================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------
FORM 10-Q
-----------------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from to
Commission File Number 001-16707
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Prudential Financial, Inc.
(Exact Name of Registrant as Specified in its Charter)
New Jersey 22-3703799
(State or Other (I.R.S.
Jurisdiction Employer Identification
of Incorporation or Number)
Organization)
751 Broad Street
Newark, New Jersey
(973) 802-6000
(Address and Telephone Number of Registrant's Principal Executive Offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
At May 7, 2002, 584,523,006 shares of the registrant's Common Stock (par
value $0.01) were outstanding. In addition, 2,000,000 shares of the
registrant's Class B Stock, for which there is no established public trading
market, were outstanding.
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INDEX
Page
Number
PART I FINANCIAL INFORMATION ------
Item 1. Financial Statements:
Unaudited Interim Consolidated Statements of Financial Position as of March 31,
2002 and December 31, 2001................................................... 1
Unaudited Interim Consolidated Statements of Operations for the three months
ended March 31, 2002 and 2001................................................ 2
Unaudited Interim Consolidated Statements of Stockholders' Equity for the three
months ended March 31, 2002 and the year ended December 31, 2001............. 3
Unaudited Interim Consolidated Statements of Cash Flows for the three months
ended March 31, 2002 and 2001................................................ 4
Notes to Unaudited Interim Consolidated Financial Statements................... 5
Unaudited Interim Supplemental Combining Financial Information:
Unaudited Interim Supplemental Combining Statement of Financial Position as
of March 31, 2002.......................................................... 17
Unaudited Interim Supplemental Combining Statement of Operations for the
three months ended March 31, 2002.......................................... 18
Notes to Unaudited Interim Supplemental Combining Financial Information...... 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................... 22
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................... 63
PART II OTHER INFORMATION
Item 1. Legal Proceedings.............................................................. 64
Item 5. Other Information-Employees................................................... 64
Item 6. Exhibits and Reports on Form 8-K............................................... 64
SIGNATURE...................................................................................... 65
Certain of the statements included in this Quarterly Report on Form 10-Q,
including but not limited to those in the Management's Discussion and Analysis
of Financial Condition and Results of Operations, constitute forward-looking
statements within the meaning of the U.S. Private Securities Litigation Reform
Act of 1995. Words such as "expects," "believes," "anticipates," "includes,"
"plans," "assumes," "estimates," "projects," "intends" or variations of such
words are generally part of forward-looking statements. Forward-looking
statements are made based on management's current expectations and beliefs
concerning future developments and their potential effects upon Prudential
Financial, Inc. and its subsidiaries. There can be no assurance that future
developments affecting Prudential Financial, Inc. and its subsidiaries will be
those anticipated by management. These forward-looking statements are not a
guarantee of future performance and involve risks and uncertainties, and there
are certain important factors that could cause actual results to differ,
possibly materially, from expectations or estimates reflected in such
forward-looking statements, including without limitation: general economic,
market and political conditions, including the performance of financial
markets, interest rate fluctuations and the continuing impact of the events of
September 11, 2001; volatility in the securities markets; reestimates of our
reserves for future policy benefits and claims; changes in our assumptions
related to deferred policy acquisition costs; our exposure to contingent
liabilities; catastrophe losses; investment losses and defaults; changes in our
claims-paying or credit ratings; competition in our product lines and for
personnel; fluctuations in foreign currency exchange rates and foreign
securities markets; risks to our international operations; the impact of
changing regulation or accounting practices; Prudential Financial, Inc.'s
primary reliance, as a holding company, on dividends from its subsidiaries to
meet debt payment obligations and the applicable regulatory restrictions on the
ability of the subsidiaries to pay such dividends; adverse litigation results;
and changes in tax law. Prudential Financial, Inc. does not intend, and is
under no obligation, to update any particular forward-looking statement
included in this Quarterly Report on Form 10-Q.
i
Throughout this Quarterly Report on Form 10-Q, "Prudential Financial" and
the "Registrant" refer to Prudential Financial, Inc., the ultimate holding
company for all of our companies. "Prudential Insurance" refers to The
Prudential Insurance Company of America, before and after its demutualization
on December 18, 2001 (the "date of demutualization"). "Prudential," the
"Company," "we" and "our" refer to our consolidated operations before and after
demutualization. The "Plan of Reorganization" refers to Prudential Insurance's
Plan of Reorganization, dated as of December 15, 2000 and as amended from time
to time thereafter, relating to Prudential Insurance's demutualization.
ii
PART I
FINANCIAL INFORMATION
ITEM 1. Financial Statements
PRUDENTIAL FINANCIAL, INC.
UNAUDITED INTERIM CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
MARCH 31, 2002 AND DECEMBER 31, 2001
(in millions, except share amounts)
March 31, December 31,
2002 2001
--------- ------------
ASSETS
Fixed maturities:
Available for sale, at fair value.................................................................... $112,400 $109,942
Held to maturity, at amortized cost.................................................................. 354 374
Trading account assets, at fair value................................................................... 6,286 5,043
Equity securities, available for sale, at fair value.................................................... 2,948 2,272
Commercial loans........................................................................................ 19,194 19,729
Policy loans............................................................................................ 8,588 8,570
Securities purchased under agreements to resell......................................................... 7,137 4,421
Cash collateral for borrowed securities................................................................. 5,628 5,210
Other long-term investments............................................................................. 5,433 5,418
Short-term investments.................................................................................. 5,158 4,855
-------- --------
Total investments................................................................................. 173,126 165,834
Cash and cash equivalents............................................................................... 13,360 18,536
Accrued investment income............................................................................... 1,835 1,828
Broker-dealer related receivables....................................................................... 7,017 7,802
Deferred policy acquisition costs....................................................................... 7,133 6,868
Other assets............................................................................................ 16,929 15,004
Separate account assets................................................................................. 78,515 77,158
-------- --------
TOTAL ASSETS...................................................................................... $297,915 $293,030
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Future policy benefits.................................................................................. $ 85,838 $ 86,991
Policyholders' account balances......................................................................... 42,984 43,333
Unpaid claims and claim adjustment expenses............................................................. 3,353 3,408
Policyholders' dividends................................................................................ 2,138 2,096
Securities sold under agreements to repurchase.......................................................... 17,188 12,385
Cash collateral for loaned securities................................................................... 9,829 9,427
Income taxes payable.................................................................................... 1,102 1,332
Broker-dealer related payables.......................................................................... 5,581 6,445
Securities sold but not yet purchased................................................................... 4,561 2,791
Short-term debt......................................................................................... 6,515 5,405
Long-term debt.......................................................................................... 5,100 5,304
Other liabilities....................................................................................... 14,482 15,812
Separate account liabilities............................................................................ 78,515 77,158
-------- --------
Total liabilities................................................................................. 277,186 271,887
-------- --------
Guaranteed minority interest in Trust holding solely debentures of Parent............................... 690 690
-------- --------
COMMITMENTS AND CONTINGENCIES (See Note 6)
STOCKHOLDERS' EQUITY
Preferred Stock ($.01 par value; 10,000,000 shares authorized; none issued)............................. -- --
Common Stock ($.01 par value; 1,500,000,000 shares authorized; 584,315,240 and 583,582,767 shares issued
and outstanding at March 31, 2002 and December 31, 2001, respectively)................................. 6 6
Class B Stock ($.01 par value; 10,000,000 shares authorized; 2,000,000 shares issued and outstanding at
March 31, 2002 and December 31, 2001).................................................................. -- --
Additional paid-in capital.............................................................................. 19,506 19,462
Accumulated other comprehensive income.................................................................. 333 944
Retained earnings....................................................................................... 194 41
-------- --------
Total stockholders' equity........................................................................ 20,039 20,453
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........................................................ $297,915 $293,030
======== ========
See Notes to Unaudited Interim Consolidated Financial Statements
1
PRUDENTIAL FINANCIAL, INC.
