time represents an accumulation of the portion of assessments received to
date expected to be needed to fund future excess payments, less any excess
payments already paid. The liability does not necessarily reflect the full
policyholder obligation the Company expects to pay at the
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conclusion of the contract since a portion of that excess payment would be funded by assessments received in the future and would be recognized in the liability at that time. Similar to as described above for DAC, the reserves are subject to adjustments based on annual reviews of assumptions and quarterly adjustments for experience, including market performance. These adjustments reflect the impact on the benefit ratio of using actual historical experience from the issuance date to the balance sheet date plus updated estimates of future experience. The updated benefit ratio is then applied to all prior periods' assessments to derive an adjustment to the reserve recognized through a benefit or charge to current period earnings. • For certain product guarantees, primarily certain optional living benefit
features of the variable annuity products in our Individual Annuities
segment including guaranteed minimum accumulation benefits ("GMAB"),
guaranteed minimum withdrawal benefits ("GMWB") and guaranteed minimum
income and withdrawal benefits ("GMIWB"), the benefits are accounted for
as embedded derivatives using a fair value accounting framework. The fairvalue of these contracts is calculated as the present value of expected
future benefit payments to contractholders less the present value of
assessed rider fees attributable to the embedded derivative feature. Under
U.S. GAAP, the fair values of these benefit features are based on
assumptions a market participant would use in valuing these embedded
derivatives. Changes in the fair value of the embedded derivatives arerecorded quarterly through a benefit or charge to current period earnings.
For additional information regarding the valuation of these embedded
derivatives, see Note 6 to the Consolidated Financial Statements.
The assumptions used in establishing reserves are generally based on the
Company's experience, industry experience and/or other factors, as applicable.
We update our actuarial assumptions, such as mortality, morbidity, retirement
and policyholder behavior assumptions, annually, unless a material change is
observed in an interim period that we feel is indicative of a long-term trend.
Generally, we do not expect trends to change significantly in the short-term
and, to the extent these trends may change, we expect such changes to be gradual
over the long-term. In a sustained low interest rate environment, there is an
increased likelihood that the reserves determined based on best estimate
assumptions may be greater than the net liabilities.
The following paragraphs provide additional details about the reserves we have established:
International Businesses. The reserves for future policy benefits of our International Businesses, which as ofDecember 31, 2019 , represented 45% of our total future policy benefit reserves, primarily relate to non-participating whole life and term life products and endowment contracts, and are generally calculated using the net premium valuation methodology, as described above. The primary assumptions used in determining expected future benefits and expenses include mortality, lapse, morbidity, investment yield and maintenance expense assumptions. Reserves also include claims reported but not yet paid, and claims incurred but not yet reported. In addition, future policy benefit reserves for certain contracts also include amounts related to our deferred profit liability, as described above. Retirement. The reserves for future policy benefits of our Retirement segment, which as ofDecember 31, 2019 , represented 23% of our total future policy benefit reserves, primarily relate to our non-participating life contingent group annuity and structured settlement products and are generally calculated using the net premium valuation methodology, as described above. The primary assumptions used in establishing these reserves include mortality, retirement, maintenance expense and investment yield assumptions. In addition, future policy benefit reserves for certain contracts also include amounts related to our deferred profit liability, as described above. Individual Annuities. The reserves for future policy benefits of our Individual Annuities segment, which as ofDecember 31, 2019 , represented 5% of our total future policy benefit reserves, primarily relate to reserves for the GMDB and GMIB features of our variable annuities, and for the optional living benefit features that are accounted for as embedded derivatives. As discussed above, in establishing reserves for GMDBs and GMIBs, we utilize current best estimate assumptions. The primary assumptions used in establishing these reserves generally include annuitization, lapse, withdrawal and mortality assumptions, as well as interest rate and equity market return assumptions. Lapse rates are adjusted at the contract level based on the in-the-moneyness of the benefit and reflect other factors, such as the applicability of any surrender charges. Lapse rates are reduced when contracts are more in-the-money. Lapse rates are also generally assumed to be lower for the period where surrender charges apply. For life contingent payout annuity contracts, we establish reserves using best estimate assumptions with provisions for adverse deviations as of inception or best estimate assumptions as of the most recent loss recognition event. The reserves for certain optional living benefit features, including GMAB, GMWB and GMIWB are accounted for as embedded derivatives at fair value, as described above. This methodology could result in either a liability or contra-liability balance, given changing capital market conditions and various actuarial assumptions. Since there is no observable active market for the transfer of these obligations, the valuations are calculated using internally-developed models with option pricing techniques. The models are based on a risk neutral valuation framework and incorporate premiums for risks inherent in valuation techniques, inputs, and the general uncertainty around the timing and amount of future cash flows. The significant inputs to the valuation models for these embedded derivatives include capital market assumptions, such as interest rate levels and volatility assumptions, 69
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the Company's market-perceived risk of its own non-performance risk ("NPR"), as
well as actuarially determined assumptions, including mortality rates and
contractholder behavior, such as lapse rates, benefit utilization rates and
withdrawal rates. Capital market inputs and actual contractholders' account
values are updated each quarter based on capital market conditions as of the end
of the quarter, including interest rates, equity markets and volatility. In the
risk neutral valuation, the initial swap curve drives the total returns used to
grow the contractholders' account values. The Company's discount rate assumption
is based on the London Inter-Bank Offered Rate swap curve adjusted for an
additional spread, which includes an estimate of NPR . Actuarial assumptions,
including contractholder behavior and mortality, are reviewed at least annually,
and updated based upon emerging experience, future expectations and other data,
including any observable market data, such as available industry studies or
market transactions such as acquisitions and reinsurance transactions. For
additional information regarding the valuation of these optional living benefit
features, see Note 6 to the Consolidated Financial Statements.
Individual Life. The reserves for future policy benefits of our Individual Life
segment, which as of December 31, 2019 , represented 6% of our total future
policy benefit reserves, primarily relate to term life, universal life and
variable life products. For term life contracts, the future policy benefit
reserves are generally calculated using the net premium valuation methodology,
as described above. The primary assumptions used in determining expected future
benefits and expenses include mortality, lapse, investment yield and maintenance
expense assumptions. For variable and universal life products, which include
universal life contracts that contain no-lapse guarantees, reserves for future
policy benefits are primarily established using the reserving methodology for
GMDB and GMIB contracts. As discussed above, in establishing reserves for GMDBs
and GMIBs, we utilize current best estimate assumptions. The primary assumptions
used in establishing these reserves generally include mortality, lapse, and
premium pattern, as well as interest rate and equity market return assumptions.
Reserves also include claims reported but not yet paid, and claims incurred but
not yet reported.
Group Insurance . The reserves for future policy benefits of our Group Insurance
segment, which as of December 31, 2019 , represented 2% of our total future
policy benefit reserves, primarily relate to reserves for group life and
disability benefits. For short-duration contracts, a liability is established
when the claim is incurred. The reserves for group life and disability benefits
also include a liability for unpaid claims and claim adjustment expenses, which
relates primarily to the group long-term disability product. This liability
represents our estimate of future disability claim payments and expenses as well
as estimates of claims that have been incurred, but have not yet been reported,
as of the balance sheet date. The liability is determined as the present value
of expected future claim payments and expenses. The primary assumptions used in
determining expected future claim payments are claim termination factors, an
assumed interest rate and expected Social Security offsets. The remaining
reserves for future policy benefits for group life and disability benefits
relate primarily to our group life business, and include reserves for Waiver of
Premium, Claims In Course of Settlement and Claims Incurred But Not Reported.
The Waiver of Premium reserve is calculated as the present value of future
benefits and utilizes assumptions such as expected mortality and recovery rates.
The Claims In Course of Settlement reserve is based on the inventory of claims
that have been reported but not yet paid. The Claims Incurred But Not Reported
reserve is estimated using expected patterns of claims reporting.
Corporate and Other. The reserves for future policy benefits of our Corporate &
Other operations, which as of December 31, 2019 , represented 3% of our total
future policy benefit reserves, primarily relate to our long-term care products
and are generally calculated using the net premium valuation methodology, as
described above. Most contracts reflect assumptions updated in 2018 due to
recognition of a premium deficiency. The primary assumptions used in
establishing these reserves include interest rate, morbidity, mortality, lapse,
premium rate increase and maintenance expense assumptions. In addition, certain
less significant reserves for our long-term care products, such as our disabled
life reserves, are established using current best estimate actuarial
assumptions.
Closed Block Division. The future policy benefit reserves for the traditional
participating life insurance products of the Closed Block division, which as of
December 31, 2019 , represented 16% of our total future policy benefit reserves
are determined using the net premium valuation methodology, as described above.
Under this method, the future policy benefit reserves are accrued as a level
proportion of the premium paid by the policyholder. In applying this method, we
use mortality assumptions to determine our expected future benefits and expected
future premiums, and apply an interest rate to determine the present value of
both of these amounts. The mortality assumptions are based on standard industry
mortality tables that were used to determine the cash surrender value of the
policies, and the interest rates used are the interest rates used to calculate
the cash surrender value of the policies.
Profits Followed by Losses
In certain instances, the policyholder liability for a particular line of
business may not be deficient in the aggregate to trigger loss recognition, but
the pattern of earnings may be such that profits are expected to be recognized
in earlier years followed by losses in later years. In these situations,
accounting standards require that an additional liability (Profits Followed by
Losses or "PFL" liability) be recognized by an amount necessary to sufficiently
offset the losses that would be recognized in later years. The PFL liability is
based on our current estimate of the present value of the amount necessary to
offset losses anticipated in future
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periods. Because the liability is measured on a discounted basis, there will also be accretion into future earnings through an interest charge, and the liability will ultimately be released into earnings as an offset to future losses. Historically, the Company's PFL liabilities have been predominantly associated with certain universal life contracts that measure net GAAP reserves using current best estimate assumptions and accordingly, have been updated each quarter using current in-force and market data and as part of the annual assumption update. At the target accrual date (i.e., date of peak deficiency), the PFL liability transitions to a premium deficiency reserve and, for universal life products, will continue to be updated each quarter using current in-force and market data and as part of the annual assumption update.
Policyholders' Account Balances
Policyholders' account balances liability represents the contract value that has
accrued to the benefit of the policyholder as of the balance sheet date. This
liability is primarily associated with the accumulated account deposits, plus
interest credited, less policyholder withdrawals and other charges assessed
against the account balance, as applicable. Our unearned revenue reserve ("URR")
also reported as a component of "Policyholders' account balances" primarily
relates to the variable and universal life products within our Individual Life
and International Businesses segments and represents policy charges for services
to be provided in future periods. The charges are deferred as unearned revenue
and are generally amortized over the expected life of the contract in proportion
to the product's estimated gross profits, similar to DAC and DSI as discussed
above. Policyholders' account balances also include amounts representing the
fair value of embedded derivative instruments associated with the index-linked
features of certain universal life and fixed annuity products. For additional
information regarding the valuation of these embedded derivatives, see Note 6 to
the Consolidated Financial Statements.
Sensitivities for Insurance Assets and Liabilities
The following table summarizes the impact that could result on each of the listed financial statement balances for the specified businesses from changes in certain key assumptions. The information below is for illustrative purposes and includes only the hypothetical direct impact onDecember 31, 2019 balances of changes in a single assumption and not changes in any combination of assumptions. The figures below are presented in aggregate for those businesses that are expected to experience a significant positive or negative impact as a result of the corresponding assumption change. Changes in current assumptions and the related impact that could result in the listed financial statement balances that are in excess of the amounts illustrated may occur in future periods. A description of the estimates and assumptions used in the preparation of each of these financial statement balances is provided further above. For traditional long duration and limited payment contracts,U.S. GAAP requires the original assumptions used when the contracts are issued to be locked-in and that those assumptions be used in all future liability calculations as long as the resulting liabilities are adequate to provide for the future benefits and expenses (i.e., there is no premium deficiency). Therefore, these products are not reflected in the sensitivity table below unless the hypothetical change in assumption would result in an adverse impact that would cause a premium deficiency. Similarly, the impact of any favorable change in assumptions for traditional long-duration and limited-payment contracts is not reflected in the table below given that the current assumption is required to remain locked-in, and instead the positive impacts would be recognized into net income over the life of the policies in force.
The impacts presented within this table exclude the following:
• The impacts of our asset liability management strategy which seeks to offset
the changes in the balances presented within this table and is primarily
comprised of investments and derivatives. See further below for a discussion
of the estimates and assumptions involved with the application of
accounting policies for these instruments and "Quantitative and Qualitative
Disclosures about Market Risk" for hypothetical impacts on related balances
as a result of changes in certain significant assumptions.
• The impacts of our
Run-off Businesses within our Corporate and Other operations.
business sensitivities are presented separately in the immediately following
table (see "-Sensitivities for the
Corporate and Other operations"). While the accounting for long-term care
products primarily follows the locked-in assumptions model described above,
as a result of our 2018 annual review and update of assumptions this business
recognized a premium deficiency and unlocked and updated the previously
locked-in assumptions used in the valuation model. Sensitivities are
presented separately in order to provide stand-alone and supplementary
information.
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December 31, 2019
Increase (Decrease) in
Deferred Policy
Acquisition Future Policy
Costs, Deferred Benefits and
Sales Inducements Policyholders'
Hypothetical change in current and Value of Account
assumptions: Business Acquired Balances(1) Net Impact
(in millions)
Long-term interest rate(2):
Increase by 25 basis points $ 65 $ (60 ) $ 125
Decrease by 25 basis points $ (65 ) $ 60 $ (125 )
Long-term equity expected rate of
return(3):
Increase by 50 basis points $ 175 $ (50 ) $ 225
Decrease by 50 basis points $ (175 ) $ 50 $ (225 )
NPR credit spread(4):
Increase by 50 basis points $ (390 ) $ (1,895 ) $ 1,505
Decrease by 50 basis points $ 435 $ 2,070 $ (1,635 )
Mortality(5):
Increase by 1% $ (50 ) $ (90 ) $ 40
Decrease by 1% $ 55 $ 100 $ (45 )
Lapse(6):
Increase by 10% $ (145 ) $ (835 ) $ 690
Decrease by 10% $ 160 $ 880 $ (720 )
__________(1) Includes GMDB/GMIB reserves, embedded derivative liabilities for certain
living benefit guaranteed features, reserves for products with a premium
deficiency, PFL liability, and URR.
(2) Represents the impact of a parallel shift in the long-term interest rate
yield curve for the Individual Life business and the Japanese insurance
operations.
(3) Represents the impact of an increase or decrease in the long-term equity
expected rate of return for the Individual Annuities business.
(4) Represents the impact of an increase or decrease in the
the Individual Annuities and Individual Life businesses.
(5) Represents the impact of an increase or decrease in mortality rates for the
Individual Annuities and Individual Life businesses.
(6) Represents the impact of an increase or decrease in lapse rates for the
Individual Annuities and Individual Life businesses.
Sensitivities for the
The following table summarizes certain significant assumptions made in establishing reserves for long-term care products and the net impact that could result from changes in these assumptions should they occur. UnderU.S. GAAP, reserves for long-term care products are primarily calculated using the locked-in assumptions concept described above. As such, the adverse hypothetical impacts illustrated in the table below are those that would increase our best estimate reserves and, when compared to our GAAP reserves, may cause a premium deficiency that would require us to unlock and update our assumptions and record a charge to net income. The favorable hypothetical impacts in the table below would decrease our best estimate reserves but they would not result in an immediate decrease to our GAAP reserves (given that we would be required to leave the current assumptions locked-in) and instead the positive impacts would be recognized into net income over the life of the policies in force. The information below is for illustrative purposes and includes the impacts of changes in a single assumption and not changes in any combination of assumptions. As a result of emerging experience, changes in current assumptions and the related impact that could result in the listed financial statement balances that are in excess of the amounts illustrated may occur in future periods. 72
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December 31, 2019
Increase
(Decrease)
in Best
Estimate
Reserve
(in
Assumption Current Assumption Assumption Change millions)
Mortality 1% per year for 20 Decrease the duration of ($325 ) -
Improvement years the 1% improvement per ($750 )
year: 10 years to none
Expected Future Based on Company and Increase / decrease in $525 -
Claim Payments / industry experience. expected future claim ($525 )
Base Morbidity No reflection of payments: +5% to -5%
future claim
management
efficiencies
Average Ultimate Individual: 0.8% -10 basis points to +10 $100 -
Lapse Rate Group: 0.6% basis points ($100 )
Investment Rate(1) Weighted average of -25 basis points to +25 $425 -
5.04% basis points ($425 )
Expected Future Approximately
+10%
__________
(1) Investment rate reflects the expected investment yield over the life of the
block of business, and is derived from the portfolio yield, current
reinvestment rates and our intermediate and long-term assumption for
investment yields.
(2) Includes expected future premium rate increases and benefit reductions in
lieu of rate increases, not yet approved.
As ofDecember 31, 2019 , our goodwill balance of$3,013 million is primarily reflected in the following reporting units:$2,128 million for Assurance IQ,$455 million for Retirement's Full Service business,$254 million forPGIM ,$156 million for Gibraltar Life and Other, and$10 million for Life Planner. We test goodwill for impairment on an annual basis, as ofDecember 31 of each year, or more frequently if events or circumstances indicate the potential for impairment is more likely than not. The goodwill impairment analysis is performed at the reporting unit level which is equal to or one level below our operating segments. We performed a qualitative assessment of goodwill reflected in the Assurance IQ reporting unit and concluded there were no circumstances since theOctober 2019 acquisition that indicated the need for a further quantitative assessment. Our other reporting units elected to perform the quantitative two step test. For additional information on goodwill and the process for testing goodwill for impairment, see Note 2 and Note 10 to the Consolidated Financial Statements. Life Planner, Gibraltar Life and Other, andPGIM completed a quantitative impairment analysis using an earnings multiple approach. The earnings multiple approach derives the value of a business based on comparison to publicly-traded comparable companies in similar lines of business. Each comparable company is analyzed based on various factors, including, but not limited to, financial risk, size, geographic diversification, profitability, adequate financial data, and an actively traded stock price. A multiple of price to earnings is developed for the comparable companies using independent analysts' consensus estimates for each company's 2020 forecasted earnings. The multiples are then aggregated and a mean and median multiple is calculated for the group. The lower of the mean or median multiple is then applied to the 2020 forecasted earnings of the reporting unit to develop a value. A control premium is then added to determine a total estimated fair value for the reporting unit. In Retirement's Full Service business, the quantitative impairment analysis was completed using a discounted cash flow approach. This approach calculates the value of a business by applying a discount rate reflecting a market expected rate of return of the reporting unit to its projected future cash flows. These projected future cash flows were based on our internal forecasts, an expected growth rate and a terminal value. The reporting unit expected rate of return represents the required rate of return on its total capitalization. The process of deriving reporting unit specific required rates of return begins with the calculation of an overall Company Weighted Average Cost of Capital, which includes the calculation of the required return on equity using a Capital Asset Pricing Model ("CAPM"). The CAPM is a generally accepted method for estimating an equity investor's return requirement, and hence a company's cost of equity capital. The calculation using the CAPM begins with the long-term risk-free rate of return, then applies a market risk premium for large company common stock, as well as company specific adjustments to address volatility versus the market. The Company then determines reporting unit specific required rates of return based on their relative volatilities, benchmarks results against reporting unit comparable companies, and ensures that the sum of the reporting unit required returns (after considering the impact of unallocated Corporate costs and capital) add up to the overall Company required return. This 73
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process results in reporting unit specific discount rates which are then applied to the expected future cash flows of Retirement's Full Service business to estimate fair value.
After completion of the first step of the quantitative tests, the fair values exceeded the carrying amounts for each of the four reporting units tested and we concluded there was no impairment as ofDecember 31, 2019 .PGIM , Life Planner, Gibraltar Life and Other, and Retirement's Full Service business had estimated fair values that exceeded their carrying amounts by a weighted average of 223%. Completion of the second step of the quantitative analysis is therefore not necessary. Estimating the fair value of reporting units is a subjective process that involves the use of significant estimates by management. For all reporting units tested, market declines or other events impacting the fair value of these businesses, including discount rates, interest rates and growth rate assumptions or increases in the level of equity required to support these businesses, could result in goodwill impairments, resulting in a charge to income.
Valuation of Investments, Including Derivatives, and the Recognition of Other-than-Temporary Impairments
Our investment portfolio consists of public and private fixed maturity
securities, commercial mortgage and other loans, equity securities, other
invested assets, and derivative financial instruments. Derivatives are financial
instruments whose values are derived from interest rates, foreign exchange
rates, financial indices or the values of securities or commodities. Derivative
financial instruments we generally use include swaps, futures, forwards and
options and may be exchange-traded or contracted in the over-the-counter ("OTC")
market. We are also party to financial instruments that contain derivative
instruments that are "embedded" in the financial instruments. Management
believes the following accounting policies related to investments, including
derivatives, are most dependent on the application of estimates and assumptions.
Each of these policies is discussed further within other relevant disclosures
related to investments and derivatives, as referenced below:
• Valuation of investments, including derivatives;
• Recognition of other-than-temporary impairments ("OTTI"); and
• Determination of the valuation allowance for losses on commercial mortgage
and other loans.
We present at fair value in the statements of financial position our debt security investments classified as available-for-sale, investments classified as trading such as our assets supporting experience-rated contractholder liabilities and certain fixed maturities, equity securities, and certain investments within "Other invested assets," such as derivatives. For additional information regarding the key estimates and assumptions surrounding the determination of fair value of fixed maturity and equity securities, as well as derivative instruments, embedded derivatives and other investments, see Note 6 to the Consolidated Financial Statements and "-Valuation of Assets and Liabilities-Fair Value of Assets and Liabilities." For our investments classified as available-for-sale, the impact of changes in fair value is recorded as an unrealized gain or loss in AOCI, a separate component of equity. For our investments classified as trading, equity securities, and derivatives, the impact of changes in fair value is recorded within "Other income (loss)." In addition, investments classified as available-for-sale, as well as those classified as held-to-maturity, are subject to impairment reviews to identify when a decline in value is other-than-temporary. For a discussion of our policies regarding other-than-temporary declines in investment value and the related methodology for recording OTTI of fixed maturity securities, see Note 2 to the Consolidated Financial Statements. Commercial mortgage and other loans are carried primarily at unpaid principal balances, net of unamortized deferred loan origination fees and expenses and unamortized premiums or discounts and a valuation allowance for losses. For a discussion of our policies regarding the valuation allowance for commercial mortgage and other loans, see Note 2 to the Consolidated Financial Statements.
Pension and Other Postretirement Benefits
We sponsor pension and other postretirement benefit plans covering employees who
meet specific eligibility requirements. Our net periodic costs for these plans
consider an assumed discount (interest) rate, an expected rate of return on plan
assets, expected increases in compensation levels, mortality and trends in
health care costs. Of these assumptions, our expected rate of return assumptions
and our discount rate assumptions have historically had the most significant
effect on our net period costs associated with these plans.
We determine our expected rate of return on plan assets based upon a building
block approach that considers plan asset mix, risk free rates, inflation, real
return, term premium, credit spreads, equity risk premium and capital
appreciation as well as expenses, the effect of active management and the effect
of rebalancing for the equity, debt and real estate asset mix applied on a
weighted average basis to our pension asset portfolio. See Note 18 to the
Consolidated Financial Statements for our actual asset allocations by asset
category and the asset allocation ranges prescribed by our investment policy
guidelines for both our pension and other
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postretirement benefit plans. Our assumed long-term rate of return for 2019 was 6.25% for our domestic pension plans and 7.00% for our other postretirement benefit plans. Given the amount of plan assets as ofDecember 31, 2018 , the beginning of the measurement year, if we had assumed an expected rate of return for both our domestic pension and other domestic postretirement benefit plans that was 100 bps higher or 100 bps lower than the rates we assumed, the change in our net periodic costs would have been as shown in the table below. The information provided in the table below considers only changes in our assumed long-term rate of return given the level and mix of invested assets at the beginning of the measurement year, without consideration of possible changes in any of the other assumptions described above that could ultimately accompany any changes in our assumed long-term rate of return. For the year
ended
Increase/(Decrease) in Net Increase/(Decrease) in Net
Periodic Pension Cost Periodic Other Postretirement Cost
(inmillions)
Increase in expected rate of return by 100 bps $ (123 ) $ (14 ) Decrease in expected rate of return by 100 bps $ 123 $ 14 Foreign pension plans represent 5% of plan assets at the beginning of 2019. An increase in expected rate of return by 100 bps would result in a decrease in net periodic pension costs of$6 million ; conversely, a decrease in expected rate of return by 100 bps would result in an increase in net periodic pension costs of$5 million . We determine our discount rate, used to value the pension and postretirement benefit obligations, based upon rates commensurate with current yields on high quality corporate bonds. See Note 18 to the Consolidated Financial Statements for information regarding theDecember 31, 2018 methodology we employed to determine our discount rate for 2019. Our assumed discount rate for 2019 was 4.30% for our domestic pension plans and 4.30% for our other domestic postretirement benefit plans. Given the amount of pension and postretirement obligations as ofDecember 31, 2018 , the beginning of the measurement year, if we had assumed a discount rate for both our domestic pension and other postretirement benefit plans that was 100 bps higher or 100 bps lower than the rates we assumed, the change in our net periodic costs would have been as shown in the table below. The information provided in the table below considers only changes in our assumed discount rate without consideration of possible changes in any of the other assumptions described above that could ultimately accompany any changes in our assumed discount rate. For the year
ended
Increase/(Decrease) in Net Increase/(Decrease) in Net
Periodic Pension Cost Periodic Other Postretirement Cost
(in millions)
Increase in discount rate by 100 bps $ (114 ) $ (8 )
Decrease in discount rate by 100 bps $ 135 $ 7
Foreign pension plans represent 15% of plan obligations at the beginning of
2019. An increase in discount rate by 100 bps would result in a decrease in net
periodic pension costs of $12 million ; conversely, a decrease in discount rate
by 100 bps would result in an increase in net periodic pension costs of $10
million .
Given the application of the authoritative guidance for accounting for pensions,
and the deferral and amortization of actuarial gains and losses arising from
changes in our assumed discount rate, the change in net periodic pension cost
arising from an increase in the assumed discount rate by 100 bps would not
always be expected to equal the change in net periodic pension cost arising from
a decrease in the assumed discount rate by 100 bps.
For a discussion of our expected rate of return on plan assets and discount rate for our qualified pension plan in 2019, see "-Results of Operations by Segment-Corporate and Other."
For purposes of calculating pension income from our own qualified pension plan for the year endedDecember 31, 2020 , we will decrease the discount rate to 3.30% from 4.30% in 2019. The expected rate of return on plan assets will decrease to 6.00% in 2020 from 6.50% in 2019, and the assumed rate of increase in compensation will remain unchanged at 4.5%. In addition to the effect of changes in our assumptions, the net periodic cost or benefit from our pension and other postretirement benefit plans may change due to factors such as actual experience being different from our assumptions, special benefits to terminated employees, or changes in benefits provided under the plans. 75
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AtDecember 31, 2019 , the sensitivity of our domestic and foreign pension and postretirement obligations to a 100 basis point change in discount rate was as follows: December 31, 2019 Increase/(Decrease) in Increase/(Decrease) in Accumulated Postretirement Pension Benefits Obligation Benefits Obligation (in millions) Increase in discount rate by 100 bps $ (1,576 ) $ (188 ) Decrease in discount rate by 100 bps $ 1,839 $ 208 Taxes on Income Our effective tax rate is based on income, non-taxable and non-deductible items, tax credits, statutory tax rates and tax planning opportunities available in the various jurisdictions in which we operate. Inherent in determining our annual tax rate are judgments regarding business plans, planning opportunities and expectations about future outcomes. The Dividend Received Deduction ("DRD") is a major reason for the difference between the Company's effective tax rate and theU.S. federal statutory rate. The DRD is an estimate that incorporates the prior and current year information, as well as the current year's equity market performance. Both the current estimate of the DRD and the DRD in future periods can vary based on factors such as, but not limited to, changes in the amount of dividends received that are eligible for the DRD, changes in the amount of distributions received from underlying fund investments, changes in the account balances of variable life and annuity contracts, and the Company's taxable income before the DRD. InDecember 2017 ,Securities and Exchange Commission ("SEC") staff issued "Staff Accounting Bulletin 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act" ("SAB 118"), which allowed the registrants to record provisional amounts during a 'measurement period' not to extend beyond one year. Under the relief provided bySAB 118, a company could recognize provisional amounts when it did not have the necessary information available, prepared or analyzed in reasonable detail to complete its accounting for the change in tax law. See Note 16 to the Consolidated Financial Statements for a discussion of provisional amounts related to The United States Tax Cuts and Jobs Act of 2017 ("Tax Act of 2017") included in "Total income tax expense (benefit) before equity in earnings of operating joint ventures" in 2017 and adjustments to provisional amounts recorded in 2018. The Tax Act of 2017 includes a provision causing post-1986 unremitted foreign earnings of at least 10% owned non-U.S. affiliates to be included in the Company'sU.S. income tax base, with an election to pay the associated tax on an eight-year installment basis. Unremitted foreign earnings from certain operations in foreign jurisdictions that impose a withholding tax on dividends are considered to be permanently reinvested for purposes of determining the applicable withholding tax expense. See Note 16 to the Consolidated Financial Statements for a discussion of unremitted earnings for which the Company providesU.S. income taxes. An increase or decrease in our effective tax rate by one percentage point would have resulted in a decrease or increase in our 2019 "Total income tax expense (benefit)" of$58 million .
Contingencies
A contingency is an existing condition that involves a degree of uncertainty that will ultimately be resolved upon the occurrence of future events. UnderU.S. GAAP, accruals for contingencies are required to be established when the future event is probable and its impact can be reasonably estimated, such as in connection with an unresolved legal matter. The initial reserve reflects management's best estimate of the probable cost of ultimate resolution of the matter and is revised accordingly as facts and circumstances change and, ultimately, when the matter is brought to closure.
Other Accounting Policies
For digital insurance brokerage placement services, the Company earns both
initial and renewal commissions as compensation for the placement of insurance
policies with insurance carriers. At the effective date of the policy, the
Company records within "Other income" the expected lifetime revenue for the
initial and renewal commissions considering estimates of the timing of future
policy cancelations. These estimates are reassessed each reporting period and
any changes in estimates are reflected in the current period.
