PRUDENTIAL FINANCIAL, INC.
TABLE OF CONTENTS
Page
Overview 57
COVID-19 57
Outlook 59
Industry Trends 61
Impact of a Low Interest Rate Environment 62
Results of Operations 64
Consolidated Results of Operations 64
Segment Results of Operations 65
Segment Measures 67
Impact of Foreign Currency Exchange Rates 68
Accounting Policies & Pronouncements 71
Application of Critical Accounting Estimates 71
Adoption of New Accounting Pronouncements 82
Results of Operations by Segment 82
PGIM 82
U.S. Businesses 86
Retirement 87
Group Insurance 89
Individual Annuities 91
Individual Life 96
Assurance IQ 98
International Businesses 99
Corporate and Other 103
Divested and Run-off Businesses 104
Closed Block Division 104
Income Taxes 105Experience-Rated Contractholder Liabilities, Assets Supporting Experience-Rated Contractholder Liabilities and Other Related Investments
106
Valuation of Assets and Liabilities 108
General Account Investments 110
Liquidity and Capital Resources 132
Ratings 146
Contractual Obligations 148
Off-Balance Sheet Arrangements 149
Risk Management 149
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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, 2019 in comparison to the year endedDecember 31, 2018 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, 2019 . Overview Our principal operations consist of PGIM (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, which we acquired inOctober 2019 (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 2021 will continue to benefit from our differentiated mix of market-leading businesses that complement each other to provide competitive advantages, earnings diversification and capital benefits from a balanced risk profile. While challenges exist in the form of a low interest rate environment (see "Impact of a Low Interest Rate Environment" below), fee compression in certain of our businesses and other market factors, including macroeconomic stress and market disruption resulting from the COVID-19 pandemic (see "-COVID-19" below), we expect that our businesses will produce appropriate returns for the current market environment. We believe we are well-positioned to tap into market opportunities to meet the evolving needs of individual customers, workplace clients, and society at large. Our mix of high-quality protection, retirement and investment management businesses enables us to offer solutions that cover a broad range of financial needs and to engage with our clients through multiple channels, including the ability to sell solutions across a broad socio-economic spectrum through Assurance IQ's digital platform. We aim to expand our addressable market, build deeper and longer-lasting relationships with customers and clients, and meaningfully improve their financial wellness. In order to further increase our competitive advantage, we are working to enhance the experience of our customers and the capabilities of our businesses, which we expect will also help us realize improved margins. In 2019, we launched programs in pursuit of these objectives that will result in multi-year investments in technology, systems and employee reskilling, as well as severance and related charges. The implementation of these programs resulted in approximately$400 million of costs in 2019, including a charge related to the Company's Voluntary Separation Program offered to certain eligibleU.S. -based employees whose employment end dates occurred in 2020. Over the course of 2020, we incurred$194 million of additional implementation costs related to these programs, resulting in cumulative implementation costs of approximately$594 million as ofDecember 31, 2020 .
Over the next several years, we also expect to see significant expense
efficiencies. The impact to the Company's 2020 results from these programs was a
benefit of
COVID-19
Beginning in the first quarter of 2020, the outbreak of COVID-19 created extreme
stress and disruption in the global economy and financial markets and elevated
mortality and morbidity experience for the global population. These events
impacted our results of operations throughout 2020 and are expected to impact
our results of operations in 2021. The Company
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has taken several measures to manage the impacts of this crisis. The actual and
expected impacts of these events and other items are set forth below:
•Liquidity. As of December 31, 2020 , we had $5.6 billion in highly liquid assets
at Prudential Financial . Since the beginning of 2020, we took several steps to
proactively manage liquidity, including refinancing $1.3 billion of junior
subordinated debt to reduce our financing costs, entering into a $1.5 billion
facility agreement with a Delaware trust to increase our alternative sources of
liquidity and issuing $1.5 billion in senior debt in part to pre-fund 2020 and
2021 maturities. We suspended Common Stock repurchases beginning April 1, 2020
under our existing repurchase authorization, after repurchasing $500 million of
shares of Prudential Financial's Common Stock in the first quarter of 2020. We
did not resume share repurchases in 2020 as the duration and severity of the
pandemic and its effect on the economy remained uncertain. On February 4, 2021 ,
we announced that our Board of Directors has authorized the repurchase of up to
$1.5 billion of our outstanding Common Stock during the period from January 1,
2021 through December 31, 2021 . The impact of COVID-19 and related market
dislocations could further strain our existing liquidity and cause us to
increase the use of our alternative sources of liquidity, which could result in
increased financial leverage on our balance sheet and negatively impact our
credit and financial strength ratings or ratings outlooks. See "-Liquidity and
Capital Resources-Liquidity" for a discussion of our liquidity.
•Capital Resources. As of December 31, 2020 , all of our significant insurance
subsidiaries maintained capital levels consistent with their ratings targets;
however, market conditions could negatively impact the statutory capital of our
insurance companies and constrain our overall capital flexibility, including as
a result of credit migration and losses in our investment portfolio, as
discussed below. Adverse market conditions could require us to take additional
management actions for our insurance subsidiaries to maintain capital consistent
with their ratings objectives, which may include redeploying financial resources
from internal sources, or using available external sources of capital or seeking
additional sources. See "-Liquidity and Capital Resources-Capital " for a
discussion of our capital resources.
•Investment Portfolio. Net unrealized gains (losses) on fixed maturity
investments (excluding securities classified as trading) were a net unrealized
gain of $58,928 million as of December 31, 2020 , compared to a net unrealized
gain of $44,891 million as of December 31, 2019 . Gross unrealized gains
increased from $46,206 million as of December 31, 2019 to $59,980 million as of
December 31, 2020 , and gross unrealized losses decreased from $1,315 million to
$980 million for the same period. The increase in gross unrealized gains and the
decrease in gross unrealized losses was primarily due to a decrease in U.S.
interest rates. The continued impact of COVID-19 on the global economy and
corporate credit may continue to result in negative credit migration and
possible losses in our investment portfolio. Due to the highly uncertain nature
of these conditions, it is not possible to estimate the overall impacts at this
time. The sectors most impacted by the COVID-19 crisis include energy, consumer
cyclical and retail related investments (see "-General Account Investments" for
additional information). During 2020, approximately 1.4% of total invested
assets were modified to allow for limited forbearance. Under the terms of
forbearance, the borrower is allowed to defer a portion of current year
principal and/or interest payments for a short period (e.g., 6 months). These
deferrals accrue additional interest and do not have a material impact on our
investment value.
•Underwriting Results. In 2020, we estimate that COVID-19 had a net negative
impact on our underwriting results, reflecting unfavorable mortality impacts in
our Group Insurance and Individual Life businesses, partially offset by
favorable mortality impacts in our Retirement business. Going forward, we
estimate that our net underwriting results will be adversely impacted by
approximately $85 million for every incremental 100,000 fatalities in the United
States ; however, the ultimate impact on our underwriting results will depend on
factors such as: an insured's age; geographic concentration; insured versus
uninsured populations among the fatalities; the transmissibility and virulence
of the virus, including the potential of further mutation; and the speed and
efficacy of the vaccine rollout. In addition, see "-Results of Operations by
Segment" for a discussion of mortality experience in each of our segments, where
applicable.
•Expenses. We experienced higher expenses of approximately $150 million in 2020
from costs associated with COVID-19, primarily related to agent compensation, as
well as technology and third-party vendor capabilities related to remote work
functionality and protecting our employees' health. However, we also experienced
cost savings associated with COVID-19 of approximately $110 million in 2020,
primarily from lower travel and entertainment costs.
We have provided a number of customer accommodations in response to the COVID-19
pandemic, including extending grace periods for premium payments, expediting
claim payments and withdrawal requests, waiving certain claims payment
requirements, waiving certain transaction fees, waiving interest on policy loans
and wiring funds at the Company's expense.
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•Business Continuity. One of the main impacts of the COVID-19 pandemic has been
executing our business continuity protocols to ensure our employees are safe and
able to serve our customers. This included effectively transitioning the vast
majority of our employees to remote work arrangements.
We believe all of our businesses can sustain remote work and social distancing
for an indefinite period while ensuring that critical business operations are
sustained. In addition, we are managing COVID-19-related impacts on third-party
provided services, and do not anticipate significant interruption in critical
operations.
In addition to the considerations disclosed above, other COVID-19 related impacts are discussed in the following sections of this document:
•Business Outlooks. See "-Outlook" for a discussion of specific outlook considerations for each of our businesses, including impacts related to COVID-19.
•Results of Operations by Segment. See "-Results of Operations by Segment" for a discussion of COVID-19 impacts on segment results, where applicable.
•Sales and Flows. See "-Segment Results of Operations" for a discussion of sales and flows in each of our segments.
•Risk Management. See "-Risk Management-COVID-19" for a discussion of our risk management framework and its incorporation of pandemic stress scenarios.
•Risk Factors. See "Risk Factors" for a discussion of the risks to our businesses posed by the COVID-19 pandemic.
•CARES Act and Other Regulatory Developments. See "Business-Regulation-Regulatory Response to the COVID-19 Pandemic" for additional information.
Outlook
We feel confident about our prospects for the future based on the foundation of our integrated and complementary businesses. We plan to continue our transformation by executing on our cost savings plan and taking additional steps to increase our growth potential and reduce our market sensitivity. Specifically, we plan to reallocate capital across the businesses with the intention of doubling the earnings contribution from our higher-growth businesses and reducing the earnings contribution from our Individual Annuities business.
Specific outlook considerations for each of our businesses include the following:
•PGIM. Our global investment management business, PGIM, is focused on maintaining strong investment performance while leveraging the scale of its approximately$1.499 trillion of assets under management through its distinctive multi-manager model. In addition to providing solutions for its third-party clients, PGIM provides ourU.S. and International Businesses with a competitive advantage through its investment expertise across a broad array of asset classes. Despite the impact of the COVID-19 pandemic, PGIM has experienced favorable equity market and credit conditions, strong performance, continued positive flows across both institutional and retail investors, gains from our seed capital and co-investments and increased levels of production and profitability from the agency business demonstrating the counter cyclical nature of the business. There remain risks to earnings across the asset management industry, including PGIM, if economic conditions remain unstable, markets decline or credit spreads widen. An economic downturn could also have impacts on real estate prices as well as transaction volumes in certain private asset classes. Adverse changes in market conditions could lead to lower fee-based revenues, incentive fees taking longer to be realized and losses emerging in our co- and seed investment portfolio. We believe PGIM's uniquely diversified global platform is well positioned to be resilient in the face of market and industry headwinds. Underpinning our growth strategy is our ability to continue to deliver robust investment performance, and to attract and retain high-caliber investment talent.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. In our full service business, we have experienced strong deposits and sales in recent years and, while we foresee the continuation of spread and fee compression, we believe 59 -------------------------------------------------------------------------------- Table of Contents these are manageable headwinds. During 2020, account values in our full-service business were impacted by the CARES Act, which provided qualified individuals the ability to withdraw from defined contribution plans and individual retirement accounts up to$100,000 penalty-free, with the withdrawal taxed over a three-year period (unless otherwise elected by the individual). We expect the impact on account values of the withdrawals made in 2020 to continue into 2021. In our pension risk transfer business, we expect our differentiated capabilities and demonstrated execution to drive our business momentum in the face of increasing competition while we maintain appropriate pricing and return expectations under changing market conditions. We expect, however, that growth will not be linear given the episodic nature of larger cases. Given that many of the products in our institutional investment products business assume longevity risk, elevated levels of mortality resulting from COVID-19 may continue to contribute to a higher level of underwriting gains in this business. In ourGroup Insurance business, we continue to focus on expanding our Premier market segment and affinity relations, while maintaining a leadership position in the National segment. However, we expect COVID-19 to continue to contribute to elevated levels of mortality resulting in increased life insurance claims in the near-term. In addition, we expect elevated unemployment to drive increased disability claims in this business. Market conditions may also continue to impact sales volumes and the utilization of workplace benefits across our Workplace Solutions businesses. •U.S. Individual Solutions. Our Individual Annuities business remains focused on helping its customers meet their investment and retirement needs. During 2020, we took actions to pivot to less interest rate-sensitive products and ensure we realize appropriate returns for the current economic environment, including the decision to discontinue sales of traditional variable annuities with guaranteed living benefits afterDecember 31, 2020 . We expect to continue to shift our focus to products that provide protected outcomes for our customers through simpler, technology-enabled channels and that deliver shareholder value across a wide range of economic environments. We also expect account values, fee income, and spread income to continue to be impacted by market conditions. Our Individual Life business continues to focus on making life insurance solutions more available to consumers and financial professionals, including building omnichannel distribution capabilities enabled by digital platforms. During 2020, we also took pricing and product actions to ensure we realize appropriate returns for the current economic environment and to diversify our product mix to further limit our sensitivity to interest rates, including the suspension of our single life guaranteed universal life product. We expect COVID-19 to continue to contribute to elevated levels of mortality, resulting in increased life insurance claims in the near-term. Across our Individual Solutions businesses, mandated social distancing has limited in-person engagement between customers and financial professionals. We have taken actions to expand our digital capabilities, which has mitigated the impact of these limitations; however, collectively, we expect the product actions we have taken along with the constrained distribution environment to adversely impact our sales prospects in the near-term. •Assurance IQ. Assurance IQ leverages data science and technology to distribute Medicare, health, life, property and casualty, and personal finance products directly to retail customers, primarily through its digital and independent agent channels. Assurance uses an open architecture platform, and the products it currently distributes are predominantly offered by third-parties. We expect that Assurance IQ will contribute to the growth of ourU.S. Businesses and has the potential to enhance the growth of our International Businesses over time. We expect the impacts of COVID-19 on our Assurance IQ business to be limited as the business does not have direct exposure to capital market conditions or mortality; however, consumer financial hardships and uncertainty created by the current economic conditions could negatively impact persistency and expected sales levels. In addition, during 2020 we experienced headwinds related to adapting components of the Assurance IQ distribution model to the remote work environment caused by COVID-19; however, we expect to mitigate these headwinds going forward through continued operational enhancements. •International Businesses. Our International Businesses remain focused on meeting customers' protection and financial needs as well as maintaining the underlying strength of our distribution channels. We continue to strengthen our position inJapan and seek to expand our footprint in select high-growth emerging markets. We continue to invest in our existing businesses and regularly assess acquisition opportunities to build scale, complement our businesses, and support our long-term growth aspirations. We also regularly evaluate strategic options for our businesses as part of ensuring their alignment with our broader business goals and strategic vision, and in 2020 we sold our life insurance operations inKorea and entered into an agreement to sell our life insurance operations inTaiwan . For additional information on our strategic acquisitions and dispositions, see "-Results of Operations by Segment-International Insurance Division-International Insurance" below. In 2020, we saw a slightly elevated level of claims due to COVID-19 and increased expenses from supporting our captive agents. Sales throughout 2020 were impacted by the global implementation of social distancing protocols that limited in-person engagement between customers and advisors within both our captive agent and third-party distribution channels; however, our distribution channels adapted quickly to employ virtual tools to adjust to these 60 -------------------------------------------------------------------------------- Table of Contents limitations. InJanuary 2021 ,Japan declared its second state of emergency regarding COVID-19, which again installed social distancing protocols, although less restrictive than the first time. While the current state of emergency inJapan is not countrywide and is more focused on social activities, further tightening of COVID-19 restrictions on personal interactions either inJapan or in other markets is possible and, depending on the specific circumstances and geographies impacted, could adversely impact our sales prospects for a period of time. We believe our needs-based selling and death protection focus are even more valuable to consumers based on the global experience of COVID-19 and will help support the continued growth of our businesses.
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. have experienced a sustained period of historically low levels, which continue to negatively impact our investment-related activity, including our investment income returns, net investment spread results, and portfolio income and reinvestment yields. 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. While our International Businesses' operations, especially inJapan , have successfully managed a low interest rate environment for many years, as discussed under "-Impact of a Low Interest Rate Environment" below, these low rates continue to negatively impact our investment-related activity, including our investment income returns, net investment spread results, and portfolio income and reinvestment yields. The current reinvestment yields for certain blocks of business are now generally lower than the current portfolio yields supporting these blocks of business. The continuation of low 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 and healthcare 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) as well as health-related products.
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.
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Impact of a Low Interest Rate Environment
As a global financial services company, market interest rates are a key driver
of our results of operations and financial condition. Changes in interest rates
can affect our results of operations and/or our financial condition in several
ways, including favorable or adverse impacts to:
•investment-related activity, including: investment income returns, net interest
margins, net investment spread results, new money rates, mortgage loan
prepayments and bond redemptions;
•hedging costs and other risk mitigation activities;
•insurance reserve levels, market experience true-ups and amortization of both
deferred policy acquisition costs ("DAC") and value of business acquired
("VOBA");
•customer account values, including their impact on fee income;
•fair value of, and possible impairments on, intangible assets such as goodwill;
•product offerings, design features, crediting rates and sales mix; and
•policyholder behavior, including surrender or withdrawal activity.
For more information on interest rate risks, see "Risk Factors-Market Risk".
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-related results if these interest rate environments are sustained.
Interest rates in theU.S. have experienced a sustained period of historically low levels with certain benchmarks reaching significant lows. While market conditions and events make uncertain the timing, amount and impact of any monetary policy decisions by 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 decline, our reinvestment yield may be below our overall portfolio yield, resulting in an unfavorable impact to earnings. Conversely, as interest rates rise, our reinvestment yield may exceed the overall portfolio yield resulting in a favorable impact to earnings. For the general account supporting 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 5.4% of the fixed maturity security and commercial mortgage loan portfolios through 2022. The portion of the general account attributable to these operations has approximately$251 billion of such assets (based on net carrying value) as ofDecember 31, 2020 . The average portfolio yield for fixed maturity securities and commercial mortgage loans is approximately 3.9%, as ofDecember 31, 2020 . Included in the$251 billion of fixed maturity securities and commercial mortgage loans are approximately$172 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$172 billion , approximately 53% 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 of December 31, 2020 (in billions) Long-duration insurance products with fixed and guaranteed terms $ 154
Contracts with adjustable crediting rates subject to guaranteed minimums
62
Participating contracts where investment income risk ultimately accrues to
contractholders 14
Total $ 230
62-------------------------------------------------------------------------------- Table of Contents The$154 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$62 billion above relates to contracts with crediting rates that may be adjusted over the life of the contract, subject to guaranteed minimums. Although we may have the ability to lower crediting rates for those contracts above guaranteed minimums, our willingness to do so may be limited by competitive pressures. The following table sets forth the related account values by range of guaranteed minimum crediting rates and the related range of the difference, in basis points ("bps"), between rates being credited to contractholders as ofDecember 31, 2020 , and the respective guaranteed minimums. Account Values
with Adjustable Crediting Rates Subject to Guaranteed Minimums:
Greater than
1-49 50-99 100-150 150
At bps above bps above bps above bps above
guaranteed guaranteed guaranteed guaranteed guaranteed
minimum minimum minimum minimum minimum Total
($ in billions)Range of Guaranteed Minimum Crediting Rates: Less than 1.00%$ 0.9 $ 1.2 $ 0.3 $ 0.0 $ 0.0 $ 2.4 1.00% - 1.99% 1.4 15.3 2.7 2.0 1.2 22.6 2.00% - 2.99% 1.3 0.9 2.0 1.2 1.3 6.7 3.00% - 4.00% 28.1 0.4 0.1 0.2 0.2 29.0 Greater than 4.00% 0.9 0.0 0.0 0.0 0.0 0.9 Total(1)$ 32.6 $ 17.8 $ 5.1 $ 3.4 $ 2.7 $ 61.6 Percentage of total 53 % 29 % 8 % 6 % 4 % 100 % __________
(1)Includes approximately
The remaining$14 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 0.85% (which is reasonably consistent with recent rates) for the period fromJanuary 1, 2021 throughDecember 31, 2021 (and credit spreads remain unchanged from average levels experienced during the fourth quarter 2020), 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$120 million and$160 million for the period fromJanuary 1, 2021 throughDecember 31, 2021 . In order to mitigate the unfavorable impact that a low interest rate environment has on our net interest margins, we employ a proactive asset/liability management program, which includes strategic asset allocation and hedging strategies within a disciplined risk management framework. These strategies seek to match the characteristics of our products, and to closely approximate the interest rate sensitivity of the assets with the estimated interest rate sensitivity of the product liabilities. Our asset/liability management program also helps manage duration gaps, currency and other risks between assets and liabilities through the use of derivatives. We adjust this dynamic process as products change, as customer behavior changes and as changes in the market environment occur. As a result, our asset/liability management process has permitted us to manage the interest rate risk associated with our products through several market cycles. Our interest rate exposure is also mitigated by our business mix, which includes lines of business for which fee-based and insurance underwriting earnings play a more prominent role in product profitability. We also regularly examine our product offerings and their profitability. As a result, we may reprice certain products and discontinue sales of other products that do not meet our profit expectations. Closed Block Division Substantially all of the$61 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 additional information on the Closed Block.
International Insurance Operations
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While our international insurance operations have experienced a low interest rate environment for many years, the current reinvestment yields for certain blocks of business in our international insurance operations are generally lower than the current portfolio yield supporting these blocks of business. In recent years, the Bank of Japan's monetary policy has resulted in even lower and, at times, negative yields for certain tenors of government bonds. Our international insurance operations employ a proactive asset/liability management program in order to mitigate, to the extent possible, the unfavorable impact that the current interest rate environment has on our net interest margins. In conjunction with this program, we have not purchased negative yielding assets to support the portfolio and we continue to purchase long-term bonds with tenors of 30 years or greater. Additionally, our diverse product portfolio in terms of currency mix and premium payment structure allows us to further mitigate the negative impact from this low interest rate environment. We also regularly examine our product offerings and their profitability. As a result, we may reprice certain products, adjust commissions for certain products and discontinue sales of 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 ofU.S. dollar-denominated products relative to products denominated in other currencies. For additional information on sales within our international insurance operations, see "-International Businesses-Sales Results," below. The following table sets forth the insurance liabilities and policyholder account balances of our Japanese operations, by type, for the date indicated: As of December 31, 2020 (in billions) Insurance products with fixed and guaranteed terms $ 140
Contracts with a market value adjustment if invested amount is not held to maturity
26
Contracts with adjustable crediting rates subject to guaranteed minimums
12
Total $ 178
The $140 billion is primarily comprised of long-duration insurance products that
have fixed and guaranteed terms, for which underlying assets may have to be
reinvested at interest rates that are lower than current portfolio yields. The
remaining insurance liabilities and policyholder account balances include $26
billion related to contracts that impose a market value adjustment if the
invested amount is not held to maturity and $12 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 0.65% and the 10-year U.S. Treasury rate is 0.85% (which is
reasonably consistent with recent rates) for the period from January 1, 2021
through December 31, 2021 (and credit spreads remain unchanged from average
levels experienced during the fourth quarter 2020), 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 $80 million for the period from
January 1, 2021 through December 31, 2021 .