UNAUDITED INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2002 AND 2001
(in millions, except per share amounts)
2002 2001
------- ------
REVENUES
Premiums................................................... $ 3,222 $2,602
Policy charges and fee income.............................. 434 392
Net investment income...................................... 2,147 2,282
Realized investment gains (losses), net.................... (175) 336
Commissions and other income............................... 1,086 1,135
------- ------
Total revenues.......................................... 6,714 6,747
------- ------
BENEFITS AND EXPENSES
Policyholders' benefits.................................... 3,203 2,655
Interest credited to policyholders' account balances....... 448 416
Dividends to policyholders................................. 673 696
General and administrative expenses........................ 2,146 2,212
Demutualization costs and expenses......................... -- 45
------- ------
Total benefits and expenses............................. 6,470 6,024
------- ------
INCOME FROM OPERATIONS BEFORE INCOME TAXES................. 244 723
Income taxes............................................... 91 286
------- ------
NET INCOME................................................. $ 153 $ 437
======= ======
EARNINGS PER SHARE (See Note 4)
Financial Services Businesses
Net income per share of Common Stock--basic and diluted. $ 0.46
=======
Closed Block Business
Net loss per share of Class B Stock--basic and diluted.. $(58.50)
=======
See Notes to Unaudited Interim Consolidated Financial Statements
2
PRUDENTIAL FINANCIAL, INC.
UNAUDITED INTERIM CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
THREE MONTHS ENDED MARCH 31, 2002 AND YEAR ENDED DECEMBER 31, 2001
(in millions)
Accumulated Other Comprehensive Income (Loss)
----------------------------------------------
Total
Foreign Net Accumulated
Additional Currency Unrealized Pension Other
Common Class B Paid-in Retained Translation Investment Liability Comprehensive
Stock Stock Capital Earnings Adjustments Gains Adjustment Income
------ ------- ---------- -------- ----------- ---------- ---------- -------------
Balance, December 31, 2000.............. $-- $-- $ -- $ 20,374 $(107) $ 359 $(18) $ 234
Common Stock issued in
demutualization....................... 5 -- 15,985 (15,990) -- -- -- --
Policy credits issued and cash payments
to eligible policyholders.............. -- -- -- (4,189) -- -- -- --
Initial public offering of Common Stock. 1 -- 3,336 -- -- -- -- --
Private placement of Class B Stock...... -- -- 167 -- -- -- -- --
Equity security units................... -- -- (26) -- -- -- -- --
Comprehensive income:
Net loss before the date of
demutualization...................... -- -- -- (195) -- -- -- --
Net income after the date of
demutualization...................... -- -- -- 41 -- -- -- --
Other comprehensive income (loss),
net of tax:
Change in foreign currency
translation adjustments............. -- -- -- -- (130) -- -- (130)
Change in net unrealized investment
gains............................... -- -- -- -- -- 869 -- 869
Additional pension liability
adjustment.......................... -- -- -- -- -- -- (29) (29)
Other comprehensive income...........
Total comprehensive income..............
--- --- ------- -------- ----- ------ ---- -----
Balance, December 31, 2001.............. 6 -- 19,462 41 (237) 1,228 (47) 944
--- --- ------- -------- ----- ------ ---- -----
Stock based compensation................ -- -- 1 -- -- -- -- --
Adjustments to policy credits issued and
cash payments to eligible
policyholders.......................... -- -- 43 -- -- -- -- --
Comprehensive income:
Net income............................ -- -- -- 153 -- -- -- --
Other comprehensive income (loss),
net of tax:
Change in foreign currency
translation adjustments............. -- -- -- -- 6 -- -- 6
Change in net unrealized investment
gains............................... -- -- -- -- -- (617) -- (617)
Other comprehensive income
(loss)..............................
Total comprehensive income (loss).......
--- --- ------- -------- ----- ------ ---- -----
Balance, March 31, 2002................. $ 6 $-- $19,506 $ 194 $(231) $ 611 $(47) $ 333
=== === ======= ======== ===== ====== ==== =====
Total
Stockholders'
Equity
-------------
Balance, December 31, 2000.............. $20,608
Common Stock issued in
demutualization....................... --
Policy credits issued and cash payments
to eligible policyholders.............. (4,189)
Initial public offering of Common Stock. 3,337
Private placement of Class B Stock...... 167
Equity security units................... (26)
Comprehensive income:
Net loss before the date of
demutualization...................... (195)
Net income after the date of
demutualization...................... 41
Other comprehensive income (loss),
net of tax:
Change in foreign currency
translation adjustments............. (130)
Change in net unrealized investment
gains............................... 869
Additional pension liability
adjustment.......................... (29)
-------
Other comprehensive income........... 710
-------
Total comprehensive income.............. 556
-------
Balance, December 31, 2001.............. 20,453
-------
Stock based compensation................ 1
Adjustments to policy credits issued and
cash payments to eligible
policyholders.......................... 43
Comprehensive income:
Net income............................ 153
Other comprehensive income (loss),
net of tax:
Change in foreign currency
translation adjustments............. 6
Change in net unrealized investment
gains............................... (617)
-------
Other comprehensive income
(loss).............................. (611)
-------
Total comprehensive income (loss)....... (458)
-------
Balance, March 31, 2002................. $20,039
=======
See Notes to Unaudited Interim Consolidated Financial Statements
3
PRUDENTIAL FINANCIAL, INC.
UNAUDITED INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2002 AND 2001
(in millions)
2002 2001
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income....................................................................... $ 153 $ 437
Adjustments to reconcile net income to net cash provided by operating activities:
Realized investment (gains) losses, net...................................... 175 (336)
Policy charges and fee income................................................ (117) (94)
Interest credited to policyholders' account balances......................... 448 416
Depreciation and amortization, including premiums and discounts.............. 72 115
Change in:
Deferred policy acquisition costs........................................... (62) (18)
Future policy benefits and other insurance liabilities...................... 304 518
Trading account assets...................................................... (1,249) (1,886)
Income taxes payable........................................................ (7) (231)
Broker-dealer related receivables/payables.................................. (79) 1,021
Securities purchased under agreements to resell............................. (2,716) 869
Cash collateral for borrowed securities..................................... (418) 317
Cash collateral for loaned securities....................................... 402 (179)
Securities sold but not yet purchased....................................... 1,770 228
Securities sold under agreements to repurchase.............................. 4,803 158
Other, net.................................................................. (836) (2,159)
-------- --------
Cash flows from (used in) operating activities............................ 2,643 (824)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from the sale/maturity of:
Fixed maturities, available for sale......................................... 11,107 41,549
Fixed maturities, held to maturity........................................... 16 116
Equity securities, available for sale........................................ 688 759
Commercial loans............................................................. 580 440
Other long-term investments.................................................. 364 275
Payments for the purchase of:
Fixed maturities, available for sale......................................... (17,025) (42,344)
Fixed maturities, held to maturity........................................... (1) --
Equity securities, available for sale........................................ (1,398) (859)
Commercial loans............................................................. (347) (267)
Other long-term investments.................................................. (327) (337)
Short-term investments........................................................... (41) 1,966
-------- --------
Cash flows (used in) from investing activities............................ (6,384) 1,298
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Policyholders' account deposits.................................................. 2,039 1,664
Policyholders' account withdrawals............................................... (1,996) (1,869)
Net increase in short-term debt.................................................. 1,257 843
Proceeds from the issuance of long-term debt..................................... 9 434
Repayments of long-term debt..................................................... (375) (28)
Cash payments to eligible policyholders.......................................... (2,369) --
-------- --------
Cash flows (used in) from financing activities............................ (1,435) 1,044
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................. (5,176) 1,518
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD................................... 18,536 7,676
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD......................................... $ 13,360 $ 9,194
======== ========
See Notes to Unaudited Interim Consolidated Financial Statements
4
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
1. BUSINESS AND BASIS OF PRESENTATION
Prudential Financial, Inc. ("Prudential Financial") and its subsidiaries
(collectively, "Prudential" or the "Company") provide a wide range of
insurance, investment management, securities and other financial products and
services to both retail and institutional customers throughout the United
States and in many other countries. Principal products and services provided
include life insurance, property and casualty insurance, annuities, mutual
funds, pension and retirement related investments and administration, asset
management, and securities brokerage. The Company has organized its principal
operations into the Financial Services Businesses and the Closed Block
Business. The Financial Services Businesses operate through four operating
divisions: U.S. Consumer, Employee Benefits, International and Asset
Management. Businesses that are not sufficiently material to warrant separate
disclosure are included in Corporate and Other operations within the Financial
Services Businesses. The Closed Block Business, which is managed separately
from the Financial Services Businesses, was established on the date of
demutualization and includes the Company's in force participating insurance and
annuity products and assets that are used for the payment of benefits and
policyholder dividends on these products, as well as other assets and equity
that support these products and related liabilities. In connection with the
demutualization, the Company has ceased offering these participating products.