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Adoption of New Accounting Pronouncements
ASU 2018-12, Financial Services - Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts, was issued by theFinancial Accounting Standards Board ("FASB") onAugust 15, 2018 and is expected to have a significant impact on the Consolidated Financial Statements and Notes to the Consolidated Financial Statements. InOctober 2019 , the FASB issued ASU 2019-09, Financial Services - Insurance (Topic 944): Effective Date to affirm its decision to defer the effective date of ASU 2018-12 toJanuary 1, 2022 (with early adoption permitted), representing a one year extension from the original effective date ofJanuary 1, 2021 . This ASU will impact, at least to some extent, the accounting and disclosure requirements for all long-duration insurance and investment contracts issued by the Company. In addition to the impacts to the balance sheet upon adoption, the Company also expects an impact to how earnings emerge thereafter. See Note 2 to the Consolidated Financial Statements for a more detailed discussion of ASU 2018-12, as well as other accounting pronouncements issued but not yet adopted and newly adopted accounting pronouncements. Results of Operations by SegmentPGIM Business Update
• In the first quarter of 2019, we completed the acquisition of Wadhwani Asset
management firm, and renamed the firm
part of our QMA business with an independent investment platform.
• In the third quarter of 2019, we completed the acquisition of our joint
venture partner's share of our
Management.
Operating Results
The following table sets forth PGIM's operating results for the periods
indicated.
Year ended December 31,
2019 2018 2017
(in millions)
Operating results(1):
Revenues $ 3,589 $ 3,294 $ 3,355
Expenses 2,591 2,335 2,376
Adjusted operating income 998 959 979 Realized investment gains (losses), net, and related adjustments
(1 ) (10 ) (4 ) Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests
8 (21 ) 95
Income (loss) before income taxes and equity in
earnings of operating joint ventures $ 1,005 $
928
__________
(1) Certain of
the
risk. The financial results of
arrangement with our Corporate and Other operations designed to mitigate the
impact of exchange rate changes on
For more information related to this intercompany arrangement, see "-Results
of Operations-Impact of Foreign Currency Exchange Rates," above.
Adjusted Operating Income
2019 to 2018 Annual Comparison. Adjusted operating income increased$39 million . The increase reflected higher asset management fees due to an increase in average assets under management as a result of market appreciation and fixed income flows, partially offset by higher related expenses including certain long-term employee compensation plans driven by equity market performance. Also contributing to the increase were higher other related revenues, net of associated expenses, primarily driven by higher net performance-based incentive fees and higher strategic investing results due to favorable investment performance. These increases were partially offset by an increase in non-compensation related expenses, including those supporting business growth and charges associated with a joint venture.
Revenues and Expenses
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The following table sets forth
Year ended December 31,
2019 2018 2017
(in millions)
Revenues by type:
Asset management fees by source:
Institutional customers $ 1,283 $ 1,204 $ 1,147
Retail customers(1) 878 867 800
General account 521 471 470
Total asset management fees 2,682 2,542 2,417
Other related revenues by source:
Incentive fees 169 59 197
Transaction fees 22 33 27
Strategic investing 79 57 88
Commercial mortgage(2) 110 121 127
Total other related revenues(3) 380 270 439
Service, distribution and other revenues(4) 527 482 499 Total revenues$ 3,589 $ 3,294 $ 3,355 __________
(1) Consists of fees from: individual mutual funds and variable annuities and
variable life insurance separate account assets; funds invested in
proprietary mutual funds through our defined contribution plan products; and
third-party sub-advisory relationships. Revenues from fixed annuities and the
fixed-rate accounts of variable annuities and variable life insurance are
included in the general account.
(2) Includes mortgage origination and spread lending revenues from our commercial
mortgage origination and servicing business.
(3) Future revenues will be impacted by the level and diversification of our
strategic investments, the commercial real estate market, and other domestic
and international markets.
(4) Includes payments from Wells Fargo under an agreement dated as of
2004, implementing arrangements with respect to money market mutual funds in
connection with the combination of our retail securities brokerage and
clearing operations with those of Wells Fargo. The agreement extended for ten
years from the
this agreement was
ended
2019 to 2018 Annual Comparison. Revenues increased$295 million . Asset management fees increased primarily reflecting an increase in average assets under management as a result of market appreciation and fixed income flows. Other related revenues increased primarily driven by higher gross performance-based incentive fees and higher strategic investing results due to favorable investment performance. These increases were partially offset by charges associated with a joint venture. Expenses increased$256 million , primarily reflecting higher compensation expenses attributable to growth in incentive fees and higher earnings, and costs for certain long-term employee compensation plans, as discussed above. Also contributing to the increase were higher non-compensation expenses including those supporting business growth initiatives and increased commissions related to higher sales of our retail products.
Assets Under Management
The following table sets forth assets under management by asset class and source as of the dates indicated.
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December 31,
2019 2018 2017
(in billions)
Assets Under Management (at fair value):
Institutional customers:
Equity $ 62.7 $ 54.7 $ 68.0
Fixed income 447.0 395.1 379.4
Real estate 43.1 43.7 42.1
Institutional customers(1) 552.8 493.5 489.5
Retail customers:
Equity 130.5 112.9 132.4
Fixed income 150.3 125.2 111.5
Real estate 2.0 2.0 1.7
Retail customers(2) 282.8 240.1 245.6
General account:
Equity 6.0 5.1 5.8
Fixed income 464.6 420.8 412.5
Real estate 2.0 1.9 1.9
General account 472.6 427.8 420.2
Total PGIM assets under management $ 1,308.2 Assets under management within other reporting segments(3) 242.7
215.9 238.3
Total PFI assets under management $ 1,550.9 __________
(1) Consists of third-party institutional assets and group insurance contracts.
(2) Consists of: individual mutual funds and variable annuities and variable life
insurance separate account assets; funds invested in proprietary mutual funds
through our defined contribution plan products; and third-party sub-advisory
relationships. Fixed annuities and the fixed-rate accounts of variable
annuities and variable life insurance are included in the general account.
(3) These amounts primarily include certain assets related to annuity and
variable life products in our
and group life products in our
general account assets of our International Businesses. These assets are not
directly managed by
are managed by either the divisions themselves or our Chief Investment
Officer Organization.
2019 to 2018 Annual Comparison. PGIM's assets under management increased $147
billion to $1.308 trillion in 2019, primarily reflecting market appreciation and
higher fixed income flows driven by strong retail sales and institutional flows.
The following table sets forth the component changes in
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December 31,
2019 2018 2017
(in billions)
Institutional Customers:
Beginning assets under management $ 493.5 $ 489.5 $ 431.5
Net additions (withdrawals), excluding money market
activity:
Third-party (6.5 ) 14.1 11.6
Third-party via affiliates(1) 0.2 (0.5 ) 2.4
Total (6.3 ) 13.6 14.0
Market appreciation (depreciation)(2) 62.4 (10.3 ) 42.9
Other increases (decreases)(3) 3.2 0.7 1.1
Ending assets under management $ 552.8 $ 493.5 $ 489.5
Retail Customers:
Beginning assets under management $ 240.1 $ 245.6 $ 209.2
Net additions (withdrawals), excluding money market
activity:
Third-party 5.7 (0.4 ) 4.1
Third-party via affiliates(1) (8.5 ) 2.3 (2.0 )
Total (2.8 ) 1.9 2.1
Market appreciation (depreciation)(2) 45.1 (7.2 ) 34.6
Other increases (decreases)(3) 0.4 (0.2 ) (0.3 )
Ending assets under management $ 282.8 $ 240.1 $ 245.6
General Account:
Beginning assets under management $ 427.8 $ 420.2 $ 399.4
Net additions (withdrawals), excluding money market
activity:
Third-party 0.0 0.0 0.0
Affiliated 6.1 9.2 3.9
Total 6.1 9.2 3.9
Market appreciation (depreciation)(2) 36.8 (4.2 ) 15.1
Other increases (decreases)(3) 1.9 2.6 1.8
Ending assets under management $ 472.6 $ 427.8 $ 420.2
Total assets under management $ 1,308.2 $
1,161.4
__________
(1) Represents assets that
segments within the Company. Additions and withdrawals of these assets are
attributable to third-party product inflows and outflows in other reporting
segments.
(2) Includes income reinvestment, where applicable.
(3) Includes the effect of foreign exchange rate changes, net money market
activity and the impact of acquired business. The impact from foreign
currency fluctuations, which primarily impact the general account, resulted
in gains of
Strategic Investments
The following table sets forthPGIM's strategic investments at carrying value (including the value of derivative instruments used to mitigate equity market and currency risk) by asset class and source as of the dates indicated. December 31, 2019 2018 (in millions) Co-Investments: Real estate$ 176 $ 207 Fixed income 479 438 Seed Investments: Real estate 60 50 Public equity 770 738 Fixed income 333 272 Total$ 1,818 $ 1,705
The increase of
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Table of ContentsU.S. Businesses Operating Results The following table sets forth the operating results for ourU.S. Businesses for the periods indicated. Year ended December 31, 2019 2018 2017 (in millions) Adjusted operating income before income taxes:U.S. Businesses:U.S. Workplace Solutions division: Retirement$ 1,301 $ 1,049 $ 1,244 Group Insurance 285 229 253 Total U.S. Workplace Solutions division 1,586 1,278 1,497U.S. Individual Solutions division: Individual Annuities 1,843 1,925 2,198 Individual Life 87 223 (191 ) Total U.S. Individual Solutions division 1,930 2,148 2,007 Assurance IQ division: Assurance IQ (9 ) 0 0 Total Assurance IQ division (9 ) 0 0 Total U.S. Businesses 3,507 3,426 3,504 Reconciling Items: Realized investment gains (losses), net, and related adjustments(1) (1,881 ) 88 (991 ) Charges related to realized investment gains (losses), net (58 ) (333 ) 588 Market experience updates(2) (408 ) 0 0 Other adjustments(3) (47 ) 0 0
Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests
2 (1 ) 0 Income (loss) before income taxes and equity in earnings of operating joint ventures
$ 1,115 $
3,180
________
(1) Prior period numbers have been reclassified to conform to current period
presentation.
(2) Represents the immediate impacts in current period results from changes in
current market conditions on estimates of profitability, which are excluded
from adjusted operating income beginning with the second quarter of 2019. The
Company had historically recognized these impacts in adjusted operating
income. See Note 22 to the Consolidated Financial Statements for additional
information.
(3) Represents adjustments not included in the above reconciling items. "Other
adjustments" include certain components of the consideration for the
Assurance IQ acquisition, which are recognized as compensation expense over
the requisite service periods, as well as changes in the fair value of
contingent consideration. See Note 22 to the Consolidated Financial
Statements for additional information.
2019 to 2018 Annual Comparison. Adjusted operating income for our
• Higher net investment spread results driven by continued business growth
and higher income on non-coupon investments and higher prepayment fee
income;
• An unfavorable impact from changes in market conditions on estimates of
profitability in the prior period, which beginning with the second quarter
of 2019 is excluded from adjusted operating income (see Note 22 to the
Consolidated Financial Statements for additional information); and
• A favorable comparative net impact from our annual reviews and update of
assumptions and other refinements.
Partially offsetting these increases were the following items:
• Higher expenses, including costs associated with business growth and
business initiatives;
• Lower fee income, net of distribution expenses and other associated costs,
in our Individual Annuities business; and
• Lower underwriting results in our Individual Life business.
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Retirement
Operating Results
The following table sets forth Retirement's operating results for the periods
indicated.
Year ended December 31,
2019 2018 2017
(in millions)
Operating results(1):
Revenues $ 15,064 $ 16,825 $ 13,843
Benefits and expenses 13,763 15,776 12,599
Adjusted operating income 1,301 1,049 1,244 Realized investment gains (losses), net, and related adjustments(2)
332 (402 ) 123
Charges related to realized investment gains (losses), net 4 (5 ) (90 ) Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests
2 (1 ) 0
Income (loss) before income taxes and equity in earnings of
operating joint ventures $ 1,639 $ 641 $ 1,277
__________
(1) Certain of Retirement's non-
longevity reinsurance contracts, which are denominated in British pounds
sterling, and are therefore subject to foreign currency exchange rate risk.
For the year ended
the impact of an intercompany arrangement with Corporate and Other designed
to mitigate the impact of exchange rate changes on Retirement's
dollar-equivalent earnings. Effective
arrangement was terminated and the foreign currency exchange rate risk is now
managed within Retirement using a strategy that may include external hedges.
The impact of the agreement and the termination was not significant to
Retirement's results. For more information related to this intercompany
arrangement, see "-Results of Operations-Impact of Foreign Currency Exchange
Rates," above.
(2) Prior period amounts have been updated to conform to current period
presentation.
Adjusted Operating Income
2019 to 2018 Annual Comparison. Adjusted operating income increased $252
million . Results for 2019 included a net benefit of $154 million from our annual
reviews and update of assumptions and other refinements primarily driven by a
reduction in expected benefit payments, while results for 2018 included a net
charge of $68 million from these updates, primarily driven by updates to our
assumptions for benefit payments. Excluding these impacts, adjusted operating
income increased $30 million , primarily driven by higher net investment spread
results, partially offset by higher expenses and less favorable reserve
experience. The increase in net investment spread results primarily reflected
higher income on non-coupon investments, higher prepayment fee income and higher
asset balances within our pension risk transfer business, partially offset by
the impact from higher crediting rates on full service account values. The
increase in expenses was primarily driven by higher costs supporting business
growth initiatives. The lower contribution from reserve experience primarily
reflected lower mortality gains on a comparative basis within our pension risk
transfer business.
Revenues, Benefits and Expenses
2019 to 2018 Annual Comparison. Revenues decreased$1,761 million . Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, revenues decreased$1,755 million . This decrease primarily reflected lower funded pension risk transfer premiums with corresponding offsets in policyholders' benefits, as discussed below. The decrease was partially offset by higher net investment income, primarily reflecting higher income on non-coupon investments, higher prepayment fee income and higher asset balances within our pension risk transfer business. Benefits and expenses decreased$2,013 million . Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, benefits and expenses decreased$1,785 million . Policyholders' benefits, including the change in policy reserves, decreased primarily related to the decrease in premiums discussed above, driven by lower comparative funded pension risk transfer premiums. The decrease was partially offset by an increase in interest credited to policyholders' account balances, including the impact of higher crediting rates on experience-rated account balances and higher account values. Account Values
Account values are a significant driver of our operating results, and are primarily driven by net additions (withdrawals) and the impact of market changes. The income we earn on most of our fee-based products varies with the level of fee-based account values, since many policy fees are determined by these values. The investment income and interest we credit to policyholders on
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our spread-based products varies with the level of general account values. To a lesser extent, changes in account values impact our pattern of amortization of DAC and VOBA and general and administrative expenses. The following table shows the changes in the account values and net additions (withdrawals) of Retirement's products for the periods indicated. Net additions (withdrawals) are plan sales and participant deposits or additions, as applicable, minus plan and participant withdrawals and benefits. Account values include both internally- and externally-managed client balances as the total balances drive revenue for the Retirement business. For more information on internally-managed balances, see "-PGIM ." Year ended December 31, 2019 2018 2017 (in millions) Full Service: Beginning total account value$ 231,669 $ 234,616 $ 202,802 Deposits and sales 36,394 33,116 29,527 Withdrawals and benefits (35,706 )
(26,429 ) (24,811 ) Change in market value, interest credited and interest income and other activity
40,091 (9,634 ) 27,098
Ending total account value $ 272,448 $ 231,669 $ 234,616
Institutional Investment Products:
Beginning total account value $ 200,759 $ 194,492 $ 183,376
Additions(1) 31,101 21,310 21,630
Withdrawals and benefits (16,743 ) (15,409 ) (17,406 )
Change in market value, interest credited and interest
income 9,089 3,303 5,190
Other(2) 3,390 (2,937 ) 1,702
Ending total account value $ 227,596 $ 200,759 $ 194,492
__________(1) Additions primarily include: group annuities calculated based on premiums
received; longevity reinsurance contracts calculated as the present value of
future projected benefits; and investment-only stable value contracts
calculated as the fair value of customers' funds held in a client-owned
trust.
(2) "Other" activity includes the effect of foreign exchange rate changes
associated with our British pounds sterling denominated longevity reinsurance
business and changes in asset balances for externally-managed accounts. For
the years ended
million in receipts offset by
related to funding agreements backed by commercial paper which typically have
maturities of less than 90 days.
2019 to 2018 Annual Comparison. The increase in full service account values primarily reflected the favorable changes in the market value of customer funds and positive net plan sales.
The increase in institutional investment products account values primarily reflected net additions from funded pension risk transfer transactions and the favorable changes in the market value of account assets.
Operating Results
The following table sets forth
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Year ended December 31,
2019 2018 2017
(in millions)
Operating results:
Revenues $ 5,750 $ 5,685 $ 5,471
Benefits and expenses 5,465 5,456 5,218
Adjusted operating income 285 229 253 Realized investment gains (losses), net, and related adjustments
(20 ) (38 ) (53 )
Income (loss) before income taxes and equity in earnings
of operating joint ventures $ 265 $ 191 $ 200
Benefits ratio(1):
Group life(2) 87.4 % 87.2 % 88.9 %
Group disability(2) 75.4 % 75.8 % 71.8 %
Total Group Insurance (2) 84.7 % 84.9 % 85.8 %
Administrative operating expense ratio(3):
Group life 12.7 % 12.2 % 11.2 %
Group disability 24.1 % 27.1 % 29.4 %
Total Group Insurance 15.2 % 15.1 % 14.6 %
__________(1) Ratio of policyholder benefits to earned premiums plus policy charges and fee
income.
(2) Benefits ratios reflect the impacts of our annual reviews and update of
assumptions and other refinements. Excluding these impacts, the group life,
group disability and total
and 84.9% for 2019, respectively, 87.4%, 77.8% and 85.5% for 2018,
respectively, and 88.7%, 78.9% and 86.9% for 2017, respectively.
(3) Ratio of general and administrative expenses (excluding commissions) to gross
premiums plus policy charges and fee income.
Adjusted Operating Income
2019 to 2018 Annual Comparison. Adjusted operating income increased$56 million , including an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Results for both 2019 and 2018 included a net benefit from this update of$9 million and$31 million , respectively. Excluding this item, adjusted operating income increased$78 million , primarily driven by more favorable underwriting results in our group disability and group life businesses, higher net investment spread results driven by higher income on non-coupon investments, and lower expenses driven by the absence of costs related to the termination of a third-party underwriting service provider contract in 2018. The more favorable underwriting results were driven by favorable claim experience on long-term products in our group disability business and favorable claim experience on non-experience rated contracts in our group life business.
Revenues, Benefits and Expenses
2019 to 2018 Annual Comparison. Revenues increased$65 million . Excluding an unfavorable comparative impact of$10 million resulting from our annual reviews and update of assumptions and other refinements, as discussed above, revenues increased$75 million . The increase primarily reflected higher premiums and policy charges and fee income driven by growth in our group disability business, with offsets in policyholders' benefits and changes in reserves, as discussed below, and higher net investment income driven by higher income on non-coupon investments. Benefits and expenses increased$9 million . Excluding an unfavorable comparative impact of$12 million resulting from our annual reviews and update of assumptions and other refinements, as discussed above, benefits and expenses decreased$3 million . The decrease primarily reflected lower general and administrative expenses driven by the absence of costs related to the termination of a third-party underwriting service provider contract in 2018, as discussed above. This decrease was partially offset by higher policyholders' benefits and changes in reserves in our group disability business driven by business growth, with offsets in premiums and policy charges and fee income, as discussed above. The higher policyholders' benefits and changes in reserves were partially offset by favorable claim experience in both our group life and disability businesses.
Sales Results
The following table sets forth
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Year ended December 31,
2019 2018 2017
(in millions)
Annualized new business premiums(1):
Group life $ 254 $ 376 $ 287
Group disability 159 183 153
Total $ 413 $ 559 $ 440
__________(1) Amounts exclude new premiums resulting from rate changes on existing
policies, from additional coverage under our Servicemembers' Group Life
Insurance contract and from excess premiums on group universal life insurance
that build cash value but do not purchase face amounts.
2019 to 2018 Annual Comparison. Total annualized new business premiums decreased$146 million compared to 2018, primarily driven by large life client sales in the prior year period.
Individual Annuities
Our Individual Annuities business includes both fixed and variable annuities which may include optional guaranteed living benefits riders (e.g., GMIB, GMAB, GMWB and GMIWB), and/or optional death benefit riders (e.g., GMDB). We also offer fixed annuities that provide a guarantee of principal and interest credited at rates we determine (subject to certain contractual minimums) or at rates based upon the performance of an index (subject to caps or participation rates). The drivers of our business results are generally included in adjusted operating income, with exceptions related to certain guarantees, as discussed below. TheU.S. GAAP accounting and our adjusted operating income treatment for our guarantees differ depending upon the specific contractual features. UnderU.S. GAAP, the reserves for GMIB and GMDB are accounted for in accordance with an insurance fulfillment accounting framework and the results are included in adjusted operating income in a manner generally consistent withU.S. GAAP. In contrast, certain of our guaranteed living benefit riders (e.g., GMAB, GMWB and GMIWB) are accounted for underU.S. GAAP as embedded derivatives and reported using a fair value accounting framework. For purposes of measuring segment performance, adjusted operating income excludes the changes in fair value and instead reflects the performance of these riders using an insurance fulfillment accounting framework. Under this framework, adjusted operating income recognized each period reflects the rider fees earned during the period, less the portion of such fees estimated to be required to cover future benefit payments and hedging costs. For more information on how we determine the portion of fees needed to cover estimated future benefit payments and hedging costs, see "-Risks and Risk Mitigants" below.
Operating Results
The following table sets forth Individual Annuities' operating results for the
periods indicated.
Year ended December 31,
2019 2018 2017
(in millions)
Operating results:
Revenues $ 4,995 $ 4,966 $ 5,110
Benefits and expenses 3,152 3,041 2,912
Adjusted operating income 1,843 1,925 2,198 Realized investment gains (losses), net, and related adjustments
(2,551 ) 846 (1,157 ) Charges related to realized investment gains (losses), net 59 (407 ) 577
Market experience updates(1) (100 ) 0 0
Income (loss) before income taxes and equity in earnings of
operating joint ventures $ (749 ) $ 2,364 $ 1,618
________(1) Represents the immediate impacts in current period results from changes in
current market conditions on estimates of profitability, which are excluded
from adjusted operating income beginning with the second quarter of 2019. The
Company had historically recognized these impacts in adjusted operating
income. See Note 22 to the Consolidated Financial Statements for additional
information.
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Adjusted Operating Income
2019 to 2018 Annual Comparison. Adjusted operating income decreased$82 million , including an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Results from the annual reviews included a net charge of$12 million and a net benefit of$10 million in 2019 and 2018, respectively. Excluding this item, adjusted operating income decreased$60 million primarily driven by lower fee income, net of distribution expenses and other associated costs, and higher expenses, partially offset by higher net investment spread results and an unfavorable impact from changes in market conditions on the estimates of profitability in the prior period. Fee income, net of distribution expenses and other associated costs, declined due to certain products reaching contractual milestones for fee tier reduction, unfavorable impacts from our living benefit guarantees as a result of declining interest rates, lower average account values resulting from net outflows which were partially offset by market appreciation, and higher capital hedge costs reflecting the impacts of equity market performance. The increase in expenses was primarily driven by initiatives to generate business growth. The increase in net investment income was primarily due to a higher level of invested assets. The unfavorable impact on the estimates of profitability in the prior period was driven by market conditions, and beginning with the second quarter of 2019, this activity is excluded from adjusted operating income (see Note 22 to the Consolidated Financial Statements for further information).
Revenues, Benefits and Expenses
2019 to 2018 Annual Comparison. Revenues increased$29 million . Excluding the impact from our annual reviews and update of assumptions and other refinements, discussed above, revenues increased$47 million . The increase was driven by higher net investment income primarily reflecting a higher level of invested assets, and higher premiums mostly reflecting an increase in single premium immediate annuity sales, with offsets in policyholders' benefits as discussed below. These increases were partially offset by lower policy charges and fee income reflecting certain products reaching contractual milestones for fee tier reduction, unfavorable impacts from our living benefit guarantees as a result of declining interest rates, and lower average account values resulting from net outflows which were partially offset by market appreciation. Also contributing to the decrease were lower asset management and service fees and other income primarily due to higher capital hedge costs reflecting the impacts of equity market performance. Benefits and expenses increased$111 million . Excluding the impact from our annual reviews and update of assumptions and other refinements, discussed above, benefits and expenses increased$107 million primarily driven by policyholders' benefits, including changes in reserves, due to higher reserve provisions resulting from an increase in single premium immediate annuity sales, with offsets in premiums, as discussed above.
Account Values
Account values are a significant driver of our operating results. Since most
fees are determined by the level of separate account assets, fee income varies
primarily based on the level of account values. Additionally, our fee income
generally drives other items such as the pattern of amortization of DAC and
other costs. Account values are driven by net flows from new business sales,
surrenders, withdrawals and benefit payments, policy charges and the impact of
positive or negative market value changes. The annuity industry's competitive
and regulatory landscapes, which have been dynamic over the last few years, may
impact our net flows, including new business sales. The following table sets
forth account value information for the periods indicated.
Year ended December 31,
2019 2018 2017
(in millions)
Total Individual Annuities(1):
Beginning total account value $ 151,080 $ 168,626 $ 156,783
Sales 9,720 8,270 5,894
Full surrenders and death benefits(2) (9,374 ) (8,958 ) (7,372 )
Sales, net of full surrenders and death benefits(2) 346 (688 ) (1,478 )
Partial withdrawals and other benefit payments(2) (5,163 ) (4,814 ) (4,322 )
Net flows (4,817 ) (5,502 ) (5,800 )
Change in market value, interest credited and other activity 27,072 (8,341 ) 21,355
Policy charges (3,654 ) (3,703 ) (3,712 )
Ending total account value $ 169,681 $ 151,080 $ 168,626
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__________
(1) Includes gross variable and fixed annuities sold as retail investment
products. Investments sold through defined contribution plan products are
included with such products within our Retirement business. Variable annuity
account values were
were
2018 and 2017, respectively.
(2) Prior period amounts have been reclassified to conform to current period
presentation.
2019 to 2018 Annual Comparison. The increase in account values during 2019 was primarily driven by favorable changes in the market value of contractholder funds, partially offset by net outflows and policy charges.
Sales, net of full surrenders and death benefits, for 2019 increased compared to 2018, primarily due to an increase in sales attributable to product design and pricing actions implemented to enhance product competitiveness in both our variable and fixed annuity products.
Risks and Risk Mitigants
Fixed Annuity Risks and Risk Mitigants. The primary risk exposure of our fixed annuity products relates to investment risks we bear for providing customers a minimum guaranteed interest rate required to be credited to the customer's account value, interest rate fluctuations and/or sustained periods of low interest rates, and credit risk related to the underlying investments. We manage these risk exposures primarily through a combination of product design features and external reinsurance. Our product design features include rate resetting subject to the guaranteed interest rate as well as surrender charges applied during the early years of the policy that help to provide protection for premature withdrawals. In addition, a portion our fixed products have a market value adjustment provision that provides protection of lapse in the case of rising interest rates. For information on our external reinsurance agreements, refer to the "Business" section. Variable Annuity Risks and Risk Mitigants. The primary risk exposures of our variable annuity contracts relate to actual deviations from, or changes to, the assumptions used in the original pricing of these products, including capital markets assumptions such as equity market returns, interest rates and market volatility, along with actuarial assumptions such as contractholder mortality, the timing and amount of annuitization and withdrawals, and contract lapses. For these risk exposures, achievement of our expected returns and profitability is subject to the risk that actual experience will differ from the assumptions used in the original pricing of these products. We currently manage our exposure to certain risks driven by fluctuations in capital markets primarily through a combination of i) Product Design Features, ii) Asset Liability Management Strategy, and iii) Capital Hedge Program as discussed below. We also manage these risk exposures through external reinsurance. For information on our external reinsurance agreements, refer to the "Business" section and Note 14 to the Consolidated Financial Statements.
i. Product Design Features:
A portion of the variable annuity contracts that we offer include an automatic
rebalancing feature, also referred to as an asset transfer feature. This feature
is implemented at the contract level, and transfers assets between certain
variable investment sub-accounts selected by the annuity contractholder and,
depending on the benefit feature, a fixed-rate account in the general account or
a bond fund sub-account within the separate accounts. The automatic rebalancing
feature associated with currently-sold variable annuity products with the
highest daily benefit uses a designated bond fund sub-account within the
separate accounts. The transfers are based on a static mathematical formula used
with the particular benefit which considers a number of factors, including, but
not limited to, the impact of investment performance on the contractholder's
total account value. The objective of the automatic rebalancing feature is to
reduce our exposure to equity market risk and market volatility. Other product
design features we utilize include, among others, asset allocation restrictions,
minimum issuance age requirements and certain limitations on the amount of
contractholder deposits, as well as a required minimum allocation to our general
account for certain of our products. We continue to introduce products that
diversify our risk profile and have incorporated provisions in product design
allowing frequent revisions of key pricing elements for certain of our products.
In addition, there is diversity in our fee arrangements, as certain fees are
primarily based on the benefit guarantee amount, the contractholder account
value and/or premiums, which helps preserve certain revenue streams when market
fluctuations cause account values to decline.
ii. Asset Liability Management ("ALM") Strategy (including fixed income
instruments and derivatives):
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We employ an ALM strategy that utilizes a combination of both traditional fixed
income instruments and derivatives to help defray potential claims associated
with our variable annuity living benefit guarantees. The economic liability we
manage with this ALM strategy consists of expected living benefit claims under
less severe market conditions, which are managed through the accumulation of
fixed income instruments, and potential living benefit claims resulting from
more severe market conditions, which are hedged using derivative instruments.
For our Prudential Defined Income ("PDI") variable annuity, we utilize fixed
income instruments to help defray potential claims. For the portion of our ALM
strategy executed with derivatives, we enter into a range of exchange-traded and
OTC equity and interest rate derivatives, including, but not limited to: equity
and treasury futures; total return and interest rate swaps; and options,
including equity options, swaptions, and floors and caps. The intent of this
strategy is to more efficiently manage the capital and liquidity associated with
these products while continuing to mitigate fluctuations in net income due to
movements in capital markets.
Under our ALM strategy, adjusted operating income includes the fees earned that
are in excess of the estimated portion of fees required to cover expected claims
and hedge costs for the economic liability. The portion of fees required to
cover such costs is updated quarterly to reflect revised estimates and actual
experience. The effectiveness of our hedging program is measured by comparing
the change in value of our hedging assets to the change in value of the
liability we are attempting to hedge and is reflected in adjusted operating
income over time through the inclusion of actual hedge costs. Expected costs are
updated periodically along with our expectation of claims. For adjusted
operating income purposes, DAC and other costs are fully amortized over the life
of the contracts proportional to our actual and estimated gross profits under
the adjusted operating income framework described above.
The following table provides a reconciliation between the liability reported
under U.S. GAAP and the economic liability we manage through our ALM strategy as
of the periods indicated.