Results of OperationsConsolidated Results of Operations
The following table summarizes net income (loss) for the periods presented:
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Year ended December 31,
2020 2019 2018
(in millions)
Revenues $ 57,033 $ 64,807 $ 62,992
Benefits and expenses 57,356 59,722 58,158Income (loss) before income taxes and equity in earnings of operating joint ventures
(323) 5,085 4,834
Income tax expense (benefit) (81) 947 822
Income (loss) before equity in earnings of operating joint ventures
(242) 4,138 4,012
Equity in earnings of operating joint ventures, net of taxes 96 100 76
Net income (loss) (146) 4,238 4,088
Less: Income attributable to noncontrolling interests 228 52 14
Net income (loss) attributable to Prudential Financial, Inc. $
(374)
2020 to 2019 Annual Comparison. The
•$2,801 million unfavorable variance, on a pre-tax basis, from realized investment gains and losses forPrudential Financial, Inc. excluding 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); •$1,444 million unfavorable variance, on a pre-tax basis, from a loss in the current period from our Divested and Run-off Businesses compared to a gain in the prior year period (see "Results of Operations by Segment-Divested and Run-off Businesses" for additional information); •$707 million unfavorable variance, on a pre-tax basis, from lower adjusted operating income from our business segments (see "Segment Results of Operations" for additional information); •$351 million unfavorable variance, on a pre-tax basis, reflecting the impact from changes in the value of our embedded derivatives and related hedge positions, net of DAC and other costs, associated with certain variable annuities (see "Results of Operations by Segment-U.S. Businesses-U.S. Individual Solutions Division-Individual Annuities-Risks and Risk Mitigants" for additional information); and •$339 million unfavorable variance, on a pre-tax basis, from investment related activities that are primarily within "Other income (loss)" for PFI excluding our Divested and Run-off Businesses. These unfavorable impacts were primarily driven by unrealized gains (losses) from equity securities.
Partially offsetting these decreases in "Net income (loss) attributable to
•$1,028 million favorable variance from a lower tax expense.
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 the Consolidated
Statements of Operations.
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Table of Contents
Year ended December 31,
2020 2019 2018
(in millions)Adjusted operating income before income taxes by segment: PGIM
$ 1,262 $ 998 $ 959 U.S. Businesses:U.S. Workplace Solutions division: Retirement 1,436 1,301 1,049 Group Insurance (16) 285 229 Total U.S. Workplace Solutions division 1,420 1,586 1,278U.S. Individual Solutions division: Individual Annuities 1,470 1,843 1,925 Individual Life (48) 87 223 Total U.S. Individual Solutions division 1,422 1,930 2,148 Assurance IQ division(1): Assurance IQ (88) (9) 0 Total Assurance IQ division (88) (9) 0 Total U.S. Businesses 2,754 3,507 3,426 International Businesses(2) 2,952 3,112 3,019 Corporate and Other (1,824) (1,766) (1,283) Total segment adjusted operating income before income taxes 5,144 5,851 6,121
Reconciling items: Realized investment gains (losses), net, and related adjustments(3)
(4,156) (835) 611
Charges related to realized investment gains (losses), net(4) (159) (123) (315)
Market experience updates(5) (640) (449) 0
Divested and Run-off Businesses(6):
Closed Block division (24) 36 (62)
Other Divested and Run-off Businesses(2) (629) 755 (1,434)
Other adjustments(7) 51 (47) 0
Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests(8)
90 (103) (87)
Consolidated income (loss) before income taxes and equity in earnings of operating joint ventures
$
(323)
__________
(1)Assurance IQ was acquired by the Company inOctober 2019 . See Note 1 to the Consolidated Financial Statements and "-Assurance IQ" for additional information. (2)Effective second quarter of 2020, the results of POK and the impact of its sale are excluded from the International Businesses and are included in the Divested and Run-off Businesses in Corporate and Other. Effective third quarter of 2020, the results of POT and the impact of its anticipated sale are excluded from the International Businesses and are included in the Divested and Run-off Businesses in Corporate and Other. Prior period amounts have been updated to conform to current period presentation. See Note 1 to the Consolidated Financial Statements for additional information. (3)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. (4)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"). Prior period amounts have been updated to conform to current period presentation. (5)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. See Note 22 to the Consolidated Financial Statements for additional information. Prior period amounts have been updated to conform to current period presentation. (6)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 underU.S. GAAP. See "-Divested and Run-off Businesses" for additional information. (7)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. (8)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-taxU.S. GAAP basis as a separate line in the Consolidated Statements 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 aU.S. GAAP basis as a separate line in the Consolidated 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. 66 -------------------------------------------------------------------------------- Table of Contents Segment results for 2020 presented above reflect the following: PGIM. Results for 2020 increased in comparison to 2019, primarily reflecting an increase in asset management fees and other related revenues, partially offset by higher expenses.
Retirement. Results for 2020 increased in comparison to 2019, including an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Excluding this item, results increased primarily driven by higher reserve gains and lower expenses.
Individual Annuities. Results for 2020 decreased in comparison to 2019, including an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Excluding this item, results decreased primarily driven by lower fee income, net of distribution expenses and other associated costs.
Individual Life. Results for 2020 decreased in comparison to 2019, including a favorable comparative net impact from our annual reviews and update of assumptions and other refinements. Excluding this item, results decreased primarily reflecting lower underwriting results, and a change in business practice related to the level of premiums collected on certain policies that resulted in reserve refinements.
Assurance IQ. Results for 2020 were
International Businesses. Results for 2020 decreased in comparison to 2019, inclusive of unfavorable net impacts from foreign currency exchange rates and unfavorable comparative net impacts from our annual reviews and update of assumptions and other refinements. Excluding these items, results decreased primarily reflecting lower net investment spread results and lower earnings from our joint venture investments, partially offset by favorable underwriting results including business growth. Corporate and Other. Results for 2020 reflected increased losses in comparison to 2019, primarily driven by lower investment income and higher interest expense on debt, partially offset by lower charges related to corporate costs and initiatives, as well as favorable pension and employee benefit results.
Closed Block Division. Results for 2020 decreased in comparison to 2019, primarily driven by lower net investment activity results, partially offset by a decrease in 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 additional 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. 67 -------------------------------------------------------------------------------- Table of Contents 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 our PGIM 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 . 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, 2020 2019 (in billions) Foreign currency hedging instruments: Hedging USD-equivalent earnings: Forward currency contracts (notional amount outstanding)$ 0.4 $ 0.6 Hedging USD-equivalent equity: USD-denominated assets held in yen-based entities(1) 10.1 13.1 Dual currency and synthetic dual currency investments(2) 0.5 0.6 Total USD-equivalent equity foreign currency hedging instruments 10.6 13.7 Total foreign currency hedges$ 11.0 $ 14.3 __________ (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$65.8 billion and$57.8 billion as ofDecember 31, 2020 and 2019, respectively, of USD-denominated assets supporting USD-denominated liabilities related to USD-denominated products. 68 -------------------------------------------------------------------------------- Table of Contents (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. 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 and PGIM reflect the impact of intercompany arrangements with our Corporate and Other operations pursuant to which these segments' non-USD-denominated earnings are translated at fixed currency exchange rates. Results of our Corporate and Other operations include 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 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 expected 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, 2020 , approximately 2% of the segment's earnings were yen-based and, as ofDecember 31, 2020 , we have hedged 100%, 72% and 31% of expected yen-based earnings for 2021, 2022 and 2023, 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' results for 2020, 2019 and 2018 reflect the impact of translating yen-denominated earnings at fixed currency exchange rates of 104, 105, and111 yen per USD, respectively. We expect our 2021 results to reflect the impact of translating yen-denominated earnings at a fixed currency exchange rate of103 yen 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. For PGIM 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 Corporate and Other operations, reflecting the impact of these intercompany arrangements. 69
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Table of Contents
Year ended December 31,
2020 2019 2018
(in millions)
Segment impacts of intercompany arrangements:
International Businesses(3) $ 64 $ 39 $ 21
PGIM (4) 6 0
Impact of intercompany arrangements(1) 60 45 21
Corporate and Other:
Impact of intercompany arrangements(1)(3) (60) (45) (21)
Settlement gains (losses) on forward currency contracts(2)(3) 67 55 (1)
Net benefit (detriment) to Corporate and Other 7 10 (22)
Net impact on consolidated revenues and adjusted operating income
__________
(1)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. (2)As ofDecember 31, 2020 , 2019 and 2018, the total notional amounts of these forward currency contracts within our Corporate and Other operations were$1.0 billion ,$1.3 billion and$2.1 billion , respectively, of which$0.4 billion ,$0.6 billion and$1.3 billion , respectively, were related to our Japanese insurance operations. (3)Excludes impacts related to POK. Prior period amounts have been updated to conform to current period presentation. Effective second quarter of 2020, the intercompany arrangement for the Korean won between our International Businesses and Corporate and Other operations was terminated and the related hedges were repurposed in relation to the anticipated sale of POK. Effective second quarter of 2020, Korean won-denominated earnings for 2020 and 2019 that were translated at fixed currency exchange rates of 1,090 and1,110 Korean won per USD, respectively, are excluded from the International Businesses and are included in the Divested and Run-off Businesses included in Corporate and Other. See Note 1 to the Consolidated Financial Statements for additional information.
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. This
is most notable in our Japanese operations, which currently offer primarily
USD-denominated products, but have also historically offered 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 $2.3 billion and $2.7 billion as of December 31, 2020
and 2019, 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 13% of the $2.3 billion balance as of December 31, 2020 will be
recognized in 2021, approximately 11% will be recognized in 2022, and the
remaining balance will be recognized from 2023 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 70 -------------------------------------------------------------------------------- Table of Contents 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. Accounting Policies & Pronouncements
Application 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, 2020 , DAC and DSI for PFI excluding the Closed
Block division were $18.8 billion and $0.8 billion , respectively, and DAC in our
Closed Block division was $209 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 certain universal life and 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 71
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Table of Contents 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."
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, 2020 , the excess of actual cumulative earnings over the expected cumulative earnings was$2,920 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, 2020 .
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 that have resulted 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 DSI 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, 2020 , our domestic variable annuities and variable life insurance businesses assume an 8.0% long-term equity expected rate of return and a 1.3% near-term mean reversion equity expected rate of return, and our 72 -------------------------------------------------------------------------------- Table of Contents international variable life insurance business assumes a 4.8% long-term equity expected rate of return and a 1.5% 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 2020 annual reviews and update of assumptions and other refinements, we reduced our long-term expectation of the (i) 10-yearU.S. Treasury rate by 50 basis points and now grade to a rate of 3.25% over ten years, and (ii) 10-year Japanese Government Bond yield by 30 basis points and now grade to a rate of 1.00% 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 that 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, 2020 , VOBA was$1.1 billion , and included$0.9 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$0.2 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 when premium
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 for future 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 be needed 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
period earnings. 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 policy charges for administration, mortality, expense, surrender,
and other, regardless of how characterized) are recognized. This liability is
established using current best estimate assumptions and is based on the
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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 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 fair value 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 are recorded 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.
•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 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.
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, 2020 , represented 42% 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. 74 -------------------------------------------------------------------------------- Table of Contents Retirement. The reserves for future policy benefits of our Retirement segment, which as ofDecember 31, 2020 , represented 22% 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, 2020 , represented 7% 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, 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 ("LIBOR") swap curve adjusted for an additional spread, which includes an estimate ofNPR . 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 ofDecember 31, 2020 , represented 7% 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 ourGroup Insurance segment, which as ofDecember 31, 2020 , 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 expectedSocial 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 reported but not yet paid, and claims incurred but not yet reported. The waiver of premium reserve is calculated as the present value of future benefits and utilizes assumptions such as expected 75 -------------------------------------------------------------------------------- Table of Contents mortality and recovery rates. The reserve for claims reported but not yet paid is based on the inventory of claims that have been reported but not yet paid. The reserve for claims incurred but not yet reported is estimated using expected patterns of claims reporting. Corporate and Other. The reserves for future policy benefits of our Corporate & Other operations, which as ofDecember 31, 2020 , represented 5% 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. Due to the recognition of a premium deficiency in the first quarter of 2020 as a result of the decline in interest rates, most contracts are valued with the best estimate assumptions at that time. 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 ofDecember 31, 2020 , represented 15% 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.
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 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 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 aggregate impact that could result on each of the listed financial statement balances from changes in certain key assumptions. The figures below are presented in aggregate for the Company. The information below is for illustrative purposes and includes only the hypothetical direct impact onDecember 31, 2020 balances of changes in a single assumption and not changes in any combination of assumptions. Additionally, the illustration of the insurance assumption impacts below reflects a parallel shift in the insurance assumptions across the Company; however, these may be non-parallel in practice and only applicable to specific businesses. Changes in current assumptions could result in impacts to financial statement balances that are in excess of the amounts illustrated. A description of the estimates and assumptions used in the preparation of each of these financial statement balances is provided 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 composed of investments and derivatives. See further below for a discussion of the estimates and assumptions involved with the application ofU.S. GAAP 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. 76 -------------------------------------------------------------------------------- Table of Contents •The impacts of our Long-Term Care business, a component of our Divested and Run-off Businesses within our Corporate and Other operations. Long-Term Care business sensitivities are presented separately from the immediately following table (see "-Sensitivities for the Long-Term Care business within our 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 the decline in interest rates in the first quarter of 2020, 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.December 31, 2020 Increase (Decrease) in Deferred Policy Acquisition Costs, Deferred Future Policy Sales Inducements Benefits and and Value of Policyholders' Hypothetical change in current assumptions: Business Acquired
Account Balances
(in millions)
Long-term interest rate:
Increase by 25 basis points $ 55 $ (60) $ 115
Decrease by 25 basis points $ (50) $ 45 $ (95)
Long-term equity expected rate of return:
Increase by 50 basis points $ 185 $ (140) $ 325
Decrease by 50 basis points $ (165) $ 145 $ (310)
NPR credit spread:
Increase by 50 basis points $ (485) $ (2,275) $ 1,790
Decrease by 50 basis points $ 545 $ 2,535 $ (1,990)
Mortality:
Increase by 1% $ (45) $ (165) $ 120
Decrease by 1% $ 45 $ 165 $ (120)
Lapse:
Increase by 10% $ (150) $ (980) $ 830
Decrease by 10% $ 160 $ 1,010 $ (850) Sensitivities for the Long-Term Care Business within Corporate and Other
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); rather, 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. 77
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December 31, 2020
Increase (Decrease)
in Best Estimate
Reserve
Assumption Current Assumption Assumption Change (in millions)
Mortality Improvement Based on "G2" industry Remove all mortality $(350)
mortality improvement scale, improvement on healthy lives
grossed up to apply to only
healthy lives
Claim Incidence Based on Company and industry
Increase / decrease in expected
experience. No reflection of incidence: +5% to -5%
future claim management
efficiencies
Average Ultimate Lapse Rate Individual: 0.7% -10 basis points to +10 basis $125 - $(125)
Group: 0.7% points
Investment Rate(1) Weighted average of 4.74% -25 basis points to +25 basis$400 -$(400)
points
Expected Future Premium Rate Approximately
Decrease / increase unapproved$50 -$(50) Increase Approvals the rate increase program(2)
rate increases by: -10% to +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, 2020 , our goodwill balance of$3,035 million is primarily reflected in the following reporting units:$2,140 million for Assurance IQ,$455 million for Retirement's Full Service business,$258 million for PGIM, and$136 million for Gibraltar Life and Other. 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 the same as, or one level below, our operating segments. Although accounting guidance provides for an optional qualitative assessment for testing goodwill impairment, all of our reporting units elected to perform the quantitative test, which compares each reporting unit's fair value to its carrying value. The carrying value represents the capital that the business would require if operating as a standalone entity. For additional information on goodwill and our reporting segments, see Note 2 and Note 10 to the Consolidated Financial Statements. As ofDecember 31, 2019 , the Company performed a qualitative goodwill impairment assessment for Assurance IQ, following the acquisition of the business inOctober 2019 . A quantitative impairment assessment of the goodwill allocated to Assurance IQ was performed for the first time as ofDecember 31, 2020 . The assessment included both a discounted cash flow approach and a market approach based on sales, Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") and earnings multiples. The estimated fair value of Assurance IQ as ofDecember 31, 2020 was based on weighting the results of each approach. The discounted cash flow approach calculated the value of Assurance IQ by applying a discount rate, derived from a capital asset pricing model and reflecting a market expected rate of return for the reporting unit, to its projected future cash flows. The projected future cash flows involved significant judgement and were based on our internal forecasts and a terminal value, which incorporates an expected long-term growth rate and market-based multiples. The internal forecasts were based on management's current outlook on the product mix and future performance of the business and incorporated expected industry and market conditions and trends. 78 -------------------------------------------------------------------------------- Table of Contents The market approach derived the value of Assurance IQ based on comparable publicly traded companies. Each comparable company was assigned a relative weight based on various factors, primarily focused on the comparability of lines of business and business mix, with additional considerations given to comparability of business lifecycle, growth and profitability. Market multiples were developed for the comparable companies using independent analysts' consensus estimates for each company's forecasted sales, EBITDA and earnings. The market multiples were then applied to Assurance IQ's forecasted results, and a control premium, reflective of observable premiums paid for comparable change-in-control transactions, was added to determine a total estimated fair value for the reporting unit. The market multiples used to determine the fair value of Assurance IQ were higher as ofDecember 31, 2020 , when compared to the prior year. See "Risk Factors-Strategic Risk" for additional information on risks that may impact the performance and fair value of Assurance IQ. The estimated fair value of Assurance IQ, based on a weighted average of the valuation approaches described above, exceeded the carrying value by 10%, as ofDecember 31, 2020 . Gibraltar Life and Other and PGIM completed a quantitative impairment analysis using an earnings multiple approach, while Retirement's Full Service business used a discounted cash flow approach to estimate its fair value as ofDecember 31, 2020 . The significant inputs and considerations applied under each approach are similar to the ones applied by Assurance IQ. The fair value of the reporting units, excluding Assurance IQ, exceeded their carrying value by a weighted average of 229% as ofDecember 31, 2020 . 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, unanticipated changes in business performance or the regulatory environment, market declines or other events impacting the fair value of these businesses, including changes in market multiples, discount rates, interest rates and growth rate assumptions or increases in the level of equity required to support these businesses, could cause an impairment of goodwill, resulting in a charge to income.
Valuation of Investments, Including Derivatives, Measurement of Allowance for Credit Losses, 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;
•Measurement of the allowance for credit losses on fixed maturity securities
classified as available-for-sale or held-to-maturity, commercial mortgage loans,
and other loans; and
•Recognition of other-than-temporary impairments ("OTTI") for equity method
investments.
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 and equity
securities, the impact of changes in fair value is recorded within "Other income
(loss)." Our investments classified as held-to-maturity are carried at the
acquisition price, net of any unamortized premiums or discounts. Our 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.
In addition, an allowance for credit losses is measured each quarter for
available-for-sale fixed maturity securities, held-to-maturity fixed maturity
securities, commercial mortgage and other loans. For additional information
regarding our policies regarding the measurement of credit losses, see Note 2 to
the Consolidated Financial Statements.
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For equity method investments, 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.
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 postretirement benefit plans. Our assumed long-term rate of return for 2020 was 6.50% for our domestic pension plans and 7.00% for our other postretirement benefit plans. Given the amount of plan assets as ofDecember 31, 2019 , 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 Other Postretirement
Periodic Pension Cost Cost
(in millions)
Increase in expected rate of return by 100 bps $ (132) $ (15)
Decrease in expected rate of return by 100 bps $ 132 $ 15
Foreign pension plans represent 5% of plan assets at the beginning of 2020. 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
$4 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 the December 31, 2019 methodology we employed to
determine our discount rate for 2020. Our assumed discount rate for 2020 was
3.30% for our domestic pension plans and 3.25% for our other domestic
postretirement benefit plans. Given the amount of pension and postretirement
obligations as of December 31, 2019 , 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 Other Postretirement
Periodic Pension Cost Cost
(in millions)
Increase in discount rate by 100 bps $ (136) $ (7)
Decrease in discount rate by 100 bps $ 159 $ 4
Foreign pension plans represent 14% of plan obligations at the beginning of
2020. An increase in discount rate by 100 bps would result in a decrease in net
periodic pension costs of $14 million ; conversely, a decrease in discount rate
by 100 bps would result in an increase in net periodic pension costs of $9
million .
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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 2020, 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, 2021 , we decreased the discount rate to 2.55% from 3.30% in 2020. The expected rate of return on plan assets will decrease to 5.75% in 2021 from 6.00% in 2020, 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. AtDecember 31, 2020 , 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, 2020 Increase/(Decrease) in Increase/(Decrease) in Accumulated Postretirement Pension Benefits Obligation Benefits Obligation (in millions) Increase in discount rate by 100 bps $ (1,690) $ (190) Decrease in discount rate by 100 bps $ 2,056 $ 228 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 refinements to 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 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 2020 "Total income tax expense (benefit)" of$3 million . 81 -------------------------------------------------------------------------------- Table of Contents The CARES Act. OnMarch 27, 2020 , the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") was enacted into law. One provision of the CARES Act amends the Tax Act of 2017 and allows companies with net operating losses ("NOLs") originating in 2018, 2019, or 2020 to carry back those losses up to five years. For 2020, the Company has recorded an income tax benefit of$51 million and$149 million from carrying the 2018 NOL and estimated 2020 NOL back to tax years that have a 35% tax rate.