Demutualization and Initial Public Offering
On December 18, 2001 (the "date of demutualization"), The Prudential
Insurance Company of America ("Prudential Insurance") converted from a mutual
life insurance company to a stock life insurance company and became an
indirect, wholly owned subsidiary of Prudential Financial. Concurrent with the
demutualization, Prudential Insurance completed a corporate reorganization
whereby various subsidiaries (and certain related assets and liabilities) of
Prudential Insurance were dividended so that they became wholly owned
subsidiaries of Prudential Financial rather than of Prudential Insurance.
On the date of demutualization, Prudential Financial completed an initial
public offering of 110.0 million shares of Common Stock at a price of $27.50
per share and, on December 21, 2001, Prudential Financial issued an additional
16.5 million shares of Common Stock as a result of the exercise of the
over-allotment option granted to underwriters in the initial public offering.
Also on the date of demutualization, Prudential Financial completed the sale,
through a private placement, of 2.0 million shares of Class B Stock, a separate
class of common stock, at a price of $87.50 per share. The Common Stock
reflects the performance of the Financial Services Businesses, and the Class B
Stock reflects the performance of the Closed Block Business.
Basis of Presentation
The unaudited interim consolidated financial statements include the accounts
of Prudential Financial, its majority-owned subsidiaries and those partnerships
and joint ventures in which the Company has a controlling financial interest,
except in those instances where the Company cannot exercise control because the
minority owners have substantive participating rights in the operating and
capital decisions of the entity. The consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in
the United States of America ("GAAP"). Intercompany balances and transactions
have been eliminated. Effective on the date of demutualization and corporate
reorganization, the historical consolidated financial statements of Prudential
Insurance became the historical consolidated financial statements of Prudential
Financial.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities, in particular deferred policy acquisition costs,
investment allowances, future policy benefits, disclosure of contingent
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the period. Actual results could differ from those
estimates.
5
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
1. BUSINESS AND BASIS OF PRESENTATION (continued)
In the opinion of management, all adjustments necessary for a fair statement
of the financial position and results of operations have been made. All such
adjustments are of a normal, recurring nature. Operating results for the three
months ended March 31, 2002 are not necessarily indicative of the results that
may be expected for the full year. These financial statements should be read in
conjunction with the Company's audited Consolidated Financial Statements,
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2001.
2. NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 142 requires that an intangible asset acquired either
individually or with a group of other assets shall initially be recognized and
measured based on fair value. An intangible asset with a finite life is
amortized over its useful life to the reporting entity; an intangible asset
with an indefinite useful life, including goodwill, is not amortized. All
indefinite lived intangible assets shall be tested for impairment in accordance
with the statement. The Company has adopted SFAS No. 142 as of January 1, 2002.
The Company has ceased the amortization of goodwill as of that date and has
determined that the implementation of the transition provisions of this
statement does not result in an impairment loss as of the adoption date of the
standard. In the second half of 2002, the Company will commence the regular
annual impairment tests of goodwill required by the statement. Goodwill
amounted to $335 million at December 31, 2001, and amortization amounted to $5
million for the three months ended March 31, 2001. Goodwill is included in
"Other assets."
3. CLOSED BLOCK
On the date of demutualization, Prudential Insurance established a Closed
Block for certain individual life insurance policies and annuities issued by
Prudential Insurance in the United States. The Closed Block forms the principal
component of the Closed Block Business. For a discussion of the Closed Block
Business, see Note 5. The Company established a separate closed block for
participating individual life insurance policies issued by the Canadian branch
of Prudential Insurance. Because of the substantially smaller number of
outstanding Canadian policies, this separate closed block is insignificant in
size and is not included in the information presented below.
The recorded assets and liabilities were allocated to the Closed Block at
their historical carrying amounts. During the first quarter of 2002, the
Company completed a GAAP and statutory reconciliation of the assets and
liabilities allocated to the Closed Block and the amounts reported as Closed
Block assets and liabilities at December 31, 2001. As a result of this
reconciliation, it was determined that net assets of $94 million on a GAAP
basis that had been included in the Financial Services Businesses should have
been included in the Closed Block. During the first quarter of 2002, such
assets were reclassified to the Closed Block from the Financial Services
Businesses. The statutory amounts were unaffected.
The excess of Closed Block Liabilities over Closed Block Assets at the date
of the demutualization (adjusted to eliminate the impact of related amounts in
"Accumulated other comprehensive income (loss)") represented the estimated
maximum future earnings at that date from the Closed Block expected to result
from operations attributed to the Closed Block after income taxes. As required
by Statement of Position 00-3, the Company developed an actuarial calculation
of the timing of such maximum future earnings. If actual cumulative earnings of
the Closed Block from inception through the end of any given period are greater
than the expected cumulative earnings, only the expected earnings will be
recognized in income. Any excess of actual cumulative earnings over expected
cumulative earnings will represent undistributed accumulated earnings
attributable to
6
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
3. CLOSED BLOCK (continued)
policyholders and will be recorded as a policyholder dividend obligation to be
paid to Closed Block policyholders as an additional policyholder dividend
unless otherwise offset by future Closed Block performance that is less
favorable than originally expected. As of March 31, 2002, no such additional
policyholder dividends were recorded. Alternatively, if the actual cumulative
earnings of the Closed Block from its inception through the end of any given
period are less than the expected cumulative earnings of the Closed Block, the
Company will recognize only the actual earnings in income. However, the Company
may reduce policyholder dividend scales in the future, which would be intended
to increase future actual earnings until the actual cumulative earnings equaled
the expected cumulative earnings.