December 31,
2019 2018
(in millions)
U.S. GAAP liability (including non-performance risk) $ 12,697 $ 8,860
Non-performance risk adjustment 3,437 4,619
Subtotal 16,134
13,479
Adjustments including risk margins and valuation methodology differences
(4,385 ) (4,084 )
Economic liability managed through the ALM strategy $ 11,749
As of
Under our ALM strategy, we expect differences in theU.S. GAAP net income impact between the changes in value of the fixed income instruments and derivatives, as compared to the changes in the embedded derivative liability these assets support. These differences can be primarily attributed to three distinct areas:
• Different valuation methodologies in measuring the liability we intend to
cover with fixed income instruments and derivatives versus the liability
reported under
the economic liability we intend to defray with fixed income instruments and
derivatives is different from that required to be utilized to measure the
liability under
liability excludes certain items that are included within the
liability, such as
possibility of our own default), as well as risk margins (required by
GAAP but not included in our best estimate).
• Different accounting treatment between liabilities and assets supporting
those liabilities-Under
derivative liability and derivative instruments used to hedge a portion of
the economic liability are immediately reflected in net income. In contrast,
changes in fair value of fixed income instruments that support a portion of
the economic liability are designated as available-for-sale and are recorded
as unrealized gains (losses) in other comprehensive income versus net
income.
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• General hedge results-For the derivative portion of the ALM strategy, the
net hedging impact (the extent to which the changes in value of the hedging
instruments offset the change in value of the portion of the economic
liability we are hedging) may be impacted by a number of factors including:
cash flow timing differences between our hedging instruments and the
corresponding portion of the economic liability we are hedging, basis
differences attributable to actual underlying contractholder funds to be
hedged versus hedgeable indices, rebalancing costs related to dynamicrebalancing of hedging instruments as markets move, certain elements of the
economic liability that may not be hedged (including certain actuarial
assumptions), and implied and realized market volatility on the hedge
positions relative to the portion of the economic liability we seek to
hedge.
The following table illustrates the net impact to our Consolidated Statements of
Operations from changes in the U.S. GAAP embedded derivative liability and hedge
positions under the ALM strategy, and the related amortization of DAC and other
costs, that are excluded from adjusted operating income for the periods
indicated:
Year ended December 31,
2019 2018 2017
(in millions)(1)
Excluding impact of assumption updates and other
refinements:
Net hedging impact(2) $ (199 ) $ (234 ) $ 620
Change in portions of U.S. GAAP liability, before NPR(3) (254 ) (959 ) 2,477
Change in the NPR adjustment (1,064 ) 1,472 (3,890 )
Net impact from changes in the U.S. GAAP embedded
derivative and hedge positions (1,517 ) 279 (793 ) Related benefit (charge) to amortization of DAC and other costs
247 (190 ) 159
Net impact of assumption updates and other refinements 17 (173 ) (85 )
Net impact from changes in the U.S. GAAP embedded
derivative and hedge positions, after the impact of NPR ,
DAC and other costs $ (1,253 ) $ (84 ) $ (719 )
_________(1) Positive amount represents income; negative amount represents a loss.
(2) Net hedging impact represents the difference between the change in fair value
of the risk we seek to hedge using derivatives and the change in fair value
of the derivatives utilized with respect to that risk.
(3) Represents risk margins and valuation methodology differences between the
economic liability managed by the ALM strategy and the
For 2019, the loss of$1,253 million primarily reflected the impact of a$1,517 million net charge from the changes in theU.S. GAAP embedded derivative and hedge positions. This net charge was primarily driven by the impacts of declining interest rates and credit spreads tightening, partially offset by the favorable equity market performance. This net charge was partially offset by a benefit related to the amortization of DAC and other costs of$247 million . For 2018, the loss of$84 million primarily reflected the impact of a$173 million charge from our annual review and update of assumptions, driven by modifications to both our actuarial assumptions, including updates to expected withdrawal rates, as well as to economic assumptions. These charges were largely offset by changes in theU.S. GAAP embedded derivative and hedge positions as a result of credit spreads widening, partially offset by declining interest rates and unfavorable equity market performance.
For information regarding the Risk Appetite Framework ("RAF") we use to evaluate
and support the risks of the ALM strategy, see "-Liquidity and
iii. Capital Hedge Program: We employ a capital hedge program to hedge equity market impacts. The program is intended to protect a portion of the overall capital position of the variable annuities business against its exposure to the equity markets. The capital hedge program is conducted using equity derivatives which include equity call and put options, total return swaps and futures contracts. The changes in value of these derivatives are recognized in adjusted operating income over the expected duration of the capital hedge program.
Product Specific Risks and Risk Mitigants
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For certain living benefits guarantees, claims will primarily represent the
funding of contractholder lifetime withdrawals after the cumulative withdrawals
have first exhausted the contractholder account value. Due to the age of the
in-force block, limited claim payments have occurred to date, and they are not
expected to increase significantly within the next five years, based upon
current assumptions. The timing and amount of future claims will depend on
actual returns on contractholder account value and actual contractholder
behavior relative to our assumptions. The majority of our current living
benefits guarantees provide for guaranteed lifetime contractholder withdrawal
payments inclusive of a "highest daily" contract value guarantee. Our Prudential
Defined Income ("PDI") variable annuity complements our variable annuity
products with the highest daily benefit and provides for guaranteed lifetime
contractholder withdrawal payments, but restricts contractholder asset
allocation to a single bond fund sub-account within the separate accounts.
The majority of our variable annuity contracts with living benefits guarantees,
and all new contracts sold with our highest daily living benefits feature,
include risk mitigants in the form of an automatic rebalancing feature and/or
inclusion in our ALM strategy. We may also utilize external reinsurance as a
form of additional risk mitigation. The risks associated with the guaranteed
benefits of certain legacy products that were sold prior to our development of
the automatic rebalancing feature are also managed through our ALM strategy.
Certain legacy GMAB products include the automatic rebalancing feature but are
not included in the ALM strategy.
For our GMDBs, we provide a benefit payable in the event of death. Our base GMDB
is generally equal to a return of cumulative deposits adjusted for any partial
withdrawals. Certain products include an optional enhanced GMDB based on the
greater of a minimum return on the contract value or an enhanced value. We have
retained the risk that the total amount of death benefit payable may be greater
than the contractholder account value; however, a substantial portion of the
account values associated with GMDBs are subject to an automatic rebalancing
feature because the contractholder also selected a living benefit guarantee
which includes an automatic rebalancing feature. All of the variable annuity
account values with living benefit guarantees also contain GMDBs. The living and
death benefit features for these contracts cover the same insured life and,
consequently, we have insured both the longevity and mortality risk on these
contracts.
The following table sets forth the risk management profile of our living benefit guarantees and GMDB features as of the periods indicated.
December 31,
2019 2018 2017
Account Value % of Total Account Value % of Total Account Value % of Total
(in millions)
Living benefit/GMDB features(1):
Both ALM strategy and automatic
rebalancing(2)(3) $ 111,535 68 % $ 101,496 69 % $ 114,686 69 %
ALM strategy only(3) 7,703 5 % 7,520 5 % 9,317 6 %
Automatic rebalancing only 732 1 % 804 1 % 1,003 1 %
External reinsurance(4) 3,150 2 % 2,873 2 % 3,227 2 %
PDI 16,296 9 % 11,237 7 % 9,996 5 %
Other products 2,457 1 % 2,306 2 % 2,791 2 %
Total living benefit/GMDB
features $ 141,873 $ 126,236 $ 141,020
GMDB features and other(5) 23,055 14 % 21,103 14 % 24,133 15 %
Total variable annuity account
value $ 164,928 $ 147,339 $ 165,153
_________(1) All contracts with living benefit guarantees also contain GMDB features,
which cover the same insured contract.
(2) Contracts with living benefits that are included in our ALM strategy and that
have an automatic rebalancing feature.
(3) Excludes PDI which is presented separately within this table.
(4) Represents contracts subject to a reinsurance transaction with an external
counterparty covering certain new HDI v.3.0 business for the period
2015 through
have an automatic rebalancing feature. See Note 14 to the Consolidated
Financial Statements for additional information.
(5) Includes contracts that have a GMDB feature and do not have an automatic
rebalancing feature.
Individual Life
Operating Results
The following table sets forth Individual Life's operating results for the periods indicated.
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Year ended December 31,
2019 2018 2017
(in millions)
Operating results:
Revenues $ 6,115 $ 5,831 $ 4,974
Benefits and expenses 6,028 5,608 5,165
Adjusted operating income 87 223 (191 ) Realized investment gains (losses), net, and related adjustments
358 (318 ) 96
Charges related to realized investment gains
(losses), net (121 ) 79 101
Market experience updates(1) (308 ) 0 0
Income (loss) before income taxes and equity in
earnings of operating joint ventures $ 16 $
(16 )
________
(1) Represents the immediate impacts in current period results from changes in
current market conditions on estimates of profitability, which are excluded
from adjusted operating income beginning with the second quarter of 2019. The
Company had historically recognized these impacts in adjusted operating
income. See Note 22 to the Consolidated Financial Statements for additional
information.
Adjusted Operating Income
2019 to 2018 Annual Comparison. Adjusted operating income decreased $136
million , primarily reflecting an unfavorable comparative net impact from our
annual reviews and update of assumptions and other refinements. Results for 2019
included a $208 million net charge from this annual review, mainly driven by
unfavorable impacts related to mortality rate assumptions. Results for 2018
included a $65 million net charge from this annual review, mainly driven by
unfavorable impacts related to lapse and mortality rate assumptions. Excluding
this item, adjusted operating income increased $7 million , primarily reflecting
a higher contribution from net investment spread results driven by higher income
on non-coupon investments and higher prepayment fee income, and an unfavorable
impact from changes in market conditions on estimates of profitability in the
prior period. Beginning with the second quarter of 2019, the impact from this
activity is excluded from adjusted operating income (see Note 22 to the
Consolidated Financial Statements for additional information). These increases
were mostly offset by lower underwriting results, driven by an unfavorable
impact from mortality experience, net of reinsurance, and the unfavorable
ongoing impact of our annual reviews and update of assumptions and other
refinements, and higher expenses.
Revenues, Benefits and Expenses
2019 to 2018 Annual Comparison. Revenues increased$284 million . Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, revenues increased$321 million . This increase was primarily driven by an increase in net investment income from higher average invested assets resulting from business growth, higher income on non-coupon investments and higher prepayment fee income, and higher investment income from unaffiliated reserve financing activity that resulted in a corresponding increase in interest expense, as discussed below. Also contributing to the increase was higher policy charges and fee income driven by business growth and equity market appreciation. Benefits and expenses increased$420 million . Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, benefits and expenses increased$314 million . This increase was primarily driven by higher policyholders' benefits and interest credited to account balances attributable to an unfavorable impact from mortality experience, net of reinsurance, the unfavorable ongoing impact of the assumption update and other refinements, as discussed above, and business growth. Also contributing to the increase was higher reserve financing costs, as discussed above.
Sales Results
The following table sets forth Individual Life's annualized new business premiums, as defined under "-Results of Operations-Segment Measures" above, by distribution channel and product, for the periods indicated.
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2019 2018 2017
Prudential Third Prudential Third Prudential Third
Advisors Party Total Advisors Party Total Advisors Party Total
(in millions)
Term Life $ 27 $ 173 $ 200 $ 28 $ 185 $ 213 $ 30 $ 183 $ 213
Guaranteed
Universal Life(1) 8 87 95 8 89 97 16 140 156
Other Universal
Life(1) 38 117 155 45 105 150 37 88 125
Variable Life 78 200 278 54 109 163 35 95 130
Total $ 151 $ 577 $ 728 $ 135 $ 488 $ 623 $ 118 $ 506 $ 624
__________(1) Single pay life premiums and excess (unscheduled) premiums are included in
annualized new business premiums based on a 10% credit and represented
approximately 4%, 7% and 15% of Guaranteed Universal Life and 0%, 0% and 1%
of Other Universal Life annualized new business premiums for the years ended
2019 to 2018 Annual Comparison. Total annualized new business premiums increased$105 million , primarily reflecting higher sales of variable life products driven by product design and pricing actions implemented inSeptember 2018 .U.S. Businesses-Assurance IQ Division Assurance IQ
Business Update
• In
consumer solutions platform that offers a range of solutions that help
meet consumers' financial needs (see "Business" and Note 1 to the
Consolidated Financial Statements for additional information).
Operating Results
The following table sets forth Assurance IQ's operating results for the period
indicated.
For Period Beginning on
October 10, 2019
and Ending on December 31,
2019
(in millions)
Operating results:
Revenues 101
Expenses 110
Adjusted operating income (9 )
Other adjustments(1) (47 )
Income (loss) before income taxes and equity in
earnings of operating joint ventures $ (56 )
__________
(1) "Other adjustments" include certain components of the consideration for the
Assurance IQ acquisition, which are recognized as compensation expense over
the requisite service periods, as well as changes in the fair value of
contingent consideration. See Note 22 to the Consolidated Financial
Statements.
Adjusted Operating Income
For the period from October 10, 2019 ("acquisition date") to December 31, 2019 ,
adjusted operating income was $(9) million . Adjusted operating income reflects
the starting period of Assurance IQ's earnings with Prudential and includes
revenues, net of marketing and distribution expenses, related to seasonal
enrollments within our health (Health Under 65 and Medicare) product line, which
are generally most significant in the fourth quarter. Results also include
operating expenses and amortization expenses related to intangible assets
recognized as part of purchase accounting (see Note 1 and Note 10 to the
Consolidated Financial Statements for additional information).
Revenues and Expenses
Revenues were$101 million , primarily reflecting commissions and marketing referral revenues from our health (Health Under 65 and Medicare), life insurance, and property and casualty product lines. Expenses were$110 million driven by marketing and distribution costs, general and administrative operating expenses, and amortization expenses related to intangible assets. 92
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Table of Contents International Businesses Business Update
• In
de Pensiones Colfondos S.A. ("AFP Colfondos"), a leading provider of
retirement services in Colombia .
• The Company is exploring strategic options for its Korean insurance business.
Operating Results The results of our International Businesses' operations are translated on the basis of weighted average monthly exchange rates, inclusive of the effects of the intercompany arrangement discussed in "-Results of Operations-Impact of Foreign Currency Exchange Rates" above. To provide a better understanding of operating performance within International Businesses, where indicated below, we have analyzed our results of operations excluding the effect of the year over year change in foreign currency exchange rates. Our results of operations, excluding the effect of foreign currency fluctuations, were derived by translating foreign currencies to USD at uniform exchange rates for all periods presented, including for constant dollar information discussed below. The exchange rates used were Japanese yen at a rate of105 yen per USD and Korean won at a rate of1,110 won per USD, both of which were determined in connection with the foreign currency income hedging program discussed in "-Results of Operations-Impact of Foreign Currency Exchange Rates" above. In addition, for constant dollar information discussed below, activity denominated in USD is generally reported based on the amounts as transacted in USD. Annualized new business premiums presented on a constant exchange rate basis in the "Sales Results" section below reflect translation based on these same uniform exchange rates. The following table sets forth International Businesses' operating results for the periods indicated. Year ended December 31, 2019 2018 2017 (in millions) Operating results: Revenues: Life Planner$ 11,864 $ 11,176 $ 10,644 Gibraltar Life and Other 11,331 11,058 10,916 Total revenues 23,195 22,234 21,560 Benefits and expenses: Life Planner 10,184 9,586 9,151 Gibraltar Life and Other 9,652 9,382 9,211 Total benefits and expenses 19,836 18,968 18,362 Adjusted operating income: Life Planner 1,680 1,590 1,493 Gibraltar Life and Other 1,679 1,676 1,705 Total adjusted operating income 3,359
3,266 3,198 Realized investment gains (losses), net, and related adjustments(1)
1,311 172 985
Charges related to realized investment gains (losses), net (14 ) 10 (18 )
Market experience updates(2) (44 ) 0 0
Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests
(107 ) (69 ) (43 ) Income (loss) before income taxes and equity in earnings of operating joint ventures
$ 4,505 $
3,379
__________
(1) Prior period amounts have been updated to conform to current period
presentation.
(2) Represents the immediate impacts in current period results from changes in
current market conditions on estimates of profitability, which are excluded
from adjusted operating income beginning with the second quarter of 2019. The
Company had historically recognized these impacts in adjusted operating
income. See Note 22 to the Consolidated Financial Statements for additional
information.
Adjusted Operating Income
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2019 to 2018 Annual Comparison. Adjusted operating income from our Life Planner operations increased$90 million including a net favorable impact of$19 million from currency fluctuations, inclusive of the currency hedging program discussed above. Both periods also include the impact of our annual reviews and update of assumptions and other refinements, which resulted in a$1 million net benefit in 2019 compared to a$49 million net charge in 2018. The net charge in 2018 was primarily driven by the impact from unfavorable economic assumption updates driven by a lower long-term interest rate assumption inJapan . Excluding these items, adjusted operating income from our Life Planner operations increased$21 million , primarily reflecting business growth inJapan , higher underwriting results driven by a favorable impact from mortality experience and policyholders' behavior, and higher net investment spread results driven by higher income on non-coupon investments and higher prepayment fee income. Also contributing to the increase was an unfavorable impact from changes in market conditions on estimates of profitability in the prior period. Beginning in the second quarter of 2019, the impact from this activity is excluded from adjusted operating income (see Note 22 to the Consolidated Financial Statements for additional information). These increases were partially offset by higher expenses driven by updates to legal reserves, as well as higher costs including those related to business growth and business initiatives. Adjusted operating income from our Gibraltar Life and Other operations increased$3 million including a net favorable impact of$14 million from currency fluctuations, inclusive of the currency hedging program discussed above. Both periods also include the impact of our annual reviews and update of assumptions and other refinements, which resulted in a$7 million net benefit in 2019 compared to a$32 million net charge in 2018. The net benefit in 2019 reflected a net positive impact primarily related to updates to lapse assumptions. The net charge in 2018 was primarily driven by the impact from unfavorable economic assumption updates driven by a lower long-term interest rate assumption inJapan , as well as other refinements. Excluding these items, adjusted operating income from our Gibraltar Life and Other operations decreased$50 million , primarily reflecting higher expenses related to costs associated with business growth and business initiatives, including enhancements to sales processes and distribution. Also contributing to the decrease were lower underwriting results driven by an unfavorable impact from mortality experience and policyholders' behavior. These decreases were partially offset by the favorable impact from growth of business in force, higher net investment spread results driven by higher income on non-coupon investments and higher prepayment fee income, and higher other income driven by a favorable impact from our joint venture investments.
Revenues, Benefits and Expenses
2019 to 2018 Annual Comparison. Revenues from our Life Planner operations increased$688 million including a net unfavorable impact of$98 million from currency fluctuations and a net charge of$16 million from our annual reviews and update of assumptions and other refinements. Excluding these items, revenues increased$802 million , primarily driven by higher premiums related to the business growth, and higher net investment spread results driven by higher income on non-coupon investments and higher prepayment fee income. Benefits and expenses from our Life Planner operations increased$598 million including a net favorable impact of$117 million from currency fluctuations and a net benefit of$66 million from our annual review and update of assumptions and other refinements. Excluding these items, benefits and expenses increased$781 million , primarily reflecting higher policyholders' benefits, including changes in reserves, driven by business growth, and higher expenses driven by updates to legal reserves, as well as higher costs including those related to business growth and business initiatives. Revenues from our Gibraltar Life and Other operations increased$273 million , including a net favorable impact of$30 million from currency fluctuations. Excluding this item, revenues increased$243 million , primarily reflecting higher net investment results driven by higher income on non-coupon investments and higher prepayment fee income, and higher other income driven by a favorable impact from our joint venture investments. Benefits and expenses from our Gibraltar Life and Other operations increased$270 million including a net unfavorable impact of$16 million from currency fluctuations and a net benefit of$39 million from our annual reviews and update of assumptions and other refinements. Excluding these items, benefits and expenses increased$293 million , primarily driven by an increase in policyholders' benefits, including changes in reserves, driven by growth of business in force, and higher expenses related to costs associated with business growth and business initiatives, including enhancements to sales processes and distribution. Sales Results
The following table sets forth annualized new business premiums, as defined under "-Results of Operations-Segment Measures" above, on an actual and constant exchange rate basis for the periods indicated.
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Year ended December 31,
2019 2018 2017
(in millions)
Annualized new business premiums:
On an actual exchange rate basis:
Life Planner $ 1,392 $ 1,257 $ 1,391
Gibraltar Life and Other 1,213 1,483 1,595
Total $ 2,605 $ 2,740 $ 2,986
On a constant exchange rate basis:
Life Planner 1,420 1,262 1,402
Gibraltar Life and Other 1,219 1,490 1,619
Total $ 2,639 $ 2,752 $ 3,021
The amount of annualized new business premiums and the sales mix in terms of
types and currency denomination of products for any given period can be
significantly impacted by several factors, including but not limited to: the
addition of new products, discontinuation of existing products, changes in
credited interest rates for certain products and other product modifications,
changes in premium rates, changes in interest rates or fluctuations in currency
markets, changes in tax laws, changes in life insurance regulations or changes
in the competitive environment. Sales volume may increase or decrease prior to
certain of these changes becoming effective, and then fluctuate in the other
direction following such changes.
Our diverse product portfolio in Japan , in terms of currency mix and premium
payment structure, allows us to adapt to changing market and competitive
dynamics, including the extremely low interest rate environment. We regularly
examine our product offerings and their related profitability and, as a result,
we have repriced or discontinued sales of certain products that do not meet our
profit expectations. The impact of these actions, coupled with the introduction
of certain new products, has generally resulted in an increase in sales of
products denominated in USD relative to products denominated in other
currencies.
2019 to 2018 Annual Comparison. The table below presents annualized new business
premiums on a constant exchange rate basis, by product category and distribution
channel, for the periods indicated.
Year Ended December 31, 2019 Year Ended December 31, 2018
Accident Accident
& Retirement & Retirement
Life Health (1) Annuity Total Life Health (1) Annuity Total
(in millions)
Life Planner $ 769 $ 115 $ 430 $ 106 $ 1,420 $ 704 $ 119 $ 347 $ 92 $ 1,262
Gibraltar Life
and Other:
Life
Consultants 348 40 82 142 612 313 46 101 329 789
Banks(2) 378 0 38 12 428 413 1 28 38 480
Independent
Agency 88 7 68 16 179 114 11 62 34 221
Subtotal 814 47 188 170 1,219 840 58 191 401 1,490
Total $ 1,583 $ 162 $ 618 $ 276 $ 2,639 $ 1,544 $ 177 $ 538 $ 493 $ 2,752
__________(1) Includes retirement income, endowment and savings variable universal life.
(2) Single pay life annualized new business premiums, which include 10% of first
year premiums, and 3-year limited pay annualized new business premiums, which
include 100% of new business premiums, represented 1% and 66%, respectively,
of total Japanese bank distribution channel annualized new business premiums,
excluding annuity products, for the year ended
71%, respectively, of total Japanese bank distribution channel annualized new
business premiums, excluding annuity products, for the year ended
December 31, 2018 .
Annualized new business premiums, on a constant exchange rate basis, from our
Life Planner operations increased $158 million driven by growth in Life Planner
headcount, as discussed below, as well as higher average premium sizes in our
Japan , Korea and Brazil operations.
Annualized new business premiums, on a constant exchange rate basis, from our
Gibraltar Life and Other operations decreased $271 million . Life Consultants
sales decreased $177 million , primarily reflecting lower sales of
USD-denominated fixed annuity products driven by declines in crediting rates, a
lower Life Consultant headcount, as discussed below, and prioritization of our
strategy to focus on recurring pay protection products. Bank channel sales
decreased $52 million , primarily from lower sales of
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protection products and lower sales of USD-denominated products due to increased competition.Independent Agency sales decreased$42 million , primarily driven by the suspension of corporate term products in the first quarter of 2019 (see "Business-Regulation-International Taxation") and declines in crediting rates for fixed annuity products. Sales Force The following table sets forth the number ofLife Planners and Life Consultants for the periods indicated. As of December 31, 2019 2018 2017 Life Planners: Japan 4,356 4,183 3,941 All other countries 4,062 3,786 3,890 Gibraltar Life Consultants 7,403 7,964 8,326 Total 15,821 15,933 16,157 2019 to 2018 Comparison. The number of Life Planners increased by 449, driven by an increase of 173 inJapan as a result of recruiting efforts and fewer terminations. Life Planners increased by 276 in other operations, primarily due to increases inBrazil andKorea as a result of recruiting efforts. The number ofGibraltar Life Consultants decreased by 561, primarily reflecting more selective recruiting efforts and retention standards.
Corporate and Other
Corporate and Other includes corporate operations, after allocations to our
business segments, and Divested and Run-off Businesses other than those that
qualify for "discontinued operations" accounting treatment under
Year ended December 31,
2019 2018 2017
(in millions)
Operating results:
Capital debt interest expense $ (787 ) $ (726 ) $ (705 )
Investment income, net of operating debt interest expense 171 86 96
Pension and employee benefits 149 195 157
Other corporate activities(1) (1,299 ) (838 ) (985 )
Adjusted operating income (1,766 ) (1,283 ) (1,437 ) Realized investment gains (losses), net, and related adjustments
(193 ) 216 (407 )
Charges related to realized investment gains (losses), net (53 ) 7 (26 )
Market experience updates(2) (10 ) 0 0
Divested and Run-off Businesses 452 (1,535 ) 38 Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests
(6 ) 4 (19 )
Income (loss) before income taxes and equity in earnings
of operating joint ventures $ (1,576 ) $ (2,591 ) $ (1,851 )
__________(1) Includes consolidating adjustments.
(2) Represents the immediate impacts in current period results from changes in
current market conditions on estimates of profitability, which are excluded
from adjusted operating income beginning with the second quarter of 2019. The
Company had historically recognized these impacts in adjusted operating
income. See Note 22 to the Consolidated Financial Statements for additional
information.
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2019 to 2018 Annual Comparison. The loss from Corporate and Other operations, on an adjusted operating income basis, increased$483 million . Net charges from other corporate activities increased$461 million , primarily reflecting implementation costs for certain programs that are expected to result in margin improvements, including a charge related to the Company's Voluntary Separation Program (see "-Overview" above). The increase also reflected higher costs for long-term and deferred compensation plans tied to Company stock and equity market performance, and certain acquisition costs in the current period, partially offset by lower enhanced supervision costs and decreases in other corporate charges. Capital debt interest expense increased$61 million , reflecting higher average debt balances. Results for investment income, net of operating debt interest expense, increased$85 million , driven by an increase in net investment income driven by higher average invested assets and higher income on highly liquid assets. Beginning in the fourth quarter of 2019, the Company implemented certain changes that are expected to reduce market-based earnings volatility on the long-term and deferred compensation plans. Results from pension and employee benefits were less favorable by$46 million , primarily reflecting lower income from our qualified pension plan, due to higher interest costs on plan obligations driven by the increase in interest rates in 2018. For purposes of calculating pension income from our qualified pension plan for the year endedDecember 31, 2020 , we will decrease the discount rate from 4.30% to 3.30% as ofDecember 31, 2019 . The expected rate of return on plan assets will decrease from 6.50% in 2019 to 6.00% in 2020. The assumed rate of increase in compensation will remain unchanged at 4.50%. Giving effect to the foregoing assumptions and other factors, we expect income from our qualified pension plan in 2020 to be approximately$25 million to$30 million higher than 2019 levels. The increase is driven by higher expected returns on plan assets due to higher than expected plan fixed income asset growth in 2019 as well as lower interest costs on the plan obligation due to the lower discount rate. For purposes of calculating postretirement benefit expenses for the year endedDecember 31, 2020 , we will decrease the discount rate from 4.30% to 3.25% as ofDecember 31, 2019 . The expected rate of return on plan assets will decrease from 7.00% in 2019 to 6.75% in 2020. Giving effect to the foregoing assumptions and other factors, we expect postretirement benefit expenses in 2020 to be approximately$20 million to$25 million lower than 2019 levels. The decrease in expenses is driven by higher expected returns on plan assets due to higher than expected asset growth in 2019, as well as lower interest costs on the plan obligation due to the lower discount rate. In 2020, pension and other postretirement benefit service costs related to active employees will continue to be allocated to our business segments. For further information regarding our pension and postretirement plans, see Note 18 to the Consolidated Financial Statements.
Divested and Run-off Businesses
Divested and Run-off Businesses Included in Corporate and Other
Income from our Divested and Run-off Businesses includes results from several businesses that have been or will be sold or exited, including businesses that have been placed in wind down status that do not qualify for "discontinued operations" accounting treatment underU.S. GAAP. The results of these Divested and Run-off Businesses are reflected in our Corporate and Other operations, but are excluded from adjusted operating income. A summary of the results of the Divested and Run-off Businesses reflected in our Corporate and Other operations is as follows for the periods indicated: Year ended December 31, 2019 2018 2017 (in millions) Long-Term Care$ 469 $ (1,458 ) $ 42 Other (17 )
(77 ) (4 ) Total Divested and Run-off Businesses income (loss) excluded from adjusted operating income
$ 452
Long-Term Care . Results for the year endedDecember 31, 2019 increased compared to 2018, primarily reflecting a favorable comparative net impact from our annual reviews and update of assumptions and other refinements. Results for 2019 included a$9 million net charge from these updates and results for 2018 included a$1,458 million net charge from these updates, including the removal of our assumption of expected future morbidity improvement, reflecting unfavorable morbidity experience relative to prior expectations. Excluding these items, results for 2019 increased compared to 2018, reflecting net realized investment gains in the current period compared to net realized investment losses in the prior year period, driven by the favorable comparative 97
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change in the market value of derivatives used for duration management. The increase also reflects the favorable comparative change in the market value of investments in equity securities.
Other. Results for the year endedDecember 31, 2019 reflect less unfavorable results in comparison to the prior year period primarily reflecting lower comparative losses in 2019 related to the sale of ourPramerica ofItaly subsidiary, which closed inDecember 2019 , and the exit of our PGIM Brazil operations in 2018, partially offset by the absence of a gain related to the sale of ourPramerica ofPoland subsidiary in 2018.
Closed Block Division
The Closed Block division includes certain in-force traditional domestic participating life insurance and annuity products and assets that are used for the payment of benefits and policyholder dividends on these policies (collectively, the "Closed Block"), as well as certain related assets and liabilities. We no longer offer these traditional domestic participating policies. See Note 15 to the Consolidated Financial Statements for additional details. Each year, the Board of Directors ofThe Prudential Insurance Company of America ("PICA") determines the dividends payable on participating policies for the following year based on the experience of the Closed Block, including investment income, net realized and unrealized investment gains (losses), mortality experience and other factors. Although Closed Block experience for dividend action decisions is based upon statutory results, at the time the Closed Block was established, we developed, as required byU.S. GAAP, an actuarial calculation of the timing of the maximum future earnings from the policies included in the Closed Block. If actual cumulative earnings in any given period are greater than the cumulative earnings we expected, we record this excess as a policyholder dividend obligation. We will subsequently pay this excess to Closed Block policyholders as an additional dividend unless it is otherwise offset by future Closed Block performance that is less favorable than we originally expected. The policyholder dividends we charge to expense within the Closed Block division will include any change in our policyholder dividend obligation that we recognize for the excess of actual cumulative earnings in any given period over the cumulative earnings we expected in addition to the actual policyholder dividends declared by the Board of Directors of PICA. As ofDecember 31, 2019 , the excess of actual cumulative earnings over the expected cumulative earnings was$2,816 million , which was recorded as a policyholder dividend obligation. Actual cumulative earnings, as required byU.S. GAAP, reflect the recognition of realized investment gains and losses in the current period, as well as changes in assets and related liabilities that support the Closed Block policies. Additionally, the accumulation of net unrealized investment gains that have arisen subsequent to the establishment of the Closed Block has been reflected as a policyholder dividend obligation of$3,332 million atDecember 31, 2019 , to be paid to Closed Block policyholders unless offset by future experience, with a corresponding amount reported in AOCI.