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 cancellations. These estimates are reassessed each reporting period and any changes in estimates are reflected in the current period.
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 . As a result of the COVID-19 pandemic, inNovember 2020 the FASB issued ASU 2020-11,Financial Services-Insurance (Topic 944): Effective Date and Early Application to defer for an additional one year the effective date of ASU 2018-12 fromJanuary 1, 2022 toJanuary 1, 2023 , and to provide transition relief to facilitate the early adoption of the ASU. The transition relief would allow large calendar-year public companies that early adopt ASU 2018-12 to apply the guidance either as ofJanuary 1, 2020 orJanuary 1, 2021 (and record transition adjustments as ofJanuary 1, 2020 orJanuary 1, 2021 , respectively) in the 2022 financial statements. Companies that do not early adopt ASU 2018-12 would apply the guidance as ofJanuary 1, 2021 (and record transition adjustments as ofJanuary 1, 2021 ) in the 2023 financial statements. The Company currently intends to adopt ASU 2018-12 effectiveJanuary 1, 2023 . ASU 2018-12 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 Segment PGIM Operating Results
The following table sets forth PGIM's operating results for the periods indicated:
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Year ended December 31,
2020 2019 2018
(in millions)
Operating results(1):
Revenues $ 4,153 $ 3,589 $ 3,294
Expenses 2,891 2,591 2,335
Adjusted operating income 1,262 998 959
Realized investment gains (losses), net, and related adjustments 0 (1) (10)
Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests
159 8 (21)
Income (loss) before income taxes and equity in earnings of
operating joint ventures $ 1,421 $ 1,005 $ 928
__________
(1)Certain of PGIM's investment activities are based in currencies other than
the U.S. dollar and are therefore subject to foreign currency exchange rate
risk. The financial results of PGIM include the impact of an intercompany
arrangement with our Corporate and Other operations designed to mitigate the
impact of exchange rate changes on PGIM's U.S. dollar-equivalent earnings. For
more information related to this intercompany arrangement, see "-Results of
Operations-Impact of Foreign Currency Exchange Rates," above.
Adjusted Operating Income
2020 to 2019 Annual Comparison. Adjusted operating income increased$264 million , primarily reflecting an increase in asset management fees, net of related expenses, due to higher average assets under management as a result of market appreciation, strong investment performance and public fixed income inflows. The increase also reflected an increase in other related revenues, net of related expenses, primarily due to higher commercial mortgage origination revenue driven by higher loan production and profitability, higher net performance-based incentive fees, and favorable co- and seed investment results driven by strong underlying investment performance. These increases were partially offset by higher expenses primarily reflecting higher compensation driven by business growth, as well as a decrease in service, distribution and other revenues primarily due to the absence of fees in the current year period related to the Wells Fargo agreement (see the "Revenues by type" table in "-Revenues and Expenses," below).
Revenues and Expenses
The following table sets forth PGIM's revenues, presented on a basis consistent with the table above under "-Operating Results," by type:
Year ended December 31,
2020 2019 2018
(in millions)
Revenues by type:
Asset management fees by source:
Institutional customers $ 1,350 $ 1,283 $ 1,204
Retail customers(1) 1,003 878 867
General account 557 521 471
Total asset management fees 2,910 2,682 2,542
Other related revenues by source:
Incentive fees 206 169 59
Transaction fees 26 22 33
Co- and seed investments 122 79 57
Commercial mortgage(2) 198 110 121
Total other related revenues 552 380 270Service, distribution and other revenues(3) 691 527
482 Total revenues$ 4,153 $ 3,589 $ 3,294 __________ (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 revenues from our commercial mortgage origination and servicing business. 83 -------------------------------------------------------------------------------- Table of Contents (3)Includes payments from Wells Fargo under an agreement dated as ofJuly 30, 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 theWachovia Securities joint venture termination date ofDecember 31, 2009 toDecember 31, 2019 . The revenue from Wells Fargo under this agreement was$60 million and$70 million for the years endedDecember 31, 2019 and 2018, respectively. 2020 to 2019 Annual Comparison. Revenues increased$564 million . Asset management fees increased primarily reflecting higher average assets under management as a result of market appreciation, strong investment performance and public fixed income inflows. Other related revenues increased primarily reflecting higher commercial mortgage origination revenue driven by higher loan production and profitability, favorable co- and seed investment results driven by strong underlying investment performance, and higher performance-based incentive fees. Service, distribution and other revenues increased primarily reflecting higher revenues from certain consolidated funds (which were fully offset by higher expenses related to noncontrolling interests in these funds), partially offset by the absence of fees in the current year period related to the Wells Fargo agreement. Expenses increased$300 million . This increase primarily reflects higher expenses for service, distribution and other revenues largely driven by higher revenues associated with certain consolidated funds, as discussed above. The increase also includes higher variable expenses associated with an increase in overall segment earnings and higher performance-based incentive fee revenues, higher compensation expenses driven by business growth, and expenses related to the startup of a closed-end retail fund in the current year period. These increases were partially offset by lower expenses related to travel and entertainment resulting from COVID-19.
Assets Under Management
The following table sets forth assets under management by asset class as of the
dates indicated.
December 31,
2020 2019 2018
(in billions)
Assets Under Management(1) (at fair value):
Public equity $ 202.4 $ 165.7 $ 147.0
Public fixed income 1,004.5 885.9 773.1
Real estate 121.5 117.1 110.3
Private credit and other alternatives 106.5 97.5 87.1
Multi-asset 63.7 64.8 64.0
Total PGIM assets under management(2) $
1,498.6
Assets under management within other reporting segments(2)(3) 222.3
219.9 195.8
Total PFI assets under management $
1,720.9
__________
(1)Prior period amounts have been updated to conform to current period presentation. "Public equity" represents stock ownership interest in a corporation or partnership (excluding hedge funds) or real estate investment trust. "Public fixed income" represents debt instruments that pay interest and usually have a maturity (excluding mortgages). "Real estate" includes direct real estate equity and real estate mortgages. "Private credit and other alternatives" includes private credit, private equity, hedge funds and other alternative strategies. "Multi-asset" includes funds or products that invest in more than one asset class, balancing equity and fixed income funds and target date funds. (2)Effective first quarter of 2020, certain assets have been reclassified from theU.S. Individual Solutions division to PGIM. Prior period amounts have been updated to conform to current period presentation. (3)Primarily includes certain assets related to annuity and variable life products in ourU.S. Individual Solutions division, retirement and group life products in ourU.S. Workplace Solutions division and certain general account assets of our International Businesses. These assets are not directly managed by PGIM, but rather are invested in non-proprietary funds or are managed by either the divisions themselves or by our Chief Investment Officer Organization. 2020 to 2019 Annual Comparison. PGIM's assets under management increased$168 billion in 2020, primarily reflecting market appreciation, strong investment performance and public fixed income inflows.
The following table sets forth assets under management by source as of the dates indicated.
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December 31,
2020 2019 2018
(in billions)
Assets Under Management(1) (at fair value):
Institutional customers $ 614.9 $ 552.8 $ 493.5
Retail customers 372.0 305.6 260.2
General account 511.7 472.6 427.8
Total PGIM assets under management(2) $
1,498.6
Assets under management within other reporting segments(2)(3) 222.3
219.9 195.8
Total PFI assets under management $
1,720.9
__________
(1)Prior period amounts have been updated to conform to current period presentation. "Institutional customers" consist of third-party institutional assets and group insurance contracts. "Retail customers" consist 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. "General account" also includes fixed annuities and the fixed-rate accounts of variable annuities and variable life insurance. (2)Effective first quarter of 2020, certain assets have been reclassified from theU.S. Individual Solutions division to PGIM. Prior period amounts have been updated to conform to current period presentation. (3)Primarily includes certain assets related to annuity and variable life products in ourU.S. Individual Solutions division, retirement and group life products in ourU.S. Workplace Solutions division and certain general account assets of our International Businesses. These assets are not directly managed by PGIM, but rather are invested in non-proprietary funds or are managed by either the divisions themselves or by our Chief Investment Officer Organization.
The following table sets forth the component changes in PGIM's assets under management for the periods indicated.
December 31,
2020 2019 2018
(in billions)
Beginning assets under management $ 1,331.0 $ 1,181.5 $ 1,180.0
Institutional third-party flows 3.0 (6.5) 14.1
Retail third-party flows 17.2 5.7 (0.4)
Total third-party flows 20.2 (0.8) 13.7
Affiliated flows(1) (8.5) (3.9) 7.9
Market appreciation (depreciation)(2) 146.7 148.6 (23.0)
Foreign exchange rate impact 6.8 0.5 1.2
Net money market activity and other increases (decreases) 2.4 5.1 1.7
Ending assets under management(3) $
1,498.6
__________
(1)Represents assets that PGIM manages for the benefit of other reporting 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)Prior period amounts have been updated to conform to current period presentation.
Private Capital Deployment
Private capital deployment is indicative of the pace and magnitude of capital that is invested and will result in future revenues that may include management fees, transaction fees, incentive fees and servicing revenues, as well as future costs to manage these assets. Private capital deployment represents the gross value of private capital invested in real estate debt and equity, and private credit and equity asset classes. Assets under management resulting from private capital deployment are included in "Real estate" and "Private credit and other alternatives" in the "-Assets Under Management- by asset class table" above, and these accounted for a net increase of approximately$12 billion of assets under management in 2020. The increase was primarily driven by private debt originations and real estate equity acquisitions, partially offset by maturities and capital returned to investors. Private capital deployment includes PGIM's real estate agency debt business, which consists of agency commercial loans that are originated and sold to third party investors. PGIM continues to service these commercial loans; however, they are not included in assets under management.
The following table sets forth PGIM's private capital deployed by asset class for the periods indicated.
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December 31,
2020 2019 2018
(in billions)
Private capital deployed:
Real estate debt and equity
Co- and Seed Investments
The following table sets forth PGIM's co- and seed 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,
2020 2019(1)
(in millions)
Co-Investments:
Public fixed income $ 489 $ 462
Real estate 170 228
Private credit and other alternatives 26 19
Seed Investments:
Public equity 675 671
Public fixed income 356 325
Real estate 33 34
Private credit and other alternatives 79 59
Multi-asset 62 74
Total $ 1,890 $ 1,872
__________(1)Prior period amounts have been updated to conform to current period presentation.
The increase of$18 million in co- and seed investments was primarily driven by strong public fixed income and private credit and other alternatives investment performance, partially offset by a liquidation of a significant real estate co-investment.U.S. Businesses Operating Results
The following table sets forth the operating results for our
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Year ended December 31,
2020 2019 2018
(in millions)
Adjusted operating income before income taxes:
U.S. Businesses:
U.S. Workplace Solutions division:
Retirement $ 1,436 $ 1,301 $ 1,049
Group Insurance (16) 285 229
Total U.S. Workplace Solutions division 1,420 1,586 1,278
U.S. Individual Solutions division:
Individual Annuities 1,470 1,843 1,925
Individual Life (48) 87 223
Total U.S. Individual Solutions division 1,422 1,930 2,148
Assurance IQ division(1):
Assurance IQ (88) (9) 0
Total Assurance IQ division (88) (9) 0
Total U.S. Businesses 2,754 3,507 3,426Reconciling Items: Realized investment gains (losses), net, and related adjustments(2)
(2,526) (1,881) 88
Charges related to realized investment gains (losses), net (120) (58) (333)
Market experience updates(3) (591) (408) 0
Other adjustments(4) 51 (47) 0Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests
4 2 (1)
Income (loss) before income taxes and equity in earnings of
operating joint ventures $ (428) $ 1,115 $ 3,180
________
(1)Assurance IQ was acquired by the Company in October 2019 . See Note 1 to the
Consolidated Financial Statements for additional information.
(2)Prior period amounts have been updated to conform to current period
presentation.
(3)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. See Note 22
to the Consolidated Financial Statements for additional information.
(4)Represents 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.
2020 to 2019 Annual Comparison. Adjusted operating income for our
•Lower fee income, net of distribution expenses and other associated costs, in our Individual Annuities business;
•Lower underwriting results primarily driven by COVID-19 related net mortality experience; and
•An unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements.
•Partially offsetting these decreases were lower expenses, including those associated with cost savings initiatives.
Retirement
Operating Results
The following table sets forth Retirement's operating results for the periods indicated:
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Year ended December 31,
2020 2019 2018
(in millions)
Operating results:
Revenues $ 12,034 $ 15,064 $ 16,825
Benefits and expenses 10,598 13,763 15,776
Adjusted operating income 1,436 1,301 1,049
Realized investment gains (losses), net, and related adjustments (23) 332 (402)
Charges related to realized investment gains (losses), net 0 4 (5)
Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests
3 2 (1)
Income (loss) before income taxes and equity in earnings of operating
joint ventures $ 1,416 $ 1,639 $ 641
Adjusted Operating Income
2020 to 2019 Annual Comparison. Adjusted operating income increased $135
million , including an unfavorable comparative net impact from our annual reviews
and update of assumptions and other refinements. Results for 2020 included a net
charge of $22 million from these updates primarily driven by an increase in
expected benefit payments, while results for 2019 included a net benefit of $154
million from these updates, primarily driven by a reduction in expected benefit
payments. Excluding this item, adjusted operating income increased $311 million ,
primarily driven by higher reserve gains due to COVID-19 related mortality
gains, and lower expenses primarily due to lower costs resulting from expense
savings initiatives. Net investment spread results remained relatively flat as
lower reinvestment yields were largely offset by higher income on non-coupon
investments and the impact of lower crediting rates.
Revenues, Benefits and Expenses
2020 to 2019 Annual Comparison. Revenues decreased$3,030 million . Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, revenues decreased$3,037 million . This decrease primarily reflected lower pension risk transfer premiums with corresponding offsets in policyholders' benefits, as discussed below. Benefits and expenses decreased$3,165 million . Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, benefits and expenses decreased$3,348 million . Policyholders' benefits, including the change in policy reserves, decreased primarily related to the decrease in pension risk transfer premiums discussed above, as well as more favorable reserve experience primarily driven by COVID-19 related mortality gains.
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
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
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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,
2020 2019 2018
(in millions)
Full Service:
Beginning total account value $ 272,448 $ 231,669 $ 234,616
Deposits and sales 40,914 36,394 33,116
Withdrawals and benefits (34,652) (35,706) (26,429)Change in market value, interest credited and interest income and other activity
36,517 40,091 (9,634)
Ending total account value $ 315,227 $ 272,448 $ 231,669
Institutional Investment Products:
Beginning total account value $ 227,596 $ 200,759 $ 194,492
Additions(1) 22,469 31,101 21,310
Withdrawals and benefits (18,288) (16,743) (15,409)
Change in market value, interest credited and interest income 8,854 9,089 3,303
Other(2) 2,756 3,390 (2,937)
Ending total account value $ 243,387 $ 227,596 $ 200,759
__________
(1)Additions primarily include: group annuities and funded pension reinsurance
calculated based on premiums received; funding agreements issued; unfunded
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 December 31, 2020 and 2019, "Other" activity also includes $6,989
million in receipts offset by $6,695 million in payments and $3,804 million in
receipts offset by $3,104 million in payments, respectively, related to funding
agreements backed by commercial paper which typically have maturities of less
than 90 days.
2020 to 2019 Annual Comparison. The increase in Full Service account values primarily reflected favorable changes in the market value of customer funds and net deposits and sales.
The increase in Institutional Investment Products account values primarily reflected a favorable change in the market value of account values, net additions driven by investment-only stable value accounts and collateralized funding agreements.
Group Insurance Operating Results
The following table sets forth
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Year ended December 31,
2020 2019 2018
(in millions)
Operating results:
Revenues $ 5,786 $ 5,750 $ 5,685
Benefits and expenses 5,802 5,465 5,456
Adjusted operating income (16) 285 229
Realized investment gains (losses), net, and related adjustments 48 (20) (38)
Income (loss) before income taxes and equity in earnings of
operating joint ventures $ 32 $ 265 $ 191
Benefits ratio(1)(4):
Group life(2) 93.4 % 87.4 % 87.2 %
Group disability(2) 78.4 % 75.4 % 75.8 %
Total Group Insurance (2) 90.2 % 84.7 % 84.9 %
Administrative operating expense ratio(3)(4):
Group life 12.4 % 12.7 % 12.2 %
Group disability 26.1 % 24.1 % 27.1 %
Total Group Insurance 15.4 % 15.2 % 15.1 %
__________
(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 Group Insurance benefits ratios were 93.6%, 78.8% and
90.4% for 2020, respectively, 87.0%, 77.7% and 84.9% for 2019, respectively, and
87.4%, 77.8% and 85.5% for 2018, respectively.
(3)Ratio of general and administrative expenses (excluding commissions) to gross
premiums plus policy charges and fee income.
(4)The benefit and administrative ratios are measures used to evaluate
profitability and efficiency.
Adjusted Operating Income
2020 to 2019 Annual Comparison. Adjusted operating income decreased$301 million , including a favorable comparative net impact from our annual reviews and update of assumptions and other refinements. Results for 2020 and 2019 included a net benefit from this update of$11 million and$9 million , respectively. Excluding this item, adjusted operating income decreased$303 million , primarily reflecting lower underwriting results in our group life business driven by unfavorable claim experience primarily due to COVID-19 impacts on non-experience-rated contracts. The decrease also reflected lower underwriting results in our group disability business driven by the impact to reserves from lower interest rates, and lower net investment spread results driven by lower reinvestment yields and lower prepayment fee income.
Revenues, Benefits and Expenses
2020 to 2019 Annual Comparison. Revenues increased$36 million . Excluding the impact from our annual reviews and update of assumptions and other refinements, as discussed above, revenues increased$5 million . The increase primarily reflected higher premiums and policy charges and fee income driven by growth in our group life business, mostly offset by lower net investment income driven by lower reinvestment yields and lower prepayment fee income, with partial offsets in interest credited to policyholder account balances, as discussed below. Benefits and expenses increased$337 million . Excluding the impact from our annual reviews and update of assumptions and other refinements, as discussed above, benefits and expenses increased$308 million . The increase primarily reflected higher policyholders' benefits and changes in reserves, including increases in our group life business mostly due to COVID-19 impacts. The increase was partially offset by lower interest credited to policyholder account balances, offset in net investment income, as discussed above.
Sales Results
The following table sets forth
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Year ended December 31,
2020 2019 2018
(in millions)
Annualized new business premiums(1):
Group life $ 243 $ 254 $ 376
Group disability 163 159 183
Total $ 406 $ 413 $ 559
__________
(1)Amounts exclude new premiums resulting from rate changes on existing
policies, from additional coverage under our
2020 to 2019 Annual Comparison. Total annualized new business premiums decreased$7 million compared to 2019, primarily driven by lower sales in our group life business, partially offset by higher sales in our group disability business. Sales levels reflect pricing competitiveness and reduced levels of client case movement within the National segment.
Individual Annuities
Our Individual Annuities business includes both fixed and variable annuities which may include optional guaranteed living benefit 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), as well as indexed variable annuities that provide several index crediting strategies and varying levels of downside protection at predetermined levels and durations. 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. Sales of traditional variable annuities with guaranteed living benefit riders have been discontinued as ofDecember 31, 2020 . See "Business-Individual Annuities" for more information about these products.
Operating Results
The following table sets forth Individual Annuities' operating results for the
periods indicated:
Year ended December 31,
2020 2019 2018
(in millions)
Operating results:
Revenues $ 4,440 $ 4,995 $ 4,966
Benefits and expenses 2,970 3,152 3,041
Adjusted operating income 1,470 1,843 1,925Realized investment gains (losses), net, and related adjustments (2,911) (2,551)
846
Charges related to realized investment gains (losses), net 4 59 (407)
Market experience updates(1) (324) (100) 0
Income (loss) before income taxes and equity in earnings of
operating joint ventures $ (1,761) $ (749) $ 2,364
________
(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. See Note 22
to the Consolidated Financial Statements for additional information.
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Adjusted Operating Income
2020 to 2019 Annual Comparison. Adjusted operating income decreased$373 million , including an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Results for 2020 included a$136 million net charge from these updates primarily driven by unfavorable impacts related to a decrease in long-term interest rate assumptions. Results for 2019 included a$12 million net charge from these updates. Excluding this item, adjusted operating income decreased$249 million primarily driven by lower fee income, net of distribution expenses and other associated costs, due to unfavorable impacts from our traditional living benefit guarantees resulting from declining interest rates, as well as certain products reaching contractual milestones for fee tier reduction.
Revenues, Benefits and Expenses
2020 to 2019 Annual Comparison. Revenues decreased$555 million . Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, revenues decreased$423 million . The decrease was primarily driven by lower policy charges and fee income reflecting unfavorable impacts from our traditional living benefit guarantees resulting from declining interest rates, as well as certain products reaching contractual milestones for fee tier reductions. Also contributing to the decrease were lower premiums resulting from lower single premium immediate annuity sales, with offsets in policyholders' benefits as discussed below. Benefits and expenses decreased$182 million . Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, benefits and expenses decreased$174 million primarily driven by lower policyholders' benefits, including changes in reserves, due to lower reserve provisions resulting from a decrease 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,
2020 2019 2018
(in millions)
Total Individual Annuities(1):
Beginning total account value $ 169,681 $ 151,080 $ 168,626
Sales 6,815 9,720 8,270
Full surrenders and death benefits (7,845) (9,374) (8,958)
Sales, net of full surrenders and death benefits (1,030) 346 (688)
Partial withdrawals and other benefit payments (5,191) (5,163) (4,814)
Net flows (6,221) (4,817) (5,502)
Change in market value, interest credited and other activity 16,360 27,072 (8,341)
Policy charges (3,540) (3,654) (3,703)
Ending total account value $ 176,280 $ 169,681 $ 151,080
__________
(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 $170.5 billion , $164.9 billion and $147.3 billion as of
December 31, 2020 , 2019 and 2018, respectively. Fixed annuity account values
were $5.7 billion , $4.8 billion and $3.7 billion as of December 31, 2020 , 2019
and 2018, respectively.