Closed Block Liabilities and Assets designated to the Closed Block as of
March 31, 2002 and December 31, 2001, as well as maximum future earnings to be
recognized from Closed Block Liabilities and Closed Block Assets, are as
follows:
March 31, December 31,
2002 2001
--------- ------------
(in millions)
Closed Block Liabilities and Closed Block Assets
Closed Block Liabilities
Future policy benefits................................................... $47,435 $47,239
Policyholders' dividends payable......................................... 1,244 1,171
Policyholders' account balances.......................................... 5,425 5,394
Other Closed Block liabilities........................................... 7,539 4,603
------- -------
Total Closed Block Liabilities....................................... 61,643 58,407
------- -------
Closed Block Assets
Total investments........................................................ 54,031 52,492
Cash..................................................................... 2,883 1,810
Accrued investment income................................................ 750 716
Other Closed Block assets................................................ 693 635
------- -------
Total Closed Block Assets............................................ 58,357 55,653
------- -------
Excess of reported Closed Block Liabilities over Closed Block Assets........ 3,286 2,754
Portion of above representing other comprehensive income.................... 288 792
------- -------
Maximum future earnings to be recognized from Closed Block Assets and Closed
Block Liabilities......................................................... $ 3,574 $ 3,546
======= =======
7
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
3. CLOSED BLOCK (continued)
Closed Block revenues and benefits and expenses for the three months ended
March 31, 2002 were as follows:
For the three
months ended
March 31, 2002
--------------
(in millions)
Closed Block Revenues and Benefits and Expenses
Revenues
Premiums......................................................................... $ 944
Net investment income............................................................ 821
Realized investment losses....................................................... (70)
Other income..................................................................... 21
------
Total Closed Block revenues.................................................. 1,716
------
Benefits and Expenses
Policyholders' benefits.......................................................... 1,028
Interest credited to policyholders' account balances............................. 34
Dividends to policyholders....................................................... 643
General and administrative expense charge........................................ 215
------
Total Closed Block benefits and expenses..................................... 1,920
------
Closed Block revenues, net of Closed Block benefits and expenses before income taxes (204)
------
Income tax benefit.................................................................. 82
------
Closed Block revenues, net of Closed Block benefits and expenses and income taxes... $ (122)
======
The negative amount of Closed Block revenues, net of the Closed Block
benefits and expenses and income taxes, represents an addition to the estimated
maximum amount of future earnings expected to result from operations attributed
to the Closed Block after income taxes.
4. EARNINGS PER SHARE
The Company has outstanding two separate classes of common stock. The Common
Stock reflects the performance of the Financial Services Businesses, and the
Class B Stock reflects the performance of the Closed Block Business.
Accordingly, earnings per share is calculated separately for each of these two
classes of common stock. Earnings per share amounts are based on the earnings
available to common stockholders for the period subsequent to the date of
demutualization.
Net income for the Financial Services Businesses and the Closed Block
Business is determined in accordance with GAAP and includes general and
administrative expenses charged to each of the respective businesses based on
the Company's methodology for the allocation of such expenses. Cash flows
between the Financial Services Businesses and the Closed Block Business related
to administrative expenses are determined by a policy servicing fee arrangement
that is based upon insurance in force and statutory cash premiums. To the
extent reported administrative expenses vary from these cash flow amounts, the
differences are recorded, on an after tax basis, as direct equity adjustments
to the equity balances of the businesses. The direct equity adjustments are
used to modify net income to determine the earnings available to the classes of
common stock for earnings per share purposes.
8
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
4. EARNINGS PER SHARE (continued)
Common Stock
A reconciliation of the numerators and denominators of the basic and diluted
per share computations for the three months ended March 31, 2002 is as follows:
For the three months ended
March 31, 2002
-----------------------------------
Income Per Share
(in millions) Shares Amount
------------- ----------- ---------
Basic earnings per share
Net income attributable to the Financial Services Businesses............. $263
Direct equity adjustment................................................. 7
----
Net income attributable to the Financial Services Businesses available to
holders of Common Stock after direct equity adjustment................. $270 584,315,048 $0.46
==== =========== =====
Effect of dilutive securities
Stock options............................................................ 794,312
-----------
Diluted earnings per share
Net income attributable to the Financial Services Businesses available to
holders of Common Stock after direct equity adjustment................. $270 585,109,360 $0.46
==== =========== =====
The Company's equity security units issued on the date of demutualization
include contracts requiring the holders to purchase shares of Common Stock, for
$50 per share, on November 15, 2004. The purchase contracts are reflected in
the diluted earnings per share calculation using the treasury stock method.
Under this method, the number of shares of Common Stock used in calculating
earnings per share for any period are deemed to be increased by the excess, if
any, of the number of shares that would be required to be issued upon
settlement of the purchase contracts over the number of shares that could be
purchased in the market, at the average market price during that period, using
the proceeds that would be required to be paid upon settlement. Consequently,
the purchase contracts are dilutive to earnings per share when the average
market price of the Common Stock is above $34.10.
Class B Stock
The net loss attributable to the Closed Block Business available to holders
of Class B Stock after direct equity adjustment for the three months ended
March 31, 2002 amounted to $117 million. The direct equity adjustment resulted
in an increase of $7 million in the net loss attributable to the Closed Block
Business applicable to holders of Class B Stock for earnings per share
purposes. The weighted average number of shares of Class B Stock used in the
calculation of basic earnings per share amounted to 2,000,000 shares. There are
no potentially dilutive shares associated with the Class B Stock.
5. SEGMENT INFORMATION
The Company has organized its principal operations into the Financial
Services Businesses and the Closed Block Business. Within the Financial
Services Businesses, the Company operates through four divisions, which
together encompass ten reportable segments. The four operating divisions within
the Financial Services Businesses are: U.S. Consumer, Employee Benefits,
International and Asset Management. Businesses that are not sufficiently
material to warrant separate disclosure are included in Corporate and Other
operations. Collectively, the businesses that comprise the four operating
divisions and Corporate and Other are referred to as
9
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
5. SEGMENT INFORMATION (continued)
the Financial Services Businesses. The segments within the Financial Services
Businesses as well as the Closed Block Business correspond to businesses for
which discrete financial information is available and reviewed by management.
First quarter 2002 results of the International Insurance segment include
Gibraltar Life Insurance Company, Ltd. ("Gibraltar Life"), which the Company
acquired in April 2001.
Adjusted Operating Income
In managing the Financial Services Businesses, the Company analyzes the
operating performance of each segment using "adjusted operating income," which
is a non-GAAP measure. Adjusted operating income is calculated by adjusting
income from operations before income taxes to exclude certain items. The items
excluded are realized investment gains, net of losses and related charges;
demutualization costs and expenses; and the gains, losses and contribution to
income/loss of divested businesses that have been sold but do not qualify for
"discontinued operations" treatment under GAAP.
The excluded items are important to an understanding of overall results of
operations. Adjusted operating income is not a substitute for net income
determined in accordance with GAAP, and the Company's definition of adjusted
operating income may differ from that used by other companies. However, the
Company believes that the presentation of adjusted operating income as measured
for management purposes enhances the understanding of results of operations by
highlighting the results from ongoing operations and the underlying
profitability factors of the Financial Services Businesses.
The Company excludes realized investment gains, net of losses and related
charges, from adjusted operating income because the timing of transactions
resulting in recognition of gains or losses is largely at the Company's
discretion and the amount of these gains or losses is heavily influenced by and
fluctuates in part according to the availability of market opportunities.
Including the fluctuating effects of these transactions could distort trends in
the underlying profitability of the businesses. The Company excludes
demutualization costs and expenses as they are directly related to
demutualization and could distort the trends associated with our business
operations. The Company excludes the gains and losses and contribution to
income/loss of divested businesses because, as a result of the decision to
dispose of these businesses, these results are not relevant to the
profitability of the Financial Services Businesses' ongoing operations and
could distort the trends associated with its ongoing businesses.