Operating Results
The following table sets forth the Closed Block division's results for the
periods indicated.
Year ended December 31,
2019 2018 2017
(in millions)
U.S. GAAP results:
Revenues $ 5,642 $ 4,678 $ 5,826
Benefits and expenses 5,606 4,740 5,781 Income (loss) before income taxes and equity in earnings of operating joint ventures
$ 36 $ (62 ) $ 45
Income (loss) Before Income Taxes and Equity in Earnings of
2019 to 2018 Annual Comparison. Income (loss) before income taxes and equity in earnings of operating joint ventures increased$98 million . Results for 2019 primarily reflected an increase in net realized investment gains and related activity primarily driven by gains from sales of fixed maturities and favorable changes in the value of equity securities. Net investment income increased primarily due to higher income on non-coupon investments and higher prepayment fee income, partially offset by lower income on fixed income investments. Net insurance activity results increased primarily as a result of a decrease in the 2020 dividend scale, partially offset by a decrease in premiums as a result of runoff of policies in force and higher benefit payments. As a result of the above and other variances, a$564 million increase in the policyholder dividend obligation was recorded in 2019, compared to a$508 million reduction in 2018. If actual cumulative earnings fall below expected cumulative earnings in future periods, earnings volatility in the Closed Block division, which is primarily due to changes in investment results, may not be offset by changes in the cumulative earnings policyholder dividend obligation. For a discussion of the Closed Block division's realized investment gains (losses), net, see "-General Account Investments." 98
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Revenues, Benefits and Expenses
2019 to 2018 Annual Comparison. Revenues increased$964 million primarily driven by an increase in net realized investment gains and related activity, and net investment income, as discussed above. Benefits and expenses increased$866 million , primarily driven by an increase in dividends to policyholders, reflecting an increase in the policyholder dividend obligation expense due to changes in cumulative earnings, as discussed above. Income Taxes The differences between income taxes expected at theU.S. federal statutory income tax rate of 21% applicable for 2019 and 2018 and 35% applicable for 2017, and the reported income tax (benefit) expense are provided in the following table: Year Ended December 31, 2019 2018 2017 (in millions)
Expected federal income tax expense (benefit) at federal statutory rate
$ 1,068 $ 1,015 $ 2,270 Non-taxable investment income (270 ) (246 ) (369 ) Foreign taxes at other than U.S. rate 225 349 (249 ) Low-income housing and other tax credits (118 ) (112 ) (126 ) Changes in tax law 0 (321 ) (2,858 ) Other 42 137 (106 ) Reported income tax expense (benefit)$ 947 $ 822 $ (1,438 ) Effective tax rate 18.6 % 17.0 % (22.2 )% Effective Tax Rate The effective tax rate is the ratio of "Total income tax expense (benefit)" divided by "Income before income taxes and equity in earnings of operating joint ventures." Our effective tax rate for fiscal years 2019, 2018 and 2017 was 18.6%, 17.0%, and (22.2)%, respectively. For a detailed description of the nature of each significant reconciling item, see Note 16 to the Consolidated Financial Statements. The increase in the effective tax rate from (22.2)% in 2017 to 17.0% in 2018, and to 18.6% in 2019 was primarily driven by the impacts of the Tax Act of 2017 in 2017 and 2018.
Unrecognized Tax Benefits
The Company's liability for income taxes includes the liability for unrecognized tax benefits and interest that relate to tax years still subject to review by the Internal Revenue Service or other taxing authorities. The completion of review or the expiration of the Federal statute of limitations for a given audit period could result in an adjustment to the liability for income taxes. The total unrecognized benefit as ofDecember 31, 2019 , 2018 and 2017 was$18 million ,$20 million and$45 million , respectively. We do not anticipate any significant changes within the next twelve months to our total unrecognized tax benefits related to tax years for which the statute of limitations has not expired.
Income Tax Expense vs. Income Tax Paid in Cash
Income tax expense recorded underU.S. GAAP routinely differs from the income taxes paid in cash in any given year. Income tax expense recorded underU.S. GAAP is based on income reported in our Consolidated Statements of Operations for the current period and it includes both current and deferred taxes. Income taxes paid during the year include tax installments made for the current year as well as tax payments and refunds related to prior periods.
For additional information on income tax related items, see "Business-Regulation" and Note 16 to the Consolidated Financial Statements.
Experience-Rated Contractholder Liabilities,
Assets Supporting Experience-Rated Contractholder Liabilities and Other Related
Investments
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Certain products included in the Retirement and International Businesses segments are experience-rated in that investment results associated with these products are expected to ultimately accrue to contractholders. The majority of investments supporting these experience-rated products are carried at fair value. These investments are reflected on the Consolidated Statements of Financial Position as "Assets supporting experience-rated contractholder liabilities, at fair value." Realized and unrealized gains (losses) for these investments are reported in "Other income (loss)." Interest and dividend income for these investments is reported in "Net investment income." To a lesser extent, these experience-rated products are also supported by derivatives and commercial mortgage and other loans. The derivatives that support these experience-rated products are reflected on the Consolidated Statements of Financial Position as "Other invested assets" and are carried at fair value, and the realized and unrealized gains (losses) are reported in "Realized investment gains (losses), net." The commercial mortgage and other loans that support these experience-rated products are carried at unpaid principal, net of unamortized discounts and an allowance for losses, and are reflected on the Consolidated Statements of Financial Position as "Commercial mortgage and other loans." Gains (losses) on sales and changes in the valuation allowance for commercial mortgage and other loans are reported in "Realized investment gains (losses), net." Our Retirement segment has two types of experience-rated products that are supported by assets supporting experience-rated contractholder liabilities and other related investments. Fully participating products are those for which the entire return on underlying investments is passed back to the policyholders through a corresponding adjustment to the related liability, primarily classified in the Consolidated Statements of Financial Position as "Policyholders' account balances." The adjustment to the liability is based on changes in the fair value of all of the related assets, including commercial mortgage and other loans, which are carried at amortized cost, less any valuation allowance. Partially participating products are those for which only a portion of the return on underlying investments is passed back to the policyholders over time through changes to the contractual crediting rates. The crediting rates are typically reset semiannually, often subject to a minimum crediting rate, and returns are required to be passed back within ten years. In our International Businesses, the experience-rated products are fully participating. As a result, the entire return on the underlying investments is passed back to policyholders through a corresponding adjustment to the related liability. Adjusted operating income excludes net investment gains (losses) on assets supporting experience-rated contractholder liabilities, related derivatives and commercial mortgage and other loans. This is consistent with the exclusion of realized investment gains (losses) with respect to other investments supporting insurance liabilities managed on a consistent basis. In addition, to be consistent with the historical treatment of charges related to realized investment gains (losses) on investments, adjusted operating income also excludes the change in contractholder liabilities due to asset value changes in the pool of investments (including changes in the fair value of commercial mortgage and other loans) supporting these experience-rated contracts, which are reflected in "Interest credited to policyholders' account balances." The result of this approach is that adjusted operating income for these products includes net fee revenue and interest spread we earn on these experience-rated contracts, and excludes changes in fair value of the pool of investments, both realized and unrealized, that we expect will ultimately accrue to the contractholders.
The following table sets forth the impact on results for the periods indicated of these items that are excluded from adjusted operating income:
Year ended December 31,
2019 2018 2017
(in millions)
Retirement:
Investment gains (losses) on assets supporting
experience-rated contractholder liabilities, net(1) $ 699 $ (472 ) $ (57 )
Change in experience-rated contractholder liabilities due
to asset value changes (682 ) 435 67
Gains (losses), net, on experienced rated contracts(2)(3) $ 17 $ (37 ) $ 10
International Businesses:
Investment gains (losses) on assets supporting
experience-rated contractholder liabilities, net $ 267 $ (275 ) $ 218 Change in experience-rated contractholder liabilities due to asset value changes
(267 ) 275 (218 )
Gains (losses), net, on experienced rated contracts $ 0 $ 0 $ 0
Total:
Investment gains (losses) on assets supporting
experience-rated contractholder liabilities, net(1) $ 966 $ (747 ) $ 161
Change in experience-rated contractholder liabilities due
to asset value changes (949 ) 710 (151 ) Gains (losses), net, on experienced rated contracts(2)(3) $ 17 $ (37 ) $ 10
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__________
(1) Prior period amounts have been reclassified to conform to current period
presentation.
(2) Decreases to contractholder liabilities due to asset value changes are
limited by certain floors and therefore do not reflect cumulative declines in
recorded asset values of $7 million, $99 million and $18 million as of
December 31, 2019, 2018 and 2017, respectively. We have recovered and expect
to recover in future periods these declines in recorded asset values through
subsequent increases in recorded asset values or reductions in crediting
rates on contractholder liabilities.
(3) Included in the amounts above related to the change in the liability to
contractholders as a result of commercial mortgage and other loans are an
increase of $57 million, and decreases of $23 million and $21 million for the
years ended December 31, 2019, 2018 and 2017, respectively. As prescribed by
held for investment in our general account, other than when associated with
impairments, are not recognized in income in the current period, while the
impact of these changes in fair value are reflected as a change in the
liability to fully participating contractholders in the current period.
The net impacts, for the Retirement segment, of changes in experience-rated
contractholder liabilities and investment gains (losses) on assets supporting
experience-rated contractholder liabilities and other related investments
reflect timing differences between the recognition of the mark-to-market
adjustments and the recognition of the recovery of these adjustments in future
periods through subsequent increases in asset values or reductions in crediting
rates on contractholder liabilities for partially participating products. These
impacts also reflect the difference between the fair value of the underlying
commercial mortgages and other loans and the amortized cost, less any valuation
allowance, of these loans, as described above.
Valuation of Assets and LiabilitiesFair Value of Assets and Liabilities
The authoritative guidance related to fair value measurement establishes a framework that includes a three-level hierarchy used to classify the inputs used in measuring fair value. The level in the hierarchy within which the fair value falls is determined based on the lowest level input that is significant to the measurement. The fair values of assets and liabilities classified as Level 3 include at least one significant unobservable input in the measurement. See Note 6 to the Consolidated Financial Statements for an additional description of the valuation hierarchy levels as well as for the balances of assets and liabilities measured at fair value on a recurring basis by hierarchy level presented on a consolidated basis. The table below presents the balances of assets and liabilities measured at fair value on a recurring basis, as of the periods indicated, and the portion of such assets and liabilities that are classified in Level 3 of the valuation hierarchy. The table also provides details about these assets and liabilities excluding those held in the Closed Block division. We believe the amounts excluding the Closed Block division are most relevant to an understanding of our operations that are pertinent to investors inPrudential Financial because substantially all Closed Block division assets support obligations and liabilities relating to the Closed Block policies only. See Note 15 to the Consolidated Financial Statements for further information on the Closed Block. 101
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As of December 31, 2019 As of December 31, 2018
PFI excluding Closed Block PFI excluding Closed Block
Division Closed Block Division Division Closed Block Division
Total at Total Total at Total Total at Total Total at Total
Fair Value Level 3(1) Fair Value Level 3(1) Fair Value Level 3(1) Fair Value Level 3(1)
(in millions)
Fixed maturities,
available-for-sale $ 349,720 $ 3,570 $ 41,376 $ 745 $ 314,911 $ 3,455 $ 38,745 $ 780
Assets supporting
experience-rated
contractholder liabilities:
Fixed maturities 19,530 730 0 0 19,579 818 0 0
Equity securities 1,790 0 0 0 1,460 1 0 0
All other(2) 261 0 0 0 215 0 0 0
Subtotal 21,581 730 0 0 21,254 819 0 0
Fixed maturities, trading 3,628 275 256 12 3,048 204 195 2
Equity securities 5,140 557 2,245 76 4,316 604 1,784 67
Commercial mortgage and other
loans 228 0 0 0 763 0 0 0
Other invested assets(3) 1,433 567 0 0 1,404 263 5 0
Short-term investments 3,789 119 147 36 5,040 65 453 24
Cash equivalents 8,855 99 151 32 9,027 59 451 18
Other assets 113 113 0 0 25 25 0 0
Separate account assets 288,724 1,717 0 0 254,066 1,534 0 0
Total assets $ 683,211 $ 7,747 $ 44,175 $ 901 $ 613,854 $ 7,028 $ 41,633 $ 891
Future policy benefits $ 12,831 $ 12,831 $ 0 $ 0 $ 8,926 $ 8,926 $ 0 $ 0
Policyholders' account
balances 1,316 1,316 0 0 56 56 0 0
Other liabilities(3) 928 105 8 0 135 0 0 0
Notes issued by consolidated
variable interest entities
("VIEs") 800 800 0 0 595 595 0 0
Total liabilities $ 15,875 $ 15,052 $ 8 $ 0 $ 9,712 $ 9,577 $ 0 $ 0
__________(1) Level 3 assets expressed as a percentage of total assets measured at fair
value on a recurring basis for PFI excluding the Closed Block division and
for the Closed Block division totaled 1.1% and 2.0%, respectively, as of
December 31, 2019 and 1.1% and 2.1%, respectively, as of December 31, 2018.
(2) "All other" represents cash equivalents and short-term investments.
(3) "Other invested assets" and "Other liabilities" primarily include
derivatives. The amounts include the impact of netting subject to master
netting agreements.
The determination of fair value, which for certain assets and liabilities is
dependent on the application of estimates and assumptions, can have a
significant impact on our results of operations and may require the application
of a greater degree of judgment depending on market conditions, as the ability
to value assets and liabilities can be significantly impacted by a decrease in
market activity or a lack of transactions executed in an orderly manner.
Fixed maturity securities included in Level 3 in our fair value hierarchy are
generally priced based on internally-developed valuations or indicative broker
quotes. For certain private fixed maturity and equity securities, the internal
valuation models use significant unobservable inputs and, accordingly, such
securities are included in Level 3 in our fair value hierarchy. Level 3 fixed
maturity securities for PFI excluding the Closed Block division included
approximately $1.8 billion of public fixed maturities as of December 31, 2019
with values primarily based on indicative broker quotes, and approximately $2.8
billion of private fixed maturities, with values primarily based on
internally-developed models. Significant unobservable inputs used in their
valuation included: issue specific spread adjustments, material non-public
financial information, management judgment, estimation of future earnings and
cash flows, default rate assumptions, liquidity assumptions and indicative
quotes from market makers. Separate account assets included in Level 3 in our
fair value hierarchy primarily include corporate securities and commercial
mortgage loans.
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Embedded derivatives reported in "Future policy benefits" and "Policyholders' account balances" that are included in level 3 of our fair value hierarchy represent general account liabilities pertaining to living benefit features of the Company's variable annuity contracts and the index-linked interest credited features on certain life and annuity products. These are carried at fair value with changes in fair value included in "Realized investment gains (losses), net." These embedded derivatives are valued using internally-developed models that require significant estimates and assumptions developed by management. Changes in these estimates and assumptions can have a significant impact on the results of our operations.
For additional information about the valuation techniques and the key estimates and assumptions used in our determination of fair value, see Note 6 to the Consolidated Financial Statements.
General Account Investments
We maintain diversified investment portfolios in our general account to support
our liabilities to customers as well as our other general liabilities.
Investments and other assets that do not support general account liabilities,
and are therefore excluded from our general account, are as follows:
• assets of our derivative operations;
• assets of our investment management operations, including investments
managed for third-parties; and
• those assets classified as "Separate account assets" on our balance sheet.
The general account portfolios are managed pursuant to the distinct objectives
and investment policy statements of PFI excluding the Closed Block division and
of the Closed Block division. The primary investment objectives of PFI excluding
the Closed Block division include:
• hedging and otherwise managing the market risk characteristics of the
major product liabilities and other obligations of the Company;
• optimizing investment income yield within risk constraints over time; and
• for certain portfolios, optimizing total return, including both investment
income yield and capital appreciation, within risk constraints over time,
while managing the market risk exposures associated with the corresponding
product liabilities.
We pursue our objective to optimize investment income yield for PFI excluding the Closed Block division over time through:
• the investment of net operating cash flows, including new product premium
inflows, and proceeds from investment sales, repayments and prepayments
into investments with attractive risk-adjusted yields; and
• the sale of investments, where appropriate, either to meet various cashflow needs or to manage the portfolio's risk exposure profile with respect
to duration, credit, currency and other risk factors, while considering
the impact on taxes and capital.
The primary investment objectives of the Closed Block division include:
• providing for the reasonable dividend expectations of the participating
policyholders within the Closed Block division; and
• optimizing total return, including both investment income yield andcapital appreciation, within risk constraints, while managing the market
risk exposures associated with the major products in the Closed Block
division.
Our portfolio management approach, while emphasizing our investment income yield
and asset/liability risk management objectives, also takes into account the
capital and tax implications of portfolio activity and our assertions regarding
our ability and intent to hold debt securities to recovery. For a further
discussion of our OTTI policies, including our assertions regarding any
intention or requirement to sell debt securities before anticipated recovery,
see "-Realized Investment Gains and Losses-Impairments" below.
Management of Investments
The Investment Committee of our Board of Directors ("Board") oversees our
proprietary investments, including our general account portfolios, and regularly
reviews performance and risk positions. Our Chief Investment Officer
Organization ("CIO Organization") develops investment policies subject to risk
limits proposed by our Enterprise Risk Management ("ERM") group for the general
account portfolios of our domestic and international insurance subsidiaries and
directs and oversees management of the general account portfolios within risk
limits and exposure ranges approved annually by the Investment Committee.
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The CIO Organization, including related functions within our insurance subsidiaries, works closely with product actuaries and ERM to understand the characteristics of our products and their associated market risk exposures. This information is incorporated into the development of target asset portfolios that manage market risk exposures associated with the liability characteristics and establish investment risk exposures, within tolerances prescribed by Prudential's investment risk limits, on which we expect to earn an attractive risk-adjusted return. We develop asset strategies for specific classes of product liabilities and attributed or accumulated surplus, each with distinct risk characteristics. Market risk exposures associated with the liabilities include interest rate risk, which is addressed through the duration characteristics of the target asset mix, and currency risk, which is addressed by the currency profile of the target asset mix. In certain of our smaller markets outside of theU.S. andJapan , capital markets limitations hinder our ability to hedge interest rate exposure to the same extent we do for ourU.S. andJapan businesses and lead us to accept a higher degree of interest rate risk in these smaller portfolios. General account portfolios typically include allocations to credit and other investment risks as a means to enhance investment yields and returns over time.
Most of our products can be categorized into the following three classes:
• interest-crediting products for which the rates credited to customers are
periodically adjusted to reflect market and competitive forces and actual
investment experience, such as fixed annuities and universal life
insurance;
• participating individual and experience-rated group products in which
customers participate in actual investment and business results through
annual dividends, interest or return of premium; and
• products with fixed or guaranteed terms, such as traditional whole lifeand endowment products, guaranteed investment contracts ("GICs"), funding
agreements and payout annuities.
Our total investment portfolio is composed of a number of operating portfolios. Each operating portfolio backs a specific set of liabilities, and the portfolios have a target asset mix that supports the liability characteristics, including duration, cash flow, liquidity needs and other criteria. As of December 31, 2019, the average duration of our domestic general account investment portfolios attributable to PFI excluding the Closed Block division, including the impact of derivatives, was approximately 7 years. As of December 31, 2019, the average duration of our international general account portfolios attributable to our Japanese insurance operations, including the impact of derivatives, was between 11 and 12 years and represented a blend of yen-denominated andU.S. dollar and Australian dollar-denominated investments, which have distinct average durations supporting the insurance liabilities we have issued in those currencies. Our asset/liability management process has enabled us to manage our portfolios through several market cycles. We implement our portfolio strategies primarily through investment in a broad range of fixed income assets, including government and agency securities, public and private corporate bonds and structured securities and commercial mortgage loans. In addition, we hold allocations of non-coupon investments, which include equity securities and other invested assets such as LPs/LLCs, real estate held through direct ownership, derivative instruments, and seed money investments in separate accounts. We manage our public fixed maturity portfolio to a risk profile directed or overseen by the CIO Organization and ERM groups and to a profile that also reflects the market environments impacting both our domestic and international insurance portfolios. The return that we earn on the portfolio will be reflected in investment income and in realized gains or losses on investments. We use privately-placed corporate debt securities and commercial mortgage loans, which consist of mortgages on diversified properties in terms of geography, property type and borrowers, to enhance the yield on our portfolio and to improve the overall diversification of the portfolios. Private placements typically offer enhanced yields due to an illiquidity premium and generally offer enhanced credit protection in the form of covenants. Our origination capability offers the opportunity to lead transactions and gives us the opportunity for better terms, including covenants and call protection, and to take advantage of innovative deal structures. Derivative strategies are employed in the context of our risk management framework to enhance our ability to manage interest rate and currency risk exposures of the asset portfolio relative to the liabilities and to manage credit and equity positions in the investment portfolios. For a discussion of our risk management process, see "Quantitative and Qualitative Disclosures About Market Risk" below. Our portfolio asset allocation reflects our emphasis on diversification across asset classes, sectors and issuers. The CIO Organization, directly and through related functions within the insurance subsidiaries, implements portfolio strategies primarily through various investment management units within Prudential'sPGIM segment. Activities of thePGIM segment on behalf of the general account portfolios are directed and overseen by the CIO Organization and monitored by ERM for compliance with investment risk limits. 104
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In executing the activities on behalf of the general account portfolio, Prudential investment management units are incorporating environmental, social and governance factors into their respective investment processes as appropriate. These factors include investing in opportunities to support diversity and inclusion and to help mitigate climate change by pursuing relevant investments across asset classes.
Portfolio Composition
Our investment portfolio consists of public and private fixed maturity securities, commercial mortgage and other loans, policy loans and non-coupon investments as defined above. The composition of our general account reflects, within the discipline provided by our risk management approach, our need for competitive results and the selection of diverse investment alternatives available primarily through ourPGIM segment. The size of our portfolio enables us to invest in asset classes that may be unavailable to the typical investor. 105
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The following tables set forth the composition of our general account investment
portfolio apportioned between PFI excluding the Closed Block division and the
Closed Block division, as of the dates indicated:
December 31, 2019
PFI Excluding Closed Block
Closed Block Division Division Total
($ in millions)
Fixed maturities:
Public, available-for-sale, at fair value $ 296,382 64.9 % $ 29,011 $ 325,393
Public, held-to-maturity, at amortized
cost 1,705 0.4 0 1,705
Private, available-for-sale, at fair value 52,750 11.6 12,365 65,115
Private, held-to-maturity, at amortized
cost 228 0.1 0 228
Fixed maturities, trading, at fair value 2,467 0.5 256 2,723
Assets supporting experience-rated
contractholder liabilities, at fair value 21,597 4.7 0 21,597
Equity securities, at fair value 4,586 1.0 2,245 6,831
Commercial mortgage and other loans, at
book value 54,671 12.0 8,629 63,300
Policy loans, at outstanding balance 7,832 1.7 4,264 12,096
Other invested assets(1) 9,210 2.0 3,334 12,544
Short-term investments 5,223 1.1 227 5,450
Total general account investments 456,651 100.0 % 60,331 516,982
Invested assets of other entities and
operations(2) 5,778 0 5,778
Total investments $ 462,429 $ 60,331 $ 522,760
December 31, 2018
PFI Excluding Closed Block
Closed Block Division Division Total
($ in millions)
Fixed maturities:
Public, available-for-sale, at fair value $ 269,109 64.8 % $ 26,203 $ 295,312
Public, held-to-maturity, at amortized
cost 1,745 0.4 0 1,745
Private, available-for-sale, at fair value 45,328 10.9 12,542 57,870
Private, held-to-maturity, at amortized
cost 268 0.1 0 268
Fixed maturities, trading, at fair value 1,893 0.5 195 2,088
Assets supporting experience-rated
contractholder liabilities, at fair value 21,254 5.1 0 21,254
Equity securities, at fair value 3,849 0.9 1,784 5,633
Commercial mortgage and other loans, at
book value 50,251 12.1 8,782 59,033
Policy loans, at outstanding balance 7,606 1.8 4,410 12,016
Other invested assets(1) 8,407 2.0 3,316 11,723
Short-term investments 5,948 1.4 478 6,426
Total general account investments 415,658 100.0 % 57,710 473,368
Invested assets of other entities and
operations(2) 5,877 0 5,877
Total investments $ 421,535 $ 57,710 $ 479,245
__________(1) Other invested assets consist of investments in LPs/LLCs, investment real
estate held through direct ownership, derivative instruments and other
miscellaneous investments. For additional information regarding these
investments, see "-Other Invested Assets" below.
(2) Includes invested assets of our investment management and derivative
operations. Excludes assets of our investment management operations that are
managed for third-parties and those assets classified as "Separate account
assets" on our balance sheet. For additional information regarding these
investments, see "-Invested Assets of Other Entities and Operations" below.
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The increase in general account investments attributable to PFI excluding the Closed Block division in 2019 was primarily due to market appreciation from a decrease inU.S. andJapan interest rates and tighter credit spreads, the reinvestment of net investment income and net business inflows. For information regarding the methodology used in determining the fair value of our fixed maturities, see Note 6 to the Consolidated Financial Statements. As of December 31, 2019 and 2018, 42% and 43%, respectively, of our general account investments attributable to PFI excluding the Closed Block division related to our Japanese insurance operations. The following table sets forth the composition of the investments of our Japanese insurance operations' general account, as of the dates indicated: December 31, 2019 2018 (in millions) Fixed maturities: Public, available-for-sale, at fair value $ 142,220 $
133,084
Public, held-to-maturity, at amortized cost 1,705
1,745
Private, available-for-sale, at fair value 19,189
16,222
Private, held-to-maturity, at amortized cost 228
268
Fixed maturities, trading, at fair value 492
328
Assets supporting experience-rated contractholder liabilities, at fair value 2,777
2,441
Equity securities, at fair value 2,185
1,972
Commercial mortgage and other loans, at book value 19,138
17,228
Policy loans, at outstanding balance 2,859 2,715 Other invested assets(1) 2,187 1,957 Short-term investments 165 451 Total Japanese general account investments $ 193,145 $
178,411
__________
(1) Other invested assets consist of investments in LPs/LLCs, investment real
estate held through direct ownership, derivative instruments and other
miscellaneous investments.
The increase in general account investments related to our Japanese insurance
operations in 2019 was primarily attributable to market appreciation from a
decrease in
As of December 31, 2019, our Japanese insurance operations had $77.1 billion, at carrying value, of investments denominated inU.S. dollars, including $2.1 billion that were hedged to yen through third-party derivative contracts and $62.4 billion that support liabilities denominated inU.S. dollars, with the remainder hedging our foreign currency exchange rate exposure onU.S. dollar-equivalent equity. As of December 31, 2018, our Japanese insurance operations had $64.9 billion, at carrying value, of investments denominated inU.S. dollars, including $2.5 billion that were hedged to yen through third-party derivative contracts and $50.0 billion that support liabilities denominated inU.S. dollars, with the remainder hedging our foreign currency exchange rate exposure onU.S. dollar-equivalent equity. The $12.2 billion increase in the carrying value ofU.S. dollar-denominated investments from December 31, 2018 was primarily attributable to the impact of the decrease in theU.S. treasury bond rates and credit rate spreads, portfolio growth as a result of net business inflows and the reinvestment of net investment income. Our Japanese insurance operations had $9.9 billion and $10.1 billion, at carrying value, of investments denominated in Australian dollars that support liabilities denominated in Australian dollars, as of December 31, 2019 and 2018, respectively. The $0.2 billion decrease in the carrying value of Australian dollar-denominated investments from December 31, 2018 was primarily attributable to the run off of the portfolio. For additional information regardingU.S. and Australian dollar investments held in our Japanese insurance operations and a discussion of our yen hedging strategy, see "-Segment Results of Operations-Impact of Foreign Currency Exchange Rates" above.