2020 to 2019 Annual Comparison. The increase in account values during 2020 was primarily driven by favorable changes in the market value of contractholder funds, partially offset by net outflows and policy charges.
The decrease in sales, net of full surrenders and death benefits, reflects lower
gross sales driven by benefit rate reductions and pricing actions in response to
capital market conditions, and lower full surrenders driven by general
uncertainty around COVID-19 as well as recent market volatility.
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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 or an index-linked interest rate required to be credited to the customer's account value, which include 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 our investment strategies and product design features, which include credit rate resetting subject to the minimum guaranteed interest rate as well as surrender charges applied during the early years of the contract that help to provide protection for premature withdrawals. In addition, a portion of our fixed products has a market value adjustment provision that affords protection of lapse in the case of rising interest rates. We also manage these risk exposures through external reinsurance for certain of our fixed annuity products. For information on our external reinsurance agreements, see "Business-Individual Annuities" and Note 14 to the Consolidated Financial Statements. Indexed Variable Annuity Risks and Risk Mitigants. The primary risk exposure of our indexed variable annuity products relates to the investment risks we bear in order to credit to the customer's account balance the required crediting rate based on the performance of the elected indices at the end of each term. We manage this risk primarily through our investment strategies including derivatives and product design features, which include credit rate resetting subject to contractual minimums as well as surrender charges applied during the early years of the contract that help to provide protection for premature withdrawals. In addition, our indexed variable annuity strategies have an interim value provision that provides protection from lapse in the case of rising interest rates. 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 is subject to the risk that actual experience will differ from the assumptions used in the original pricing of these products. We manage our exposure to certain risks driven by fluctuations in capital markets primarily through a combination of i) Product Design Features, ii) our Asset Liability Management Strategy, and iii) our Capital Hedge Program, as discussed below. We also manage these risk exposures through external reinsurance for certain of our variable annuity products. For information on our external reinsurance agreements, see "Business-Individual Annuities" and Note 14 to the Consolidated Financial Statements. Sales of traditional variable annuities with guaranteed living benefit riders have been discontinued as ofDecember 31, 2020 . See "Business-Individual Annuities" for more information about these products. 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 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 purchase payments, 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): 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 using fixed income and derivative 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, interest rate and credit derivatives, including, but not limited to: equity and treasury futures; total return, credit default 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. 93 -------------------------------------------------------------------------------- Table of Contents Under our ALM strategy, the difference between the change in value of our hedging instruments and the change in value of the portion of the economic liability that is being hedged, has historically been reflected in adjusted operating income over time. Beginning with the second quarter of 2020, this impact is excluded from adjusted operating income, which the Company believes enhances the understanding of underlying performance trends. The valuation of the economic liability we seek to defray excludes certain items that are included within theU.S. GAAP liability, such asNPR in order to maximize protection irrespective of the possibility of our own default, as well as risk margins (required byU.S. GAAP but different from our best estimate) and valuation methodology differences. The following table provides a reconciliation between the liability reported underU.S. GAAP and the economic liability we manage through our ALM strategy as of the periods indicated.December 31, 2020 2019 (in millions)
$ 18,537 $ 12,612 NPR adjustment, net of reinsurance recoverables(1) 4,103 3,522 Subtotal 22,640 16,134
Adjustments including risk margins and valuation methodology differences
(5,080) (4,385)
Economic liability managed through the ALM strategy ________
(1) Prior period amounts have been updated to conform to current period presentation.
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 underU.S. GAAP. The valuation methodology utilized in estimating 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 underU.S. GAAP. Additionally, the valuation of the economic liability excludes certain items that are included within theU.S. GAAP liability, such asNPR in order to maximize protection irrespective of the possibility of our own default and risk margins (required byU.S. GAAP but different from our best estimate). •Different accounting treatment between liabilities and assets supporting those liabilities. UnderU.S. GAAP, changes in value of the embedded 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. •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 dynamic rebalancing 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. iii.Capital Hedge Program: We employ a capital hedge program 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 have historically been recognized in adjusted operating income over the expected duration of the capital hedge program. Beginning with the second quarter of 2020, changes in value of these derivatives are excluded from adjusted operating income which the Company believes enhances the understanding of underlying performance trends. 94 -------------------------------------------------------------------------------- Table of Contents Results excluded from adjusted operating income The following table provides the net impact to the Consolidated Statements of Operations from the results excluded from adjusted operating income, which is primarily driven by the changes in theU.S. GAAP embedded derivative liability and hedge positions under the ALM strategy as described above, and the related amortization of DAC and other costs.
Year ended
2020 2019 2018
Results excluded from adjusted operating income(2) (in millions)(1)
Change in value of U.S. GAAP liability, pre-NPR(3) $ (4,979) $ (1,510) $ (681)
Change in the NPR adjustment 581 (1,103) 1,394 Change in fair value of hedge assets, excluding capital hedges(4)
2,251 695 (427)
Change in fair value of capital hedges(5) (900) (1,024) 404
Other 136 391 156
Realized investment gains (losses), net, and related adjustments
(2,911) (2,551) 846
Market experience updates(6) (324) (100) 0
Charges related to realized investment gains (losses), net 4 59 (407)
Total results excluded from adjusted operating income(7)
__________
(1)Positive amounts represent income; negative amounts represent a loss. (2)Includes the impact of annual reviews and update of assumptions and other refinements. (3)Represents the change in the liability (excludingNPR ) for our variable annuities living benefit guarantees, which is measured utilizing a valuation methodology that is required underU.S. GAAP. This liability includes such items as risk margins which are required byU.S. GAAP but not included in our best estimate of the liability. (4)Represents the change in fair value of the derivatives utilized to hedge potential claims associated with our variable annuity living benefit guarantees. (5)Represents the changes in fair value of equity derivatives of the capital hedge program intended to protect a portion of the overall capital position of the variable annuities business against its exposure to the equity markets. (6)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. (7)Excludes amounts from the changes in fair value of fixed income instruments recorded in OCI (versus net income): a gain of$1,384 million , a gain of$845 million and a loss of$14 million as ofDecember 31, 2020 , 2019 and 2018, respectively. For 2020, the loss of$3,231 million was driven by an unfavorable impact related to the portions of theU.S. GAAP liability beforeNPR , net of the change in fair value of hedge assets (excluding the change in fair value of capital hedges) largely due to unfavorable hedge breakage resulting from equity market volatility, as well as the unfavorable impact on the unhedged portion of the economic liability as a result of declining interest rates, partially offset by favorable equity market performance. Contributing to the overall loss were losses associated with our capital hedge program. Partially offsetting these items was a favorableNPR adjustment. For 2019, the loss of$2,592 million was driven by an unfavorableNPR adjustment, losses associated with our capital hedge program, and an unfavorable impact related to the portions of theU.S. GAAP liability beforeNPR , net of the change in fair value of hedge assets (excluding the change in fair value of capital hedges) largely due to declining interest rates, partially offset by favorable equity market performance.
Product Specific Risks and Risk Mitigants
For certain living benefit 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 benefit
guarantees provide for guaranteed lifetime contractholder withdrawal payments
inclusive of a "highest daily" contract value guarantee. Our Prudential Defined
Income 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.
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The majority of our traditional variable annuity contracts with living benefit
guarantees, and contracts sold with our highest daily living benefit features,
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 products with GMAB rider options include the automatic
rebalancing feature but are not included in the ALM strategy. As discussed
above, sales of traditional variable annuities with living benefit guarantees
and automatic rebalancing features have been discontinued as of December 31,
2020 . See "Business-Individual Annuities" for more information about these
products.
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 guaranteed minimum death benefit ("GMDB") features as of the
periods indicated:
December 31,
2020 2019 2018
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) $ 112,177 66 % $ 111,535 68 % $ 101,496 69 %
ALM strategy only(3) 7,410 4 % 7,703 5 % 7,520 5 %
Automatic rebalancing only 634 1 % 732 1 % 804 1 %
External reinsurance(4) 3,173 2 % 3,150 2 % 2,873 2 %
PDI 18,540 11 % 16,296 9 % 11,237 7 %
Other products 2,492 1 % 2,457 1 % 2,306 2 %
Total living benefit/GMDB features $ 144,426 $ 141,873 $ 126,236
GMDB features and other(5) 26,120 15 % 23,055 14 % 21,103 14 %
Total variable annuity account value $ 170,546 $ 164,928 $ 147,339
_________
(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 Highest Daily Lifetime Income ("HDI") v.3.0
business for the period April 1, 2015 through December 31, 2016 . These contracts
with living benefits also 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,
2020 2019 2018
(in millions)
Operating results:
Revenues $ 6,398 $ 6,115 $ 5,831
Benefits and expenses 6,446 6,028 5,608
Adjusted operating income (48) 87 223
Realized investment gains (losses), net, and related adjustments 359 358 (318)
Charges related to realized investment gains (losses), net (124) (121) 79
Market experience updates(1) (267) (308) 0
Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests
1 0 0
Income (loss) before income taxes and equity in earnings of
operating joint ventures $ (79) $ 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. See Note 22
to the Consolidated Financial Statements for additional information.
Adjusted Operating Income
2020 to 2019 Annual Comparison. Adjusted operating income decreased $135
million , including a favorable comparative net impact from our annual reviews
and update of assumptions and other refinements. Results for 2020 included a $92
million net charge from these updates, mainly driven by unfavorable impacts
related to a decrease in long-term interest rate assumptions. Results for 2019
included a $208 million net charge from these updates, mainly driven by
unfavorable impacts related to mortality assumptions. Excluding this item,
adjusted operating income decreased $251 million , primarily reflecting lower
underwriting results, driven by an unfavorable impact from mortality experience,
net of reinsurance, primarily attributable to COVID-19 related claims, a change
in business practice related to the level of premiums collected on certain
policies that resulted in reserve refinements, and the absence of a favorable
impact from changes in market conditions on estimates of profitability in the
prior year period. These decreases were partially offset by lower expenses from
cost savings initiatives.
Revenues, Benefits and Expenses
2020 to 2019 Annual Comparison. Revenues increased$283 million . Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, revenues increased$212 million . This increase was primarily driven by higher policy charges and fee income driven by business growth, and higher net investment income due to higher average invested assets resulting from business growth, partially offset by lower investment yields. Benefits and expenses increased$418 million . Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, benefits and expenses increased$463 million . This increase reflected higher policyholders' benefits, including changes in reserves, driven by an unfavorable impact from mortality experience, net of reinsurance, primarily attributable to COVID-19 related claims as well as a change in business practice related to the level of premiums collected on certain policies that resulted in reserve refinements and the absence of a favorable impact from changes in market conditions on estimates of profitability in the prior year period, as discussed above. The increase also reflected higher general and administrative expenses, net of capitalization, due to an increase in VOBA amortization, partially offset by lower expenses from cost savings initiatives.
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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2020 2019 2018
Prudential Third Prudential Third Prudential Third
Advisors Party Total Advisors Party Total Advisors Party Total
(in millions)
Term Life $ 26 $ 122 $ 148 $ 27 $ 173 $ 200 $ 28 $ 185 $ 213
Guaranteed Universal
Life(1) 3 91 94 8 87 95 8 89 97
Other Universal Life(1) 17 74 91 38 117 155 45 105 150
Variable Life 100 349 449 78 200 278 54 109 163
Total $ 146 $ 636 $ 782 $ 151 $ 577 $ 728 $ 135 $ 488 $ 623
__________
(1)Single pay life premiums and excess (unscheduled) premiums are included in
annualized new business premiums based on a 10% credit and represented
approximately 7%, 9% and 13% of Guaranteed Universal Life and 7%, 14% and 26% of
Other Universal Life annualized new business premiums for the years ended
December 31, 2020 , 2019 and 2018, respectively. Prior period percentages have
been updated to conform to current period presentation.
2020 to 2019 Annual Comparison. Total annualized new business premiums increased
$54 million , primarily reflecting higher sales of variable life products
throughout the year including the impact of increased sales prior to pricing
actions taken in the fourth quarter of 2020, partially offset by lower sales of
other universal life products due to the absence of large case activity in 2020
and lower sales of term life products due to pricing actions.
U.S. Businesses-Assurance IQ Division
Assurance IQ
Operating Results
The following table sets forth Assurance IQ's operating results for the periods
indicated. Results for 2019 only reflect activity from
2020 2019(1)
(in millions)
Operating results:
Revenues $ 391 $ 101
Expenses 479 110
Adjusted operating income (88) (9)
Realized investment gains (losses), net, and related adjustments 1 0
Other adjustments(2) 51 (47)
Income (loss) before income taxes and equity in earnings of operating
joint ventures $ (36) $ (56)
__________
(1)Represents activity from the acquisition date through December 31, 2019 . See
Note 1 to the Consolidated Financial Statements for additional information.
(2)"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.
Adjusted Operating Income
Adjusted operating income for the year endedDecember 31, 2020 was$(88) million , reflecting revenues, net of marketing and distribution expenses, primarily related to our health (Medicare and Health Under 65) and life insurance product lines. Results also include amortization expenses related to intangible assets recognized as part of purchase accounting (see Note 1 and Note 10 to the Consolidated Financial Statements for additional information). For the period from the acquisition date throughDecember 31, 2019 , adjusted operating income was$(9) million , reflecting 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 product line, as well as operating expenses and amortization expenses related to intangible assets recognized as part of purchase accounting.
Revenues and Expenses
Revenues for the year endedDecember 31, 2020 were$391 million , primarily reflecting commissions and marketing referral revenues from our health (Medicare and Health Under 65) and life insurance product lines. Expenses for the year ended 98 -------------------------------------------------------------------------------- Table of ContentsDecember 31, 2020 were$479 million driven by marketing and distribution costs, general and administrative operating expenses including certain expenses (e.g., advertising costs) incurred in preparation for the annual Medicare enrollment period, and amortization expenses related to intangible assets. Revenues for the period from the acquisition date throughDecember 31, 2019 were$101 million , primarily reflecting commissions and marketing referral revenues from our health, life insurance, and property and casualty product lines. Expenses for the period from the acquisition date throughDecember 31, 2019 were$110 million driven by marketing and distribution costs, general and administrative operating expenses, and amortization expenses related to intangible assets. International Businesses Business Updates •In the third quarter of 2020, we completed the sale of ThePrudential Life Insurance Company of Korea, Ltd. ("POK") to KB Financial Group Inc., for cash consideration of approximately2.3 trillion Korean Won , equal to approximately$1.9 billion . See Note 1 to the Consolidated Financial Statements for additional information. Effective in the second quarter of 2020, the results of this business and the impact of its sale were reflected in the Divested and Run-off Businesses that are included in Corporate and Other, and all prior period amounts have been updated to conform to the current period presentation. See "-Divested and Run-off Businesses" for additional information. •In the third quarter of 2020, we entered into a definitive agreement with Taishin Financial Holding Co, Ltd., a Taiwanese financial services provider, to sellPrudential Life Insurance Company of Taiwan Inc. ("POT") for cash consideration of approximately$195 million at current exchange rates, to be paid at closing, and contingent consideration with a fair value of approximately$15 million atDecember 31, 2020 . The transaction is expected to close in 2021, subject to regulatory approvals and customary closing conditions. Beginning in the third quarter of 2020, we reported our investment in POT as "held for sale" and have recognized an approximate$350 million after-tax charge to earnings, throughDecember 31, 2020 , to adjust the carrying value of POT to the fair market value reflected in the purchase price (see Note 1 to the Consolidated Financial Statements for additional information). Also, effective in the third quarter of 2020, the results of this business and the impact of its anticipated sale were reflected in the Divested and Run-off Businesses that are included in Corporate and Other, and all prior period amounts have been updated to conform to the current period presentation. We intend to use the proceeds of the transaction for general corporate purposes.
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 the 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. For ourJapan operations, we used an exchange rate of104 yen per USD, which was 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 the International Businesses' operating results for the periods indicated:
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Year ended December 31,
2020 2019 2018
(in millions)Operating results(1): Revenues: Life Planner$ 10,122 $ 9,605 $ 9,000 Gibraltar Life and Other 11,454 11,331 11,058 Total revenues 21,576 20,936 20,058 Benefits and expenses: Life Planner 8,618 8,172 7,657 Gibraltar Life and Other 10,006 9,652 9,382 Total benefits and expenses 18,624 17,824 17,039 Adjusted operating income: Life Planner 1,504 1,433 1,343 Gibraltar Life and Other 1,448 1,679 1,676 Total adjusted operating income 2,952 3,112 3,019
Realized investment gains (losses), net, and related adjustments(2)
727 1,240 317
Charges related to realized investment gains (losses), net (42) (12) 11
Market experience updates(3) (39) (31) 0
Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests
(48) (107) (69)
Income (loss) before income taxes and equity in earnings of operating
joint ventures $ 3,550 $ 4,202 $ 3,278
__________
(1)Effective second quarter of 2020, the results of POK and the impact of its
sale are excluded from the International Businesses and are included in the
Divested and Run-off Businesses in Corporate and Other. Effective third quarter
of 2020, the results of POT and the impact of its anticipated sale are excluded
from the International Businesses and are included in the Divested and Run-off
Businesses in Corporate and Other. Prior period amounts have been updated to
conform to current period presentation. See Note 1 to the Consolidated Financial
Statements for additional information.
(2)Prior period amounts have been updated to conform to current period
presentation.
(3)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. See Note 22
to the Consolidated Financial Statements for additional information.
Adjusted Operating Income
2020 to 2019 Annual Comparison. Adjusted operating income from our Life Planner operations increased$71 million including a net unfavorable impact of$1 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$42 million net charge in 2020 compared to a$5 million net benefit in 2019. The net charge in 2020 was primarily driven by unfavorable impacts related to a decrease in long-term interest rate assumptions. Excluding these items, adjusted operating income from our Life Planner operations increased$119 million , primarily reflecting favorable underwriting results due to the growth of business in force in ourJapan andBrazil operations and favorable policyholder experience, partially offset by an unfavorable impact from mortality experience. Also contributing to the increase were lower expenses primarily driven by the absence of updates to legal reserves incurred in the prior year period, partially offset by higher expenses driven by costs associated with COVID-19 (see "Overview-COVID-19-Expenses") and higher costs related to business growth and business initiatives. These increases were partially offset by lower net investment spread results primarily driven by lower reinvestment yields. Adjusted operating income from our Gibraltar Life and Other operations decreased$231 million including a net unfavorable impact of$9 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$52 million net charge in 2020 compared to a$7 million net benefit in 2019. The net charge in 2020 was primarily driven by updates of reserves reflecting the impact of a decrease in long-term interest rate assumptions, as well as other refinements. Excluding these items, adjusted operating income from our Gibraltar Life and Other operations decreased$163 million , primarily reflecting lower net investment spread results driven by lower reinvestment yields, and lower earnings from our joint venture investments, as well as higher expenses driven by costs associated with COVID-19 (see "Overview-COVID-19-Expenses"). These decreases were partially offset by favorable underwriting results and a favorable impact from mortality experience. 100
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Revenues, Benefits and Expenses
2020 to 2019 Annual Comparison. Revenues from our Life Planner operations increased$517 million including a net unfavorable impact of$109 million from currency fluctuations and a net benefit of$33 million from our annual reviews and update of assumptions and other refinements. Excluding these items, revenues increased$593 million , primarily driven by higher premiums and policy charges and fee income attributable to the growth of business in force. Benefits and expenses from our Life Planner operations increased$446 million including a net favorable impact of$108 million from currency fluctuations and a net charge of$80 million from our annual reviews and update of assumptions and other refinements. Excluding these items, benefits and expenses increased$474 million , primarily reflecting higher policyholders' benefits, including changes in reserves, driven by the growth of business in force, as well as an unfavorable impact from mortality experience. These increases were partially offset by lower expenses primarily driven by the absence of updates to legal reserves incurred in the prior year period, partially offset by higher expenses driven by costs associated with COVID-19 impacts. Revenues from our Gibraltar Life and Other operations increased$123 million , including a net favorable impact of$98 million from currency fluctuations and a net charge of$9 million from our annual reviews and update of assumptions and other refinements. Excluding these items, revenues increased$34 million primarily driven by higher premiums, partially offset by lower net investment results driven by lower reinvestment yields, and lower other income driven by an unfavorable impact from our joint venture investments. Benefits and expenses from our Gibraltar Life and Other operations increased$354 million including a net unfavorable impact of$107 million from currency fluctuations and a net charge of$50 million from our annual reviews and update of assumptions and other refinements. Excluding these items, benefits and expenses increased$197 million , primarily reflecting higher policyholders' benefits, including changes in reserves, as well as higher expenses driven by costs associated with COVID-19 impacts.
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:
Year ended December 31,
2020 2019 2018
(in millions)
Annualized new business premiums(1):
On an actual exchange rate basis:
Life Planner $ 1,041 $ 1,097 $ 1,023
Gibraltar Life and Other 1,149 1,213 1,483
Total $ 2,190 $ 2,310 $ 2,506
On a constant exchange rate basis:
Life Planner 1,087 1,105 1,021
Gibraltar Life and Other 1,153 1,220 1,492
Total $ 2,240 $ 2,325 $ 2,513
__________
(1)Effective second quarter of 2020, the results of POK and the impact of its
sale are excluded from the International Businesses and are included in the
Divested and Run-off Businesses in Corporate and Other. Effective third quarter
of 2020, the results of POT and the impact of its anticipated sale are excluded
from the International Businesses and are included in the Divested and Run-off
Businesses in Corporate and Other. Prior period amounts have been updated to
conform to current period presentation. See Note 1 to the Consolidated Financial
Statements for additional information.
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.
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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.
2020 to 2019 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, 2020
Year Ended
Accident Accident
& Retirement & Retirement
Life Health (1) Annuity Total Life Health (1) Annuity Total
(in millions)
Life Planner(2) $ 578 $ 71 $ 438 $ 0 $ 1,087 $ 607 $ 92 $ 405 $ 1 $ 1,105
Gibraltar Life and Other:
Life Consultants 340 33 58 63 494 349 40 82 142 613
Banks(3) 418 0 23 18 459 378 0 37 12 427
Independent Agency 100 4 91 5 200 88 8 68 16 180
Subtotal 858 37 172 86 1,153 815 48 187 170 1,220
Total $ 1,436 $ 108 $ 610 $ 86 $ 2,240 $ 1,422 $ 140 $ 592 $ 171 $ 2,325
__________
(1)Includes retirement income, endowment and savings variable universal life.