The related charges offset against net realized investment gains and losses
relate to policyholder dividends, amortization of deferred policy acquisition
costs and reserves for future policy benefits. A percentage of net realized
investment gains on specified Gibraltar Life assets is required to be paid as
dividends to Gibraltar Life policyholders. Deferred policy acquisition costs
for certain investment-type products are amortized based on estimated gross
profits, which include net realized investment gains and losses on the
underlying invested assets, and the related charge for amortization of deferred
policy acquisition costs represents the portion of this amortization associated
with net realized investment gains and losses. The reserves for certain
policies are adjusted when cash flows related to these policies are affected by
net realized investment gains and losses, and the related charge for reserves
for future policy benefits represents that adjustment.
Adjusted operating income of the International Insurance segment reflects
the impact of forward currency transactions designed to mitigate the risk that
unfavorable changes in currency exchange rates will reduce U.S. dollar
equivalent earnings generated by certain non-U.S. businesses, primarily
Japanese insurance operations.
10
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
5. SEGMENT INFORMATION (continued)
The Company executes forward sales of the hedged currency in exchange for
U.S. dollars at a specified exchange rate. The maturities of these forwards
correspond with the future periods in which the non-U.S. earnings are expected
to be generated. These contracts do not qualify for hedge accounting under
GAAP. When contracts are terminated in the same period as the expected
earnings, the resulting positive or negative cash flow is included in adjusted
operating income (revenues of $20.9 million in the first three months of 2002
and $3.7 million in the first three months of 2001). Changes in the fair value
of open contracts are included in "Realized investment gains (losses), net." As
of March 31, 2002, the fair value of open contracts used for this purpose was
$72.6 million.
The Other Asset Management segment utilizes derivative contracts to mitigate
the risk that operating results will be adversely affected by unfavorable
changes in the fair value of mortgage loan inventory held for future
securitization. On a consolidated basis, changes in the fair value of such
derivative contracts (losses of $16 million in the 2001 first quarter and gains
of $9 million in the 2002 first quarter) are included on a current basis in
adjusted operating income while the related mortgage loans are recorded at the
lower of aggregate cost or fair value. For segment reporting changes in the
fair value of the mortgage loans are included on a current basis in adjusted
operating income of the Other Asset Management segment with an offsetting
adjustment in adjusted operating income of Corporate and Other operations.
Adjusted operating income for each segment includes earnings on attributed
equity established at a level which management considers necessary to support
the segment's risks.
Prior to the date of demutualization, we also analyzed the results of the
Traditional Participating Products segment based on adjusted operating income.
Beginning in 2002, management no longer uses adjusted operating income as the
measure to assess operating performance of the Closed Block Business.
Consequently, results of the Closed Block Business for all periods are
presented only in accordance with GAAP.
Segment Results
For the three months ended March 31, 2001, the results of the Closed Block
Business are those of the Traditional Participating Products segment, which
historically sold primarily participating insurance and annuity products that
the Company ceased offering in connection with demutualization. Upon the
establishment of the Closed Block Business, $5.6 billion of net assets
previously associated with the Traditional Participating Products segment was
transferred to the Financial Services Businesses. Consequently, the results of
the Financial Services Businesses for the three months ended March 31, 2002
include returns on these assets. A minor portion of the Traditional
Participating Products segment consisted of other traditional insurance
products that are now included in the Financial Services Businesses and not in
the Closed Block Business.
Operating expenses specifically identifiable to a particular segment are
allocated to that segment as incurred. Operating expenses not identifiable to a
specific segment that are incurred in connection with the generation of segment
revenues are generally allocated based upon the segment's historical percentage
of general and administrative expenses.
The Investment Management and Advisory Services segment revenues include
intersegment revenues of $102 million and $109 million for the three months
ended March 31, 2002 and 2001, respectively, which primarily consist of
asset-based management fees from the businesses of the U.S. Consumer, Employee
Benefits and International divisions and the Closed Block Business. Management
has determined the intersegment fees for the various asset classes with
reference to market rates. These fees are eliminated in consolidation.
11
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
5. SEGMENT INFORMATION (continued)
The summary below reconciles adjusted operating income to income from
operations before income taxes for the three months ended March 31, 2002 and
2001:
For the three months ended March 31, 2002
-----------------------------------------------------------------------------
Reconciling Items
-------------------------------------------------------
Realized Charges Income from
Adjusted Investment Related to Demutualization Operations
Operating Gains Realized Gains Divested Costs and Before
Income (Losses), Net (Losses), Net Businesses Expenses Income Taxes
--------- ------------- -------------- ---------- --------------- ------------
(in millions)
Individual Life Insurance... $117 $ (5) $-- $-- $-- $ 112
Private Client Group........ (19) (1) -- -- -- (20)
Retail Investments.......... 51 (14) 1 -- -- 38
Property and Casualty
Insurance................. 22 1 -- -- -- 23
---- ----- --- --- --- -----
Total U.S. Consumer
Division............... 171 (19) 1 -- -- 153
---- ----- --- --- --- -----
Group Insurance............. 37 (3) -- -- -- 34
Other Employee Benefits..... 29 (30) 3 -- -- 2
---- ----- --- --- --- -----
Total Employee Benefits
Division............... 66 (33) 3 -- -- 36
---- ----- --- --- --- -----
International Insurance..... 204 (86) 1 -- -- 119
International Securities and
Investments............... (4) -- -- -- -- (4)
---- ----- --- --- --- -----
Total International
Division............... 200 (86) 1 -- -- 115
---- ----- --- --- --- -----
Investment Management and
Advisory Services......... 39 59 -- -- -- 98
Other Asset Management...... 24 -- -- -- -- 24
---- ----- --- --- --- -----
Total Asset Management
Division............... 63 59 -- -- -- 122
---- ----- --- --- --- -----
Corporate and Other......... 23 (22) -- (8) -- (7)
---- ----- --- --- --- -----
Total Financial Services
Businesses............. $523 $(101) $ 5 $(8) $-- $ 419
==== ===== === === === =====
Closed Block Business.... (175)
-----
Total.................... $ 244
=====
12
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
5. SEGMENT INFORMATION (continued)
For the three months ended March 31, 2001
-----------------------------------------------------------------------------
Reconciling Items
------------------------------------------------------
Realized Charges Income from
Adjusted Investment Related to Demutualization Operations
Operating Gains Realized Gains Divested Costs and Before
Income (Losses), Net (Losses), Net Businesses Expenses Income Taxes
--------- ------------- -------------- ---------- --------------- ------------
(in millions)
Individual Life Insurance... $ 79 $ 4 $-- $ -- $ -- $ 83
Private Client Group........ (6) (1) -- -- -- (7)
Retail Investments.......... 61 7 (2) -- -- 66
Property and Casualty
Insurance................. 60 19 -- -- -- 79
---- ---- --- ---- ---- ----
Total U.S. Consumer
Division............... 194 29 (2) -- -- 221
---- ---- --- ---- ---- ----
Group Insurance............. 47 26 -- -- -- 73
Other Employee Benefits..... 57 69 (2) -- -- 124
---- ---- --- ---- ---- ----
Total Employee Benefits
Division............... 104 95 (2) -- -- 197
---- ---- --- ---- ---- ----
International Insurance..... 95 6 -- -- -- 101
International Securities and
Investments............... 3 -- -- -- -- 3
---- ---- --- ---- ---- ----
Total International
Division............... 98 6 -- -- -- 104
---- ---- --- ---- ---- ----
Investment Management and
Advisory Services......... 34 1 -- -- -- 35
Other Asset Management...... 44 -- -- -- -- 44
---- ---- --- ---- ---- ----
Total Asset Management
Division............... 78 1 -- -- -- 79
---- ---- --- ---- ---- ----
Corporate and Other......... (1) 116 -- (22) (45) 48
---- ---- --- ---- ---- ----
Total Financial Services
Businesses............. $473 $247 $(4) $(22) $(45) $649
==== ==== === ==== ==== ====
Closed Block Business.... 74
----
Total.................... $723
====
13
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