Investment Results
The following tables set forth the investment results of our general account
apportioned between PFI excluding the Closed Block division and the Closed Block
division, for the periods indicated. The yields are based on net investment
income as reported
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under
Year Ended December 31, 2019
PFI Excluding Closed Block
Division and Japanese PFI Excluding Closed Block Closed Block
Operations Japanese Insurance Operations Division Division Total(5)
Yield(1) Amount Yield(1) Amount Yield(1) Amount Amount Amount
($ in millions)
Fixed maturities(2) 4.71 % $ 7,567 2.87 % $ 3,842 3.87 % $ 11,409 $ 1,713 $ 13,122
Assets supporting
experience-rated
contractholder
liabilities 3.61 678 1.99 52 3.42 730 0 730
Equity securities 2.30 49 3.27 66 2.77 115 45 160
Commercial mortgage
and other loans 4.21 1,406 4.29 767 4.24 2,173 388 2,561
Policy loans 5.36 256 3.92 107 4.84 363 255 618
Short-term
investments and cash
equivalents 2.58 373 3.40 27 2.62 400 32 432
Gross investment
income 4.41 10,329 3.04 4,861 3.86 15,190 2,433 17,623
Investment expenses (0.13 ) (400 ) (0.14 ) (280 ) (0.13 ) (680 ) (209 ) (889 )
Investment income
after investment
expenses 4.28 % 9,929 2.90 % 4,581 3.73 % 14,510 2,224 16,734
Other invested
assets(3) 378 184 562 99 661
Investment results of
other entities and
operations(4) 190 0 190 0 190
Total investment
income $ 10,497 $ 4,765 $ 15,262 $ 2,323 $ 17,585
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Year Ended December 31, 2018
PFI Excluding Closed Block
Division and Japanese PFI Excluding Closed Block Closed Block
Operations Japanese Insurance Operations Division Division Total(5)
Yield(1) Amount Yield(1) Amount Yield(1) Amount Amount Amount
($ in millions)
Fixed maturities(2) 4.68 % $ 7,004 2.93 % $ 3,707 3.87 % $ 10,711 $ 1,692 $ 12,403
Assets supporting
experience-rated
contractholder
liabilities 3.62 674 1.81 46 3.41 720 0 720
Equity securities 2.28 48 3.45 72 2.86 120 45 165
Commercial mortgage
and other loans 4.03 1,299 3.96 623 4.01 1,922 407 2,329
Policy loans 5.44 258 3.92 101 4.91 359 263 622
Short-term
investments and cash
equivalents 2.20 265 2.83 33 2.25 298 30 328
Gross investment
income 4.36 9,548 3.04 4,582 3.82 14,130 2,437 16,567
Investment expenses (0.15 ) (397 ) (0.13 ) (237 ) (0.14 ) (634 ) (204 ) (838 )
Investment income
after investment
expenses 4.21 % 9,151 2.91 % 4,345 3.68 % 13,496 2,233 15,729
Other invested
assets(3) 221 93 314 55 369
Investment results of
other entities and
operations(4) 78 0 78 0 78
Total investment
income $ 9,450 $ 4,438 $ 13,888 $ 2,288 $ 16,176
Year Ended December 31, 2017
PFI Excluding Closed Block
Division and Japanese PFI Excluding Closed Block Closed Block
Operations Japanese Insurance Operations Division Division Total(5)
Yield(1) Amount Yield(1) Amount Yield(1) Amount Amount Amount
($ in millions)
Fixed maturities(2) 4.61 % $ 6,464 3.06 % $ 3,624 3.90 % $ 10,088 $ 1,770 $ 11,858
Assets supporting
experience-rated
contractholder
liabilities 3.61 695 1.73 41 3.40 736 0 736
Equity securities 5.75 247 2.91 79 4.65 326 50 376
Commercial mortgage
and other loans 4.13 1,285 4.05 515 4.10 1,800 449 2,249
Policy loans 5.41 250 4.00 97 4.92 347 271 618
Short-term
investments and cash
equivalents 1.31 158 1.25 14 1.31 172 25 197
Gross investment
income 4.02 9,099 3.11 4,370 3.66 13,469 2,565 16,034
Investment expenses (0.14 ) (306 ) (0.12 ) (184 ) (0.13 ) (490 ) (177 ) (667 )
Investment income
after investment
expenses 3.88 % 8,793 2.99 % 4,186 3.53 % 12,979 2,388 15,367
Other invested
assets(3) 498 132 630 265 895
Investment results of
other entities and
operations(4) 173 0 173 0 173
Total investment
income $ 9,464 $ 4,318 $ 13,782 $ 2,653 $ 16,435
__________(1) The denominator in the yield percentage is based on quarterly average
carrying values for all asset types except for fixed maturities which are
based on amortized cost. Amounts for fixed maturities, short-term investments
and cash equivalents are also netted for securities lending activity (i.e.,
income netted for rebate expenses and asset values netted for securities
lending liabilities). A yield is not presented for other invested assets as
it is not considered a meaningful measure of investment performance. Total
yields exclude investment income and assets related to other invested assets.
(2) Includes fixed maturity securities classified as available-for-sale and
held-to-maturity and excludes fixed maturity securities classified as
trading, which are included in other invested assets.
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(3) Other invested assets consist of investments in LPs/LLCs, investment real
estate held through direct ownership, derivative instruments, fixed
maturities classified as trading and other miscellaneous investments.
(4) Includes net investment income of our investment management operations.
(5) The total yield was 3.81%, 3.77% and 3.68% for the years ended December 31,
2019, 2018 and 2017, respectively.
The increase in investment income after investment expenses yield attributable to our general account investments, excluding both the Closed Block division and the Japanese insurance operations' portfolio, for 2019 compared to 2018 was primarily the result of higher fixed income prepayment fees and call premiums and higher returns on short-term investments based on an increase in short-term rates. The decrease in investment income after investment expenses yield attributable to the Japanese insurance operations' portfolio for 2019 compared to 2018 was primarily the result of lower reinvestment rates. Both theU.S. dollar-denominated and Australian dollar-denominated fixed maturities that are not hedged to yen through third-party derivative contracts provide a yield that is substantially higher than the yield on comparable yen-denominated fixed maturities. The average amortized cost ofU.S. dollar-denominated fixed maturities that are not hedged to yen through third-party derivative contracts was approximately $47.5 billion and $44.3 billion, for the years ended December 31, 2019 and 2018, respectively. The majority ofU.S. dollar-denominated fixed maturities support liabilities that are denominated inU.S. dollars. The average amortized cost of Australian dollar-denominated fixed maturities that are not hedged to yen through third-party derivative contracts was approximately $8.4 billion and $9.8 billion, for the years ended December 31, 2019 and 2018, respectively. The majority of Australian dollar-denominated fixed maturities support liabilities that are denominated in Australian dollars. For additional information regardingU.S. and Australian dollar investments held in our Japanese insurance operations, see "-Results of Operations-Impact of Foreign Currency Exchange Rates" above.
Realized Investment Gains and Losses
The following table sets forth "Realized investment gains (losses), net" of our
general account apportioned between PFI excluding Closed Block division and the
Closed Block division by investment type as well as related charges and
adjustments, for the periods indicated:
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Years Ended December 31,
2019 2018 2017
(in millions)
PFI excluding Closed Block Division:
Realized investment gains (losses), net:
Due to foreign exchange movements on
securities approaching maturity $ (53 ) $ (23 ) $ (36 )
Due to securities actively marketed for sale (4 ) (24 ) (12 )
Due to credit or adverse conditions of the
respective issuer(1) (175 ) (169 ) (121 )
OTTI losses on fixed maturities recognized
in earnings(2) (232 ) (216 ) (169 )
Net gains (losses) on sales and maturities 867 504 577
Fixed maturity securities(3) 635 288 408
OTTI losses on equity securities recognized
in earnings(4) 0 0 (23 )
Net gains (losses) on sales and maturities 0 0 588
Equity securities(5) 0 0 565
Commercial mortgage and other loans (6 ) (15 ) (2 )
Derivatives (1,623 ) 1,249 (1,061 )
OTTI losses on other invested assets
recognized in earnings(6) (18 ) (7 ) (19 )
Other net gains (losses) 70 106 18
Other 52 99 (1 )
Subtotal (942 ) 1,621 (91 )
Investment results of other entities and
operations(7) (38 ) 226 (11 )
Total - PFI excluding Closed Block Division (980 ) 1,847 (102 )
Related adjustments 216 (1,381 ) (500 )
Realized investment gains (losses), net, and
related adjustments (764 ) 466 (602 )
Related charges (125 ) (316 ) 544
Realized investment gains (losses), net, and
related charges and adjustments $ (889 ) $ 150 $ (58 )
Closed Block Division:
Realized investment gains (losses), net:
Due to foreign exchange movements on
securities approaching maturity $ (56 ) $ (28 ) $ (15 )
Due to securities actively marketed for sale 0 (9 ) (13 )
Due to credit or adverse conditions of the
respective issuer(1) (27 ) (26 ) (70 )
OTTI losses on fixed maturities recognized
in earnings(2) (83 ) (63 ) (98 )
Net gains (losses) on sales and maturities 417 3 271
Fixed maturity securities(3) 334 (60 ) 173
OTTI losses on equity securities recognized
in earnings(4) 0 0 (4 )
Net gains (losses) on sales and maturities 0 0 505
Equity securities(5) 0 0 501
Commercial mortgage and other loans 3 (6 ) 0
Derivatives 193 193 (128 )
OTTI losses on other invested assets
recognized in earnings(6) 0 (1 ) (14 )
Other net gains (losses) (9 ) 4 2
Other (9 ) 3 (12 )
Subtotal - Closed Block Division 521 130 534
Consolidated PFI realized investment gains
(losses), net $ (459 ) $ 1,977 $ 432
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__________
(1) Represents circumstances where we believe credit events or other adverse
conditions of the respective issuers have caused or will lead to a deficiency
in the contractual cash flows related to the investment. The amount of the
impairment recorded in earnings is the difference between the amortized cost
of the debt security and the net present value of its projected future cash
flows discounted at the effective interest rate implicit in the debt security
prior to impairment.
(2) Excludes the portion of OTTI recorded in OCI, representing any difference
between the fair value of the impaired debt security and the net present
value of its projected future cash flows at the time of impairment.
(3) Includes fixed maturity securities classified as available-for-sale and
held-to-maturity and excludes fixed maturity securities classified as
trading.
(4) Effective January 1, 2018, the identification of OTTI for equity securities
is no longer needed as all of these investments are now measured at fair
value with changes in fair value reported in earnings.
(5) Effective January 1, 2018, realized gains (losses) on equity securities are
recorded within "Other income (loss)."
(6) Primarily includes OTTI related to investments in LPs/LLCs and real estate
held through direct ownership.
(7) Includes "realized investment gains (losses), net" of our investment
management operations.
2019 to 2018 Annual Comparison
Net gains on sales and maturities of fixed maturity securities were $867 million and $504 million for the years ended December 31, 2019 and 2018, respectively, primarily driven by the impact of foreign currency exchange rate movements ofU.S. and Australian dollar-denominated securities that matured or were sold within our International Businesses segment. Net realized losses on derivative instruments of $1,623 million, for the year ended December 31, 2019, primarily included: • $2,677 million of losses on product-related embedded derivatives and
related hedge positions associated with certain variable annuity
contracts; and
• $1,070 million of losses on capital hedges due to increases in equity indices.
Partially offsetting these losses were:
• $1,354 million of gains on interest rate derivatives due to decreases
in swap and U.S. Treasury rates;
• $378 million of gains on foreign currency hedges due to U.S. dollar
appreciation versus the euro;
• $145 million of gains for fees earned on fee-based synthetic GICs; and
• $124 million of gains on credit default swaps primarily due to spreads
tightening.
Net realized gains on derivative instruments of $1,249 million, for the year
ended December 31, 2018, primarily included:
• $575 million of gains on foreign currency hedges due to U.S. dollar and
Japanese yen appreciation;
• $529 million of gains on product-related embedded derivatives and
related hedge positions associated with certain variable annuity
contracts;
• $363 million of gains on capital hedges due to decreases in equity
indices; and
• $150 million of gains for fees earned on fee-based synthetic GICs.
Partially offsetting these gains were:
• $362 million of losses on interest rate derivatives due to increases in
swap and
For a discussion of living benefit guarantees and related hedge positions in our Individual Annuities segment, see "-Results of Operations-U.S. Businesses-U.S. Individual Solutions Division-Individual Annuities" above. Related adjustments include the portions of "Realized investment gains (losses), net" that are included in adjusted operating income and the portions of "Other income (loss)" and "Net investment income" that are excluded from adjusted operating income. These adjustments are made to arrive at "Realized investment gains (losses), net, and related adjustments" which are excluded from adjusted operating income. Results for the years ended December 31, 2019 and 2018 reflected related adjustments of net positive of $216 million and net negative $1,381 million, respectively. Both periods' results reflected settlements and changes in values related to interest rate and currency derivatives, as well as changes in fair value of equity securities recorded in "Other income (loss)." Charges that relate to "Realized investment gains (losses), net" are also excluded from adjusted operating income and may be reflected as net charges or net benefits. Results for the years ended December 31, 2019 and 2018 reflected net related charges of $125 million and $316 million, respectively. Both periods' results were primarily driven by the impact of derivative activity on the amortization of DAC and other costs and certain policyholder reserves. Impairments 112
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The level of OTTI generally reflects economic conditions and is expected to increase when economic conditions worsen and to decrease when economic conditions improve. Historically, the causes of OTTI have been specific to each individual issuer and have not directly resulted in impairments to other securities within the same industry or geographic region. We may also realize additional credit and interest rate-related losses through sales of investments pursuant to our credit risk and portfolio management objectives. We maintain separate monitoring processes for public and private fixed maturities and create watch lists to highlight securities that require special scrutiny and management. For private placements, our credit and portfolio management processes help ensure prudent controls over valuation and management. We have separate pricing and authorization processes to establish "checks and balances" for new investments. We apply consistent standards of credit analysis and due diligence for all transactions, whether they originate through our own in-house origination staff or through agents. Our regional offices closely monitor the portfolios in their regions. We set all valuation standards centrally, and we assess the fair value of all investments quarterly. Our public and private fixed maturity investment managers formally review all public and private fixed maturity holdings on a quarterly basis and more frequently when necessary to identify potential credit deterioration whether due to ratings downgrades, unexpected price variances and/or company or industry-specific concerns. For LPs/LLCs accounted for using the equity method, the carrying value of these investments is written down or impaired to fair value when a decline in value is considered to be other-than-temporary. For additional information regarding our OTTI policies, see Note 2 to the Consolidated Financial Statements.
Retail-Related Investments
As of December 31, 2019, PFI excluding the Closed Block division had retail-related investments of approximately $14 billion consisting primarily of $6 billion of corporate fixed maturities of which 90% were considered investment grade; $7 billion of commercial mortgage loans with a weighted-average loan-to-value ratio of approximately 51% and weighted-average debt service coverage ratio of 2.43 times; and $1 billion of real estate held through direct ownership and real estate-related LPs/LLCs. In addition, we held approximately $11 billion of commercial mortgage-backed securities, of which approximately 79% and 20% were ratedAAA (super-senior) and AA, respectively, and comprised of diversified collateral pools. Approximately 30% of the collateral pools were comprised of retail-related investments, with no pools solely collateralized by retail-related investments. For additional information regarding commercial mortgage-backed securities, see "-Fixed Maturity Securities-Fixed Maturity Securities Credit Quality" below.
General Account Investments of PFI excluding Closed Block Division
In the following sections, we provide details about our investment portfolio, excluding investments held in the Closed Block division. We believe the details of the composition of our investment portfolio excluding the Closed Block division are most relevant to an understanding of our operations that are pertinent to investors inPrudential Financial, Inc. because substantially all Closed Block division assets support obligations and liabilities relating to the Closed Block policies only. See Note 15 to the Consolidated Financial Statements for further information on the Closed Block.
Fixed Maturity Securities
In the following sections, we provide details about our fixed maturity securities portfolio, which excludes fixed maturity securities classified as assets supporting experienced-rated contractholder liabilities and classified as trading.
Fixed Maturity Securities by Contractual Maturity Date
The following table sets forth the breakdown of the amortized cost of our fixed maturity securities portfolio by contractual maturity, as of the date indicated:
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December 31, 2019
Amortized
Cost % of Total
($ in millions)
Corporate & government securities:
Maturing in 2020 $ 10,693 3.5 %
Maturing in 2021 10,825 3.5
Maturing in 2022 10,097 3.3
Maturing in 2023 11,959 3.8
Maturing in 2024 12,591 4.1
Maturing in 2025 11,697 3.8
Maturing in 2026 13,689 4.4
Maturing in 2027 13,726 4.4
Maturing in 2028 10,586 3.4
Maturing in 2029 12,936 4.2
Maturing in 2030 8,126 2.6
Maturing in 2031 and beyond 159,344 51.5Total corporate & government securities 286,269 92.5 Asset-backed securities
9,832 3.2
Commercial mortgage-backed securities 10,211 3.3 Residential mortgage-backed securities 3,265 1.0 Total fixed maturities
$ 309,577 100.0 %
Fixed Maturity Securities and Unrealized Gains and Losses by Industry
The following table sets forth the composition of the portion of our fixed
maturity securities portfolio by industry category attributable to PFI excluding
the Closed Block division and the associated gross unrealized gains and losses,
as of the dates indicated:
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December 31, 2019 December 31, 2018
Gross Gross Gross Gross
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized FairIndustry(1) Cost Gains(2) Losses(2) Value Cost Gains(2) Losses(2) Value
(in millions)
Corporate securities:
Finance $ 35,338 $ 2,860 $ 85 $ 38,113 $ 29,831 $ 726 $ 724 $ 29,833 Consumer non-cyclical 24,941
2,846 112 27,675 24,136 1,172 748 24,560
Utility 22,341 2,498 81 24,758 22,179 1,073 624 22,628
Capital goods 12,287 1,150 83 13,354 11,623 561 386 11,798
Consumer cyclical 10,871 994 45 11,820 11,001 429 330 11,100
Foreign agencies 5,670 928 10 6,588 5,946 785 91 6,640
Energy 12,922 1,126 186 13,862 11,753 524 553 11,724
Communications 5,916 939 34 6,821 6,163 455 234 6,384
Basic industry 5,949 499 38 6,410 5,431 238 158 5,511
Transportation 9,443 833 34 10,242 8,633 428 225 8,836
Technology 3,395 278 13 3,660 3,855 155 99 3,911
Industrial other 3,894 351 33 4,212 3,764 151 154 3,761
Total corporate
securities 152,967 15,302 754 167,515 144,315 6,697 4,326 146,686
Foreign government(3) 98,771 20,940 63 119,648 97,087 16,942 301 113,728
Residential
mortgage-backed(4) 3,265 175 1 3,439 3,205 120 31 3,294 Asset-backed 9,832 123 34 9,921 9,803 122 62 9,863
Commercial
mortgage-backed 10,211 441 9 10,643 8,953 87 86 8,954 U.S. Government 24,938 4,511 94 29,355 22,290 2,563 569 24,284 State & Municipal 9,593 1,327 7 10,913 9,456 607 63 10,000 Total(5) $ 309,577 $ 42,819 $ 962 $ 351,434 $ 295,109 $ 27,138 $ 5,438 $ 316,809 __________
(1) Investment data has been classified based on standard industry
categorizations for domestic public holdings and similar classifications by
industry for all other holdings.
(2) Includes $369 million of gross unrealized gains, as of December 31, 2019,
compared to $359 million of gross unrealized gains and less than $1 million
of gross unrealized losses, as of December 31, 2018, on securities classified
as held-to-maturity.
(3) As of December 31, 2019 and 2018, based on amortized cost, 77% and 76%,
respectively, represent Japanese government bonds held by our Japanese
insurance operations with no other individual country representing more than
11% of the balance.
(4) As of both December 31, 2019 and 2018, based on amortized cost, more than 99%
were rated A or higher.
(5) Excluded from the table above are securities held outside the general account
in other entities and operations. For additional information regarding
investments held outside the general account, see "-Invested Assets of Other
Entities and Operations" below.
The increase in net unrealized gains from December 31, 2018 to December 31, 2019
was primarily due to a decrease in
Fixed Maturity Securities Credit Quality
The Securities Valuation Office ("SVO") of the National Association of Insurance
Commissioners ("NAIC") evaluates the investments of insurers for statutory
reporting purposes and assigns fixed maturity securities to one of six
categories called "NAIC Designations." In general, NAIC Designations of "1"
highest quality, or "2" high quality, include fixed maturities considered
investment grade, which include securities rated Baa3 or higher by Moody's
Investor Service, Inc. ("Moody's") or BBB- or higher by Standard & Poor's Rating
Services ("S&P"). NAIC Designations of "3" through "6" generally include fixed
maturities referred to as below investment grade, which include securities rated
Ba1 or lower by Moody's and BB+ or lower by S&P. The NAIC Designations for
commercial mortgage-backed securities and non-agency residential mortgage-backed
securities, including our asset-backed securities collateralized by sub-prime
mortgages, are based on security level expected losses as modeled by an
independent third-party (engaged by the NAIC) and the statutory carrying value
of the security, including any purchase discounts or impairment charges
previously recognized.
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As a result of time lags between the funding of investments, the finalization of
legal documents, and the completion of the SVO filing process, the fixed
maturity portfolio includes certain securities that have not yet been designated
by the SVO as of each balance sheet date. Pending receipt of SVO designations,
the categorization of these securities by NAIC Designation is based on the
expected ratings indicated by internal analysis.
Investments of our international insurance companies are not subject to NAIC
guidelines. Investments of our Japanese insurance operations are regulated
locally by the Financial Services Agency ("FSA"), an agency of the Japanese
government. The FSA has its own investment quality criteria and risk control
standards. Our Japanese insurance companies comply with the FSA's credit quality
review and risk monitoring guidelines. The credit quality ratings of the
investments of our Japanese insurance companies are based on ratings assigned by
nationally recognized credit rating agencies, including Moody's and S&P, or
rating equivalents based on ratings assigned by Japanese credit ratings
agencies.
The following table sets forth our fixed maturity portfolio by NAIC Designation
or equivalent rating attributable to PFI excluding the Closed Block division, as
of the dates indicated:
December 31, 2019 December 31, 2018
Gross Gross Gross Gross
NAIC Amortized Unrealized Unrealized
Fair Amortized Unrealized Unrealized Fair
Designation(1)(2) Cost Gains(3) Losses(3)(4) Value Cost Gains(3) Losses(3)(4) Value
(in millions)
1 $ 233,782 $ 36,274 $ 287 $ 269,769 $ 222,290 $ 24,138 $ 2,568 $ 243,860
2 59,304 5,216 384 64,136 55,768 2,267 1,999 56,036
Subtotal High or
Highest Quality
Securities(5) 293,086 41,490 671 333,905 278,058 26,405 4,567 299,896
3 10,033 854 93 10,794 10,149 330 408 10,071
4 4,914 248 98 5,064 5,254 291 368 5,177
5 1,280 196 83 1,393 1,395 99 77 1,417
6 264 31 17 278 253 13 18 248
Subtotal Other
Securities(6)(7) 16,491 1,329 291 17,529 17,051 733 871 16,913
Total fixed
maturities $ 309,577 $ 42,819 $ 962 $ 351,434 $ 295,109 $ 27,138 $ 5,438 $ 316,809
__________(1) Reflects equivalent ratings for investments of the international insurance
operations.
(2) Includes, as of December 31, 2019 and 2018, 796 securities with amortized
cost of $3,073 million (fair value, $3,130 million) and 1,744 securities with
amortized cost of $9,079 million (fair value, $9,135 million), respectively,
that have been categorized based on expected NAIC Designations pending
receipt of SVO ratings.
(3) Includes $369 million of gross unrealized gains, as of December 31, 2019,
compared to $359 million of gross unrealized gains and less than $1 million
of gross unrealized losses, as of December 31, 2018, on securities classified
as held-to-maturity.
(4) As of December 31, 2019, includes gross unrealized losses of $188 million on
public fixed maturities and $103 million on private fixed maturities
considered to be other than high or highest quality and, as of December 31,
2018, includes gross unrealized losses of $591 million on public fixed
maturities and $280 million on private fixed maturities considered to be
other than high or highest quality.
(5) On an amortized cost basis, as of December 31, 2019, includes $249,884
million of public fixed maturities and $43,202 million of private fixed
maturities and, as of December 31, 2018, includes $238,824 million of public
fixed maturities and $39,234 million of private fixed maturities.
(6) On an amortized cost basis, as of December 31, 2019, includes $9,049 million
of public fixed maturities and $7,442 million of private fixed maturities
and, as of December 31, 2018, includes $10,588 million of public fixed
maturities and $6,463 million of private fixed maturities.
(7) On an amortized cost basis, as of December 31, 2019, securities considered
below investment grade based on lowest of external rating agency ratings
total $17,527 million, or approximately 6% of the total fixed maturities, and
include securities considered high or highest quality by the NAIC based on
the rules described above.
Asset-Backed and Commercial Mortgage-Backed Securities
The following table sets forth the amortized cost and fair value of asset-backed and commercial mortgage-backed securities within our fixed maturity available-for-sale portfolio attributable to PFI excluding the Closed Block division by credit quality, as of the dates indicated:
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December 31, 2019 December 31, 2018
Asset-Backed Commercial Mortgage-Backed Asset-Backed Commercial Mortgage-Backed
Securities(2) Securities(3) Securities(2) Securities(3)
Lowest Rating Amortized
Agency Rating(1) Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Cost Fair Value
(in millions)
AAA $ 9,381 $ 9,377 $ 8,128 $ 8,454 $ 9,188 $ 9,151 $ 7,523 $ 7,528
AA 288 304 2,068 2,173 405 430 1,415 1,410
A 5 6 6 7 30 36 6 7
BBB 12 12 9 9 15 15 9 9
BB and below 146 222 0 0 165 231 0 0
Total(4) $ 9,832 $ 9,921 $ 10,211 $ 10,643 $ 9,803 $ 9,863 $ 8,953 $ 8,954
__________(1) The table above provides ratings as assigned by nationally recognized rating
agencies as of December 31, 2019, including S&P, Moody's,
("Fitch") and Morningstar, Inc. ("Morningstar").
(2) Includes collateralized loan obligations ("CLOs"), credit-tranched securities
collateralized by auto loans, education loans, credit cards and other asset
types.
(3) As of December 31, 2019 and 2018, based on amortized cost, 97% and 96% were
securities with vintages of 2013 or later, respectively.
(4) Excludes fixed maturity securities classified as "Assets supporting
experience-rated contractholder liabilities" and "Fixed maturities, trading"
as well as securities held outside the general account in other entities and
operations.
Included in "Asset-backed securities" above are investments in CLOs. The following table sets forth information pertaining to these investments in CLOs within our fixed maturity available-for-sale portfolio attributable to PFI excluding the Closed Block division, as of the dates indicated:
December 31, 2019 December 31, 2018
Collateralized Loan Obligations
Lowest Rating Agency
Rating(1) Amortized Cost Fair Value Amortized Cost Fair Value
(in millions)
AAA $ 7,294 $ 7,271 $ 7,355 $ 7,318
AA 0 0 0 0
A 0 0 0 0
BBB 0 0 0 0
BB and below 0 0 0 0
Total(2) $ 7,294 $ 7,271 $ 7,355 $ 7,318
__________(1) The table above provides ratings as assigned by nationally recognized rating
agencies as of December 31, 2019, including S&P, Moody's, Fitch and
Morningstar.
(2) Excludes fixed maturity securities classified as "Assets supporting
experience-rated contractholder liabilities" and "Fixed maturities, trading"
as well as securities held outside the general account in other entities and
operations.
Assets Supporting Experience-Rated Contractholder Liabilities
For information regarding the composition of "Assets supporting experience-rated contractholder liabilities," see Note 3 to the Consolidated Financial Statements.
Commercial Mortgage and Other Loans
Investment Mix
The following table sets forth the composition of our commercial mortgage and
other loans portfolio attributable to PFI excluding the Closed Block division,
as of the dates indicated:
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December 31, 2019 December 31, 2018
(in millions)
Commercial mortgage and agricultural property loans $ 53,928 $ 49,524
Uncollateralized loans 656 658
Residential property loans 124 158
Other collateralized loans 65 17
Total recorded investment gross of allowance(1) 54,773 50,357
Allowance for credit losses (102 ) (106 )
Total net commercial mortgage and other loans(2) $ 54,671 $ 50,251
__________
(1) As a percentage of recorded investment gross of allowance, more than 99% of
these assets were current as of both December 31, 2019 and 2018.
(2) Excluded from the table above are commercial mortgage and other loans held
outside the general account in other entities and operations. For additional
information regarding commercial mortgage and other loans held outside the
general account, see "-Invested Assets of Other Entities and Operations"
below.
We originate commercial mortgage and agricultural property loans using a
dedicated sales and underwriting staff through our various regional offices in
the U.S. and international offices primarily in London and Tokyo . All loans are
underwritten consistently to our standards using a proprietary quality rating
system that has been developed from our industry experience in real estate and
mortgage lending.
Uncollateralized loans primarily represent corporate loans which do not meet the definition of a security under authoritative accounting guidance.
Residential property loans primarily include Japanese recourse loans. Upon default of these recourse loans, we can make a claim against the personal assets of the property owner, in addition to the mortgaged property. These loans are also backed by third-party guarantors.
Other collateralized loans include consumer loans.
Composition of Commercial Mortgage and Agricultural Property Loans
Our commercial mortgage and agricultural property loan portfolio strategy emphasizes diversification by property type and geographic location. The following tables set forth the breakdown of the gross carrying values of commercial mortgage and agricultural property loans attributable to PFI excluding the Closed Block division by geographic region and property type, as of the dates indicated:
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December 31, 2019 December 31, 2018
Gross Gross
Carrying % of Carrying % of
Value Total Value Total
($ in millions)
Commercial mortgage and agricultural
property loans by region:
U.S. Regions(1):
Pacific $ 18,061 33.5 % $ 16,553 33.4 %
South Atlantic 8,943 16.6 8,633 17.4
Middle Atlantic 6,664 12.4 6,088 12.3
East North Central 3,413 6.3 2,813 5.7
West South Central 5,439 10.1 5,044 10.2
Mountain 2,442 4.5 2,508 5.0
New England 1,902 3.5 1,879 3.8
West North Central 454 0.8 476 1.0
East South Central 622 1.2 595 1.2
Subtotal-U.S. 47,940 88.9 44,589 90.0
Europe 3,781 7.0 3,077 6.2
Asia 886 1.6 733 1.5
Other 1,321 2.5 1,125 2.3
Total commercial mortgage and agricultural
property loans $ 53,928 100.0 % $ 49,524 100.0 %
__________(1) Regions as defined by the United States Census Bureau.
December 31, 2019 December 31, 2018
Gross Gross
Carrying % of Carrying % of
Value Total Value Total
($ in millions)
Commercial mortgage and agricultural
property loans by property type:
Industrial $ 12,224 22.7 % $ 10,490 21.2 %
Retail 6,524 12.1 6,693 13.5
Office 11,203 20.8 10,971 22.1
Apartments/Multi-Family 15,176 28.1 13,818 27.9
Agricultural properties 2,856 5.3 2,710 5.5
Hospitality 2,066 3.8 1,587 3.2
Other 3,879 7.2 3,255 6.6
Total commercial mortgage and agricultural
property loans $ 53,928 100.0 % $ 49,524 100.0 %
Loan-to-value and debt service coverage ratios are measures commonly used to
assess the quality of commercial mortgage and agricultural property loans. The
loan-to-value ratio compares the amount of the loan to the fair value of the
underlying property collateralizing the loan and is commonly expressed as a
percentage. A loan-to-value ratio less than 100% indicates an excess of
collateral value over the loan amount. Loan-to-value ratios greater than 100%
indicate that the loan amount exceeds the collateral value. The debt service
coverage ratio compares a property's net operating income to its debt service
payments. Debt service coverage ratios less than 1.0 times indicate that
property operations do not generate enough income to cover the loan's current
debt payments. A debt service coverage ratio greater than 1.0 times indicates an
excess of net operating income over the debt service payments.
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As of December 31, 2019, our commercial mortgage and agricultural property loans
attributable to PFI excluding the Closed Block division had a weighted-average
debt service coverage ratio of 2.46 times and a weighted-average loan-to-value
ratio of 56%. As of December 31, 2019, 95% of commercial mortgage and
agricultural property loans were fixed rate loans. For those commercial mortgage
and agricultural property loans that were originated in 2019, the
weighted-average debt service coverage ratio was 2.68 times, and the
weighted-average loan-to-value ratio was 63%.
The values utilized in calculating these loan-to-value ratios are developed as
part of our periodic review of the commercial mortgage and agricultural property
loan portfolio, which includes an internal evaluation of the underlying
collateral value. Our periodic review also includes a quality re-rating process,
whereby we update the internal quality rating originally assigned at
underwriting based on the proprietary quality rating system mentioned above. As
discussed below, the internal quality rating is a key input in determining our
allowance for credit losses.