(2)Effective second quarter of 2020, the results of POK and the impact of its
sale are excluded from the International Businesses and are included in the
Divested and Run-off Businesses in Corporate and Other. Effective third quarter
of 2020, the results of POT and the impact of its anticipated sale are excluded
from the International Businesses and are included in the Divested and Run-off
Businesses in Corporate and Other. Prior period amounts have been updated to
conform to current period presentation. See Note 1 to the Consolidated Financial
Statements for additional information.
(3)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 3% and 71%, respectively, of
total Japanese bank distribution channel annualized new business premiums,
excluding annuity products, for the year ended December 31, 2020 , and 1% and
66%, respectively, of total Japanese bank distribution channel annualized new
business premiums, excluding annuity products, for the year ended December 31,
2019 .
Annualized new business premiums, on a constant exchange rate basis, from our
Life Planner operations decreased $18 million primarily driven by lower sales
due to COVID-19 impacts, lower sales of corporate term products in Japan driven
by the corporate product tax rule change effective July 2019 , and lower Life
Planner headcount, as discussed below. The decreases were partially offset by
higher sales of USD-denominated products ahead of pricing increases in the third
quarter of 2020.
Annualized new business premiums, on a constant exchange rate basis, from our
Gibraltar Life and Other operations decreased $67 million . Life Consultants
sales decreased $119 million , primarily driven by COVID-19 impacts, lower sales
of USD-denominated fixed annuity products driven by declines in crediting rates,
and lower Life Consultant headcount (as discussed under "Sales Force" below).
Bank channel sales increased $32 million , reflecting higher sales of
USD-denominated protection products ahead of pricing increases in the third
quarter of 2020, partially offset by lower sales due to COVID-19 impacts.
Independent Agency sales increased $20 million , reflecting higher sales of
USD-denominated protection and endowment products ahead of pricing increases in
the third quarter of 2020, partially offset by lower sales of USD-denominated
fixed annuity products.
Sales Force
The following table sets forth the number of Life Planners and Life Consultants
for the periods indicated:
As of December 31,
2020 2019 2018
Life Planners:
Japan 4,555 4,356 4,183
All other countries(1) 1,511 1,833 1,640
Gibraltar Life Consultants 7,254 7,403 7,964
Total 13,320 13,592 13,787
102-------------------------------------------------------------------------------- Table of Contents __________ (1)Effective second quarter of 2020, the results of POK and the impact of its sale are excluded from the International Businesses and are included in the Divested and Run-off Businesses in Corporate and Other. Effective third quarter of 2020, the results of POT and the impact of its anticipated sale are excluded from the International Businesses and are included in the Divested and Run-off Businesses in Corporate and Other. Prior period amounts have been updated to conform to current period presentation. See Note 1 to the Consolidated Financial Statements for additional information. 2020 to 2019 Comparison. The number of Life Planners decreased by 123, driven by a decrease of 322 in other operations, primarily attributable to a decrease inBrazil as a result of increased terminations related to enhanced agency contract requirements. Life Planners inJapan increased by 199 as a result of recruiting efforts and fewer terminations. The number ofGibraltar Life Consultants decreased by 136, 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,
2020 2019 2018
(in millions)Operating results: Interest expense on debt(1)$ (894) $ (866) $ (809) Investment income(1) 134 250 169 Pension and employee benefits 191 149 195 Other corporate activities(2) (1,255) (1,299) (838) Adjusted operating income (1,824) (1,766) (1,283) Realized investment gains (losses), net, and related adjustments (2,357) (193) 216 Charges related to realized investment gains (losses), net 3 (53) 7 Market experience updates(3) (10) (10) 0 Divested and Run-off Businesses(4) (629) 755 (1,434)
Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests
(25) (6) 4
Income (loss) before income taxes and equity in earnings of operating
joint ventures $ (4,842) $ (1,273) $ (2,490)
__________
(1)Prior period amounts have been updated to conform to current period
presentation.
(2)Includes consolidating adjustments.
(3)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. See Note 22
to the Consolidated Financial Statements for additional information.
(4)Effective second quarter of 2020, the results of POK and the impact of its
sale are excluded from the International Businesses and are included in the
Divested and Run-off Businesses in Corporate and Other. Effective third quarter
of 2020, the results of POT and the impact of its anticipated sale are excluded
from the International Businesses and are included in the Divested and Run-off
Businesses in Corporate and Other. Prior period amounts have been updated to
conform to current period presentation. See Note 1 to the Consolidated Financial
Statements for additional information.
2020 to 2019 Annual Comparison. The loss from Corporate and Other operations, on
an adjusted operating income basis, increased $58 million. Investment income
decreased $116 million primarily driven by lower income on highly liquid assets
due to lower investment yields, a decrease in average invested assets and lower
income on non-coupon investments. Interest expense on debt increased $28
million, reflecting higher average debt balances. Net charges from other
corporate activities decreased $44 million, primarily reflecting higher charges
in the prior year period for certain corporate costs and initiatives, including
a significant charge related to the implementation of the Company's Voluntary
Separation Program (see "-Overview" above), partially offset by increases to
legal reserves in the current year period.
Results from pension and employee benefits were favorable by $42 million, primarily driven by a decrease in employee health benefit costs.
For purposes of calculating pension income from our qualified pension plan for
the year ended December 31, 2021, we decreased the discount rate from 3.30% to
2.55% as of December 31, 2020. The expected rate of return on plan assets will
decrease from 6.00% in 2020 to 5.75% in 2021. 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 2021 to be
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approximately $85 million to $90 million higher than 2020 levels. The increase
is driven by lower interest costs on the plan obligation due to the lower
discount rate.
For purposes of calculating postretirement benefit expenses for the year ended
December 31, 2021, we decreased the discount rate from 3.25% to 2.40% as of
December 31, 2020. The expected rate of return on plan assets will remain
unchanged at 6.75%. Giving effect to the foregoing assumptions and other
factors, we expect postretirement income in 2021 to be approximately $15 million
to $20 million higher than 2020 levels. The increase is driven by lower interest
costs on the plan obligation due to the lower discount rate.
In 2021, 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, 2020 2019 2018 (in millions) Long-Term Care $ 351 $ 469 $ (1,458) Other(1) (980) 286 24 Total Divested and Run-off Businesses income (loss) excluded from adjusted operating income $ (629) $ 755 $ (1,434) __________ (1)Effective second quarter of 2020, the results of POK and the impact of its sale are excluded from the International Businesses and are included in the Divested and Run-off Businesses in Corporate and Other. Effective third quarter of 2020, the results of POT and the impact of its anticipated sale are excluded from the International Businesses and are included in the Divested and Run-off Businesses in Corporate and Other. Prior period amounts have been updated to conform to current period presentation. See Note 1 to the Consolidated Financial Statements for additional information. Long-Term Care. Results for the year ended December 31, 2020 decreased $118 million compared to 2019, including an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Results for 2020 included a $33 million net charge from these updates, while results for 2019 included a $9 million net charge from these updates. Excluding these items, results decreased $94 million primarily reflecting less favorable underwriting results including less favorable claim experience, an increase in reserves as a result of an unlocking of assumptions in the first quarter of 2020 due to the decline in interest rates, and a less favorable increase in the market value of equity securities. These decreases were partially offset by a more favorable increase in the market value of derivatives used for duration management. Other. Results for the year ended December 31, 2020 primarily reflect the results of POK and the impact of its sale which was completed in August 2020, as well as the results of POT and the impact of its anticipated sale. See Note 1 to the Consolidated Financial Statements for additional information.
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
information.
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Each year, the Board of Directors of The 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 the Closed Block experience for dividend
action decisions is based upon statutory results, at the time the Closed Block
was established, we developed, as required by U.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 of December 31, 2020, the excess of actual cumulative earnings over the
expected cumulative earnings was $2,920 million, which was recorded as a
policyholder dividend obligation. Actual cumulative earnings, as required by
U.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
$5,867 million at December 31, 2020, 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,
2020 2019 2018
(in millions)
U.S. GAAP results:
Revenues $ 4,766 $ 5,642 $ 4,678
Benefits and expenses 4,790 5,606 4,740
Income (loss) before income taxes and equity in earnings of
operating joint ventures $ (24) $ 36 $ (62)
Income (loss) Before Income Taxes and Equity in Earnings of Operating Joint Ventures
2020 to 2019 Annual Comparison. Income (loss) before income taxes and equity in earnings of operating joint ventures decreased $60 million. Net investment activity results decreased primarily reflecting lower realized investment gains driven by unfavorable changes in the value of derivatives used in risk management activities, and a decrease in other income driven by less favorable changes in the value of equity securities. Net insurance activity results reflected a favorable comparative change driven by a decrease in the 2021 dividend scale and runoff of policies in force. As a result of the above and other variances, a $117 million increase in the policyholder dividend obligation was recorded in 2020, compared to a $564 million increase in 2019. 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."
Revenues, Benefits and Expenses
2020 to 2019 Annual Comparison. Revenues decreased $876 million primarily driven
by a decrease in net realized investment gains, a decrease in other income, and
lower premiums due to runoff of policies in force, as discussed above.
Benefits and expenses decreased $816 million primarily driven by a decrease in
dividends to policyholders, reflecting a decrease in the policyholder dividend
obligation expense due to changes in cumulative earnings, as discussed above.
Income Taxes
The differences between income taxes expected at the
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Year Ended December 31,
2020 2019(1) 2018(1)
(in millions)Expected federal income tax expense (benefit) at federal statutory rate
$ (68) $ 1,068 $ 1,015
Non-taxable investment income (228) (270) (250)
Foreign taxes at other than U.S. rate 252 234 347
Low-income housing and other tax credits (112) (118) (112)
Changes in tax law (194) (2) (321)
Sale of subsidiary 277 4 10
Non-controlling interest (48) (11) 0
Non-deductible expenses 14 23 33
Change in valuation allowance 17 (1) (6)
State taxes 10 1 6
Other (1) 19 100
Reported income tax expense (benefit) $ (81) $ 947 $ 822
Effective tax rate 25.1 % 18.6 % 17.0 %
__________(1)Prior period amounts have been updated to conform to current period presentation.
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 2020, 2019 and 2018 was 25.1%, 18.6%, and 17.0%, respectively. For a detailed description of the nature of each significant reconciling item, see Note 16 to the Consolidated Financial Statements. The change in the effective tax rate from 18.6% in 2019 to 25.0% in 2020 was primarily driven by a decrease in pre-tax net income, the sale of a subsidiary and the impact of the CARES Act. The increase in the effective tax rate from 17.0% in 2018 to 18.6% in 2019 was primarily driven by the impacts of the Tax Act of 2017 in 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 of December 31, 2020, 2019 and 2018 was $17 million, $18 million and $20 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
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
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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,
2020 2019 2018
(in millions)Retirement:
Investment gains (losses) on assets supporting experience-rated contractholder liabilities, net(1)
$ 602 $ 699 $ (472) Change in experience-rated contractholder liabilities due to asset value changes
(625) (682) 435
Gains (losses), net, on experienced rated contracts(2)(3) $ (23) $ 17 $ (37)
International Businesses:
Investment gains (losses) on assets supporting experience-rated
contractholder liabilities, net $ 68 $ 267 $ (275) Change in experience-rated contractholder liabilities due to asset value changes
(68) (267) 275
Gains (losses), net, on experienced rated contracts $ 0 $ 0 $ 0
Total:
Investment gains (losses) on assets supporting experience-rated
contractholder liabilities, net(1) $ 670 $ 966 $ (747) Change in experience-rated contractholder liabilities due to asset value changes
(693) (949) 710
Gains (losses), net, on experienced rated contracts(2)(3) $ (23) $ 17 $ (37)
__________
(1)Prior period amounts have been updated 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 $3 million, $7 million and $99 million as of
December 31, 2020, 2019 and 2018, 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.
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(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 increases
of $6 million and $57 million, and a decrease of $23 million for the years ended
December 31, 2020, 2019 and 2018, respectively. As prescribed by U.S. GAAP,
changes in the fair value of commercial mortgage and other loans 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. 108
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As of December 31, 2020 As of December 31, 2019
PFI excluding Closed Block Division Closed Block Division PFI excluding Closed Block 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 $ 370,681 $ 5,005 $ 42,224
$ 1,038 $ 349,720 $ 3,570 $ 41,376 $ 745
Assets supporting experience-rated
contractholder liabilities:
Fixed maturities 21,414 615 0 0 19,530 730 0 0
Equity securities 2,043 0 0 0 1,790 0 0 0
All other(2) 619 20 0 0 261 0 0 0
Subtotal 24,076 635 0 0 21,581 730 0 0
Fixed maturities, trading 3,636 230 278 13 3,628 275 256 12
Equity securities 5,653 576 2,345 84 5,140 557 2,245 76
Commercial mortgage and other loans 1,092 0 0 0 228 0 0 0
Other invested assets(3) 2,268 366 3 0 1,433 567 0 0
Short-term investments 6,222 146 88 31 3,789 119 147 36
Cash equivalents 5,241 1 241 0 8,855 99 151 32
Other assets 268 268 0 0 113 113 0 0
Separate account assets 304,270 1,821 0 0 288,724 1,717 0 0
Total assets $ 723,407 $ 9,048 $ 45,179 $ 1,166 $ 683,211 $ 7,747 $ 44,175 $ 901 Future policy benefits
$ 18,879 $ 18,879 $ 0 $ 0 $ 12,831 $ 12,831 $ 0 $ 0
Policyholders' account balances 1,914 1,914 0 0 1,316 1,316 0 0
Other liabilities(3) 385 0 0 0 928 105 8 0
Notes issued by consolidated variable
interest entities ("VIEs") 0 0 0 0 800 800 0 0
Total liabilities $ 21,178 $ 20,793 $ 0 $ 0 $ 15,875 $ 15,052 $ 8 $ 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 1.3% and 2.6%, respectively, as of
December 31, 2020 and 1.1% and 2.0%, respectively, as of December 31, 2019.
(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 $1.3 billion of public fixed maturities as of December 31, 2020
with values primarily based on indicative broker quotes, and approximately $4.6
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 cash flow
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 and capital
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 allowance for credit losses, including our assertions
regarding any intention or requirement to sell debt securities before
anticipated recovery, see "-Realized Investment Gains and Losses-Credit Losses"
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
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oversees management of the general account portfolios within risk limits and
exposure ranges approved annually by the Investment Committee.
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 the U.S. and Japan , capital markets limitations hinder our
ability to hedge interest rate exposure to the same extent we do for our U.S.
and Japan 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 life and
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,
2020, the average duration of our domestic general account investment portfolios
attributable to PFI excluding the Closed Block division, including the impact of
derivatives, was between 7 and 8 years. As of December 31, 2020, the average
duration of our international general account portfolios attributable to our
Japanese insurance operations, including the impact of derivatives, was between
12 and 13 years and represented a blend of yen-denominated and U.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's PGIM segment. Activities of the PGIM segment on behalf of
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the general account portfolios are directed and overseen by the CIO Organization
and monitored by ERM for compliance with investment risk limits.
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 our PGIM segment. The size of our portfolio enables
us to invest in asset classes that may be unavailable to the typical investor.
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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, 2020
PFI Excluding Closed Block
Closed Block Division Division Total
($ in millions)
Fixed maturities:
Public, available-for-sale, at fair value $ 309,813 63.7 % $ 29,475 $ 339,288
Public, held-to-maturity, at amortized cost, net of allowance
1,719 0.4 0 1,719
Private, available-for-sale, at fair value 60,224 12.4 12,749 72,973
Private, held-to-maturity, at amortized cost, net of allowance
211 0.1 0 211
Fixed maturities, trading, at fair value 3,425 0.7 277 3,702
Assets supporting experience-rated contractholder
liabilities, at fair value 24,115 5.0 0 24,115
Equity securities, at fair value 5,108 1.1 2,345 7,453
Commercial mortgage and other loans, at book value, net of allowance
55,892 11.5 8,421 64,313
Policy loans, at outstanding balance 7,207 1.5 4,064 11,271
Other invested assets, net of allowance(1) 10,716 2.1 3,610 14,326
Short-term investments, net of allowance 7,640 1.5 124 7,764
Total general account investments 486,070 100.0 % 61,065 547,135
Invested assets of other entities and operations(2) 6,485 0 6,485
Total investments $ 492,555 $ 61,065 $ 553,620
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, net of allowance
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
__________
(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 2020 was primarily due to a decrease in interest rates,
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, 2020 and 2019, 43% and 42%, 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,
2020 2019
(in millions)
Fixed maturities:
Public, available-for-sale, at fair value $ 154,261 $ 142,220
Public, held-to-maturity, at amortized cost, net of allowance 1,719 1,705
Private, available-for-sale, at fair value 21,748 19,189
Private, held-to-maturity, at amortized cost, net of allowance 211 228
Fixed maturities, trading, at fair value 550 492
Assets supporting experience-rated contractholder liabilities, at fair value
3,149 2,777
Equity securities, at fair value 2,134 2,185
Commercial mortgage and other loans, at book value, net of allowance
19,915 19,138
Policy loans, at outstanding balance 3,078 2,859
Other invested assets(1) 3,045 2,187
Short-term investments, net of allowance 438 165
Total Japanese general account investments $ 210,248 $ 193,145
__________
(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 2020 was primarily attributable to a decrease in interest rates, the reinvestment of net investment income and net business inflows. As of December 31, 2020, our Japanese insurance operations had $89.2 billion, at carrying value, of investments denominated inU.S. dollars, including $1.8 billion that were hedged to yen through third-party derivative contracts and $74.8 billion that support liabilities denominated inU.S. dollars, with the remainder as part of the hedging of foreign currency exchange rate exposure toU.S. dollar-equivalent equity. 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 as part of the hedging of foreign currency exchange rate exposure ofU.S. dollar-equivalent equity. The $12.1 billion increase in the carrying value ofU.S. dollar-denominated investments from December 31, 2019 was primarily attributable to a decrease in theU.S. treasury bond rates, reinvestment of net investment income and portfolio growth as a result of net business inflows. Our Japanese insurance operations had $10.2 billion and $9.9 billion, at carrying value, of investments denominated in Australian dollars that support liabilities denominated in Australian dollars as of December 31, 2020 and 2019, respectively. The $0.3 billion increase in the carrying value of Australian dollar-denominated investments from December 31, 2019 was primarily attributable to the translation impact of the Australian dollar strengthening against theU.S. dollar, partially offset by run off of the portfolio. For additional information regardingU.S. and Australian dollar investments held in our Japanese insurance operations and a discussion of our yen hedging strategy, see "-Results of Operations by Segment-Impact of Foreign Currency Exchange Rates" above. Investment Results The following tables set forth the investment results of our general account apportioned between PFI excluding the Closed Block division and the Closed Block division, for the periods indicated. The yields are based on net investment income as 114 -------------------------------------------------------------------------------- Table of Contents reported underU.S. GAAP and as such do not include certain interest-related items, such as settlements of duration management swaps which are included in "Realized investment gains (losses), net." Year Ended December 31, 2020 PFI Excluding Closed Block Division and Japanese PFI Excluding Closed Block Closed Block Operations Japanese Insurance Operations Division Division Total(5) Yield(1) Amount Yield(1) Amount Yield(1) Amount Amount Amount ($ in millions) Fixed maturities(2) 4.59 % $ 7,416 2.78 % $ 3,875 3.75 % $ 11,291 $ 1,566 $ 12,857 Assets supporting experience-rated contractholder liabilities 3.22 637 1.88 52 3.06 689 0 689 Equity securities 2.01 48 3.62 72 2.74 120 42 162 Commercial mortgage and other loans 3.95 1,377 2.89 731 3.91 2,108 358 2,466 Policy loans 5.31 238 3.23 98 4.47 336 247 583 Short-term investments and cash equivalents 0.83 171 0.86 14 0.83 185 6 191 Gross investment income 4.06 9,887 2.89 4,842 3.58 14,729 2,219 16,948 Investment expenses (0.12) (272) (0.14) (245) (0.13) (517) (136) (653) Investment income after investment expenses 3.94 % 9,615 2.75 % 4,597 3.45 % 14,212 2,083 16,295 Other invested assets(3) 413 245 658 157 815 Investment results of other entities and operations(4) 300 0 300 0 300 Total investment income $ 10,328 $ 4,842 $ 15,170 $ 2,240 $ 17,410 115
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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
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
__________
(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 (2019 and 2018) and amortized cost, net of allowance (2020).
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.
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(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.
(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 3.54%, 3.81% and 3.77% for the years ended December 31,
2020, 2019 and 2018, respectively.
The decrease 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 2020 compared to 2019 was
primarily the result of lower fixed income reinvestment rates.
The decrease in investment income after investment expenses yield attributable
to the Japanese insurance operations' portfolio for 2020 compared to 2019 was
primarily the result of lower fixed income reinvestment rates.