5. SEGMENT INFORMATION (continued)
The summary below presents revenues for the Company's reportable segments
for the three months ended March 31, 2002 and 2001:
2002 2001
------ ------
(in millions)
Financial Services Businesses:
Individual Life Insurance................................. $ 443 $ 467
Private Client Group...................................... 527 606
Retail Investments........................................ 340 386
Property and Casualty Insurance........................... 531 489
------ ------
Total U.S. Consumer Division.......................... 1,841 1,948
------ ------
Group Insurance........................................... 890 768
Other Employee Benefits................................... 634 693
------ ------
Total Employee Benefits Division...................... 1,524 1,461
------ ------
International Insurance................................... 1,249 521
International Securities and Investments.................. 137 151
------ ------
Total International Division.......................... 1,386 672
------ ------
Investment Management and Advisory Services............... 198 205
Other Asset Management.................................... 93 124
------ ------
Total Asset Management Division....................... 291 329
------ ------
Corporate and Other....................................... 14 (2)
------ ------
Total................................................. 5,056 4,408
------ ------
Items excluded from adjusted operating income:
Realized investment gains (losses), net................... (101) 247
Revenues from divested businesses......................... (18) 8
------ ------
Total Financial Services Businesses................ 4,937 4,663
------ ------
Closed Block Business.............................. 1,777 2,084
------ ------
Total per Consolidated Financial Statements........ $6,714 $6,747
====== ======
6. CONTINGENCIES AND LITIGATION
Contingencies
On September 19, 2000, the Company sold Gibraltar Casualty Company
("Gibraltar Casualty"), a subsidiary engaged in the commercial property and
casualty insurance business, to Everest Re Group, Ltd. ("Everest"). Upon
closing of the sale, the Company entered into a stop-loss reinsurance agreement
with Everest whereby the Company will reinsure Everest for up to 80% of the
first $200 million of any adverse loss development in excess of Gibraltar
Casualty's carried reserves as of the closing of the sale. As of March 31,
2002, no liability has been recorded in connection with this agreement.
The Company's property and casualty operations are subject to rate and other
laws and regulations covering a range of trade and claim settlement practices.
State insurance regulatory authorities have broad discretion in approving an
insurer's proposed rates. A significant portion of the Company's automobile
insurance is written in
14
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
6. CONTINGENCIES AND LITIGATION (continued)
the state of New Jersey. Under certain circumstances, New Jersey insurance laws
require an insurer to provide a refund or credit to policyholders based upon
the profits earned on automobile insurance.
It is possible that the results of operations or the cash flow of the
Company in a particular quarterly or annual period could be materially affected
as a result of payments in connection with the matters discussed above
depending, in part, upon the results of operations or cash flow for such
period. Management believes, however, that ultimate payments in connection with
these matters should not have a material adverse effect on the Company's
financial position.
The Financial Services Businesses will bear any expenses and liabilities
from litigation affecting the Closed Block policies as well as the consequences
of certain adverse tax determinations.
Litigation
The Company is subject to legal and regulatory actions in the ordinary
course of its businesses. Pending legal and regulatory actions include
proceedings relating to aspects of our businesses and operations that are
specific to the Company and proceedings that are typical of the businesses in
which the Company operates, including in both cases businesses that have either
been divested or placed in wind-down status. Some of these proceedings have
been brought on behalf of various alleged classes of complainants. In certain
of these matters, the plaintiffs are seeking large and/or indeterminate
amounts, including punitive or exemplary damages.
In particular, the Company has been subject to substantial regulatory
actions and civil litigation involving individual life insurance sales
practices. In 1996, the Company entered into settlement agreements with
relevant insurance regulatory authorities and plaintiffs in the principal life
insurance sales practices class action lawsuit covering policyholders of
individual permanent life insurance policies issued in the United States from
1982 to 1995. Pursuant to the settlements, the Company agreed to various
changes to its sales and business practices controls, to a series of fines, and
to provide specific forms of relief to eligible class members. Virtually all
claims by class members filed in connection with the settlements have been
resolved and virtually all aspects of the remediation program have been
satisfied. While the approval of the class action settlement is now final, the
Company remains subject to oversight and review by insurance regulators and
other regulatory authorities with respect to its sales practices and the
conduct of the remediation program. The U.S. District Court has also retained
jurisdiction as to all matters relating to the administration, consummation,
enforcement and interpretation of the settlements.
As of March 31, 2002, the Company remained a party to approximately 42
individual sales practices actions filed by policyholders who "opted out" of
the class action settlement relating to permanent life insurance policies the
Company issued in the United States between 1982 and 1995. In addition, there
were 18 sales practices actions pending that were filed by policyholders who
were members of the class and who failed to "opt out" of the class action
settlement. The Company believes that those actions are governed by the class
settlement release and expects them to be enjoined and/or dismissed. Additional
suits may be filed by class members who "opted out" of the class settlement or
who failed to "opt out" but nevertheless seek to proceed against the Company. A
number of the plaintiffs in these cases seek large and/or indeterminate
amounts, including punitive or exemplary damages. Some of these actions are
brought on behalf of multiple plaintiffs. It is possible that substantial
punitive damages might be awarded in any of these actions and particularly in
an action involving multiple plaintiffs.
The Company believes that its reserves related to sales practices, as of
March 31, 2002, are adequate. No incremental provisions were recorded in the
first three months of 2002 or 2001.
15
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Consolidated Financial Statements
6. CONTINGENCIES AND LITIGATION (continued)
The Company retained all liabilities for the litigation associated with its
discontinued healthcare business that existed at the date of closing of the
sale of that business to Aetna (August 6, 1999), or commenced within two years
of that date, with respect to claims relating to events that occurred prior to
the closing date. This litigation includes purported class actions and
individual suits involving various issues, including payment of claims, denial
of benefits, vicarious liability for malpractice claims, and contract disputes
with provider groups and former policyholders. Some of the purported class
actions challenge practices of the Company's former managed care operations and
assert nationwide classes. On October 23, 2000, by Order of the Judicial Panel
on Multi-district Litigation, a number of these class actions were consolidated
for pre-trial purposes, along with lawsuits pending against other managed
health care companies, in the United States District Court for the Southern
District of Florida in a consolidated proceeding captioned In Re Managed Care
Litigation. Some of these class actions allege, among other things,
misrepresentation of the level of services and quality of care, failure to
disclose financial incentive agreements with physicians, interference with the
physician-patient relationship, breach of contract and fiduciary duty,
violations of ERISA, violations of and conspiracy to violate RICO, deprivation
of plaintiffs' rights to the delivery of honest medical services and
industry-wide conspiracy to defraud physicians by failing to pay under provider
agreements and by unlawfully coercing providers to enter into agreements with
unfair and unreasonable terms. The remedies sought include unspecified damages,
restitution, disgorgement of profits, treble damages, punitive damages and
injunctive relief. Motions to dismiss certain of the amended complaints and
plaintiff's motions to certify nationwide classes in the consolidated
proceedings are pending. In one of the consolidated actions the court granted
our motion to dismiss, in part. Both plaintiffs and defendants have appealed
certain rulings by the court to the United States Court of Appeals for the
Eleventh Circuit.