For loans with collateral under construction, renovation or lease-up, a
stabilized value and projected net operating income are used in the calculation
of the loan-to-value and debt service coverage ratios. Our commercial mortgage
and agricultural property loan portfolio included $1.8 billion and approximately
$0.7 billion of such loans as of December 31, 2019 and 2018, respectively. All
else being equal, these loans are inherently riskier than those collateralized
by properties that have already stabilized. As of December 31, 2019, there were
no loan-specific reserves related to these loans. In addition, these
unstabilized loans are included in the calculation of our portfolio reserve, as
discussed below.
The following table sets forth the gross carrying value of our commercial
mortgage and agricultural property loans attributable to PFI excluding the
Closed Block division by loan-to-value and debt service coverage ratios, as of
the date indicated:
December 31, 2019
Debt Service Coverage Ratio
Total
Commercial Mortgage
1.0x and Agricultural
to Property
> 1.2x < 1.2x < 1.0x Loans
Loan-to-Value Ratio (in millions)
0%-59.99% $ 28,720 $ 676 $ 166 $ 29,562
60%-69.99% 14,768 968 42 15,778
70%-79.99% 7,670 595 28 8,293
80% or greater 179 114 2 295
Total commercial mortgage and agricultural
property loans $ 51,337 $ 2,353 $ 238 $ 53,928
The following table sets forth the breakdown of our commercial mortgage and agricultural property loans attributable to PFI excluding the Closed Block division by year of origination, as of the date indicated:
December 31, 2019
Gross
Carrying % of
Value Total
Year of Origination ($ in millions)
2019 $ 9,726 18.0 %
2018 8,699 16.1
2017 7,365 13.7
2016 6,603 12.2
2015 6,231 11.6
2014 4,843 9.0
2013 4,972 9.2
2012 & Prior 5,489 10.2Total commercial mortgage and agricultural property loans $ 53,928 100.0 %
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Commercial Mortgage and Other Loans by Contractual Maturity Date
The following table sets forth the breakdown of our commercial mortgage and other loans portfolio by contractual maturity, as of the date indicated:
December 31, 2019
Gross
Carrying Value % of Total
Vintage ($ in millions)
Maturing in 2020 $ 2,572 4.7 %
Maturing in 2021 3,015 5.5
Maturing in 2022 3,993 7.3
Maturing in 2023 3,534 6.4
Maturing in 2024 5,922 10.8
Maturing in 2025 6,576 12.0
Maturing in 2026 5,839 10.7
Maturing in 2027 4,668 8.5
Maturing in 2028 5,019 9.2
Maturing in 2029 4,694 8.6
Maturing in 2030 2,834 5.2
Maturing in 2031 and beyond 6,107 11.1Total commercial mortgage and other loans $ 54,773 100.0 %
Commercial Mortgage and Other Loans Quality
The commercial mortgage and other loans portfolio is monitored on an ongoing basis. If certain criteria are met, loans are assigned to either of the following "watch list" categories:
(1) "Closely Monitored," which includes a variety of considerations, such as when loan metrics fall below acceptable levels, the borrower is not cooperative or has requested a material modification, or the portfolio manager has directed a change in category; or (2) "Not in Good Standing," which includes loans in default or with a high probability of loss of principal, such as when the loan is in the process of foreclosure or the borrower is in bankruptcy. Our workout and special servicing professionals manage the loans on the watch list. We establish an allowance for credit losses to provide for the risk of credit losses inherent in the lending process. The allowance includes loan-specific reserves for loans that are determined to be impaired as a result of our loan review process and a portfolio reserve for probable incurred but not specifically identified losses for loans which are not on the watch list. We define an impaired loan as a loan for which we estimate it is probable that amounts due according to the contractual terms of the loan agreement will not be collected. The loan-specific portion of the allowance for credit losses is based on our assessment as to ultimate collectability of loan principal and interest. An allowance for credit losses for an impaired loan is recorded based on the present value of expected future cash flows discounted at the loan's effective interest rate, or based on the fair value of the collateral if the loan is collateral dependent. The portfolio reserve for incurred but not specifically identified losses considers the current credit composition of the portfolio based on the internal quality ratings mentioned above. The portfolio reserves are determined using past loan experience, including historical credit migration, loss probability and loss severity factors by property type. These factors are reviewed and updated as appropriate. The allowance for credit losses for commercial mortgage and other loans can increase or decrease from period to period based on these factors.
The following table sets forth the change in allowance for credit losses for our commercial mortgage and other loans portfolio, as of the dates indicated:
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December 31, 2019 December 31, 2018
(in millions)
Allowance, beginning of period $ 106 $ 91
Addition to (release of) allowance for credit losses (4 ) 15
Allowance, end of period $ 102 $ 106
Loan-specific reserve $ 1 $ 11
Portfolio reserve $ 101 $ 95
The allowance for credit losses as of December 31, 2019 decreased compared to December 31, 2018 primarily due to the payoff of a loan included in the loan-specific reserve.
Equity Securities
The equity securities attributable to PFI excluding the Closed Block division
consist principally of investments in Common and Preferred Stock of
publicly-traded companies, as well as mutual fund shares. The following table
sets forth the composition of our equity securities portfolio and the associated
gross unrealized gains and losses, as of the dates indicated:
December 31, 2019 December 31, 2018
Gross Gross Gross Gross
Unrealized Unrealized Fair Unrealized Unrealized Fair
Cost Gains Losses Value Cost Gains Losses Value
(in millions)
Mutual funds $ 817 $ 258 $ 1 $ 1,074 $ 769 $ 87 $ 13 $ 843
Other Common Stocks 2,429 1,091 57 3,463 2,353 751 118 2,986
Non-redeemable
Preferred Stocks 51 3 5 49 24 0 4 20
Total equity
securities, at fair
value(1) $ 3,297 $ 1,352 $ 63 $ 4,586 $ 3,146 $ 838 $ 135 $ 3,849
__________(1) Amounts presented exclude investments in private equity and hedge funds and
other investments which are reported in "Other invested assets."
The net change in unrealized gains (losses) from equity securities attributable to PFI excluding Closed Block division still held at period end, recorded within "Other income (loss)," was $586 million and $(569) million during the year ended December 31, 2019 and 2018, respectively.
Other Invested Assets
The following table sets forth the composition of "Other invested assets" attributable to PFI excluding the Closed Block division, as of the dates indicated:
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December 31, 2019 December 31, 2018
(in millions)
LPs/LLCs:
Equity method:
Private equity $ 2,740 $ 2,318
Hedge funds 1,362 836
Real estate-related 792 544
Subtotal equity method 4,894 3,698
Fair value:
Private equity 990 938
Hedge funds 1,233 1,256
Real estate-related 50 44
Subtotal fair value 2,273 2,238
Total LPs/LLCs 7,167 5,936
Real estate held through direct ownership(1) 1,350 1,777
Derivative instruments 73 42
Other(2) 620 652
Total other invested assets $ 9,210 $ 8,407
__________(1) As of December 31, 2019 and 2018, real estate held through direct ownership
had mortgage debt of $537 million and $776 million, respectively.
(2) Primarily includes leveraged leases and member and activity stock held in the
Federal Home Loan Banks of
regarding our holdings in the Federal Home Loan Banks of
see Note 17 to the Consolidated Financial Statements.
Invested Assets of Other Entities and Operations
"Invested Assets of Other Entities and Operations" presented below includes
investments held outside the general account and primarily represents
investments associated with our investment management operations and derivative
operations. Our derivative operations act on behalf of affiliates primarily to
manage interest rate, foreign currency, credit and equity exposures. Assets
within our investment management operations that are managed for third parties
and those assets classified as "Separate account assets" on our balance sheet
are not included.
December 31, 2019 December 31, 2018
(in millions)
Fixed maturities:
Public, available-for-sale, at fair value(1) $ 587 $ 473
Private, available-for-sale, at fair value 1 1
Fixed maturities, trading, at fair value(1) 1,161 1,155
Equity securities, at fair value 691 605
Commercial mortgage and other loans, at book value(2) 259 797
Other invested assets(1) 3,062 2,803
Short-term investments 17 43
Total investments $ 5,778 $ 5,877
__________(1) As of December 31, 2019 and 2018, balances include investments in CLOs with
fair value of $438 million and $408 million, respectively.
(2) Book value is generally based on unpaid principal balance, net of any
allowance for credit losses, or at fair value, when the fair value option has
been elected.
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Fixed Maturities, Trading
"Fixed maturities, trading, at fair value" are primarily related to assets
associated with consolidated variable interest entities ("VIEs") for which the
Company is the investment manager. The assets of the consolidated VIEs are
generally offset by liabilities for which the fair value option has been
elected. For further information on these consolidated VIEs, see Note 4 to the
Consolidated Financial Statements.
Commercial Mortgage and Other Loans
Our investment management operations include our commercial mortgage operations, which provide mortgage origination, investment management and servicing for our general account, institutional clients, theFederal Housing Administration and government-sponsored entities such as Fannie Mae and Freddie Mac. The mortgage loans of our commercial mortgage operations are included in "Commercial mortgage and other loans." Derivatives and other hedging instruments related to our commercial mortgage operations are primarily included in "Other invested assets." Other Invested Assets
"Other invested assets" primarily include assets of our derivative operations used to manage interest rate, foreign currency, credit and equity exposures.
Furthermore, other invested assets include strategic investments made as part of
our investment management operations. We make these strategic investments in
real estate, as well as fixed income, public equity and real estate securities,
including controlling interests. Certain of these investments are made primarily
for purposes of co-investment in our managed funds and structured products.
Other strategic investments are made with the intention to sell or syndicate to
investors, including our general account, or for placement in funds and
structured products that we offer and manage (seed investments). As part of our
investment management operations, we also make loans to our managed funds that
are secured by equity commitments from investors or assets of the funds. "Other
invested assets" also includes certain assets in consolidated investment funds
where the Company is deemed to exercise control over the funds.
Liquidity and Capital Resources
Overview
Liquidity refers to the ability to generate sufficient cash resources to meet
the payment obligations of the Company. Capital refers to the long-term
financial resources available to support the operations of our businesses, fund
business growth, and provide a cushion to withstand adverse circumstances. Our
ability to generate and maintain sufficient liquidity and capital depends on the
profitability of our businesses, general economic conditions and our access to
the capital markets and the alternate sources of liquidity and capital described
herein.
Effective and prudent liquidity and capital management is a priority across the
organization. Management monitors the liquidity of Prudential Financial and its
subsidiaries on a daily basis and projects borrowing and capital needs over a
multi-year time horizon through our periodic planning process. We believe that
capital and liquidity resources are sufficient to satisfy the capital and
liquidity requirements of Prudential Financial and its subsidiaries, including
under reasonably foreseeable stress scenarios. We use a Risk Appetite Framework
("RAF") to ensure that all risks taken across the Company align with our
capacity and willingness to take those risks. The RAF provides a dynamic
assessment of capital and liquidity stress impacts and is intended to ensure
that sufficient resources are available to absorb those impacts under
comprehensive stresses.
Our businesses are subject to comprehensive regulation and supervision by
domestic and international regulators. These regulations currently include, or
may include in the future requirements and limitations (many of which are the
subject of ongoing rule-making) relating to capital, leverage, liquidity,
stress-testing, overall risk management, credit exposure reporting and credit
concentration. For information on these regulatory initiatives and their
potential impact on us, see "Business-Regulation."
During 2019, we took the following significant actions that impacted our liquidity and capital position:
• We repurchased $2.5 billion of shares of
Stock in accordance with our 2019 share repurchase authorization and
declared aggregate Common Stock dividends of $1.6 billion;
• We issued $2.5 billion of senior notes to be utilized for general corporate
purposes, including refinancing portions of our senior notes maturing
during 2019 and 2020, and to fund the acquisition of Assurance IQ;
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• In October 2019, we completed the acquisition of Assurance IQ. See Note 1
to the Consolidated Financial Statements for additional information about
the acquisition, including the purchase consideration;
• On September 30, 2019, we entered into a ¥100 billion five-year credit
facility with a syndicate of lenders, with terms similar to the prior
three-year syndicated credit facility expiring on that date. There were no
borrowings under the facility as of December 31, 2019;
• In August 2019, we issued approximately 6.2 million shares of Prudential
Financial's Common Stock to the holders of PICA's $500 million of
exchangeable surplus notes upon their exercise of the exchange option. The
Company's obligations under the surplus notes are now satisfied; and
• In the second quarter of 2019, PGIM closed on a $300 million
limited-recourse credit facility that is secured by certain of PGIM's fund
investments.
Capital
Our capital management framework is primarily based on statutory Risk-Based Capital ("RBC") and solvency margin measures. Due to our diverse mix of businesses and applicable regulatory requirements, we apply certain refinements to the framework that are designed to more appropriately reflect risks associated with our businesses on a consistent basis across the Company.
We believePrudential Financial's capitalization and financial profile are consistent with its ratings targets. Our long-term senior debt rating targets forPrudential Financial are "A" for S&P, Moody's, and Fitch, and "a" forA.M. Best Company ("A.M. Best"). Our financial strength rating targets for our life insurance companies are "AA/Aa/AA" for S&P, Moody's and Fitch, respectively, and "A+" forA.M. Best . Some entities may currently be rated below these targets, and not all life insurance companies are rated by each of these rating agencies. See "-Ratings" below for a description of the potential impacts of ratings downgrades.
Capital Governance
Our capital management framework is ultimately reviewed and approved by our Board. The Board has authorized our Chairman and Chief Executive Officer and Vice Chair to approve certain capital actions on behalf of the Company and to further delegate authority with respect to capital actions to appropriate officers, up to specified limits. Any capital commitment that exceeds the authority granted to senior management must be separately authorized by the Board. In addition, our Capital andFinance Committee ("CFC") reviews the use and allocation of capital above certain threshold amounts to promote the efficient use of capital, consistent with our strategic objectives, ratings aspirations and other goals and targets. This management committee provides a multi-disciplinary due diligence review of specific initiatives or transactions requiring the use of capital, including mergers and acquisitions. The CFC also reviews our annual capital plan (and updates to this plan), as well as our capital, liquidity and financial position, borrowing plans, and related matters prior to the discussion of these items with the Board.
Capitalization
The primary components of the Company's capitalization consist of equity and
outstanding capital debt, including junior subordinated debt. As shown in the
table below, as of December 31, 2019, the Company had $53.7 billion in capital,
all of which was available to support the aggregate capital requirements of its
businesses and its Corporate and Other operations. Based on our assessment of
these businesses and operations, we believe this level of capital is consistent
with our ratings targets.
December 31,
2019 2018
(in millions)
Equity(1) $ 39,076 $ 37,711
Junior subordinated debt (including hybrid securities) 7,575 7,568
Other capital debt 7,001 5,793
Total capital $ 53,652 $ 51,072
__________
(1) Amounts attributable to
Insurance Regulatory Capital
We manage PICA, The
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measure of the capital adequacy of our domestic insurance subsidiaries and the solvency margin ratio as a primary measure of the capital adequacy of our Japanese insurance subsidiaries.
RBC is calculated based on statutory financial statements and risk formulas consistent with the practices of the NAIC. RBC considers, among other things, risks related to the type and quality of the invested assets, insurance-related risks associated with an insurer's products and liabilities, interest rate risks and general business risks. RBC ratio calculations are intended to assist insurance regulators in measuring an insurer's solvency and ability to pay future claims. The reporting of RBC measures is not intended for the purpose of ranking any insurance company or for use in connection with any marketing, advertising or promotional activities, but is available to the public.
The table below presents the RBC ratios of our most significant domestic insurance subsidiaries as of December 31, 2018, the most recent statutory fiscal year-end for these subsidiaries for which RBC information has been filed.
Ratio
PICA(1) 385 %
417 %
__________
(1) Includes Prudential Retirement Insurance and Annuity Company ("PRIAC"), Pruco
Life Insurance Company ("Pruco Life"),
Jersey ("PLNJ"), which is a subsidiary of Pruco Life, and Prudential Legacy
Insurance Company of
(2) Includes PICA and its subsidiaries, as noted above, and PALAC. Composite RBC
is not reported to regulators and is based on the summation of total adjusted
capital and risk charges for the included companies as determined under
statutory accounting and RBC guidance to calculate a composite numerator and
denominator, respectively, for purposes of calculating the composite ratio.
Although not yet filed, we expect our RBC ratios as of December 31, 2019 to be above our "AA" financial strength target levels.
Similar to the RBC ratios that are employed byU.S. insurance regulators, regulatory authorities in the international jurisdictions in which we operate generally establish some form of minimum solvency margin requirements for insurance companies based on local statutory accounting practices. These solvency margins are a primary measure of the capital adequacy of our international insurance operations. Maintenance of our solvency margins at certain levels is also important to our competitive positioning, as in certain jurisdictions, such asJapan , these solvency margins are required to be disclosed to the public and therefore impact the public perception of an insurer's financial strength.
The table below presents the solvency margin ratios of our most significant international insurance subsidiaries as of September 30, 2019, the most recent date for which this information is available.
Ratio
Prudential of Japan consolidated(1) 875 %
Gibraltar Life consolidated(2) 885 %
__________
(1) Includes Prudential Trust Co., Ltd., a subsidiary of Prudential of
(2) Includes Prudential Gibraltar Financial Life Insurance Co., Ltd. ("PGFL"), a
subsidiary of Gibraltar Life.
Although not yet filed, we expect the solvency margin ratio for each of these subsidiaries to be greater than 700% (3.5 times the regulatory required minimums) as of December 31, 2019.
All of our domestic and significant international insurance subsidiaries have
capital levels that substantially exceed the minimum level required by
applicable insurance regulations. Our regulatory capital levels may be affected
in the future by changes to the applicable regulations, proposals for which are
currently under consideration by both domestic and international insurance
regulators. For further information on the calculation of RBC and solvency
margin ratios, as well as regulatory minimums, see Note 19 to the Consolidated
Financial Statements.
Risk Appetite Framework
We manage our capital consistent with our RAF to determine the amount of capital
the Company needs to hold given its risk profile. The RAF is designed to ensure
that all risks taken across the Company align with our capacity and willingness
to take those risks. It allows for a cohesive assessment of risk and available
resources and supports management's decision-making. The RAF is supported by our
comprehensive stress testing framework to provide a dynamic assessment of stress
impacts and the resources available to absorb those impacts under stress
scenarios. It incorporates the objectives of what we previously referred to as
our Capital Protection Framework.
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Captive Reinsurance Companies
We use captive reinsurance companies to more effectively manage our reserves and capital on an economic basis and to enable the aggregation and transfer of risks. Our captive reinsurance companies assume business from affiliates only. To support the risks they assume, our captives are capitalized to a level we believe is consistent with the "AA" financial strength rating targets of our insurance subsidiaries. All of our captives are subject to internal policies governing their activities. In the normal course of business we contribute capital to the captives to support business growth and other needs.Prudential Financial has also entered into support agreements with several of the captives in connection with financing arrangements. For a description of captive reinsurance company financing activities, see below under "-Financing Activities-Subsidiary Borrowings-Term and Universal Life Reserve Financing."
Shareholder Distributions
Share Repurchase Program and Shareholder Dividends
In December 2018, our Board of Directors (the "Board") authorized the Company to repurchase at management's discretion up to $2.0 billion of its outstanding Common Stock during the period from January 1, 2019 through December 31, 2019. In September 2019, the Board authorized a $500 million increase to the authorization for calendar year 2019. As a result, the Company's aggregate share repurchase authorization for calendar year 2019 was $2.5 billion. In December 2019, the Board authorized the Company to repurchase at management's discretion up to $2.0 billion of its outstanding Common Stock during the period from January 1, 2020 through December 31, 2020. The timing and amount of share repurchases are determined by management based on market conditions and other considerations, including any increased capital needs of our businesses due to, among other things, changes in regulatory capital requirements and opportunities for growth and acquisitions. Repurchases may be executed in the open market, through derivative, accelerated repurchase and other negotiated transactions and through plans designed to comply with Rule 10b5-1(c) under the Securities Exchange Act of 1934. The following table sets forth information about declarations of Common Stock dividends, as well as repurchases of shares ofPrudential Financial's Common Stock, for each of the quarterly periods in 2019 and for the prior four years. Dividend Amount Shares Repurchased Quarterly period ended: Per Share Aggregate Shares Total Cost (in millions, except per share data) December 31, 2019 $ 1.00 $ 406 5.4 $ 500 September 30, 2019 $ 1.00 $ 412 11.4 $ 1,000 June 30, 2019 $ 1.00 $ 411 5.0 $ 500 March 31, 2019 $ 1.00 $ 415 5.4 $ 500 Dividend Amount Shares Repurchased Year ended: Per Share Aggregate Shares Total Cost (in millions, except per share data) December 31, 2019 $ 4.00 $ 1,644 27.2 $ 2,500 December 31, 2018 $ 3.60 $ 1,525 14.9 $ 1,500 December 31, 2017 $ 3.00 $ 1,300 11.5 $ 1,250 December 31, 2016 $ 2.80 $ 1,245 25.1 $ 2,000 December 31, 2015 $ 2.44 $ 1,115 12.1 $ 1,000
In addition, on February 4, 2020,
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Liquidity
The principles of our liquidity management framework are described in an enterprise-wide policy that is reviewed and approved by the Board. Liquidity management and stress testing are performed on a legal entity basis as the ability to transfer funds between subsidiaries is limited due in part to regulatory restrictions. Liquidity needs are determined through daily and quarterly cash flow forecasting at the holding company and within our operating subsidiaries. We seek to maintain a minimum balance of highly liquid assets to ensure that adequate liquidity is available atPrudential Financial to cover fixed expenses in the event that we experience reduced cash flows from our operating subsidiaries at a time when access to capital markets is also not available. We seek to mitigate the risk of having limited or no access to financing due to stressed market conditions by generally pre-funding debt in advance of maturity. We mitigate the refinancing risk associated with our debt that is used to fund operating needs by matching the term of debt with the assets financed. To ensure adequate liquidity in stress scenarios, stress testing is performed for our major operating subsidiaries. We seek to further mitigate liquidity risk by maintaining our access to alternative sources of liquidity, as discussed below.
Liquidity of
The principal sources of funds available toPrudential Financial , the parent holding company, are dividends, returns of capital and loans from subsidiaries, and proceeds from debt issuances and certain stock-based compensation activity. These sources of funds may be supplemented byPrudential Financial's access to the capital markets as well as the "-Alternative Sources of Liquidity" described below. The primary uses of funds atPrudential Financial include servicing debt, making capital contributions and loans to subsidiaries, making acquisitions, paying declared shareholder dividends and repurchasing outstanding shares of Common Stock executed under authority from the Board. As of December 31, 2019,Prudential Financial had highly liquid assets with a carrying value totaling $5,104 million, a decrease of $1,095 million from December 31, 2018. Highly liquid assets predominantly include cash, short-term investments,U.S. Treasury securities, obligations of otherU.S. government authorities and agencies, and/or foreign government bonds. We maintain an intercompany liquidity account that is designed to optimize the use of cash by facilitating the lending and borrowing of funds betweenPrudential Financial and its subsidiaries on a daily basis. Excluding net borrowings from this intercompany liquidity account,Prudential Financial had highly liquid assets of $4,061 million as of December 31, 2019, a decrease of $1,487 million from December 31, 2018.
The following table sets forth
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Sources and Uses of Holding Company Highly Liquid Assets Year Ended December 31,
2019 2018
(in millions)
Highly Liquid Assets, beginning of period $ 5,548 $ 4,376
Dividends and/or returns of capital from subsidiaries(1) 3,282 4,058
Affiliated loans/(borrowings) - (capital activities)(2) 818 (623 )
Capital contributions to subsidiaries(3) (521 ) (874 )
Total Business Capital Activity 3,579 2,561
Share repurchases (2,500 ) (1,500 )
Common stock dividends(4) (1,641 ) (1,521 )
M&A (Assurance IQ)(5) (1,831 ) -Total Share Repurchases, Dividends and Acquisition Activity (5,972 ) (3,021 ) Proceeds from the issuance of debt
2,465 2,531 Repayments of debt (1,114 ) (1,443 ) Total Debt Activity 1,351 1,088
Proceeds from stock-based compensation and exercise of stock options
418 312
Net income tax receipts & payments 103 231
Interest income from subsidiaries on intercompany agreements, net of interest paid
199 215
Interest paid on external debt (952 ) (890 )
Affiliated (borrowings)/loans - (operating activities)(6) (115 ) 796
Other, net (98 ) (120 )
Total Other Activity (445 ) 544
Net increase (decrease) in highly liquid assets (1,487 ) 1,172
Highly Liquid Assets, end of period $ 4,061 $ 5,548
__________
(1) See "Item 15-Schedule II-Notes to Condensed Financial Information of
Registrant-Dividends and Returns of Capital" for dividends and returns of
capital by subsidiary.
(2) Affiliated loans/(borrowings) - (capital activities) represent the investment
and deployment of capital to and from our businesses in the form of loans.
2019 includes net receipts of $818 million from international insurance
subsidiaries. 2018 includes lending of $623 million to international
subsidiaries.
(3) 2019 includes capital contributions of $200 million to PICA, $180 million to
international insurance subsidiaries, $73 million to
Assurance IQ. 2018 includes capital contributions of $590 million to PICA and
$284 million to international insurance subsidiaries.
(4) Includes cash payments made on dividends declared in prior periods.
(5) Includes $1,758 million of purchase consideration and $73 million related to
compensation expense which is recognized over the requisite service periods.
See Note 1 to the Consolidated Financial Statements for additional
information.
(6) Affiliated (borrowings)/loans - (operating activities) represent loans to and
from affiliated subsidiaries to support business operating needs.
Dividends and Returns of Capital from Subsidiaries
Domestic insurance subsidiaries. During 2019,
International insurance subsidiaries. During 2019,Prudential Financial received dividends of $1,065 million from its international insurance subsidiaries. In addition to paying Common Stock dividends, our international insurance operations may return capital toPrudential Financial through or facilitated by other means, such as the repayment of preferred stock obligations held byPrudential Financial or other affiliates, affiliated lending, affiliated derivatives and reinsurance withU.S. - andBermuda -based affiliates. In 2019, ourJapan insurance operations entered into reinsurance agreements with Gibraltar Re, ourBermuda -based reinsurance affiliate, to reinsure the mortality and morbidity risk associated with a portion of the in-force contracts as well as newly-issued contracts for certain products. We expect these transactions will allow us to more efficiently manage our capital and risk profile. Other subsidiaries. During 2019,Prudential Financial received dividends and returns of capital of $462 million fromPGIM subsidiaries and dividends of $14 million from other subsidiaries. 129
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Restriction on dividends and returns of capital from subsidiaries. Our insurance companies are subject to limitations on the payment of dividends and other transfers of funds toPrudential Financial and other affiliates under applicable insurance law and regulation. Also, more generally, the payment of dividends by any of our subsidiaries is subject to declaration by their Board of Directors and can be affected by market conditions and other factors. With respect to our domestic insurance subsidiaries, PICA is permitted to pay ordinary dividends based on calculations specified underNew Jersey insurance law, subject to prior notification to theNew Jersey Department of Banking and Insurance ("NJDOBI"). Any distributions above this amount in any twelve-month period are considered to be "extraordinary" dividends, and the approval of the NJDOBI is required prior to payment. The laws regulating dividends of the states where our other domestic insurance companies are domiciled are similar, but not identical, toNew Jersey's . Capital redeployment from our international insurance subsidiaries is subject to local regulatory requirements in the international jurisdictions in which they operate. Our most significant international insurance subsidiaries, Prudential ofJapan and Gibraltar Life, are permitted to pay common stock dividends based on calculations specified by Japanese insurance law, subject to prior notification to the FSA. Dividends in excess of these amounts and other forms of capital distribution require the prior approval of the FSA. The regulatory fiscal year end for both Prudential ofJapan and Gibraltar Life is March 31, 2020, after which time the common stock dividend amount permitted to be paid without prior approval from the FSA can be determined.
The ability of our
See Note 19 to the Consolidated Financial Statements for details on specific dividend restrictions.
Liquidity of Insurance Subsidiaries
We manage the liquidity of our insurance operations to ensure stable, reliable and cost-effective sources of cash flows to meet all of our obligations. Liquidity within each of our insurance subsidiaries is provided by a variety of sources, including portfolios of liquid assets. The investment portfolios of our subsidiaries are integral to the overall liquidity of our insurance operations. We segment our investment portfolios and employ an asset/liability management approach specific to the requirements of each of our product lines. This enhances the discipline applied in managing the liquidity, as well as the interest rate and credit risk profiles, of each portfolio in a manner consistent with the unique characteristics of the product liabilities. Liquidity is measured against internally-developed benchmarks that take into account the characteristics of both the asset portfolio and the liabilities that they support. We consider attributes of the various categories of liquid assets (for example, type of asset and credit quality) in calculating internal liquidity measures to evaluate our insurance operations' liquidity under various stress scenarios, including company-specific and market-wide events. We continue to believe that cash generated by ongoing operations and the liquidity profile of our assets provide sufficient liquidity under reasonably foreseeable stress scenarios for each of our insurance subsidiaries.
Cash Flow
The principal sources of liquidity for our insurance subsidiaries are premiums,
investment and fee income, investment maturities, sales of investments, and
sales associated with our insurance and annuity operations, as well as internal
and external borrowings. The principal uses of that liquidity include benefits,
claims and dividends paid to policyholders, and payments to policyholders and
contractholders in connection with surrenders, withdrawals and net policy loan
activity. Other uses of liquidity may include commissions, general and
administrative expenses, purchases of investments, the payment of dividends to
the parent holding company, hedging and reinsurance activity and payments in
connection with financing activities.
In each of our major insurance subsidiaries, we believe that the cash flows from
operations are adequate to satisfy current liquidity requirements. The continued
adequacy of this liquidity will depend upon factors such as future securities
market conditions, changes in interest rate levels, policyholder perceptions of
our financial strength, policyholder behavior, catastrophic events and the
relative safety and attractiveness of competing products, each of which could
lead to reduced cash inflows or increased cash outflows. Our insurance
operations' cash flows from investment activities result from repayments of
principal, proceeds from maturities and sales of invested assets and investment
income, net of amounts reinvested. The primary liquidity risks with respect to
these cash flows are the risk of default by debtors or bond insurers, our
counterparties' willingness to extend repurchase and/or securities lending
arrangements, commitments to invest and market volatility. We closely manage
these risks through our credit risk management process and regular monitoring of
our liquidity position.
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Domestic insurance operations. In managing the liquidity of our domestic
insurance operations, we consider the risk of policyholder and contractholder
withdrawals of funds earlier than our assumptions when selecting assets to
support these contractual obligations. We use surrender charges and other
contract provisions to mitigate the extent, timing and profitability impact of
withdrawals of funds by customers. The following table sets forth the
liabilities for future policy benefits and policyholders' account balances of
certain of our domestic insurance subsidiaries as of the dates indicated.