Both the U.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 of U.S.
dollar-denominated fixed maturities that are not hedged to yen through
third-party derivative contracts was approximately $54.2 billion and $47.5
billion, for the years ended December 31, 2020 and 2019, respectively. The
majority of U.S. dollar-denominated fixed maturities support liabilities that
are denominated in U.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 $8.2 billion and $8.4
billion, for the years ended December 31, 2020 and 2019, respectively. The
majority of Australian dollar-denominated fixed maturities support liabilities
that are denominated in Australian dollars. For additional information regarding
U.S. and Australian dollar investments held in our Japanese insurance
operations, see "-Results of Operations by Segment-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 "Charges related to realized
investment gains (losses), net" and adjustments, for the periods indicated:
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Years Ended December 31,
2020 2019 2018
(in millions)
PFI excluding Closed Block Division:
Realized investment gains (losses), net:
Due to foreign exchange movements on securities
approaching maturity(2) $ (26) $ (53) $ (23)
Due to securities actively marketed for sale(2) (83) (4) (24)
Due to credit or adverse conditions of the respective issuer(1)(3)
(111) (175) (169)
Allowance for credit losses on fixed maturities(1)(3) (105) N/A N/A
Net gains (losses) on sales and maturities 777 867 504
Fixed maturity securities(4) 452 635 288
Commercial mortgage and other loans 10 (6) (15)
Derivatives (4,571) (1,623) 1,249
OTTI losses on other invested assets recognized in earnings
(33) (18) (7)
Allowance for credit losses on other invested assets (1) N/A N/A
Other net gains (losses) 17 70 106
Other (17) 52 99
Subtotal (4,126) (942) 1,621
Investment results of other entities and operations(5) 57 (38) 226
Total - PFI excluding Closed Block Division (4,069) (980) 1,847
Related adjustments(6) (87) 145 (1,236)
Realized investment gains (losses), net, and related adjustments(6)
(4,156) (835) 611
Charges related to realized investment gains (losses), net
(159) (123) (315)
Realized investment gains (losses), net, and charges related to realized investment gains (losses), net and adjustments(6)
$ (4,315) $ (958) $ 296
Closed Block Division:
Realized investment gains (losses), net:
Due to foreign exchange movements on securities
approaching maturity(2) $ (69) $ (56) $ (28)
Due to securities actively marketed for sale(2) (9) 0 (9)
Due to credit or adverse conditions of the respective issuer(1)(3)
(6) (27) (26)
Allowance for credit losses on fixed maturities(1)(3) (27) N/A N/A
Net gains (losses) on sales and maturities 388 417 3
Fixed maturity securities(4) 277 334 (60)
Commercial mortgage and other loans 0 3 (6)
Derivatives (87) 193 193
OTTI losses on other invested assets recognized in earnings
0 0 (1)
Allowance for credit losses on other invested assets 0 N/A N/A
Other net gains (losses) (8) (9) 4
Other (8) (9) 3
Subtotal - Closed Block Division 182 521 130
Consolidated PFI realized investment gains (losses), net $ (3,887)
$ (459) $ 1,977
__________
(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 or allowance 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 (2019 and 2018) or allowance (2020).
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(2)Represents the difference between the fair value of the debt security and the
amortized cost at the time of the write-down.
(3)Beginning January 1, 2020, related to the implementation of ASU 2016-13,
write-offs of credit adverse securities are reported as OTTI.
(4)Includes fixed maturity securities classified as available-for-sale and
held-to-maturity and excludes fixed maturity securities classified as trading.
(5)Includes "realized investment gains (losses), net" of our investment
management operations.
(6)Prior period amounts have been updated to conform to current period
presentation.
2020 to 2019 Annual Comparison
Net gains on sales and maturities of fixed maturity securities were $777 million and $867 million for the years ended December 31, 2020 and 2019, 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 and other sales of fixed maturity securities within our domestic segments driven by interest rate declines during the investment holding period.
Net realized losses on derivative instruments of $4,571 million, for the year ended December 31, 2020, primarily included:
•$3,957 million of losses on product-related embedded derivatives and related hedge positions associated with certain variable annuity contracts; and •$2,362 million of losses on capital hedges due to increases in equity indices.
Partially offsetting these losses were:
•$1,483 million of gains on interest rate derivatives due to decreases in swap andU.S. Treasury rates; •$139 million of gains for fees earned on fee-based synthetic GICs; and •$61 million of gains on foreign currency hedges due to Japanese yen strengthening againstU.S. dollar.
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 andU.S. Treasury rates; •$378 million of gains on foreign currency hedges due toU.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.
For a discussion of living benefit guarantees and related hedge positions in our
Individual Annuities segment, see "-Results of Operations by Segment-
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, 2020 and 2019 reflected related adjustments of net negative $87 million and net positive $145 million, respectively. Both periods' results reflected settlements and changes in value related to interest rate and currency derivatives, as well as changes in the fair value of equity securities and fixed income securities designated as trading. Additionally, the results for 2020 included the impact of foreign currency exchange rate movements on certain non-local currency denominated assets and liabilities, for which the majority of the foreign currency exposure is hedged and offset in "Realized Investment gains (losses), net." 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, 2020 and 2019 reflected net related charges of $159 million and $123 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.
Credit Losses
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The level of credit losses generally reflects current and expected economic conditions and is expected to increase when economic conditions worsen and to decrease when economic conditions improve. Historically, the causes of credit losses have been specific to each individual issuer and have not directly resulted in credit losses 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 and for wholly-owned investment real estate, 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.
COVID-19
A continued impact of COVID-19 on the global economy and corporate credit may result in losses and credit migration in our investment portfolio. Due to the highly uncertain nature of these conditions, it is not possible to estimate the overall impacts at this time. We believe our investment portfolio has been diligently constructed with a strong focus on ALM discipline, risk management, and capital preservation; and although certain industries will likely be more impacted by COVID-19 driven market conditions, we expect to benefit from our experience in managing highly specialized asset classes through multiple credit cycles. The following represents some of the sectors in our investment portfolio most impacted by COVID-19. Energy Related Investments As of December 31, 2020, PFI excluding the Closed Block division had energy related exposure with a market value of approximately $14 billion including a net unrealized gain of $1 billion, which was reflected in AOCI. This $14 billion represented investments in public and private corporate fixed maturity securities (excluding trading securities) and was comprised of the midstream (43%), independent energy (25%), integrated energy (20%), oil field services (6%) and refining (6%) sub-sectors. As of December 31, 2020, the credit quality of energy sector fixed maturity securities was 86% investment grade and 14% below investment grade. Energy related investment realized losses were approximately $184 million, comprised of $126 million of write-downs and $58 million of addition to credit loss allowances for the year ended December 31, 2020. Our investments in the energy sector could experience future valuation declines or losses if energy prices maintain their recent levels or continue to decline for an extended period of time. Our assessment that securities are other-than-temporarily impaired may change due to new developments, including those developments related to COVID-19.
Consumer Cyclical Related Investments
As of December 31, 2020, PFI excluding the Closed Block division had consumer cyclical related exposure with a market value of approximately $13 billion and a net unrealized gain of $1 billion, which was reflected in AOCI. This $13 billion represented investments in public and private corporate fixed maturity securities (excluding trading securities) and included exposures in retail (37%), automotive (18%), leisure (7%), restaurants (7%), gaming (4%) and lodging (1%). As of December 31, 2020, the credit quality of consumer cyclical sector fixed maturity securities was 79% investment grade and 21% below investment grade. For additional information regarding "-Retail Related Investments," see below. Retail Related Investments As of December 31, 2020, PFI excluding the Closed Block division had retail related investments of approximately $13 billion consisting primarily of $6 billion of corporate fixed maturities of which 89% were considered investment grade (also included in "-Consumer Cyclical Related Investments"); $6 billion of commercial mortgage loans with a weighted-average loan-to-value ratio of approximately 58% and weighted-average debt service coverage ratio of 2.13 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 99% and 1% were ratedAAA (super-senior) and AA to A, 120 -------------------------------------------------------------------------------- Table of Contents 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.
Airline Related Investments
As of December 31, 2020, PFI excluding the Closed Block division had $0.1 billion of airline related corporate fixed maturities within the transportation sector of which 97% were investment grade.
General Account Investments of PFI excluding Closed Block Division
In the following sections, we provide details about our investment portfolio, excluding investments held in the Closed Block division. We believe the details of the composition of our investment portfolio excluding the Closed Block division are most relevant to an understanding of our operations that are pertinent to investors inPrudential Financial, Inc. because substantially all Closed Block division assets support obligations and liabilities relating to the Closed Block policies only. See Note 15 to the Consolidated Financial Statements for further information on the Closed Block.
Fixed Maturity Securities
In the following sections, we provide details about our fixed maturity securities portfolio, which excludes fixed maturity securities classified as assets supporting experienced-rated contractholder liabilities and classified as trading.
Fixed Maturity Securities by Contractual Maturity Date
The following table sets forth the breakdown of the amortized cost of our fixed
maturity securities portfolio by contractual maturity, as of the date indicated:
December 31, 2020
Amortized
Cost % of Total
($ in millions)
Corporate & government securities:
Maturing in 2021 $ 10,141 3.2 %
Maturing in 2022 9,391 2.9
Maturing in 2023 11,618 3.6
Maturing in 2024 12,550 3.9
Maturing in 2025 12,836 4.0
Maturing in 2026 13,795 4.3
Maturing in 2027 14,401 4.5
Maturing in 2028 10,584 3.3
Maturing in 2029 12,285 3.9
Maturing in 2030 11,356 3.6
Maturing in 2031 9,066 2.9
Maturing in 2032 and beyond 166,639 52.1
Total corporate & government securities 294,662 92.2
Asset-backed securities 11,584
3.6
Commercial mortgage-backed securities 10,296
3.2
Residential mortgage-backed securities 2,838 1.0
Total fixed maturities $ 319,380 100.0 %
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Fixed Maturity Securities by Industry
The following table sets forth the composition of the portion of our fixed
maturity, available-for-sale portfolio by industry category attributable to PFI
excluding the Closed Block division and the associated gross unrealized gains
and losses, as well as the allowance for credit losses, as of the dates
indicated:
December 31, 2020 December 31, 2019
Gross Gross Allowance for Gross Gross
Amortized Unrealized Unrealized Credit Fair Amortized Unrealized Unrealized Fair
Industry(1) Cost Gains Losses Losses (5) Value Cost Gains Losses Value
(in millions)
Corporate securities:
Finance $ 37,577 $ 5,240 $ 70 $ 0 $ 42,747 $ 34,710 $ 2,796 $ 85 $ 37,421 Consumer non-cyclical
28,891 5,085 52 0 33,924 24,941 2,846 112 27,675
Utility 24,235 4,504 60 11 28,668 22,341 2,498 81 24,758
Capital goods 13,711 1,947 49 2 15,607 12,287 1,150 83 13,354
Consumer cyclical 11,196 1,536 52 13 12,667 10,871 994 45 11,820
Foreign agencies 5,323 903 11 0 6,215 5,649 928 10 6,567
Energy 12,257 1,583 118 58 13,664 12,922 1,126 186 13,862
Communications 6,013 1,343 35 22 7,299 5,916 939 34 6,821
Basic industry 5,895 914 17 0 6,792 5,866 497 38 6,325
Transportation 10,067 1,568 40 0 11,595 9,443 833 34 10,242
Technology 3,717 381 14 0 4,084 3,395 278 13 3,660
Industrial other 4,485 778 21 0 5,242 3,894 351 33 4,212
Total corporate securities 163,367 25,782 539 106 188,504 152,235 15,236 754 166,717
Foreign government(2) 93,521 16,229 236 0 109,514 97,880 20,658 63 118,475
Residential mortgage-backed(3) 2,572 198 0 0 2,770 2,955 154 1 3,108
Asset-backed 11,584 137 67 0 11,654 9,832 123 34 9,921
Commercial mortgage-backed 10,296 883 8 0 11,171 10,211 441 9 10,643
U.S. Government 25,959 8,348 15 0 34,292 24,938 4,511 94 29,355
State & Municipal 10,142 1,991 1 0 12,132 9,593 1,327 7 10,913
Total fixed maturities,
available-for-sale(4)(5) $ 317,441 $ 53,568 $ 866 $ 106 $ 370,037 $ 307,644 $ 42,450 $ 962 $ 349,132
__________
(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)As of December 31, 2020 and 2019, based on amortized cost, 86% and 76%,
respectively, represent Japanese government bonds held by our Japanese insurance
operations with no other individual country representing more than 4% and 11% of
the balance, respectively.
(3)As of December 31, 2020 and 2019, based on amortized cost, 97% and more than
99% were rated A or higher, respectively.
(4)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.
(5)Effective January 1, 2020, due to the implementation of ASU 2016-13, an
allowance for credit losses is now presented for available-for-sale securities.
Prior period amounts have been updated to exclude held-to-maturity securities to
conform to current period presentation.
The increase in net unrealized gains from December 31, 2019 to December 31, 2020
was primarily due to a decrease in
The following table sets forth the composition of the portion of our fixed
maturity, held-to-maturity portfolio by industry category attributable to PFI
excluding the Closed Block division and the associated gross unrealized gains
and losses, as well as the allowance for credit losses, as of the dates
indicated:
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December 31, 2020 December 31, 2019
Gross Gross Allowance for Gross Gross
Amortized Unrealized Unrealized Fair Credit Amortized Unrealized Unrealized Fair
Industry(1) Cost Gains Losses Value Losses Cost Gains Losses Value
(in millions)
Corporate securities:
Finance $ 651 $ 67 $ 0 $ 718 $ 9 $ 628 $ 64 $ 0 $ 692
Foreign agencies 0 0 0 0 0 21 0 0 21
Basic industry 87 2 0 89 0 83 2 0 85
Total corporate securities 738 69 0 807 9 732 66 0 798
Foreign government(2) 935 270 0 1,205 0 891 282 0 1,173
Residential mortgage-backed(3) 266 20 0 286 0 310 21 0 331
Total fixed maturities,
held-to-maturity(4) $ 1,939 $ 359 $ 0 $ 2,298 $ 9 $ 1,933 $ 369 $ 0 $ 2,302 __________ (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)As of both December 31, 2020 and 2019, based on amortized cost, 98% represent Japanese government bonds held by our Japanese insurance operations. (3)As of both December 31, 2020 and 2019, based on amortized cost, all were rated A or higher. (4)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.
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.
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, available-for-sale portfolio
by NAIC Designation or equivalent rating attributable to PFI excluding the
Closed Block division, as of the dates indicated:
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December 31, 2020 December 31, 2019
Gross Gross Allowance for Gross Gross
Amortized Unrealized Unrealized Credit Fair Amortized Unrealized Unrealized Fair
NAIC Designation(1)(2) Cost Gains
Losses(3) Losses(7) Value Cost Gains Losses(3) Value
(in millions)
1 $ 229,951 $ 41,311 $ 381 $ 0 $ 270,881 $ 232,039 $ 35,923 $ 287 $ 267,675
2 68,458 10,683 180 0 78,961 59,114 5,198 384 63,928
Subtotal High or Highest Quality
Securities(4) 298,409 51,994 561 0 349,842 291,153 41,121 671 331,603
3 11,913 1,192 95 0 13,010 10,033 854 93 10,794
4 5,119 211 119 23 5,188 4,914 248 98 5,064
5 1,629 123 67 16 1,669 1,280 196 83 1,393
6 371 48 24 67 328 264 31 17 278
Subtotal Other Securities(5)(6) 19,032 1,574 305 106 20,195 16,491 1,329 291 17,529
Total fixed maturities,
available-for-sale(7) $ 317,441 $ 53,568 $ 866 $ 106 $ 370,037 $ 307,644 $ 42,450 $ 962 $ 349,132
__________
(1)Reflects equivalent ratings for investments of the international insurance
operations.
(2)Includes, as of December 31, 2020 and 2019, 102 securities with amortized
cost of $356 million (fair value, $382 million) and 796 securities with
amortized cost of $3,073 million (fair value, $3,130 million), respectively,
that have been categorized based on expected NAIC Designations pending receipt
of SVO ratings.
(3)As of December 31, 2020, includes gross unrealized losses of $184 million on
public fixed maturities and $121 million on private fixed maturities considered
to be other than high or highest quality and, 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.
(4)On an amortized cost basis, as of December 31, 2020, includes $253,387
million of public fixed maturities and $45,022 million of private fixed
maturities and, as of December 31, 2019, includes $248,179 million of public
fixed maturities and $42,974 million of private fixed maturities.
(5)On an amortized cost basis, as of December 31, 2020, includes $9,592 million
of public fixed maturities and $9,440 million of private fixed maturities and,
as of December 31, 2019, includes $9,049 million of public fixed maturities and
$7,442 million of private fixed maturities.
(6)On an amortized cost basis, as of December 31, 2020, securities considered
below investment grade based on low issue composite ratings total $15,747
million, or 5% of the total fixed maturities, and include securities considered
high or highest quality by the NAIC based on the rules described above.
(7)Effective January 1, 2020, due to the implementation of ASU 2016-13, an
allowance for credit losses is now presented for available-for-sale securities.
Prior period amounts have been updated to exclude held-to-maturity securities to
conform to current period presentation.
The following table sets forth our fixed maturity, held-to-maturity portfolio by
NAIC Designation or equivalent rating attributable to PFI excluding the Closed
Block division, as of the dates indicated:
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December 31, 2020 December 31, 2019
Gross Gross Allowance Gross Gross
Amortized Unrealized Unrealized Fair for Credit Amortized Unrealized Unrealized Fair
NAIC Designation(1) Cost Gains Losses(2) Value Losses Cost Gains Losses(2) Value
(in millions)
1 $ 1,839 $ 349 $ 0 $ 2,188 $ 7 $ 1,743 $ 351 $ 0 $ 2,094
2 100 10 0 110 2 190 18 0 208
Subtotal High or Highest
Quality Securities(3) 1,939 359 0 2,298 9 1,933 369 0 2,302
3 0 0 0 0 0 0 0 0 0
4 0 0 0 0 0 0 0 0 0
5 0 0 0 0 0 0 0 0 0
6 0 0 0 0 0 0 0 0 0
Subtotal Other Securities 0 0 0 0 0 0 0 0 0
Total fixed maturities,
held-to-maturity $ 1,939 $ 359 $ 0 $ 2,298 $ 9 $ 1,933 $ 369 $ 0 $ 2,302
__________
(1)Reflects equivalent ratings for investments of the international insurance
operations.
(2)As of both December 31, 2020 and December 31, 2019, there were no gross
unrealized losses on public fixed maturities and private fixed maturities
considered to be other than high or highest quality.
(3)On an amortized cost basis, as of December 31, 2020, includes $1,728 million
of public fixed maturities and $211 million of private fixed maturities and, as
of December 31, 2019, includes $1,705 million of public fixed maturities and
$228 million of private fixed maturities.
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:
December 31, 2020 December 31, 2019
Asset-Backed Commercial Mortgage-Backed Asset-Backed Commercial Mortgage-Backed
Securities(2) Securities(3) Securities(2) Securities(3)
Low Issue Composite Amortized Amortized Amortized
Rating(1) Cost Fair Value Cost Fair Value Amortized Cost Fair Value Cost Fair Value
(in millions)
AAA $ 11,327 $ 11,323 $ 10,284 $ 11,159 $ 9,585 $ 9,594 $ 10,196 $ 10,627
AA 139 144 1 2 83 86 0 0
A 16 17 2 2 40 41 6 7
BBB 12 13 9 8 19 21 9 9
BB and below 90 157 0 0 105 179 0 0
Total(4)(5) $ 11,584 $ 11,654 $ 10,296 $ 11,171 $ 9,832 $ 9,921 $ 10,211 $ 10,643
__________
(1)The table above provides ratings as assigned by nationally recognized rating
agencies as of December 31, 2020, including S&P, Moody's, Fitch Ratings Inc.
("Fitch") and Morningstar, Inc. ("Morningstar"). Low issue composite rating uses
ratings from the major credit rating agencies or if these are not available an
equivalent internal rating. For securities where the ratings assigned are not
equivalent, the second lowest rating is utilized.
(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, 2020 and 2019, based on amortized cost, 98% and 97% 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.
(5)Prior period amounts have been updated to conform to current period
presentation.
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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, 2020 December 31, 2019
Collateralized Loan Obligations
Low Issue Composite Rating(1) Amortized Cost Fair Value Amortized Cost Fair Value
(in millions)
AAA $ 9,554 $ 9,506 $ 7,294 $ 7,271
AA 2 2 0 0
A 1 1 0 0
BBB 1 1 0 0
BB and below 1 1 0 0
Total(2)(3)(4) $ 9,559 $ 9,511 $ 7,294 $ 7,271
__________
(1)The table above provides ratings as assigned by nationally recognized rating
agencies as of December 31, 2020, including S&P, Moody's, Fitch and Morningstar.
Low issue composite rating uses ratings from the major credit rating agencies or
if these are not available an equivalent internal rating. For securities where
the ratings assigned are not equivalent, the second lowest rating is utilized.
(2)There was no allowance for credit losses as of December 31, 2020.
(3)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.
(4)Prior period amounts have been updated to conform to current period
presentation.
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:
December 31, 2020 December 31, 2019
(in millions)
Commercial mortgage and agricultural property loans $ 55,223 $ 53,928
Uncollateralized loans 655 656
Residential property loans 101 124
Other collateralized loans 120 65
Total recorded investment gross of allowance(1) 56,099 54,773
Allowance for credit losses (207) (102)
Total net commercial mortgage and other loans(2) $ 55,892 $ 54,671
__________
(1)As a percentage of recorded investment gross of allowance, more than 99% of these assets were current as of both December 31, 2020 and 2019. (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 theU.S. and international offices primarily inLondon andTokyo . 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 reverse dual currency loans and corporate loans held by the company's international insurance operations.