A joint venture in which an affiliate of Prudential Securities Group Inc. is
a participant brought an arbitration claim against Kyocera Corporation
alleging, among other things, claims of breach of contract relating to the
manufacture and distribution of computer disk drives. The arbitration panel
decided in favor of the claimants. The Company's share of damages, with
interest, would exceed $250 million. A federal district court in the Northern
District of California has confirmed the award and entered judgment in favor of
the claimants. Kyocera Corporation has appealed the decision to the United
States Court of Appeals for the Ninth Circuit. As with any litigation, the
outcome remains uncertain until all appeals have been concluded or the time to
appeal has expired and, accordingly, the Company has not included the award in
its results of operations.
The Company's litigation is subject to many uncertainties, and given its
complexity and scope, the outcomes cannot be predicted. It is possible that the
results of operations or the cash flow of the Company in a particular quarterly
or annual period could be materially affected by an ultimate unfavorable
resolution of pending litigation and regulatory matters depending, in part,
upon the results of operations or cash flow for such period. Management
believes, however, that the ultimate outcome of all pending litigation and
regulatory matters, after consideration of applicable reserves, should not have
a material adverse effect on the Company's financial position.
16
PRUDENTIAL FINANCIAL, INC.
UNAUDITED INTERIM SUPPLEMENTAL COMBINING STATEMENT OF FINANCIAL POSITION
MARCH 31, 2002
(in millions)
Financial Closed
Services Block
Businesses Business Consolidated
---------- -------- ------------
ASSETS
Fixed maturities:
Available for sale, at fair value.................................... $ 70,687 $41,713 $112,400
Held to maturity, at amortized cost.................................. 354 -- 354
Trading account assets, at fair value.................................... 6,286 -- 6,286
Equity securities, available for sale, at fair value..................... 1,687 1,261 2,948
Commercial loans......................................................... 13,011 6,183 19,194
Policy loans............................................................. 2,854 5,734 8,588
Securities purchased under agreements to resell.......................... 7,137 -- 7,137
Cash collateral for borrowed securities.................................. 5,628 -- 5,628
Other long-term investments.............................................. 4,253 1,180 5,433
Short-term investments................................................... 3,095 2,063 5,158
-------- ------- --------
Total investments.................................................... 114,992 58,134 173,126
Cash and cash equivalents................................................ 10,282 3,078 13,360
Accrued investment income................................................ 1,027 808 1,835
Broker-dealer related receivables........................................ 7,017 -- 7,017
Deferred policy acquisition costs........................................ 5,660 1,473 7,133
Other assets............................................................. 15,692 1,237 16,929
Separate account assets.................................................. 78,515 -- 78,515
-------- ------- --------
TOTAL ASSETS......................................................... $233,185 $64,730 $297,915
======== ======= ========
LIABILITIES AND ATTRIBUTED EQUITY
LIABILITIES
Future policy benefits................................................... $ 38,403 $47,435 $ 85,838
Policyholders' account balances.......................................... 37,559 5,425 42,984
Unpaid claims and claim adjustment expenses.............................. 3,353 -- 3,353
Policyholders' dividends................................................. 894 1,244 2,138
Securities sold under agreements to repurchase........................... 11,704 5,484 17,188
Cash collateral for loaned securities.................................... 8,256 1,573 9,829
Income taxes payable..................................................... 1,102 -- 1,102
Broker-dealer related payables........................................... 5,581 -- 5,581
Securities sold but not yet purchased.................................... 4,561 -- 4,561
Short-term debt.......................................................... 6,515 -- 6,515
Long-term debt........................................................... 3,350 1,750 5,100
Other liabilities........................................................ 13,249 1,233 14,482
Separate account liabilities............................................. 78,515 -- 78,515
-------- ------- --------
Total liabilities.................................................... 213,042 64,144 277,186
-------- ------- --------
Guaranteed minority interest in Trust holding solely debentures of Parent 690 -- 690
-------- ------- --------
COMMITMENTS AND CONTINGENCIES
ATTRIBUTED EQUITY
Accumulated other comprehensive income................................... 164 169 333
Other attributed equity.................................................. 19,289 417 19,706
-------- ------- --------
Total attributed equity.............................................. 19,453 586 20,039
-------- ------- --------
TOTAL LIABILITIES AND ATTRIBUTED EQUITY.............................. $233,185 $64,730 $297,915
======== ======= ========
See Notes to Unaudited Interim Supplemental Combining Financial Information
17
PRUDENTIAL FINANCIAL, INC.
UNAUDITED INTERIM SUPPLEMENTAL COMBINING STATEMENT OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2002
(in millions, except per share amounts)
Financial Closed
Services Block
Businesses Business Consolidated
---------- -------- ------------
REVENUES
Premiums.................................................................. $2,278 $ 944 $ 3,222
Policy charges and fee income............................................. 434 -- 434
Net investment income..................................................... 1,261 886 2,147
Realized investment gains (losses), net................................... (101) (74) (175)
Commissions and other income.............................................. 1,065 21 1,086
------ ------- -------
Total revenues......................................................... 4,937 1,777 6,714
------ ------- -------
BENEFITS AND EXPENSES
Policyholders' benefits................................................... 2,173 1,030 3,203
Interest credited to policyholders' account balances...................... 414 34 448
Dividends to policyholders................................................ 30 643 673
General and administrative expenses....................................... 1,901 245 2,146
------ ------- -------
Total benefits and expenses............................................ 4,518 1,952 6,470
------ ------- -------
INCOME (LOSS) FROM OPERATIONS BEFORE INCOME TAXES......................... 419 (175) 244
------ ------- -------
Income tax expense (benefit).............................................. 156 (65) 91
------ ------- -------
NET INCOME (LOSS)......................................................... $ 263 $ (110) $ 153
====== ======= =======
Direct equity adjustment.................................................. 7 (7)
------ -------
NET INCOME AVAILABLE TO HOLDERS OF COMMON STOCK AND
CLASS B STOCK (See Note 6).............................................. $ 270 $ (117)
====== =======
EARNINGS PER SHARE
Financial Services Businesses
Net income per share of Common Stock--basic and diluted............. $ 0.46 $ 0.46
====== =======
Closed Block Business
Net loss per share of Class B Stock--basic and diluted.............. $(58.50) $(58.50)
======= =======
RECONCILIATION OF NET INCOME TO ADJUSTED OPERATING
INCOME
Net income................................................................ $ 263
------
Reconciling items:
Realized investment losses, net, and related charges:
Realized investment losses, net..................................... 101
Related charges..................................................... (5)
------
Total realized investment losses, net, and related charges.......... 96
Divested businesses.................................................... 8
------
Total reconciling items................................................... 104
------
Income taxes.............................................................. 35
------
Total reconciling items to calculate adjusted operating income, net of tax 69
------
ADJUSTED OPERATING INCOME AFTER INCOME TAXES.............................. $ 332
======
See Notes to Unaudited Interim Supplemental Combining Financial Information
18
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Supplemental Combining Financial Information
1. BASIS OF PRESENTATION
The supplemental combining financial information presents the consolidated
financial position and results of operations for Prudential Financial, Inc. and
its subsidiaries (the "Company") separately reporting the Financial Services
Businesses and the Closed Block Business. The Financial Services Businesses and
the Closed Block Business are both fully integrated operations of the Company
and are not separate legal entities. The supplemental combining financial
information presents the results of the Financial Services Businesses and the
Closed Block Business as if they were separate reporting entities and is
provided as supplemental information to the consolidated financial statements
of the Company. This information should be read in conjunction with the
Unaudited Interim Consolidated Financial Statements of the Company.