December 31,
2019 2018
(in billions)
PICA $ 216.7 $ 207.0
PLIC 51.8 52.6
Pruco Life 48.1 41.5
PRIAC 26.1 25.8
PALAC 19.1 14.7
Other(1) (96.0 ) (91.0 ) Total future policy benefits and policyholders' account balances(2) $ 265.8 $ 250.6
__________
(1) Includes the impact of intercompany eliminations.
(2) Amounts are reflected gross of affiliated reinsurance recoverables.
The liabilities presented above are primarily supported by invested assets in
our general account. As noted above, when selecting assets to support these
contractual obligations, we consider the risk of policyholder and contractholder
withdrawals of funds earlier than our assumptions. As a result, assets will
include both liquid assets, as discussed below, and other assets that we believe
adequately support our liabilities.
For PICA and other subsidiaries, the liabilities presented above primarily
include annuity reserves and deposit liabilities and individual life insurance
policy reserves. Individual life insurance policies may impose surrender charges
and policyholders may be subject to a new underwriting process in order to
obtain a new insurance policy. PICA's reserves for group annuity contracts
primarily relate to pension risk transfer contracts, which are generally not
subject to early withdrawal. For our individual annuity contracts, to encourage
persistency, most of our variable and fixed annuities have surrender or
withdrawal charges for a specified number of years. In addition, certain fixed
annuities impose a market value adjustment if the invested amount is not held to
maturity. The living benefit features of our variable annuities also encourage
persistency because the potential value of the living benefit is fully realized
only if the contract persists.
For PRIAC, the liabilities presented above primarily include reserves for stable
value contracts. Although many of these contracts are subject to discretionary
withdrawal, withdrawals are typically at the market value of the underlying
assets. Risk is further reduced by the high persistency of clients driven in
part by our competitive position in our target markets and contractual
provisions such as deferred payouts.
Gross account withdrawals for our domestic insurance operations' products in
2019 were generally consistent with our assumptions in asset/liability
management, and the associated cash outflows did not have a material adverse
impact on our overall liquidity.
International insurance operations. As with our domestic operations, in managing
the liquidity of our international insurance operations, we consider the risk of
policyholder and contractholder withdrawals of funds earlier than our
assumptions in selecting assets to support these contractual obligations. The
following table sets forth the liabilities for future policy benefits and
policyholders' account balances of certain of our international insurance
subsidiaries as of the dates indicated.
December 31,
2019 2018
(in billions)
Prudential of Japan(1) $ 56.4 $ 51.6
Gibraltar Life(2) 108.0 104.3
All other international insurance subsidiaries(3) 15.4 17.7 Total future policy benefits and policyholders' account balances(4) $ 179.8 $ 173.6
__________
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(1) As of December 31, 2019 and 2018, $15.7 billion and $13.4 billion,
respectively, of the insurance-related liabilities for Prudential of
are associated with
our domestic insurance operations and supported by
assets. As of December 31, 2019, $0.7 billion of the insurance-related
liabilities for Prudential of Japan are primarily associated with
yen-denominated products that are coinsured to Gibraltar Re, our
Bermuda -based reinsurance affiliate, and primarily supported by
yen-denominated assets.
(2) Includes PGFL. As of December 31, 2019 and 2018, $5.5 billion and $4.3
billion, respectively, of the insurance-related liabilities for PGFL are
associated with
domestic insurance operations and supported by
assets. As of December 31, 2019, $2.0 billion of the insurance-related
liabilities for Gibraltar Life are primarily associated with yen-denominated
products that are coinsured to Gibraltar Re, our
affiliate, and primarily supported by yen-denominated assets.
(3) Represents our international insurance operations, excluding
(4) Amounts are reflected gross of affiliated reinsurance recoverables.
The liabilities presented above are primarily supported by invested assets in our general account. When selecting assets to support these contractual obligations, we consider the risk of policyholder and contractholder withdrawals of funds earlier than our assumptions. As a result, assets will include both liquid assets, as discussed below, and other assets that we believe adequately support our liabilities.
We believe most of the longer-term recurring pay individual life insurance policies sold by our Japanese operations do not have significant withdrawal risk because policyholders may incur surrender charges and must undergo a new underwriting process to obtain a new insurance policy.
Gibraltar Life sells fixed annuities, denominated inU.S. and Australian dollars, that may be subject to increased surrenders should the yen depreciate in relation to these currencies or if interest rates inAustralia and theU.S. decline relative toJapan . A significant portion of the liabilities associated with these contracts include a market value adjustment feature, which mitigates the profitability impact from surrenders. As of December 31, 2019, products with a market value adjustment feature represented $26.1 billion of ourJapan operations' insurance-related liabilities, which included $22.7 billion attributable to non-yen denominated fixed annuities.
Liquid Assets
Liquid assets include cash and cash equivalents, short-term investments,U.S. Treasury securities, fixed maturities that are not designated as held-to-maturity and public equity securities. In addition to access to substantial investment portfolios, our insurance companies' liquidity is managed through access to a variety of instruments available for funding and/or managing cash flow mismatches, including from time to time those arising from claim levels in excess of projections. Our ability to utilize assets and liquidity between our subsidiaries is limited by regulatory and other constraints. We believe that ongoing operations and the liquidity profile of our assets provide sufficient liquidity under reasonably foreseeable stress scenarios for each of our insurance subsidiaries. The following table sets forth the fair value of certain of our domestic insurance operations' portfolio of liquid assets, as of the dates indicated. December 31, 2019 Prudential Insurance PLIC PRIAC PALAC Pruco Life Total December 31, 2018 (in billions) Cash and short-term investments $ 7.5 $ 0.4 $ 0.3 $ 3.1 $ 0.6 $ 11.9 $ 11.1 Fixed maturity investments(1): High or highest quality 126.2 37.2 19.5 13.0 5.4 201.3 179.2 Other than high or highest quality 7.5 2.8 1.1 0.5 0.3 12.2 11.3 Subtotal 133.7 40.0 20.6 13.5 5.7 213.5 190.5 Public equity securities, at fair value 0.2 2.2 0.0 0.1 0.0 2.5 1.9 Total $ 141.4 $ 42.6 $ 20.9 $ 16.7 $ 6.3 $ 227.9 $ 203.5 __________
(1) Excludes fixed maturities designated as held-to-maturity. Credit quality is
based on NAIC or equivalent rating.
The following table sets forth the fair value of our international insurance operations' portfolio of liquid assets, as of the dates indicated.
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December 31, 2019
Prudential Gibraltar All
of Japan Life(1) Other(2) Total December 31, 2018
(in billions)
Cash and short-term investments $ 1.0 $ 2.5 $ 1.5 $ 5.0 $ 4.1
Fixed maturity investments(3):
High or highest quality(4) 43.4 93.5 20.3 157.2 149.1
Other than high or highest quality 0.7 2.4 2.3 5.4 6.2
Subtotal 44.1 95.9 22.6 162.6 155.3
Public equity securities 2.1 1.8 0.8 4.7 4.0
Total $ 47.2 $ 100.2 $ 24.9 $ 172.3 $ 163.4
__________
(1) Includes PGFL.
(2) Represents our international insurance operations, excluding
(3) Excludes fixed maturities designated as held-to-maturity. Credit quality is
based on NAIC or equivalent rating.
(4) As of December 31, 2019, $122.2 billion, or 78%, were invested in government
or government agency bonds.
Given the size and liquidity profile of our investment portfolios, we believe that claim experience, including policyholder withdrawals and surrenders, varying from our projections does not constitute a significant liquidity risk. Our asset/liability management process takes into account the expected maturity of investments and expected claim payments as well as the specific nature and risk profile of the liabilities. To the extent we need to pay claims in excess of projections, we may borrow temporarily or sell investments sooner than anticipated to pay these claims, which may result in increased borrowing costs or realized investment gains or losses, including from changes in interest rates or credit spreads. The payment of claims and sale of investments earlier than anticipated would have an impact on the reported level of cash flow from operating, investing, and financing activities, in our financial statements. Historically, there has been no significant variation between the expected maturities of our investments and the payment of claims.
Liquidity associated with other activities
Hedging activities associated with Individual Annuities
For the portion of our Individual Annuities' ALM strategy executed through hedging, as well as the capital hedge program, we enter into a range of exchange-traded, cleared and other OTC equity and interest rate derivatives in order to hedge certain capital market risks related to more severe market conditions. For a full discussion of our Individual Annuities' risk management strategy, see "-Results of Operations by Segment-U.S. Businesses-U.S. Individual Solutions Division-Individual Annuities." This portion of our Individual Annuities' ALM strategy and capital hedge program requires access to liquidity to meet payment obligations relating to these derivatives, such as payments for periodic settlements, purchases, maturities and terminations. These liquidity needs can vary materially due to, among other items, changes in interest rates, equity markets, mortality and policyholder behavior. The hedging portion of our Individual Annuities' ALM strategy and capital hedge program may also result in derivative related collateral postings to (when we are in a net pay position) or from (when we are in a net receive position) counterparties. The net collateral position depends on changes in interest rates and equity markets related to the amount of the exposures hedged. Depending on market conditions, the collateral posting requirements can result in material liquidity needs when we are in a net pay position. As of December 31, 2019, the derivatives comprising the hedging portion of our ALM strategy and capital hedge program were in a net receive position of $4.7 billion compared to a net receive position of $2.9 billion as of December 31, 2018. The change in collateral position was driven by a net positive impact from declining interest rates, partially offset by rising equity markets.
Foreign exchange hedging activities
We employ various hedging strategies to manage potential exposure to foreign
currency exchange rate movements, particularly those associated with the yen.
Our overall yen hedging strategy calibrates the hedge level to preserve the
relative contribution of our yen-based business to the Company's overall return
on equity on a leverage neutral basis. The hedging strategy includes two primary
components:
Income Hedges-We hedge a portion of our prospective yen-based earnings streams
by entering into external forward currency derivative contracts that effectively
fix the currency exchange rates for that portion of earnings, thereby reducing
volatility from foreign currency exchange rate movements. As of December 31,
2019, we have hedged 100%, 72% and 28% of expected yen-based earnings for 2020,
2021 and 2022, respectively.
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Equity Hedges-We hold both internal and external hedges primarily to hedge our USD-equivalent equity. These hedges also mitigate volatility in the solvency margins of yen-based subsidiaries resulting from changes in the market value of their USD-denominated investments hedging our USD-equivalent equity attributable to changes in the yen-USD exchange rate.
For additional information on our hedging strategy, see "-Results of Operations-Impact of Foreign Currency Exchange Rates."
Cash settlements from these hedging activities result in cash flows between subsidiaries ofPrudential Financial and either international-based subsidiaries or external parties. The cash flows are dependent on changes in foreign currency exchange rates and the notional amount of the exposures hedged. For example, a significant yen depreciation over an extended period of time could result in net cash inflows, while a significant yen appreciation could result in net cash outflows. The following tables set forth information about net cash settlements and the net asset or liability resulting from these hedging activities related to the yen and other currencies for the periods indicated. Year ended December 31, Cash Settlements: Received (Paid) 2019 2018 (in millions) Income Hedges (External)(1) $ 67 $ (13 ) Equity Hedges: Internal(2) 432 105 External(3) 143 246 Total Equity Hedges 575 351 Total Cash Settlements $ 642 $ 338 As of December 31, Assets (Liabilities): 2019 2018 (in millions) Income Hedges (External)(4) $ 60 $ 67 Equity Hedges: Internal(2) 506 436 External(5) 43 78 Total Equity Hedges(6) 549 514 Total Assets (Liabilities) $ 609 $ 581
__________
(1) Includes non-yen related cash settlements of $41 million, primarily
denominated in Australian dollar, Korean won, and Brazilian real and $(11)
million, primarily denominated in Korean won, for the year ended December 31,
2019 and 2018, respectively.
(2) Represents internal transactions between international-based and
entities. Amounts noted are from the
(3) Includes Korean won related cash settlements of $17 million and $2 million
for the year ended December 31, 2019 and 2018, respectively.
(4) Includes non-yen related assets of $37 million, primarily denominated in
Korean won, Australian dollar and Chilean peso, and assets of $44 million
primarily, denominated in Australian dollar and Brazilian real, as of
December 31, 2019 and 2018, respectively.
(5) Includes Korean won related assets of $1 million and liabilities of $(2)
million as of December 31, 2019 and 2018, respectively.
(6) As of December 31, 2019, approximately $331 million, $332 million and $(115)
million of the net market values are scheduled to settle in 2020, 2021 and
thereafter, respectively. The net market value of the assets (liabilities)
will vary with changing market conditions to the extent there are no
corresponding offsetting positions.
The principal sources of liquidity for our fee-basedPGIM businesses include asset management fees and commercial mortgage origination and servicing fees. The principal uses of liquidity include general and administrative expenses, facilitating our commercial mortgage loan business, and distributions of dividends and returns of capital toPrudential Financial . The primary liquidity risks for our fee-basedPGIM businesses relate to their profitability, which is impacted by market conditions and our investment management performance. We believe the cash flows from our fee-basedPGIM businesses are adequate to satisfy the current liquidity requirements of these operations, as well as requirements that could arise under reasonably foreseeable stress scenarios, which are monitored through the use of internal measures. The principal sources of liquidity for our strategic investments held in ourPGIM businesses are cash flows from investments, the ability to liquidate investments, borrowing lines from internal sources, includingPrudential Financial andPrudential Funding, LLC ("Prudential Funding"), a wholly-owned subsidiary of PICA, and external sources, includingPGIM's limited-recourse credit facility. The principal use of liquidity for our strategic investments includes making investments to support business growth and paying interest expense from the internal and external borrowings used to fund those investments. The primary liquidity risks 134
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include the inability to sell assets in a timely manner, declines in the value
of assets and credit defaults. There have been no material changes to the
liquidity position of our
Alternative Sources of Liquidity
In addition to asset-based financing as discussed below,Prudential Financial and certain subsidiaries have access to other sources of liquidity, including syndicated, unsecured committed credit facilities, membership in the Federal Home Loan Banks, commercial paper programs, and a put option agreement. See Note 17 to the Consolidated Financial Statements for more information on these sources of liquidity.
Asset-based Financing
We conduct asset-based or secured financing within our insurance and other subsidiaries, including transactions such as securities lending, repurchase agreements and mortgage dollar rolls, to earn spread income, to borrow funds, or to facilitate trading activity. These programs are primarily driven by portfolio holdings of securities that are lendable based on counterparty demand for these securities in the marketplace. The collateral received in connection with these programs is primarily used to purchase securities in the short-term spread portfolios of our insurance entities. Investments held in the short-term spread portfolios include cash and cash equivalents, short-term investments (primarily corporate bonds), mortgage loans and fixed maturities (primarily collateralized loan obligations and other structured securities), with a weighted average life at time of purchase by the short-term portfolios of four years or less. Floating rate assets comprise the majority of our short-term spread portfolio. These short-term portfolios are subject to specific investment policy statements, which among other things, do not allow for significant asset/liability interest rate duration mismatch.
The following table sets forth our liabilities under asset-based or secured financing programs as of the dates indicated.
December 31, 2019 December 31, 2018
PFI PFI
Excluding Excluding
Closed Block Closed Closed Block Closed
Division Block Division Consolidated Division Block Division Consolidated
($ in millions)
Securities sold under
agreements to repurchase $ 6,834 $ 2,847 $ 9,681 $ 6,982 $ 2,968 $ 9,950 Cash collateral for loaned securities
3,228 986 4,214 3,063 866 3,929
Securities sold but not yet
purchased 0 0 0 9 0 9
Total(1) $ 10,062 $ 3,833 $ 13,895 $ 10,054 $ 3,834 $ 13,888
Portion of above securities
that may be returned to the
Company overnight requiring
immediate return of the cash
collateral(2) $ 10,062 $ 3,833 $ 13,895 $ 9,875 $ 3,834 $ 13,709
Weighted average maturity, in
days(2)(3) N/A N/A 10 N/A
__________(1) The daily weighted average outstanding balance for the year ended
December 31, 2019 and 2018 was $10,524 million and $9,653 million,
respectively, for PFI excluding the Closed Block division, and $4,152 million
and $4,343 million, respectively, for the Closed Block division.
(2) Prior period amounts have been updated to conform to current period
presentation.
(3) Excludes securities that may be returned to the Company overnight. "N/A"
reflects that all outstanding balances may be returned to the Company
overnight.
As of December 31, 2019, our domestic insurance entities had assets eligible for
the asset-based or secured financing programs of $123.0 billion, of which $13.9
billion were on loan. Taking into account market conditions and outstanding loan
balances as of December 31, 2019, we believe approximately $17.4 billion of the
remaining eligible assets are readily lendable, including approximately $12.4
billion relating to PFI excluding the Closed Block division, of which $4.0
billion relates to certain separate accounts and may only be used for financing
activities related to those accounts, and the remaining $4.9 billion relating to
the Closed Block division.
Financing Activities
As of December 31, 2019, total short-term and long-term debt of the Company on a
consolidated basis was $20.6 billion, an increase of $0.8 billion from
December 31, 2018. The following table sets forth total consolidated borrowings
of the Company as of the dates indicated. We may, from time to time, seek to
redeem or repurchase our outstanding debt securities through open market
purchases, individually negotiated transactions or otherwise. Any such actions
will depend on prevailing market conditions, our liquidity position and other
factors.
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December 31, 2019 December 31, 2018
Prudential Prudential
Financial Subsidiaries Consolidated Financial Subsidiaries Consolidated
(in millions)
General obligation short-term debt:
Commercial paper $ 25 $ 524 $ 549 $ 15 $ 727 $ 742 Current portion of long-term debt
1,179 0 1,179 1,100 499 1,599
Subtotal 1,204 524 1,728 1,115 1,226 2,341
General obligation long-term debt:
Senior debt 9,912 172 10,084 8,630 173 8,803
Junior subordinated debt 7,518 57 7,575 7,511 57 7,568
Surplus notes(1) 0 342 342 0 341 341
Subtotal 17,430 571 18,001 16,141 571 16,712
Total general obligations 18,634 1,095 19,729 17,256 1,797 19,053
Limited and non-recourse borrowings(2)
Short-term debt 0 13 13 0 53 53
Current portion of long-term debt 0 192 192 0 57 57
Long-term debt 0 645 645 0 666 666
Subtotal 0 850 850 0 776 776
Total borrowings $ 18,634 $ 1,945 $ 20,579 $ 17,256 $ 2,573 $ 19,829
__________(1) Amounts are net of assets under set-off arrangements of $9,749 million and
$9,095 million as of December 31, 2019 and 2018, respectively.
(2) Limited and non-recourse borrowing primarily represents mortgage debt of our
subsidiaries that has recourse only to real estate investment property of
$537 million and $776 million as of December 31, 2019 and 2018, respectively,
and a draw on a credit facility with recourse only to collateral pledged by
the Company of $300 million and $0 as of December 31, 2019 and 2018,
respectively.
As of December 31, 2019 and 2018, we were in compliance with all debt covenants
related to the borrowings in the table above. For further information on our
short- and long-term debt obligations, see Note 17 to the Consolidated Financial
Statements.
Based on the use of proceeds, we classify our borrowings as capital debt and
operating debt. Capital debt, which is debt utilized to meet the capital
requirements of our businesses, was $14.6 billion and $13.4 billion as of
December 31, 2019 and 2018, respectively. Operating debt of $5.2 billion and
$5.7 billion as of December 31, 2019 and 2018, respectively, consists of debt
issued to finance specific investment assets or portfolios of investment assets,
the proceeds from which will service the debt. Specifically, this includes
institutional spread lending investment portfolios, assets supporting reserve
requirements under Regulation XXX and Guideline AXXX as described below, as well
as funding for institutional and insurance company portfolio cash flow timing
differences. Operating debt is also utilized for business funding to meet
specific purposes, which may include funding new business acquisition costs
associated with our individual annuities business, operating needs associated
with hedging our individual annuities products as discussed above and activities
associated with our PGIM business.
Prudential Financial Borrowings
Long-term borrowings are conducted primarily by Prudential Financial. It borrows these funds to meet its capital and other funding needs, as well as the capital and funding needs of its subsidiaries. Prudential Financial maintains a shelf registration statement with the SEC that permits the issuance of public debt, equity and hybrid securities. As a "Well-Known Seasoned Issuer" under SEC rules, Prudential Financial's shelf registration statement provides for automatic effectiveness upon filing and has no stated issuance capacity. Prudential Financial's borrowings increased $1.38 billion from December 31, 2018, primarily driven by the issuance, net of related costs, of $2.47 billion of senior debt and a $10 million increase in commercial paper outstanding, partially offset by debt maturities of $1.1 billion. For more information on long-term debt, see Note 17 to the Consolidated Financial Statements.
Subsidiary Borrowings
Subsidiary borrowings principally consist of commercial paper borrowings by
Prudential Funding, asset-based financing and real estate investment financing.
Borrowings of our subsidiaries decreased $628 million from December 31, 2018 due
to $499
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million in debt maturities, a $239 million decrease in mortgage debt, and a $203 million decrease in commercial paper outstanding, primarily offset by a $300 million draw on a credit facility and a $13 million increase in short-term debt.
Term and Universal Life Reserve Financing
For business written prior to the implementation of principle-based reserving,
Regulation XXX and Guideline AXXX require domestic life insurers to establish
statutory reserves for term and universal life insurance policies with long-term
premium guarantees that are consistent with the statutory reserves required for
other individual life policies with similar guarantees. Many market participants
believe that these levels of reserves are excessive relative to the levels
reasonably required to maintain solvency for moderately adverse experience. The
difference between the statutory reserve and the amount necessary to maintain
solvency for moderately adverse experience is considered to be the non-economic
portion of the statutory reserve.
We use captive reinsurance subsidiaries to finance the portion of the statutory
reserves required to be held by our domestic life insurance companies under
Regulation XXX and Guideline AXXX that we consider to be non-economic. The
financing arrangements involve the reinsurance of term and universal life
business to our captive reinsurers and the issuance of surplus notes by those
captives that are treated as capital for statutory purposes. These surplus notes
are subordinated to policyholder obligations, and the payment of principal and
interest on the surplus notes can only be made with prior insurance regulatory
approval.
We have entered into agreements with external counterparties providing for the
issuance of surplus notes by our captive reinsurers in return for the receipt of
credit-linked notes ("Credit-Linked Note Structures"). As of December 31, 2019,
we had Credit-Linked Note Structures with an aggregate issuance capacity of
$13,700 million, of which $12,009 million was outstanding, as compared to an
aggregate issuance capacity of $13,750 million, of which $11,445 million was
outstanding, as of December 31, 2018. Under the agreements, the captive receives
in exchange for the surplus notes one or more credit-linked notes issued by a
special-purpose affiliate of the Company with an aggregate principal amount
equal to the surplus notes outstanding. The captive holds the credit-linked
notes as assets supporting Regulation XXX or Guideline AXXX non-economic
reserves, as applicable. The captive can redeem the principal amount of the
outstanding credit-linked notes for cash upon the occurrence of, and in an
amount necessary to remedy, a specified liquidity stress event affecting the
captive. Under the agreements, the external counterparties have agreed to fund
any such payments under the credit-linked notes in return for the receipt of
fees. Under certain of the transactions, Prudential Financial has agreed to make
capital contributions to the captive to reimburse it for investment losses in
excess of specified amounts and/or has agreed to reimburse the external
counterparties for any payments made under the credit-linked notes. To date, no
such payments under the credit-linked notes have been required. Under these
transactions, because valid rights of set-off exist, interest and principal
payments on the surplus notes and on the credit-linked notes are settled on a
net basis, and the surplus notes are reflected in the Company's total
consolidated borrowings on a net basis.
The following table summarizes our Credit-Linked Note Structures, which are reported on a net basis, as of December 31, 2019.
Surplus Notes
Original Maturity Outstanding as of Facility
Credit-Linked Note Structures: Issue Dates Dates December 31, 2019 Size
($ in millions)
XXX 2011-2014 2021-2024 $ 1,750 (1) $ 1,750
AXXX 2013 2033 3,248 3,500
XXX 2014-2018 2021-2034 2,360 (2) 2,450
XXX 2014-2017 2024-2037 2,265 2,400
AXXX 2017 2037 1,466 2,000
XXX 2018 2038 920 1,600
Total Credit-Linked Note Structures $ 12,009 $ 13,700
__________
(1) Prudential Financial has agreed to reimburse any amounts paid under the
credit-linked notes issued in this structure up to $0.5 billion. During the
fourth quarter of 2019, this financing facility was restructured to allow for
an extension through 2036.
(2) The $2.36 billion of surplus notes represents an intercompany transaction
that eliminates upon consolidation. Prudential Financial has agreed to
reimburse amounts paid under credit-linked notes issued in this structure up
to $1.0 billion.
As of December 31, 2019, we also had outstanding an aggregate of $2.6 billion of
debt issued for the purpose of financing Regulation XXX and Guideline AXXX
non-economic reserves, of which approximately $0.7 billion relates to Regulation
XXX reserves and approximately $1.9 billion relates to Guideline AXXX reserves.
In addition, as of December 31, 2019, for purposes of financing Guideline AXXX
reserves, one of our captives had approximately $4.0 billion of surplus notes
outstanding that were issued to affiliates.
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The Company has introduced updated versions of its products in phases over the
course of the principle-based reserving implementation period and has
transitioned all products by January 1, 2020. These updated products support the
principle-based statutory reserve level without the need for captive reserve
financing. The Company is continuing to assess the impact of this new reserving
approach on projected statutory reserve levels and product pricing for its
entire portfolio of individual life product offerings. Certain elements of the
implementation of principle-based reserving are yet to be finalized by the NAIC
and may have a material impact on statutory reserves.
Ratings
Financial strength ratings (which are sometimes referred to as "claims-paying"
ratings) and credit ratings are important factors affecting public confidence in
an insurer and its competitive position in marketing products. Our credit
ratings are also important for our ability to raise capital through the issuance
of debt and for the cost of such financing. Nationally Recognized Statistical
Ratings Organizations continually review the financial performance and financial
condition of the entities they rate, including Prudential Financial and its
rated subsidiaries.
A downgrade in the credit or financial strength ratings of Prudential Financial
or its rated subsidiaries could potentially, among other things, limit our
ability to market products, reduce our competitiveness, increase the number or
value of policy surrenders and withdrawals, increase our borrowing costs and
potentially make it more difficult to borrow funds, adversely affect the
availability of financial guarantees, such as letters of credit, cause
additional collateral requirements or other required payments under certain
agreements, allow counterparties to terminate derivative agreements and/or hurt
our relationships with creditors, distributors, or trading counterparties
thereby potentially negatively affecting our profitability, liquidity, and/or
capital. In addition, we consider our own risk of non-performance in determining
the fair value of our liabilities. Therefore, changes in our credit or financial
strength ratings may affect the fair value of our liabilities.
Financial strength ratings represent the opinions of rating agencies regarding
the financial ability of an insurance company to meet its obligations under an
insurance policy. Credit ratings represent the opinions of rating agencies
regarding an entity's ability to repay its indebtedness. The following table
summarizes the ratings for Prudential Financial and certain of its subsidiaries
as of the date of this filing.
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A.M.
Best(1) S&P(2) Moody's(3) Fitch(4)
Last review date 12/5/2019 12/20/2019 5/9/2019 9/13/2019
Current outlook Stable Stable* Positive Stable
Financial Strength Ratings:
The Prudential Insurance Company of America A+ AA- Aa3 AA-
Pruco Life Insurance Company A+ AA- Aa3 AA-
Pruco Life Insurance Company of New Jersey A+ AA- NR** AA-
Prudential Annuities Life Assurance
Corporation A+ AA- NR AA-
Prudential Retirement Insurance and Annuity
Company A+ AA- Aa3 AA-
The Prudential Life Insurance Company Ltd.
(Prudential of Japan) NR A+ NR NR
Gibraltar Life Insurance Company, Ltd. NR A+ NR NR
The Prudential Gibraltar Financial Life
Insurance Co. Ltd NR A+ NR NR
Credit Ratings:
Prudential Financial, Inc.:
Short-term borrowings AMB-1 A-1 P-2 F1
Long-term senior debt a- A A3 A-
Junior subordinated long-term debt bbb BBB+ Baa1 BBB
The Prudential Insurance Company of America:
Capital and surplus notes a A A2 A
Prudential Funding, LLC:
Short-term debt AMB-1 A-1+ P-1 F1+
Long-term senior debt a+ AA- A1 A+
PRICOA Global Funding I:
Long-term senior debt aa- AA- Aa3 AA-
__________
* The Current 'Stable' Outlook on Prudential's ratings corresponds to all S&P
rated Prudential entities except for Prudential's Japanese Subsidiaries (The
Prudential Life Insurance Company Ltd., Gibraltar Life Insurance Company, Ltd.,
and The Prudential Gibraltar Financial Life Insurance Co. Ltd.), which have
'Positive' Outlooks.
** "NR" indicates not rated.
(1) A.M. Best Company, which we refer to as A.M. Best, financial strength ratings
for insurance companies range from "A++ (superior)" to "D (Poor)". A rating
of A+ is the second highest of thirteen rating categories. A.M. Best
long-term credit ratings range from "aaa (exceptional)" to "c (Poor)". A.M.
Best short-term credit ratings range from "AMB-1+", which represents the
strongest ability to repay short-term debt obligations, to "AMB-4
(Questionable)".
(2) Standard & Poor's Rating Services, which we refer to as S&P, financial
strength ratings for insurance companies range from "AAA (extremely strong)"
to "D (default)". A rating of AA- is the fourth highest of twenty-three
rating categories. S&P's long-term issue credit ratings range from "AAA
(extremely strong)" to "D (default)". S&P short-term ratings range from "A-1
(highest category)" to "D (default)".
(3) Moody's Investors Service, Inc., which we refer to as Moody's, insurance
financial strength ratings range from "Aaa (exceptional)" to "C (lowest)". A
rating of Aa3 is the fourth highest of twenty-one rating categories. Numeric
modifiers are used to refer to the ranking within the group-with 1 being the
highest and 3 being the lowest. These modifiers are used to indicate relative
strength within a category. Moody's long-term credit ratings range from "Aaa
(highest)" to "C (default)". Moody's short-term ratings range from "Prime-1
(P-1)", which represents a superior ability for repayment of short-term debt
obligations, to "Prime-3 (P-3)", which represents an acceptable ability for
repayment of such obligations. Issuers rated "Not Prime" do not fall within
any of the Prime rating categories.
(4) Fitch Ratings Inc., which we refer to as Fitch, financial strength ratings
range from "AAA (exceptionally strong)" to "C (distressed)". A rating of AA-
is the fourth highest of twenty-one rating categories. Fitch long-term credit
ratings range from "AAA (highest credit quality)", which denotes
exceptionally strong capacity for timely payment of financial commitments, to
"D (default)". Short-term ratings range from "F1+ (highest credit quality)"
to "D (default)".