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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:
December 31, 2020 December 31, 2019
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 $ 19,186 34.7 % $ 18,061 33.5 %
South Atlantic 8,710 15.8 8,943 16.6
Middle Atlantic 6,500 11.8 6,664 12.4
East North Central 3,018 5.5 3,413 6.3
West South Central 5,426 9.8 5,439 10.1
Mountain 2,239 4.1 2,442 4.5
New England 1,664 3.0 1,902 3.5
West North Central 531 0.9 454 0.8
East South Central 836 1.5 622 1.2
Subtotal-U.S. 48,110 87.1 47,940 88.9
Europe 4,605 8.3 3,781 7.0
Asia 979 1.8 886 1.6
Other 1,529 2.8 1,321 2.5
Total commercial mortgage and agricultural property
loans $ 55,223 100.0 % $ 53,928 100.0 %
__________(1)Regions as defined by the United States Census Bureau.
December 31, 2020 December 31, 2019
Gross Gross
Carrying % of Carrying % of
Value Total Value Total
($ in millions)
Commercial mortgage and agricultural property loans by property
type:
Industrial $ 13,819 25.0 % $ 12,224 22.7 %
Retail 5,718 10.4 6,524 12.1
Office 10,719 19.4 11,203 20.8
Apartments/Multi-Family 15,316 27.7 15,176 28.1
Agricultural properties 3,273 5.9 2,856 5.3
Hospitality 2,056 3.7 2,066 3.8
Other 4,322 7.9 3,879 7.2
Total commercial mortgage and agricultural property loans $ 55,223 100.0 % $ 53,928 100.0 %
127-------------------------------------------------------------------------------- Table of Contents 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. As of December 31, 2020, 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 58%. As of December 31, 2020, 94% of commercial mortgage and agricultural property loans were fixed rate loans. For those commercial mortgage and agricultural property loans that were originated in 2020, the weighted-average debt service coverage ratio was 2.71 times, and the weighted-average loan-to-value ratio was 65%. 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 credit 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 $2.4 billion and $1.8 billion of such loans as of December 31, 2020 and 2019, respectively. All else being equal, these loans are inherently riskier than those collateralized by properties that have already stabilized. As of December 31, 2020 and 2019, there were $1 million and $0 million, respectively, of allowances 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, 2020
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% $ 26,359 $ 742 $ 467 $ 27,568
60%-69.99% 16,692 1,305 233 18,230
70%-79.99% 7,897 799 214 8,910
80% or greater 199 304 12 515
Total commercial mortgage and agricultural property
loans $ 51,147 $ 3,150 $ 926 $ 55,223
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:
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December 31, 2020
Gross
Carrying % of
Value Total
Year of Origination ($ in millions)
2020 $ 5,468 9.9 %
2019 10,103 18.3
2018 8,504 15.4
2017 7,119 12.9
2016 6,278 11.4
2015 5,513 9.9
2014 4,405 8.0
2013 & Prior 7,833 14.2
Total commercial mortgage and agricultural property loans $ 55,223 100.0 %
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, 2020
Gross
Carrying Value % of Total
Vintage ($ in millions)
Maturing in 2021 $ 2,604 4.6 %
Maturing in 2022 3,822 6.8
Maturing in 2023 3,856 6.9
Maturing in 2024 5,790 10.3
Maturing in 2025 6,881 12.3
Maturing in 2026 6,270 11.2
Maturing in 2027 5,727 10.2
Maturing in 2028 5,280 9.4
Maturing in 2029 4,949 8.8
Maturing in 2030 3,634 6.5
Maturing in 2031 815 1.5
Maturing in 2032 and beyond 6,471 11.5Total commercial mortgage and other loans $ 56,099 100.0 %
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.
The current expected credit loss ("CECL") allowance represents the Company's
best estimate of expected credit losses over the remaining life of the assets.
The determination of the allowance considers historical credit loss experience,
current
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For commercial mortgage and agricultural mortgage loans, the allowance is calculated using an internally developed CECL model.
Key inputs to the CECL model include unpaid principal balances, internal credit ratings, annual expected loss factors, average lives of the loans adjusted for prepayment considerations, current and historical interest rate assumptions and other factors influencing the Company's view of the current stage of the economic cycle and future economic conditions. Subjective considerations include a review of whether historical loss experience is representative of current market conditions and the Company's view of the credit cycle. Model assumptions and factors are reviewed and updated as appropriate. When individual loans no longer have the credit risk characteristics of the commercial or agricultural mortgage loan pools, they are removed from the pools and are evaluated individually for an allowance. The allowance is determined based on the outstanding loan balance less the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. The CECL allowance for other collateralized and uncollateralized loans carried at amortized cost is determined based on probability of default and loss given default assumptions by sector, credit quality and average lives of the loans.
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:
December 31, 2020 December 31, 2019
(in millions)
Allowance, beginning of year $ 102 $ 106
Cumulative effect of adoption of ASU 2016-13 101 0
Addition to (release of) allowance for credit losses 1 (4)
Recoveries of amounts previously written-down 0 N/A
Other 3 0
Allowance, end of period $ 207 $ 102
The allowance for credit losses as of December 31, 2020 increased compared to December 31, 2019, primarily due to the cumulative effect of adopting ASU 2016-13.
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, 2020 December 31, 2019
Gross Gross Gross Gross
Unrealized Unrealized Fair Unrealized Unrealized Fair
Cost Gains Losses Value Cost Gains Losses Value
(in millions)
Mutual funds $ 1,481 $ 410 $ 5 $ 1,886 $ 817 $ 258 $ 1 $ 1,074
Other Common Stocks 2,201 1,013 62 3,152 2,429 1,091 57 3,463
Non-redeemable Preferred Stocks 54 22 6 70 51 3 5 49
Total equity securities, at fair
value(1) $ 3,736 $ 1,445 $ 73 $ 5,108 $ 3,297 $ 1,352 $ 63 $ 4,586
__________(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 $83 million and $586 million during the year ended
December 31, 2020 and 2019, respectively.
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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:
December 31, 2020 December 31, 2019
(in millions)
LPs/LLCs:
Equity method:
Private equity $ 3,547 $ 2,740
Hedge funds 1,770 1,362
Real estate-related 1,078 792
Subtotal equity method 6,395 4,894
Fair value:
Private equity 1,063 990
Hedge funds 1,111 1,233
Real estate-related 41 50
Subtotal fair value 2,215 2,273
Total LPs/LLCs 8,610 7,167
Real estate held through direct ownership(1) 1,176 1,350
Derivative instruments 199 73
Other(2) 731 620
Total other invested assets $ 10,716 $ 9,210
__________
(1)As of December 31, 2020 and 2019, real estate held through direct ownership
had mortgage debt of $409 million and $537 million, respectively.
(2)Primarily includes leveraged leases and member and activity stock held in the
Federal Home Loan Banks of New York and Boston . For additional information
regarding our holdings in the Federal Home Loan Banks of New York and Boston ,
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, 2020 December 31, 2019
(in millions)
Fixed maturities:
Public, available-for-sale, at fair value(1) $ 644 $ 587
Private, available-for-sale, at fair value 0 1
Fixed maturities, trading, at fair value(1) 212 1,161
Equity securities, at fair value 682 691
Commercial mortgage and other loans, at book value(2) 1,112 259
Other invested assets(1) 3,799 3,062
Short-term investments 36 17
Total investments $ 6,485 $ 5,778
__________
(1)As of December 31, 2020 and 2019, balances include investments in CLOs with
fair value of $496 million and $438 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. The principles of our liquidity and capital management framework are
described in an enterprise wide policy that is reviewed and approved by our
Board.
Our businesses are subject to comprehensive regulation and supervision by domestic and international regulators. These regulations currently include requirements (many of which are the subject of ongoing rule-making) relating to capital and liquidity management. For information on these regulatory initiatives and their potential impact on us, see "Business-Regulation" and "Risk Factors."
COVID-19 and Related Market Disruptions
Beginning in the first quarter of 2020, broad market concerns over the impact of
COVID-19 have led to significant volatility and disruptions in the global
economy and financial markets. In 2020 we took the following significant
management actions that impacted our liquidity and capital position, including
in response to this macro environment and the global pandemic:
•We executed transactions to reduce our ongoing financing costs in August by
issuing $1.3 billion of junior subordinated notes at interest rates of 3.70% and
4.125% and with maturities ranging from 2050 to 2060 and using the proceeds to
redeem in September our $710 million 5.70% junior subordinated notes due in 2053
and our $575 million 5.75% junior subordinated notes due in 2052;
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•In May, we augmented our alternative sources of liquidity by entering into a
facility agreement with a Delaware trust, pursuant to which Prudential Financial
may issue and sell to the trust at any time over a ten-year period up to $1.5
billion of 2.850% senior notes due May 15, 2030 and receive in exchange a
corresponding amount of U.S. Treasury securities. The facility agreement is
similar to our existing put option agreement that allows us to issue up to $1.5
billion of senior notes to a trust, which we established in 2013 and expires in
2023;
•We suspended Common Stock repurchases under our existing repurchase
authorization beginning April 1, 2020, after repurchasing $500 million of shares
of Prudential Financial's Common Stock in the first quarter of 2020. On February
4, 2021, the Board authorized the Company to repurchase, at management's
discretion, up to $1.5 billion of its outstanding Common Stock during the period
from January 1, 2021 through December 31, 2021;
•In March, we issued $1.5 billion of senior notes, with maturities ranging from
2026 to 2040, for general corporate purposes, including pre-funding part of our
senior notes maturing through 2021. Of these senior notes, $500 million were
issued in the form of "green bonds," where proceeds are allocated to existing or
future investments in assets, businesses or projects that provide environmental
benefits;
•In March, Prudential Legacy Insurance Company of New Jersey issued $800 million
of surplus notes under its $4 billion reserve financing facility to enhance the
statutory surplus of the Closed Block. Following a partial redemption in
December 2020, the facility had $400 million of surplus notes outstanding as of
December 31, 2020. Established in 2015, this facility is intended to alleviate
any temporary impact to the Closed Block's surplus due to the timing difference
between the mark to market on assets and the decision on the level of the
policyholder dividend;
•We executed additional capital hedges that protect the capital position of our
U.S. insurance subsidiaries against additional declines in the equity markets;
and
•We accelerated our product diversification strategy and repriced certain
products, which are expected to support the capital position of our insurance
subsidiaries over time.
Liquidity. The Company continues to operate with significant liquid resources
and maintains access to substantial alternative sources of liquidity, such as
committed credit facilities, membership in the Federal Home Loan Banks,
commercial paper programs, and agreements that allow us to issue senior debt to
trust entities. As of December 31, 2020, Prudential Financial had highly liquid
assets of $5.6 billion, excluding the net borrowings from an intercompany
liquidity account. Nevertheless, adverse developments related to COVID-19 and
associated market dislocations could strain our existing liquidity. For example,
capital or liquidity needs at our subsidiaries resulting from market conditions
or business operations could require us to use our highly liquid assets or tap
alternative sources of liquidity, and our access to traditional funding sources,
such as commercial paper borrowings, could become limited due to market
conditions. Any need to increase the use of our alternative sources of liquidity
may result in increased financial leverage on our balance sheet and negatively
impact our credit and financial strength ratings or ratings outlooks.
Capital. As of December 31, 2020, all of our significant insurance subsidiaries
maintained capital levels consistent with their ratings targets. However, market
conditions could negatively impact the statutory capital of our insurance
companies and constrain our overall capital flexibility. For example, adverse
market conditions may lead to increased defaults and/or further deterioration in
the credit quality or fair values of our investment portfolio, which would
negatively impact the statutory capital of our insurance subsidiaries. Adverse
market conditions could require us to take additional management actions for our
insurance subsidiaries to maintain capital consistent with their ratings
objectives, which may include redeploying financial resources from internal
sources or using available external sources of capital or seeking additional
sources.
Liquidity and Capital Risk Management. 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. 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, including
scenarios similar to, and more severe than, those occurring due to COVID-19, and
is intended to ensure that sufficient resources are available to absorb those
impacts. We believe that our capital and liquidity resources are sufficient to
satisfy the capital and liquidity requirements of Prudential Financial and its
subsidiaries.
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.
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We believe Prudential Financial's capitalization and financial profile are
consistent with its ratings targets. Our long-term senior debt rating targets
for Prudential Financial are "A" for S&P, Moody's, and Fitch, and "a" for A.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+" for A.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, 2020, the Company had $50.2 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,
2020 2019
(in millions)
Equity(1) $ 36,687 $ 39,076Junior subordinated debt (including hybrid securities) 7,615
7,575 Other capital debt 5,856 7,001 Total capital $ 50,158 $ 53,652 __________
(1)Amounts attributable to
Insurance Regulatory Capital
We manage PICA, ThePrudential Life Insurance Company, Ltd. ("Prudential ofJapan "), Gibraltar Life, and other significant insurance subsidiaries to regulatory capital levels consistent with our "AA" ratings targets. We utilize the RBC ratio as a primary 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, 2019, the most recent statutory fiscal year-end for these subsidiaries for which RBC information has been filed:
Ratio
PICA(1) 411 %
426 %
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__________
(1)Includes Prudential Retirement Insurance and Annuity Company ("PRIAC"), Pruco
Life Insurance Company ("Pruco Life"), Pruco Life Insurance Company of New
Jersey ("PLNJ"), which is a subsidiary of Pruco Life, and Prudential Legacy
Insurance Company of New Jersey ("PLIC").
(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, 2020 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, 2020, the most recent date for which this information is available:
Ratio
Prudential of Japan consolidated(1) 907 %
Gibraltar Life consolidated(2) 956 %
__________
(1)Includes Prudential Trust Co., Ltd., a subsidiary of Prudential ofJapan . (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, 2020.
All of our domestic and significant international insurance subsidiaries have capital levels that substantially exceed the minimum level required by applicable insurance regulations. However, as discussed above, market conditions could negatively impact the statutory capital of our insurance companies and constrain our overall capital flexibility. Our regulatory capital levels also 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 additional information on the calculation of RBC and solvency margin ratios, as well as regulatory minimums, see Note 19 to the Consolidated Financial Statements.
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 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. We suspended Common Stock repurchases under this authorization beginning April 1, 2020, after purchasing $500 million of shares ofPrudential Financial's Common Stock in the first quarter of 2020. On February 4, 2021, the Board authorized the Company to repurchase, at management's discretion, up to $1.5 billion of its outstanding Common Stock during the period from January 1, 2021 through December 31, 2021. 135 -------------------------------------------------------------------------------- Table of Contents In general, 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, credit migration and losses in our investment portfolio, 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 2020 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, 2020 $ 1.10 $ 442 0.0 $ 0 September 30, 2020 $ 1.10 $ 441 0.0 $ 0 June 30, 2020 $ 1.10 $ 441 0.0 $ 0 March 31, 2020 $ 1.10 $ 445 6.7 $ 500 Dividend Amount Shares Repurchased Year ended: Per Share Aggregate Shares Total Cost (in millions, except per share data) December 31, 2020 $ 4.40 $ 1,769 6.7 $ 500 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
In addition, on February 4, 2021,
Liquidity
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. During 2020, we issued $1.5 billion of senior notes, of which $1 billion were issued for general corporate purposes, including pre-funding in part our senior notes maturing through 2021. 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 to Prudential 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 by Prudential Financial's access to
the capital markets as well as the "-Alternative Sources of Liquidity" described
below.
The primary uses of funds at Prudential 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, 2020, Prudential Financial had highly liquid assets with a
carrying value totaling $6,479 million, an increase of $1,375 million from
December 31, 2019. Highly liquid assets predominantly include cash, short-term
investments, U.S. Treasury securities, obligations of other U.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
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borrowing of funds between Prudential Financial and its subsidiaries on a daily
basis. Excluding the net borrowings from this intercompany liquidity account,
Prudential Financial had highly liquid assets of $5,560 million as of
December 31, 2020, an increase of $1,499 million from December 31, 2019.
The following table sets forth Prudential Financial's principal sources and uses
of highly liquid assets, excluding net borrowings from our intercompany
liquidity account, for the periods indicated:
Sources and Uses of Holding Company Highly Liquid Assets Year Ended December 31,
2020 2019
(in millions)
Highly Liquid Assets, beginning of period $ 4,061 $ 5,548
Dividends and/or returns of capital from subsidiaries(1) 3,698 3,282
Affiliated loans/(borrowings) - (capital activities)(2) (1,017) 818
Capital contributions to subsidiaries(3) (386) (521)
Total Business Capital Activity 2,295 3,579
Share repurchases (500) (2,500)
Common stock dividends(4) (1,766) (1,641)
Acquisition/Disposition Activity(5) 1,627 (1,831)
Total Share Repurchases, Dividends and Acquisition/Disposition Activity
(639) (5,972)
Proceeds from the issuance of debt 2,768 2,465
Repayments of debt (2,467) (1,114)
Total Debt Activity 301 1,351
Proceeds from stock-based compensation and exercise of stock options
293 418
Interest income from subsidiaries on intercompany agreements, net of interest paid
223 199
Swap terminations(7) (190) (92)
Net income tax receipts & payments 482 103
Interest paid on external debt (988) (952)
Affiliated (borrowings)/loans - (operating activities)(6) (283) (115)
Other, net(7) 5 (6)
Total Other Activity (458) (445)
Net increase (decrease) in highly liquid assets 1,499 (1,487)
Highly Liquid Assets, end of period $ 5,560 $ 4,061
__________
(1)Includes $470 million in the form of in-kind dividends in 2020. 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)Represents the investment and deployment of capital to and from our businesses in the form of loans. 2020 includes net lending of $1,017 million from international insurance subsidiaries including $470 million received by PFI in the form of the extinguishment of debt held by international subsidiaries (offset by the in-kind dividends referred to in footnote 1 above). 2019 includes net receipts of $818 million from international subsidiaries. (3)2020 primarily includes capital contributions of $217 million to PGIM, and $170 million to international insurance subsidiaries. 2019 includes capital contributions of $200 million to PICA, $180 million to international insurance subsidiaries, $73 million to PGIM, and $68 million to Assurance IQ. (4)Includes cash payments made on dividends declared in prior periods. (5)2020 represents the net proceeds from the sale of POK that were distributed to PFI. 2019 represents costs related to the acquisition of Assurance IQ, including $1,758 million of purchase consideration and $73 million of compensation expense, which is recognized over the requisite service periods. (6)Represents loans to and from affiliated subsidiaries to support business operating needs. (7)Prior period amounts have been updated to conform to current period presentation.
Dividends and Returns of Capital from Subsidiaries
Domestic insurance subsidiaries. During 2020, Prudential Financial received returns of capital of $760 million from PALAC, dividends of $500 million from PICA and $120 million from Prudential Annuities Holding Company.
International insurance subsidiaries. During 2020, Prudential Financial received
dividends of $3,531 million from its international insurance subsidiaries, which
includes $1,627 million net proceeds from the sale of POK and $470 million of
in-kind dividends in the form of the extinguishment of debt held by
international insurance subsidiaries. In addition to paying Common Stock
dividends, our international insurance operations may return capital to
Prudential Financial through or facilitated by other means, such as the
repayment of preferred stock obligations held by Prudential Financial or other
affiliates, affiliated lending, affiliated derivatives and reinsurance with
U.S.- and Bermuda-based affiliates.
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Other subsidiaries. During 2020, Prudential Financial received dividends and
returns of capital of $399 million from PGIM subsidiaries and dividends of $14
million from other subsidiaries.
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 to Prudential Financial and other affiliates under applicable
insurance law and regulation. Further, as discussed above, recent market
conditions could negatively impact capital positions of our insurance companies,
which could further restrict their ability to pay dividends. 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 under New Jersey insurance
law, subject to prior notification to the New 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, to New 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
of Japan 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 of Japan and Gibraltar Life is March 31,
2021, 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 PGIM subsidiaries and the majority of our other operating subsidiaries to pay dividends is largely unrestricted from a regulatory standpoint.
See Note 19 to the Consolidated Financial Statements for information 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 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'
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Table of Contents 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.
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,
2020 2019
(in billions)PICA $ 227.2 $ 216.7 PLIC 50.9 51.8 Pruco Life 56.7 48.1 PRIAC 29.0 26.1 PALAC 27.7 19.1 Other(1) (102.9) (96.0)
Total future policy benefits and policyholders' account balances(2)
$ 288.6 $ 265.8
__________
(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
2020 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,
2020 2019
(in billions)
Prudential of Japan(1) $ 63.3 $ 56.4
Gibraltar Life(2) 114.6 108.0
All other international insurance subsidiaries(3) 1.5 15.4
Total future policy benefits and policyholders' account balances(4)
$ 179.4 $ 179.8
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139-------------------------------------------------------------------------------- Table of Contents (1)As of December 31, 2020 and 2019, $18.3 billion and $15.7 billion, respectively, of the insurance-related liabilities for Prudential of Japan are associated with U.S. dollar-denominated products that are coinsured to our domestic insurance operations and supported by U.S. dollar-denominated assets. As of December 31, 2020, $1.4 billion of the insurance-related liabilities for Prudential of Japan are primarily associated with yen- and U.S. dollar-denominated products that are coinsured to Gibraltar Re, our Bermuda-based reinsurance affiliate, and primarily supported by yen- and U.S. dollar-denominated 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 and primarily supported by yen-denominated assets. (2)Includes PGFL. As of December 31, 2020 and 2019, $7.1 billion and $5.5 billion, respectively, of the insurance-related liabilities for PGFL are associated with U.S. dollar-denominated products that are coinsured to our domestic insurance operations and supported by U.S. dollar-denominated assets. As of December 31, 2020, $4.5 billion of the insurance-related liabilities for Gibraltar Life are primarily associated with yen- and U.S. dollar-denominated products that are coinsured to Gibraltar Re and primarily supported by yen- and U.S. dollar-denominated 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 and primarily supported by yen-denominated assets. (3)Represents our international insurance operations, excluding Japan. (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 in U.S. and Australian dollars, that may be subject to increased surrenders should the yen depreciate in relation to these currencies or if interest rates in Australia and the U.S. decline relative to Japan. 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, 2020, products with a market value adjustment feature represented $26.1 billion of our Japan operations' insurance-related liabilities, which included $22.8 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, 2020
Prudential December 31,
Insurance(1) PLIC PRIAC PALAC Pruco Life Total 2019
(in billions)
Cash and short-term investments $ 6.4 $ 0.4 $ 0.7 $ 1.4 $ 0.5 $ 9.4 $
11.9
Fixed maturity investments(2): High or highest quality 138.2 37.4 21.2 18.9 6.7 222.4
201.3
Other than high or highest quality 9.4 3.5 1.3 0.8 0.4 15.4 12.2
Subtotal 147.6 40.9 22.5 19.7 7.1 237.8 213.5
Public equity securities, at fair
value 0.4 2.3 0.1 0.3 0.1 3.2 2.5
Total $ 154.4 $ 43.6 $ 23.3 $ 21.4 $ 7.7 $ 250.4 $ 227.9
__________
(1)Represents a legal entity view and as such includes both domestic and
international sleeves.
(2)Excludes fixed maturities designated as held-to-maturity. Credit quality is
based on NAIC or equivalent rating.
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The following table sets forth the fair value of our international insurance
operations' portfolio of liquid assets, as of the dates indicated:
December 31, 2020
Prudential Gibraltar All December 31,
of Japan Life(1) Other(2) Total 2019
(in billions)
Cash and short-term investments $ 1.3 $ 3.4 $ 1.3 $ 6.0 $ 5.0 Fixed maturity investments(3): High or highest quality(4)
44.1 97.4 6.2 147.7 157.2
Other than high or highest quality 0.7 2.2 1.9 4.8 5.4
Subtotal 44.8 99.6 8.1 152.5 162.6
Public equity securities 1.7 1.9 0.0 3.6 4.7
Total $ 47.8 $ 104.9 $ 9.4 $ 162.1 $ 172.3
__________
(1)Includes PGFL.