The ratings set forth above reflect current opinions of each rating agency. Each
rating should be evaluated independently of any other rating. These ratings are
not directed toward shareholders and do not in any way reflect evaluations of
the safety and security of the Common Stock. These ratings are reviewed
periodically and may be changed at any time by the rating agencies. As a result,
we cannot assure stakeholders that we will maintain our current ratings in the
future.
Rating agencies use an "outlook" statement for both industry sectors and
individual companies. For an industry sector, a stable outlook generally implies
that over the next 12 to 18 months the rating agency expects ratings to remain
unchanged among companies in the sector. In 2019, Fitch revised the Rating
Outlook on the U.S. life insurance industry from Stable to Negative. A.M. Best,
Moody's, and S&P maintained their outlook for the U.S. life insurance sector at
Stable. For a particular company, an outlook generally indicates a medium- or
long-term trend (generally six months to two years) in credit fundamentals,
which if continued, may lead to a rating change. These indicators are not
necessarily a precursor of a rating change nor do they preclude a rating agency
from changing a rating at any time without notice. A.M. Best, Fitch, S&P and
Moody's have the Company's ratings on Stable outlook.
The following is a summary of the significant changes or actions in ratings and
rating outlooks for our Company that have occurred from January 1, 2019 through
the date of this filing:
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On May 9, 2019, Moody's Investors Service upgraded the financial strength rating
of PICA, Pruco Life and PRIAC to 'Aa3' from 'A1'with a Stable outlook. Moody's
also upgraded Prudential Financial's long-term senior debt rating to 'A3' from
'Baa1' with a Stable outlook.
Requirements to post collateral or make other payments because of ratings
downgrades under certain agreements, including derivative agreements, can be
satisfied in cash or by posting permissible securities held by the subsidiaries
subject to the agreements. In addition, a ratings downgrade by A.M. Best to "A-"
for our domestic life insurance companies would require PICA to either post
collateral or a letter of credit in the amount of approximately $1.3 billion,
based on the level of statutory reserves related to the variable annuity
business acquired from Allstate. We believe that the posting of such collateral
would not be a material liquidity event for PICA.
Contractual Obligations
The table below summarizes the future estimated cash payments related to certain
contractual obligations as of December 31, 2019. The estimated payments
reflected in this table are based on management's estimates and assumptions
about these obligations. Because these estimates and assumptions are necessarily
subjective, the actual cash outflows in future periods will vary, possibly
materially, from those reflected in the table. In addition, we do not believe
that our cash flow requirements can be adequately assessed based solely upon an
analysis of these obligations, as the table below does not contemplate all
aspects of our cash inflows, such as the level of cash flow generated by certain
of our investments, nor all aspects of our cash outflows.
Estimated Payments Due by Period
2025 and
Total 2020 2021-2022 2023-2024 thereafter
(in millions)
Short-term and long-term debt
obligations(1) $ 42,045 $ 2,930 $ 2,680 $ 2,903 $ 33,532
Operating lease obligations(2) 649 152 247 139 111
Purchase obligations:
Commitments to purchase or fund
investments(3) 7,421 4,206 1,882 590 743
Commercial mortgage loan
commitments(4) 2,129 1,822 282 25 0
Other liabilities:
Insurance liabilities(5) 1,174,006 46,614 67,856 67,902 991,634
Other(6) 14,025 13,945 53 27 0
Total $ 1,240,275 $ 69,669 $ 73,000 $ 71,586 $ 1,026,020
__________(1) The estimated payments due by period for long-term debt reflects the
contractual maturities of principal, as disclosed in Note 17 to the
Consolidated Financial Statements, as well as estimated future interest
payments. The payment of principal and estimated future interest for
short-term debt are reflected in estimated payments due in 2020. The estimate
for future interest payments includes the effect of derivatives that qualify
for hedge accounting treatment. See Note 17 to the Consolidated Financial
Statements for additional information concerning our short-term and long-term
debt.
(2) The estimated payments due by period for operating leases reflect the future
minimum lease payments under non-cancelable operating leases, as disclosed in
Note 11 to the Consolidated Financial Statements.
(3) As discussed in Note 23 to the Consolidated Financial Statements, we have
commitments to purchase or fund investments, some of which are contingent
upon events or circumstances not under our control, including those at the
discretion of our counterparties. The timing of the fulfillment of certain of
these commitments cannot be estimated, therefore the settlements of these
obligations are reflected in estimated payments due in less than one year.
Commitments to purchase or fund investments include $49 million that we
anticipate will ultimately be funded from our separate accounts.
(4) As discussed in Note 23 to the Consolidated Financial Statements, loan
commitments of our commercial mortgage operations, which are legally binding
commitments to extend credit to a counterparty, have been reflected in the
contractual obligations table above principally based on the expiration date
of the commitment; however, it is possible these loan commitments could be
funded prior to their expiration date. In certain circumstances the
counterparty may also extend the date of the expiration in exchange for a
fee.
(5) The estimated cash flows due by period for insurance liabilities reflect
future estimated cash payments to be made to policyholders and others for
future policy benefits, policyholders' account balances, policyholder's
dividends, reinsurance payables and separate account liabilities, net of
premium receipts and reinsurance recoverables. Contractual obligations are
contingent upon the receipt of premiums. These future estimated cash flows
for current policies in force generally reflect our best estimate economic
and actuarial assumptions. These cash flows are undiscounted with respect to
interest. Therefore, the sum of the cash flows shown for all years in the
table of $1,174 billion exceeds the corresponding liability amounts of
approximately $769 billion included in the Consolidated Financial Statements
as of December 31, 2019. Separate account liabilities are legally insulated
from general account obligations, and it is generally expected these
liabilities will be fully funded by separate account assets and their related
cash flows. We have made significant assumptions to determine the future
estimated cash flows related to the underlying policies and contracts. Due to
the significance of the assumptions used and the contingent nature of
contractual terms, actual cash flows and their timing will differ, possibly
materially, from these estimates. Timing of cash flows in the "2025 and
thereafter" category include long term liabilities that may extend beyond 100
years.
(6) The estimated payments due by period for other liabilities includes
securities sold under agreements to repurchase, cash collateral for loaned
securities, liabilities for unrecognized tax benefits, bank customer
liabilities, and other miscellaneous liabilities. Amounts presented in the
table also exclude $1,274 million of notes issued by consolidated VIE's which
recourse for these obligations is limited to the assets of the respective VIE
and do not have recourse to the general credit of the company.
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We also enter into agreements to purchase goods and services in the normal course of business; however, these purchase obligations are not material to our consolidated results of operations or financial position as of December 31, 2019.
Off-Balance Sheet ArrangementsGuarantees and Other Contingencies
In the course of our business, we provide certain guarantees and indemnities to third parties pursuant to which we may be contingently required to make payments in the future. See Note 23 to the Consolidated Financial Statements for additional information.
Other Contingent Commitments
We also have other commitments, some of which are contingent upon events or circumstances not under our control, including those at the discretion of our counterparties. See Note 23 to the Consolidated Financial Statements for additional information regarding these commitments. For further discussion of certain of these commitments that relate to our separate accounts, also see "-Liquidity associated with other activities-PGIM operations."
Other Off-Balance Sheet Arrangements
In 2013, we entered into a put option agreement with a Delaware trust that gives
Prudential Financial the right, at any time over a ten-year period, to issue up
to $1.5 billion of senior notes to the trust in return for principal and
interest strips of U.S. Treasury securities that are held by the trust. See Note
17 to the Consolidated Financial Statements for more information on this put
option agreement. In 2014, Prudential Financial entered into financing
transactions, pursuant to which it issued $500 million of limited recourse notes
and, in return, obtained $500 million of asset-backed notes from a Delaware
master trust and ultimately contributed the asset-backed notes to its
subsidiary, PRIAC. As of December 31, 2019, no principal payments have been
received or are currently due on the asset-backed notes and, as a result, there
was no payment obligation under the limited recourse notes. Accordingly, none of
the notes are reflected in the Consolidated Financial Statements as of that
date.
Other than as described above, we do not have retained or contingent interests
in assets transferred to unconsolidated entities, or variable interests in
unconsolidated entities or other similar transactions, arrangements or
relationships that serve as credit, liquidity or market risk support, that we
believe are reasonably likely to have a material effect on our financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or our access to or requirements for
capital resources. In addition, other than the agreements referred to above, we
do not have relationships with any unconsolidated entities that are
contractually limited to narrow activities that facilitate our transfer of or
access to associated assets.
Risk Management
Overview
We employ a risk governance structure, overseen by senior management and our
Board and managed by Enterprise Risk Management ("ERM"), to provide a common
framework for evaluating the risks embedded in and across our businesses and
corporate centers, developing risk appetites, managing these risks and
identifying current and future risk challenges and opportunities. For a
discussion of the risks of our businesses, see "Risk Factors".
Risk Governance Framework
Each of our businesses has a risk governance structure that is supported by a framework at the corporate level. Generally, our businesses are authorized to make day-to-day risk decisions that are consistent with enterprise risk policies and limits, and subject to enterprise oversight.
Board of Directors Oversight
Our Board oversees our risk profile and management's processes for assessing and managing risk. The Board also reviews strategic risks and opportunities facing the Company. Certain specific categories of risk are assigned to Board committees that report back to the full Board, as summarized below:
• Audit Committee: oversees insurance risk and operational risks, including
model risk, as well as risks related to financial controls, legal,
regulatory and compliance risks, and the overall risk management
governance structure and risk management function.
• Compensation Committee: oversees our compensation programs so that
incentives are aligned with appropriate risk taking.
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• Corporate Governance and Business Ethics Committee: oversees our corporate
governance procedures and practices, ethics and conflict of interest
policies, political contributions, lobbying expenses and overall political
strategy, as well as our strategy and reputation regarding environmental
stewardship, sustainability and corporate social responsibility.
• Finance Committee: oversees liquidity risk, including risks involving our
capital and liquidity management, the incurrence and repayment of
borrowings, the capital structure, the funding of benefit plans and
statutory insurance reserves. The Finance Committee oversees our capital
plan and receives regular updates on the sources and uses of capital
relative to plan, as well as on our RAF.
• Investment Committee: oversees investment risk and market risk and thestrength of the investment function. The Investment Committee approves
investment and market risk limits based on asset class, issuer, credit
quality and geography.
• Risk Committee: oversees the governance of significant risks throughout
the Company and the establishment and ongoing monitoring of our risk
profile, risk capacity and risk appetite. The Risk Committee also serves
to coordinate the risk oversight functions of the other committees of the
Board.
Management Oversight
Our primary risk management committee is the Enterprise Risk Committee ("ERC").
Currently, the ERC is chaired by our Chief Risk Officer and otherwise comprised
of the Vice Chairman, Head of U.S. Businesses, Head of International Businesses,
General Counsel, Chief Financial Officer, Chief Investment Officer and Chief
Actuary. Our Chief Auditor also attends meetings of the ERC. The ERC is charged
with facilitating the Company's ability to identify, assess, monitor and manage
risk. The primary focus of the Committee is the critical analysis of significant
risks and the appropriateness and alignment to the defined risk appetite of the
Company.
The ERC is supported by six Risk Oversight Committees aligned with our tactical
risks, each of which is comprised of subject matter experts and dedicated to one
of the following risk types: investment, market, insurance, operational, model
and liquidity. Significant matters or matters where there are unresolved points
of view are reviewed by the ERC. The Risk Oversight Committees provide an
opportunity to evaluate complex issues by subject matter experts within the
various risk areas. They evaluate the adequacy and effectiveness of risk
mitigation options, identify stakeholders of risks and issues, review material
assumptions for reasonability and consistency across the Company and, working
with the different risk areas, develop recommendations for risk limits, among
other responsibilities.
Each of our businesses and certain corporate centers maintains its own risk
committee. The risk committees serve as a forum for leaders within each business
or corporate center to identify, assess and monitor risk and exposure issues and
to review new business activities and initiatives, prior to being reviewed by
the Risk Oversight Committees and/or the ERC as appropriate.
Enterprise Risk Management Oversight
ERM manages the risk management framework. It operates independently and is responsible for recommending policies, limits and standards for all risks. ERM oversees these risks under the guidance of the ERC and Risk Oversight Committees. Additionally, ERM works with our businesses and corporate areas to identify, monitor and manage risks that we may face. The ERM infrastructure is generally aligned by risk type, with certain groups within ERM working across risk types.
To enable the broader organizational strategy and streamline risk governance, ERM established Chief Risk Officer roles for the U.S. Workplace Solutions division and U.S. Individual Solutions division. This change brings ERM's subject matter expertise into the business unit dialogue on a real-time basis.
Risk Identification
We rely on a combination of activities and processes to provide analysis and seek assurance that all material risks have been identified and managed as appropriate. There are three levels of activities that seek to ensure that changes in risk levels or new risks to the Company are identified and escalated as appropriate: (1) business activities, (2) corporate center activities, and (3) processes involving senior management and the Board. • Businesses: Each business area has a risk committee that meets
periodically to allow senior leaders to discuss and evaluate current, new,
and emerging risks in their own operations. Businesses are required to
develop and maintain documented risk inventories which facilitate the
identification of current risk exposures.
• Corporate Centers: The corporate centers review the results of the
business activities and examine risks from an enterprise view across
businesses under normal and stressed conditions. As a result, thecorporate centers, particularly ERM, use several processes and activities
to identify and assess the risks of the Company.
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• Senior Management and the Board: Senior management plays a critical role
in reviewing the risk profile of the Company, including by identifying
impacts to the business strategy of new or changed risks, and risks in any
new strategies under consideration. These risks are discussed with the ERC
as appropriate, and with the Board, if significant. As discussed above,
the Board oversees the Company's risk profile and management's processes
for assessing and managing risk, both as a full Board and through its
committees.
Risk Measurement and Monitoring
Our Risk Appetite Framework ("RAF") is a comprehensive process designed to
reasonably ensure that all risks taken across the Company align with the
Company's capacity and willingness to take those risks. Using common metrics
allows for a cohesive assessment of risk, resources and strategy, and supports
management and the Board in making well-informed business decisions. The Company
has a comprehensive stress testing framework, which serves as the foundation for
the RAF. The RAF evaluates the Company's exposure under various stress metrics
and stress severities. The RAF provides a dynamic assessment of stress impacts
and resources available to absorb these impacts under comprehensive stress
scenarios. The Company's capital management framework is integrated with the RAF
to determine the amount of capital the Company needs to hold given the risks
taken.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Market risk is defined as the risk of loss from changes in interest rates, equity prices and foreign currency exchange rates resulting from asset/liability mismatches where the change in the value of our liabilities is not offset by the change in value of our assets. For additional information regarding the potential impacts of interest rate and other market fluctuations, as well as general economic and market conditions on our businesses and profitability, see Item 1A. "Risk Factors" above. For additional information regarding the overall management of our general account investments and our asset mix strategies, see "Management's Discussion and Analysis of Financial Condition and Results of Operations-General Account Investments-Management of Investments" above. For additional information regarding our liquidity and capital resources, which may be impacted by changing market risks, see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources" above.
Market Risk Management
Management of market risk, which we consider to be a combination of both investment risk and market risk exposures, includes the identification and measurement of various forms of risk, the establishment of risk thresholds and the creation of processes intended to maintain risks within these thresholds while optimizing returns on the underlying assets or liabilities.
Our risk management process utilizes a variety of tools and techniques, including:
• Measures of price sensitivity to market changes (e.g., interest rates,
equity index prices, foreign exchange);
• Asset/liability management;
• Stress scenario testing; • Hedging programs; and
• Risk management governance, including policies, limits, and a committee
that oversees investment and market risk. For additional information
regarding our overall risk management framework and governance structure,
see "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Risk Management" above.
Market Risk Mitigation
Risk mitigation takes three primary forms:
• Asset/Liability Management: Managing assets to liability-based measures.
For example, investment policies identify target durations for assets
based on liability characteristics and asset portfolios are managed to
within ranges around them. This mitigates potential unanticipated economic
losses from interest rate movements.
• Hedging: Using derivatives to offset risk exposures. For example, for our
variable annuities, potential living benefit claims resulting from more
severe market conditions are hedged using derivative instruments.
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• Management of portfolio concentration risk. For example, ongoing
monitoring and management at the enterprise level of key rate, currency
and other concentration risks support diversification efforts to mitigate
exposure to individual markets and sources of risk.
Market Risk Related to Interest Rates
We perform liability-driven investing and engage in careful asset/liability management. Asset/liability mismatches create the risk that changes in liability values will differ from the changes in the value of the related assets. Additionally, changes in interest rates may impact other items including, but not limited to, the following:
• Net investment spread between the amounts that we are required to pay and
the rate of return we are able to earn on investments for certain products
supported by general account investments;
• Asset-based fees earned on assets under management or contractholder
account values;
• Estimated total gross profits and the amortization of deferred policy
acquisition and other costs;
• Net exposure to the guarantees provided under certain products; and
• Capital levels of our regulated entities.
We use duration and convexity analyses to measure price sensitivity to interest
rate changes. Duration measures the relative sensitivity of the fair value of a
financial instrument to changes in interest rates. Convexity measures the rate
of change of duration with respect to changes in interest rates. We use
asset/liability management and derivative strategies to manage our interest rate
exposure by legal entity by matching the relative sensitivity of asset and
liability values to interest rate changes, or controlling "duration mismatch" of
assets and liability duration targets. In certain markets, capital market
limitations that hinder our ability to acquire assets that approximate the
duration of some of our liabilities are considered in setting duration targets.
We consider risk-based capital and tax implications as well as current market
conditions in our asset/liability management strategies.
We assess the impact of interest rate movements on the value of our financial
assets, financial liabilities and derivatives using hypothetical test scenarios
that assume either upward or downward 100 basis point parallel shifts in the
yield curve from prevailing interest rates, reflecting changes in either credit
spreads or the risk-free rate. The following table sets forth the net estimated
potential loss in fair value on these financial instruments from a hypothetical
100 basis point upward shift as of December 31, 2019 and 2018. This table is
presented on a gross basis and excludes offsetting impacts to insurance
liabilities that are not considered financial liabilities under U.S GAAP. This
scenario results in the greatest net exposure to interest rate risk of the
hypothetical scenarios tested at those dates. While the test scenario is for
illustrative purposes only and does not reflect our expectations regarding
future interest rates or the performance of fixed income markets, it is a
near-term, reasonably possible hypothetical change that illustrates the
potential impact of such events. These test scenarios do not measure the changes
in value that could result from non-parallel shifts in the yield curve which we
would expect to produce different changes in discount rates for different
maturities. As a result, the actual loss in fair value from a 100 basis point
change in interest rates could be different from that indicated by these
calculations. The estimated changes in fair values do not include separate
account assets.
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As of December 31, 2019 As of December 31, 2018
Hypothetical Hypothetical
Fair Change in Fair Change in
Notional Value Fair Value Notional Value Fair Value
(inmillions)
Financial assets with interest rate risk: Fixed maturities(1) $ 416,812 $ (43,532 ) $ 378,850 $ (37,691 ) Commercial mortgage and other loans 65,893 (3,112 ) 59,978 (2,936 ) Derivatives with interest rate risk: Swaps $ 200,055 6,894 (4,747 ) $ 201,872 5,164 (4,455 ) Futures 18,897 (37 ) (1,004 ) 15,139 13 (778 ) Options 50,403 15 (91 ) 83,198 (337 ) 387 Forwards 30,488 (23 ) (105 ) 26,220 230 (256 ) Synthetic GICs 80,009 1 0 79,215 2 0 Embedded derivatives(2)(3) (14,147 ) 6,525 (8,926 ) 5,030 Financial liabilities with interest rate risk(4): Short-term and long-term debt (23,277 ) 4,156 (20,484 ) 3,095 Policyholders' account balances-investment contracts (102,156 ) 3,562 (98,428 ) 3,367 Net estimated potential loss $ (38,348 ) $ (34,237 )
__________
(1) Includes assets classified as "Fixed maturities, available-for-sale, at fair
value," "Assets supporting experience-rated contractholder liabilities, at
fair value" and "Fixed maturities, trading, at fair value." Approximately
$391 billion and $354 billion as of December 31, 2019 and 2018, respectively,
of fixed maturities are classified as available-for-sale.
(2) Embedded derivatives relate primarily to certain features associated with
variable annuity, indexed universal life, and fixed indexed annuity
contracts. The fair value and hypothetical change in fair value of each is
$(12,602) million and $6,315 million, $(1,119) million and $216 million, and
$(197) million and $(6) million, respectively, as of December 31, 2019.
Amounts as of December 31, 2018 relate primarily to certain features
associated with variable annuity contracts.
(3) Excludes any offsetting impact of derivative instruments purchased to hedge
changes in the embedded derivatives. Amounts reported net of third-party
reinsurance.
(4) Excludes approximately $344 billion and $324 billion as of December 31, 2019
and 2018, respectively, of insurance reserve and deposit liabilities which
are not considered financial liabilities. We believe that the interest rate
sensitivities of these insurance liabilities would serve as an offset to the
net interest rate risk of the financial assets and liabilities, including
investment contracts.
Under U.S. GAAP, the fair value of the embedded derivatives for certain features associated with variable annuity, indexed universal life, and fixed indexed annuity contracts, reflected in the table above, includes the impact of the market's perception of our NPR. For more information on NPR related to the sensitivity of the embedded derivatives to our NPR credit spread, see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Accounting Policies & Pronouncements-Application of Critical Accounting Estimates-Sensitivities for Insurance Assets and Liabilities" above.
For an additional discussion of our variable annuity optional living benefit guarantees accounted for as embedded derivatives and related derivatives used to hedge the changes in fair value of these embedded derivatives, see "Market Risk Related to Certain Variable Annuity Products" below. For additional information about the key estimates and assumptions used in our determination of fair value, see Note 6 to the Consolidated Financial Statements. For information on the impacts of a sustained low interest rate environment, see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Executive Summary-Impact of a Low Interest Rate Environment" above.
Market Risk Related to Equity Prices
We have exposure to equity risk through asset/liability mismatches, including our investments in equity securities held in our general account investment portfolio and unhedged exposure in our insurance liabilities, principally related to certain variable annuity living benefit feature embedded derivatives. Our equity-based derivatives primarily hedge the equity risk embedded in these living benefit feature embedded derivatives, and are also part of our capital hedging program. Changes in equity prices create risk that the resulting changes in asset values will differ from the changes in the value of the liabilities relating to the underlying or hedged products. Additionally, changes in equity prices may impact other items including, but not limited to, the following:
• Asset-based fees earned on assets under management or contractholder
account value;
• Estimated total gross profits and the amortization of deferred policy
acquisition and other costs; and
• Net exposure to the guarantees provided under certain products.
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We manage equity risk against benchmarks in respective markets. We benchmark our
return on equity holdings against a blend of market indices, mainly the S&P 500
and Russell 2000 for U.S. equities. We benchmark foreign equities against the
Tokyo Price Index, and the MSCI EAFE, a market index of European, Australian,
and Far Eastern equities. We target price sensitivities that approximate those
of the benchmark indices.
We estimate our equity risk from a hypothetical 10% decline in equity benchmark
market levels. The following table sets forth the net estimated potential loss
in fair value from such a decline as of December 31, 2019 and 2018. While these
scenarios are for illustrative purposes only and do not reflect our expectations
regarding future performance of equity markets or of our equity portfolio, they
represent near-term reasonably possible hypothetical changes that illustrate the
potential impact of such events. These scenarios consider only the direct impact
on fair value of declines in equity benchmark market levels and not changes in
asset-based fees recognized as revenue, changes in our estimates of total gross
profits used as a basis for amortizing deferred policy acquisition and other
costs, or changes in any other assumptions such as market volatility or
mortality, utilization or persistency rates in our variable annuity contracts
that could also impact the fair value of our living benefit features. In
addition, these scenarios do not reflect the impact of basis risk, such as
potential differences in the performance of the investment funds underlying the
variable annuity products relative to the market indices we use as a basis for
developing our hedging strategy. The impact of basis risk could result in larger
differences between the change in fair value of the equity-based derivatives and
the related living benefit features in comparison to these scenarios. In
calculating these amounts, we exclude separate account equity securities.
As of December 31, 2019 As of December 31, 2018
Hypothetical Hypothetical
Fair Change in Fair Change in
Notional Value Fair Value Notional Value Fair Value
(in millions)
Equity securities(1) $ 9,175 $ (918 ) $ 7,560 $ (756 )
Equity-based derivatives(2) $ 52,677 (719 ) 1,755 $ 77,143 867 1,528
Embedded derivatives(2)(3)(4) (14,147 ) (1,726 ) (8,926 ) (1,497 )
Net estimated potential loss $ (889 ) $ (725 )
__________
(1) Includes equity securities classified as "Assets supporting experience-rated
contractholder liabilities" and "Equity securities, at fair value."
(2) The notional and fair value of equity-based derivatives and the fair value of
embedded derivatives are also reflected in amounts under "Market Risk Related
to Interest Rates" above, and are not cumulative.
(3) Embedded derivatives relate primarily to certain features associated with
variable annuity, indexed universal life, and fixed indexed annuity
contracts. The fair value and hypothetical change in fair value of each is
$(12,602) million and $(1,833) million, $(1,119) million and $81 million, and
$(197) million and $26 million, respectively, as of December 31, 2019.
Amounts as of December 31, 2018 relate primarily to certain features
associated with variable annuity contracts.
(4) Excludes any offsetting impact of derivative instruments purchased to hedge
changes in the embedded derivatives. Amounts reported net of third-party
reinsurance.
Market Risk Related to Foreign Currency Exchange Rates
As a U.S.-based company with significant business operations outside of the
U.S., particularly in Japan, we are exposed to foreign currency exchange rate
risk related to these operations, as well as in our general account investment
portfolio and other proprietary investment portfolios.
For our international insurance operations, changes in foreign currency exchange
rates create risk that we may experience volatility in the U.S.
dollar-equivalent earnings and equity of these operations. We actively manage
this risk through various hedging strategies, including the use of foreign
currency hedges and through holding U.S. dollar-denominated securities in the
investment portfolios of certain of these operations. Additionally, our Japanese
insurance operations offer a variety of non-yen denominated products which are
supported by investments in corresponding currencies. While these non-yen
denominated assets are economically matched to the currency of the product
liabilities, the accounting treatment may differ for changes in the value of
these assets and liabilities due to moves in foreign currency exchange rates,
resulting in volatility in reported U.S. GAAP earnings. This volatility has been
mitigated by disaggregating the U.S. and Australian dollar-denominated
businesses in Gibraltar Life into separate divisions, each with its own
functional currency that aligns with the underlying products and investments.
For certain of our international insurance operations outside of Japan, we elect
to not hedge the risk of changes in our equity investments due to foreign
exchange rate movements. For further information, see "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Impact of Foreign
Currency Exchange Rates-Impact of products denominated in non-local currencies
on U.S. GAAP earnings" above.
For our domestic general account investment portfolios supporting our U.S.
insurance operations and other proprietary investment portfolios, our foreign
currency exchange rate risk arises primarily from investments that are
denominated in foreign currencies. We manage this risk by hedging substantially
all domestic foreign currency denominated fixed income investments
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into U.S. dollars. We generally do not hedge all of the foreign currency risk of our investments in equity securities of unaffiliated foreign entities.
We manage our foreign currency exchange rate risks within specified limits, and
estimate our exposure, excluding equity in our Japanese insurance operations, to
a hypothetical 10% change in foreign currency exchange rates. The following
table sets forth the net estimated potential loss in fair value from such a
change as of December 31, 2019 and 2018. While these scenarios are for
illustrative purposes only and do not reflect our expectations regarding future
changes in foreign exchange markets, they represent reasonably possible
near-term hypothetical changes that illustrate the potential impact of such
events.
As of December 31, 2019 As of December 31, 2018
Hypothetical Hypothetical
Fair Change in Fair Change in
Value Fair Value Value Fair Value
(in millions)
Unhedged portion of equity investment in
international subsidiaries and foreign
currency denominated investments in domestic
general account portfolio $ 4,834 $ (483 ) $ 5,414 $ 541
For additional information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations-General Account Investments-Portfolio Composition" and "Management's Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations by Segment-International Businesses" above.
Derivatives
We use derivative financial instruments primarily to reduce market risk from changes in interest rates, equity prices and foreign currency exchange rates, including their use to alter interest rate or foreign currency exposures arising from mismatches between assets and liabilities. Our derivatives primarily include swaps, futures, options and forward contracts that are exchange-traded or contracted in the OTC market. Our derivatives also include interest rate guarantees we provide on our synthetic GIC products. Synthetic GICs simulate the performance of traditional insurance-related GICs but are accounted for as derivatives under U.S. GAAP due to the fact that the policyholders own the underlying assets, and we only provide a book value "wrap" on the customers' funds, which are held in a client-owned trust. Since these wraps provide payment of guaranteed principal and interest to the customer, changes in interest rates create risk such that declines in the market value of customers' funds would increase our net exposure to these guarantees; however, our obligation is limited to payments that are in excess of the existing customers' fund value. Additionally, we have the ability to periodically reset crediting rates, subject to a 0% minimum floor, as well as the ability to increase prices. Further, our contract provisions provide that, although participants may withdraw funds at book value, contractholder withdrawals may only occur at market value immediately, or at book value over time. These factors, among others, result in these contracts experiencing minimal changes in fair value, despite a more significant notional value. Our derivatives also include those that are embedded in certain financial instruments, and primarily relate to certain optional living benefit features associated with our variable annuity products, as discussed in more detail in "Market Risk Related to Certain Variable Annuity Products" below. For additional information on our derivative activities, see Note 5 to the Consolidated Financial Statements.
Market Risk Related to Certain Variable Annuity Products
The primary risk exposures of our variable annuity contracts relate to actual deviations from, or changes to, the assumptions used in the original pricing of these products, including capital markets assumptions, such as equity market returns, interest rates and market volatility and actuarial assumptions. For our capital markets assumptions, we manage our exposure to the risk created by capital markets fluctuations through a combination of product design elements, such as an automatic rebalancing element and inclusion of certain optional living benefits in our living benefits hedging program. In addition, we consider external reinsurance a form of risk mitigation as well as our capital hedge program. Certain variable annuity optional living benefit features are accounted for as embedded derivatives and recorded at fair value. The market risk sensitivities associated with U.S. GAAP values of both the embedded derivatives and the related derivatives used to hedge the changes in fair value of these embedded derivatives are provided under "Market Risk Related to Interest Rates" and "Market Risk Related to Equity Prices" above.
For additional information regarding our risk management strategies, including our living benefit hedging program and other product design elements, see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations by Segment-U.S. Individual Solutions Division-Individual Annuities" above.
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