(2)Represents our international insurance operations, excluding Japan.
(3)Excludes fixed maturities designated as held-to-maturity. Credit quality is
based on NAIC or equivalent rating.
(4)As of December 31, 2020, $112.9 billion, or 76%, 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, 2020, the derivatives comprising the hedging portion of our ALM strategy and capital hedge program were in a net receive position of $3.4 billion compared to a net receive position of $4.7 billion as of December 31, 2019. The change in collateral position was primarily driven by a negative impact from increasing equities, partially offset by decreasing interest rates.
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:
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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,
2020, we have hedged 100%, 72%, and 31%, of expected yen-based earnings for
2021, 2022 and 2023, respectively.
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 of Prudential 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) 2020 2019
(in millions)
Income Hedges (External)(1) $ 74 $ 67
Equity Hedges:
Internal(2) 188 432
External(3) 230 143
Total Equity Hedges 418 575
Total Cash Settlements $ 492 $ 642
As of December 31,
Assets (Liabilities): 2020 2019
(in millions)
Income Hedges (External)(4) $ 3 $ 60
Equity Hedges:
Internal(2) 291 506
External(5) (56) 43
Total Equity Hedges(6) 235 549
Total Assets (Liabilities) $ 238 $ 609
__________
(1)Includes non-yen related cash settlements of $60 million, primarily
denominated in Brazilian real, Australian dollar and Chilean peso and $41
million, primarily denominated in Australian dollar, Korean won and Brazilian
real for the year ended December 31, 2020 and 2019, respectively.
(2)Represents internal transactions between international-based and U.S.-based
entities. Amounts noted are from the U.S.-based entities' perspectives.
(3)Includes non-yen related cash settlements of $23 million and $17 million,
denominated in Korean won for the year ended December 31, 2020 and 2019,
respectively.
(4)Includes non-yen related assets of $2 million, primarily denominated in
Brazilian real, Chilean peso and Australian dollar and assets of $37 million,
primarily denominated in Korean won, Australian dollar and Chilean peso, as of
December 31, 2020 and 2019, respectively.
(5)Includes non-yen related assets of $1 million, denominated in Korean won, as
of December 31, 2019.
(6)As of December 31, 2020, approximately $324 million, $117 million and $(207)
million of the net market values are scheduled to settle in 2021, 2022 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.
PGIM operations
The principal sources of liquidity for our fee-based PGIM businesses include
asset management fees, commercial mortgage origination and servicing fees, and
internal and external funding facilities. The principal uses of liquidity
include general and administrative expenses, facilitating our commercial
mortgage loan business, and distributions of dividends and returns of capital to
Prudential Financial. The primary liquidity risks for our fee-based PGIM
businesses relate to their profitability, which is impacted by market
conditions, our investment management performance and client redemptions. We
believe the cash flows from our fee-based PGIM 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.
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The principal sources of liquidity for our co- and seed investments held in our
PGIM businesses are cash flows from investments, the ability to liquidate
investments, borrowing lines from internal sources, including Prudential
Financial and Prudential Funding, LLC ("Prudential Funding"), a wholly-owned
subsidiary of PICA, and external sources, including PGIM's limited-recourse
credit facility. The principal use of liquidity for our co- and seed 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 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 PGIM operations since
December 31, 2020.
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. In May 2020, we entered into a facility agreement with a Delaware trust, pursuant to which Prudential Financial may issue and sell to the trust at any time over a ten-year period up to $1.5 billion of senior notes due May 15, 2030 and receive in exchange a corresponding amount of U.S. Treasury securities, thereby augmenting our alternative sources of liquidity. For more information on these sources of liquidity, see Note 17 to the Consolidated Financial Statements.
Asset-based Financing
We conduct asset-based or secured financing within our insurance and other subsidiaries, including transactions such as securities lending, repurchase agreements and mortgage dollar rolls, to earn spread income, to borrow funds, or to facilitate trading activity. These programs are primarily driven by portfolio holdings of securities that are lendable based on counterparty demand for these securities in the marketplace. The collateral received in connection with these programs is primarily used to purchase securities in the short-term spread portfolios of our insurance entities. Investments held in the short-term spread portfolios include cash and cash equivalents, short-term investments (primarily corporate bonds), mortgage loans and fixed maturities (primarily collateralized loan obligations and other structured securities), with a weighted average life at time of purchase by the short-term portfolios of four years or less. Floating rate assets comprise the majority of our short-term spread portfolio. These short-term portfolios are subject to specific investment policy statements, which among other things, do not allow for significant asset/liability interest rate duration mismatch.
The following table sets forth our liabilities under asset-based or secured financing programs as of the dates indicated:
December 31, 2020 December 31, 2019
PFI PFI
Excluding Closed Excluding Closed
Closed Block Block Closed Block Block
Division Division Consolidated Division Division Consolidated
($ in millions)
Securities sold under agreements to
repurchase $ 8,092 $ 2,802 $ 10,894 $ 6,834 $ 2,847 $ 9,681 Cash collateral for loaned securities 3,379
120 3,499 3,228 986 4,214
Securities sold but not yet purchased 2 0 2 0 0 0 Total(1)(2) $ 11,473 $ 2,922 $ 14,395 $ 10,062 $ 3,833 $ 13,895 Portion of above securities that may be returned to the Company overnight requiring immediate return of the cash collateral(3) $ 10,463 $ 2,922
$ 13,385 $ 10,062 $ 3,833 $ 13,895 Weighted average maturity, in days(3)
28 N/A N/A N/A
__________
(1)The daily weighted average outstanding balance for the year ended
December 31, 2020 and 2019 was $11,464 million and $10,524 million,
respectively, for PFI excluding the Closed Block division, and $3,290 million
and $4,152 million, respectively, for the Closed Block division.
(2)Includes utilization of external funding facilities for PGIM's commercial
mortgage origination business.
(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, 2020, our domestic insurance entities had assets eligible for
the asset-based or secured financing programs of $132.0 billion, of which $14.1
billion were on loan. Taking into account market conditions and outstanding loan
balances as of December 31, 2020, we believe approximately $16.1 billion of the
remaining eligible assets are readily lendable, including approximately $11.1
billion relating to PFI excluding the Closed Block division, of which $2.9
billion relates to certain separate accounts and may only be used for financing
activities related to those accounts, and the remaining $5.0 billion relating to
the Closed Block division.
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Financing Activities
As of December 31, 2020, total short-term and long-term debt of the Company on a
consolidated basis was $20.6 billion, an increase of $0.1 billion from
December 31, 2019. 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.
December 31, 2020 December 31, 2019
Prudential Prudential
Financial Subsidiaries Consolidated Financial Subsidiaries Consolidated
(in millions)
General obligation short-term debt:
Commercial paper $ 25 $ 355 $ 380 $ 25 $ 524
$ 549
Current portion of long-term debt 399 0 399 1,179 0 1,179
Subtotal 424 355 779 1,204 524 1,728
General obligation long-term debt:
Senior debt 11,007 173 11,179 9,912 172 10,084
Junior subordinated debt 7,554 60 7,615 7,518 57 7,575
Surplus notes(1) 0 343 343 0 342 342
Subtotal 18,561 576 19,137 17,430 571 18,001
Total general obligations 18,985 931 19,916 18,634 1,095 19,729
Limited and non-recourse borrowings(2)
Short-term debt 0 18 18 0 13 13
Current portion of long-term debt 0 128 128 0 192 192
Long-term debt 0 581 581 0 645 645
Subtotal 0 727 727 0 850 850
Total borrowings $ 18,985 $ 1,658 $ 20,643 $ 18,634 $ 1,945 $ 20,579
__________
(1)Amounts are net of assets under set-off arrangements of $10,964 million and
$9,749 million as of December 31, 2020 and 2019, respectively.
(2)Limited and non-recourse borrowing primarily represents mortgage debt of our
subsidiaries that has recourse only to real estate investment property of $409
million and $537 million as of December 31, 2020 and 2019, respectively, and a
draw on a credit facility with recourse only to collateral pledged by the
Company of $300 million as of both December 31, 2020 and 2019.
As of December 31, 2020 and 2019, we were in compliance with all debt covenants
related to the borrowings in the table above. For additional information on our
short- and long-term debt obligations, see Note 17 to the Consolidated Financial
Statements.
We executed transactions to reduce our ongoing financing costs in August 2020 by
issuing $1.3 billion of junior subordinated notes at interest rates of 3.70% and
4.125% and with maturities ranging from 2050 to 2060 and using the proceeds to
redeem in September 2020 our $710 million 5.70% junior subordinated notes due in
2053 and our $575 million 5.75% junior subordinated notes due in 2052.
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 $13.5 billion and $14.6 billion as of
December 31, 2020 and 2019, respectively. Operating debt of $6.4 billion and
$5.2 billion as of December 31, 2020 and 2019, respectively, is utilized for
business funding to meet specific purposes, which may include activities
associated with our PGIM and Assurance IQ businesses. Operating debt also
consists of debt issued to finance specific portfolios of investment assets, the
proceeds from which will service the debt. Specifically, this includes 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.
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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 $0.4 billion from December 31, 2019,
primarily driven by the issuance, net of related costs, of $1.5 billion of
senior debt and $1.3 billion of Junior subordinated debt, partially offset by
$1.2 billion in senior debt maturities and $1.3 billion in junior subordinated
debt redemptions. 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 $287 million from December 31, 2019 due primarily to a $169 million decrease in commercial paper outstanding and a $123 million decrease in limited and non-recourse borrowings.
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, 2020,
we had Credit-Linked Note Structures with an aggregate issuance capacity of
$14,825 million, of which $12,919 million was outstanding, as compared to an
aggregate issuance capacity of $13,700 million, of which $12,009 million was
outstanding, as of December 31, 2019. The increase in issuance capacity in 2020
reflects a $1,200 million Credit-Linked Note Structure entered into in June 2020
for Guideline AXXX reserves, of which $700 million was outstanding as of
December 31, 2020. Under the agreements, the captive receives in exchange for
the surplus notes one or more credit-linked notes issued by a special-purpose
affiliate of the Company with an aggregate principal amount equal to the surplus
notes outstanding. The captive holds the credit-linked notes as assets
supporting Regulation XXX or Guideline AXXX non-economic reserves, as
applicable. The captive can redeem the principal amount of the outstanding
credit-linked notes for cash upon the occurrence of, and in an amount necessary
to remedy, a specified liquidity stress event affecting the captive. Under the
agreements, the external counterparties have agreed to fund any such payments
under the credit-linked notes in return for the receipt of fees. Under certain
of the transactions, Prudential Financial has agreed to make capital
contributions to the captive to reimburse it for investment losses in excess of
specified amounts and/or has agreed to reimburse the external counterparties for
any payments made under the credit-linked notes. To date, no such payments under
the credit-linked notes have been required. Under these transactions, because
valid rights of set-off exist, interest and principal payments on the surplus
notes and on the credit-linked notes are settled on a net basis, and the surplus
notes are reflected in the Company's total consolidated borrowings on a net
basis.
The following table summarizes our Credit-Linked Note Structures, which are reported on a net basis, as of December 31, 2020:
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Surplus Notes
Original Maturity Outstanding as of Facility
Credit-Linked Note Structures: Issue Dates Dates December 31, 2020 Size
($ in millions)
XXX 2011-2014 2021-2024 $ 1,750 (1) $ 1,750
AXXX 2013 2033 3,248 3,500
XXX 2014-2018 2021-2034 2,355 (2) 2,375
XXX 2014-2017 2024-2037 2,330 2,400
AXXX 2017 2037 1,466 2,000
XXX 2018 2038 1,070 1,600
AXXX 2020 2032 700 1,200
Total Credit-Linked Note Structures $ 12,919 $ 14,825
__________
(1)Prudential Financial has agreed to reimburse 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, 2020, we also had outstanding an aggregate of $2,775 million
of debt issued for the purpose of financing Regulation XXX and Guideline AXXX
non-economic reserves, of which approximately $1,175 million relates to
Regulation XXX reserves and $1,600 million relates to Guideline AXXX reserves.
In addition, as of December 31, 2020, for purposes of financing Guideline AXXX
reserves, one of our captives had $3,982 million of surplus notes outstanding
that were issued to affiliates.
The Company has introduced updated versions of its individual life products in
conjunction with the requirement to adopt principle-based reserving by January
1, 2020. These updated products are currently priced to support the
principle-based statutory reserve level without the need for reserve financing.
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.
The Company continues to assess the impact of the implementation of
principle-based reserving on projected statutory reserve levels, product pricing
and the use of financing.
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 12/2/2020 11/25/2020 9/11/2020 5/18/2020
Current outlook Stable Stable* Stable 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 including 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
'Stable' Outlooks as of June 2020.
** "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 2020, Fitch, Moody's and AM Best
revised the Rating Outlook on the U.S. life insurance industry from Stable to
Negative. S&P maintained their outlook for the U.S. life insurance sector at
Stable. In June of 2020, S&P revised their Outlook on the Japan sovereign rating
from 'Positive' to 'Stable'. This resulted in a change in outlook to 'Stable'
for Prudential of Japan, Prudential Gibraltar Financial Life Insurance Co. and
Gibraltar, as these entities are capped by Japan's sovereign credit rating
('A+'/'Stable' Outlook).
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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.
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 $1.2 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, 2020. 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
2026 and
Total 2021 2022-2023 2024-2025 thereafter
(in millions)Short-term and long-term debt obligations(1) $ 41,534 $ 1,881 $ 2,577 $ 2,857 $ 34,219 Operating lease obligations(2)
556 156 202 118 80
Purchase obligations:
Commitments to purchase or fund investments(3) 9,903 5,219 2,650 1,171 863
Commercial mortgage loan commitments(4) 2,357 1,969 378 10 0
Other liabilities:
Insurance liabilities(5) 1,181,976 51,178 69,794 70,297 990,707
Other(6) 14,806 14,454 140 65 147
Total $ 1,251,132 $ 74,857 $ 75,741 $ 74,518 $ 1,026,016
__________
(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 2021. 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 $336 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 $1,182 billion exceeds the
corresponding liability amounts of approximately $809 billion included in the
Consolidated Financial Statements as of December 31, 2020. 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 $305 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, 2020.
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 2020, Prudential Financial entered into a ten-year facility 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. 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. 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, 2020, 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.
See Note 17 to the Consolidated Financial Statements for more information on these arrangements.
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
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Our Board oversees our risk profile and management's processes for assessing and
managing risk, through both the whole Board and its committees. The Board also
reviews strategic risks and opportunities facing the Company and its businesses.
Other important categories of risk are assigned to designated Board committees
that report back to the full Board. In general, the committees oversee the
following risks:
•Audit Committee: insurance risk and operational risk, 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: the design and operation of the Company's compensation
programs so that they do not encourage unnecessary or excessive risk-taking, as
well as broad human capital management issues;
•Corporate Governance and Business Ethics Committee: the Company's overall
ethical culture, political contributions, lobbying expenses and overall
political strategy, as well as the Company's Environmental, Social, and
Governance strategy that includes environmental risk (which includes climate
risk), sustainability and corporate social responsibility to minimize
reputational risk and focus on future sustainability;
•Finance Committee: liquidity risk and risk involving our capital and liquidity
management, including the incurrence and repayment of borrowings, the capital
structure of the Company, 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
Risk Appetite Framework;
•Investment Committee: investment risk, market risk, and review of investment
performance and risk positions. The Investment Committee approves investment and
market risk limits based on asset class, issuer, credit quality and geography;
and
•Risk Committee: the governance of significant risk throughout the Company, the
establishment and ongoing monitoring of our risk profile, risk capacity and risk
appetite, and coordination of the risk oversight functions of the other Board
committees.
Management Oversight
Our primary risk management committee is the Enterprise Risk Committee ("ERC").
The ERC is chaired by our Chief Risk Officer and otherwise consists of the Vice
Chairman, Head of U.S. Businesses, Head of International Businesses, General
Counsel, Chief Financial Officer, Chief Investment Officer, Chief Information
Officer and Chief Actuary. Our Chief Auditor also attends meetings of the ERC.
The ERC oversees the Company's risk management framework, including the
identification, assessment, monitoring and management of risks and how those
risks align with the Company's loss absorption resources. The primary focus of
the ERC is the critical analysis of significant quantitative and qualitative
risks and the appropriateness and alignment to the defined risk appetite of the
Company.
The ERC is supported by five Risk Oversight Committees aligned with our tactical
risks, each of which consists of subject matter experts and are dedicated to one
of the following risk types: investment, market (including liquidity),
insurance, operational, and model. 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 effectiveness of risk
mitigation options, identify stakeholders of risks and issues, review material
assumptions for reasonability and consistency across the Company, and develop
recommendations for risk limits, among other responsibilities.
In addition, each of our businesses and certain corporate centers maintains their own risk committee as a forum for leaders to identify, assess, and monitor risk and exposure issues and to review new business activities and initiatives.
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 and our business unit Chief Risk Officers work 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.
Risk Identification
We rely on a combination of activities to ensure 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
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•Business Activities: Each business area has a risk committee that allows 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 that facilitate the identification of current risk exposures. •Corporate Center Activities: 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, the corporate centers, particularly ERM, use several processes and activities to identify and assess the risks of the Company. Most corporate centers have their own risk committees. •Senior Management and the Board: Senior management plays a critical role in reviewing the risk profile of the Company, including identifying impacts to the business strategy 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 is a comprehensive process designed to reasonably ensure that risks taken across the Company align with the Company's capacity and willingness to take those risks. Using the Risk Appetite Framework, the Company measures, evaluates, and manages its financial risks. The comprehensive models, metrics, and stress scenarios used enable the Company to understand its current risk profile as well as how the risk profile may change over time through varying degrees of stress. The Risk Appetite Framework anchors the risk and capital management processes and supports management and the Board in making well-informed business decisions.. The Risk Appetite Framework is centered around a comprehensive and cohesive stress testing regime which includes a variety of stress scenarios designed to explore outcomes across the investment portfolios and businesses. This robust stress testing examines the sensitivity of assets and liabilities and how they interact with each other through time to identify places where the Company's capacity may be challenged by the risks taken. These analytics provide insight into the impact of stress scenarios on capital and liquidity. Additionally, the Qualitative Risk Appetite Framework helps the Company understand and manage risks that are not easily quantifiable. By continuously scanning the internal environment and reporting findings to leadership and the Board on a regular basis, the Company can monitor and mitigate operational risks in qualitative areas, such as: culture; reputation; compliance with laws, regulations, and policies; and decision-making incentives.
COVID-19
Our risk management framework incorporates severe to very severe stresses across equities, interest rates, credit migration and defaults, currencies and pandemics. This framework includes a specific "pandemic and sell-off" scenario with a mortality calamity (1.5 extra deaths per 1,000 lives in the first year) based on a modern-day interpretation of the 1918 Spanish Flu experience that is aligned with most regulatory frameworks. The stress scenario assumes an even distribution of increased mortality across the population, while current COVID-19 mortality is sharply skewed toward older ages. As the COVID-19 event continues to unfold, we continue to update our analysis and take management actions in response to this specific event. As of December 31, 2020, the COVID-19 pandemic has not reached the most severe levels included in the Company's stress testing. In addition, we expect the impact of COVID-19-related claims to be moderated by the balance between our mortality exposure (such as in our individual and group life businesses) and our longevity exposure (such as in our retirement business).
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.
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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. •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 in 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.
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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, 2020 and 2019. 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.
As of December 31, 2020 As of December 31, 2019
Hypothetical Hypothetical
Fair Change in Fair Change in
Notional Value Fair Value Notional Value Fair Value
(in millions)
Financial assets with interest rate risk:
Fixed maturities(1) $ 440,531 $ (47,271) $ 416,812 $ (43,532)
Commercial mortgage and other loans 68,676 (3,010) 65,893 (3,112)
Derivatives with interest rate risk:
Swaps $ 244,020 3,457 (6,039) $ 200,055 6,894 (4,747)
Futures 21,458 79 (1,191) 18,897 (37) (1,004)
Options 52,093 1,384 (616) 50,403 15 (91)
Forwards 41,214 86 (49) 30,488 (23) (105)
Synthetic GICs 86,264 0 0 80,009 1 0
Embedded derivatives(2)(3) (20,793) 7,775 (14,147) 6,525
Financial liabilities with interest rate
risk(4):
Short-term and long-term debt (24,408) 4,873 (23,277) 4,156
Policyholders' account balances-investment
contracts (110,473) 3,791 (102,156) 3,562
Net estimated potential loss $ (41,737) $ (38,348)
__________
(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 $413
billion and $391 billion as of December 31, 2020 and 2019, 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 indexed annuity contracts. The
fair value and hypothetical change in fair value of each is $(18,528) million
and $7,720 million, $(1,334) million and $170 million, and $(580) million and
$(115) million, respectively, as of December 31, 2020. 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.
(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 $360 billion and $344 billion as of December 31, 2020
and 2019, 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 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.
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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.
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, 2020 and 2019. 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, 2020 As of December 31, 2019
Hypothetical Hypothetical
Fair Change in Fair Change in
Notional Value Fair Value Notional Value Fair Value
(in millions)
Equity securities(1) $ 10,041 $ (1,004) $ 9,175 $ (918)
Equity-based derivatives(2) $ 64,407 (557) 1,800 $ 52,677 (719) 1,755
Embedded derivatives(2)(3)(4) (20,793) (1,676) (14,147)
(1,726)
Net estimated potential loss $ (880) $ (889) __________ (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 indexed annuity contracts. The fair value and hypothetical change in fair value of each is $(18,528) million and $(1,921) million, $(1,334) million and $59 million, and $(580) million and $186 million, respectively, as of December 31, 2020. 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. (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
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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 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, 2020 and 2019. 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, 2020 As of December 31, 2019
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
$ 3,490 $ (349) $ 4,834 $ (483)
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.
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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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