In managing its business, the Company analyzes the operating performance of
the Financial Services Businesses and individual segments within the Financial
Services Businesses using "adjusted operating income," which is a non-GAAP
measure. Adjusted operating income is calculated by adjusting income from
operations before income taxes to exclude certain items. The items excluded are
realized investment gains, net of losses and related charges; demutualization
costs and expenses; and the gains, losses and contribution to income/loss of
divested businesses which have been sold but do not qualify for "discontinued
operations" treatment under GAAP. For a complete description of the items
excluded from income from operations for determination of adjusted operating
income, see Note 5 to the Unaudited Interim Consolidated Financial Statements.
2. DEMUTUALIZATION AND RECAPITALIZATION
On the date of demutualization, the Company issued two classes of common
stock. The Common Stock reflects the performance of the Financial Services
Businesses, and the Class B Stock reflects the performance of the Closed Block
Business. Upon the establishment of the Closed Block Business, $5.6 billion of
net assets previously associated with the Traditional Participating Products
segment were transferred to the Financial Services Businesses. Concurrent with
the demutualization, Prudential Holdings, LLC, a wholly owned subsidiary of
Prudential Financial, Inc., issued $1.75 billion in senior secured notes (the
"IHC debt"), of which net proceeds of $1.66 billion were allocated to the
Financial Services Businesses. The IHC debt is serviced by the cash flows of
the Closed Block Business and the results of the Closed Block Business reflect
interest expense associated with the IHC debt.
During the first quarter of 2002, the Company completed a GAAP and statutory
reconciliation of the assets and liabilities allocated to the Closed Block and
the amounts reported as Closed Block assets and liabilities at December 31,
2001. As a result of this reconciliation, it was determined that net assets of
$94 million on a GAAP basis that had been included in the Financial Services
Businesses should have been included in the Closed Block. During the first
quarter of 2002, such assets were reclassified to the Closed Block from the
Financial Services Businesses. Consequently, the total attributed equity of the
Closed Block Business increased by the same amount. The statutory amounts were
unaffected.
3. ALLOCATION OF RESULTS
This supplemental combining financial information reflects the assets,
liabilities, revenues and expenses directly attributable to the Financial
Services Businesses and the Closed Block Business, as well as allocations
deemed reasonable by management in order to fairly present the financial
position and results of operations of each business on a stand alone basis.
While management considers the allocations utilized to be reasonable,
management has the discretion to make operational and financial decisions that
may affect the allocation
19
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Supplemental Combining Financial Information
3. ALLOCATION OF RESULTS (continued)
methods and resulting assets, liabilities, revenues and expenses of each
business. In addition, management has limited discretion over accounting
policies and the appropriate allocation of earnings between the two businesses.
The Company has agreements which provide that, in most instances, the Company
may not change the allocation methodology or accounting policies for the
allocation of earnings between the Financial Services Businesses and Closed
Block Business without the prior consent of the Class B Stock investors or IHC
debt bond insurer.
General corporate overhead not directly attributable to a specific business
that has been incurred in connection with the generation of the businesses
revenues is generally allocated based on the historical general and
administrative expenses of each business as a percentage of the total for the
Company.
Income taxes are allocated between the Financial Services Businesses and the
Closed Block Business as if they were separate companies based on the taxable
income or losses and other tax characterizations of each business. If a
business generates benefits, such as net operating losses, it is entitled to
record such tax benefits to the extent they are expected to be utilized on a
consolidated basis.
4. STOCKHOLDERS' EQUITY
The declaration and payment of dividends on the Common Stock depends
primarily upon the financial condition, results of operations, cash
requirements, future prospects and other factors relating to the Financial
Services Businesses. Dividends declared and paid on the Common Stock do not
depend upon and are not affected by the financial performance of the Closed
Block Business, unless the Closed Block Business is in financial distress.
Dividends declared and paid on the Common Stock are not affected by decisions
with respect to dividend payments on the Class B Stock except as indicated in
the following paragraph. Furthermore, dividends on the Common Stock are limited
to both the amount that is legally available for payment under New Jersey
corporate law if the Financial Services Businesses were treated as a separate
corporation thereunder and the amount that is legally available for payment
under New Jersey corporate law on a consolidated basis after taking into
account dividends on the Class B Stock.
The declaration and payment of dividends on the Class B Stock depends upon
the financial performance of the Closed Block Business and, as the Closed Block
matures, the holders of the Class B Stock will receive the surplus of the
Closed Block Business no longer required to support the Closed Block for
regulatory purposes. Dividends on the Class B Stock are payable in an aggregate
amount per year at least equal to the lesser of (1) a Target Dividend Amount of
$19.25 million or (2) the CB Distributable Cash Flow for such year, which is a
measure of the net cash flows of the Closed Block Business. Notwithstanding
this formula, as with any common stock, Prudential Financial retains the
flexibility to suspend dividends on the Class B Stock; however, if CB
Distributable Cash Flow exists and Prudential Financial chooses not to pay
dividends on the Class B Stock in an aggregate amount at least equal to the
lesser of the CB Distributable Cash Flow or the Target Dividend Amount for that
period, then cash dividends cannot be paid on the Common Stock with respect to
such period.
Holders of Common Stock have no interest in a legal entity representing the
Financial Services Businesses, and holders of the Class B Stock have no
interest in a legal entity representing the Closed Block Business, and holders
of each class of common stock are subject to all of the risks associated with
an investment in the Company.
In the event of a liquidation, dissolution or winding-up of the Company,
holders of Common Stock and holders of Class B Stock would be entitled to
receive a proportionate share of the net assets of the Company that remain
after paying all liabilities and the liquidation preferences of any preferred
stock.
20
PRUDENTIAL FINANCIAL, INC.
Notes To Unaudited Interim Supplemental Combining Financial Information
5. CONTINGENCIES
The Financial Services Businesses will bear any expenses and liabilities
from litigation affecting the Closed Block policies as well as the consequences
of certain adverse tax determinations.
6. EARNINGS PER SHARE
The Company has outstanding two separate classes of common stock. The Common
Stock reflects the performance of the Financial Services Businesses, and the
Class B Stock reflects the performance of the Closed Block Business.
Accordingly, earnings per share is calculated separately for each of these two
classes of common stock. Earnings per share amounts are based on the earnings
available to common stockholders for the period subsequent to the date of
demutualization.
Net income for the Financial Services Businesses and the Closed Block
Business is determined in accordance with GAAP and includes general and
administrative expenses charged to each of the respective businesses based on
the Company's methodology for the allocation of such expenses. Cash flows
between the Financial Services Businesses and the Closed Block Business related
to administrative expenses are determined by a policy servicing fee arrangement
that is based upon insurance in force and statutory cash premiums. To the
extent reported administrative expenses vary from these cash flow amounts, the
differences are recorded, on an after tax basis, as direct equity adjustments
to the equity balances of the businesses. The direct equity adjustments are
used to modify net income to determine the earnings available to each of the
classes of common stock for earnings per share purposes. For the three months
ended March 31, 2002, the direct equity adjustment resulted in an increase of
$7 million in the net income attributable to the Financial Services Businesses
applicable to holders of Common Stock for earnings per share purposes and an
increase of $7 million in the net loss attributable to the Closed Block
Business applicable to holders of Class B Stock for earnings per share purposes.
21
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") addresses the consolidated financial condition of
Prudential Financial as of March 31, 2002, compared with December 31, 2001, and
its consolidated results of operations for the three month periods ended March
31, 2002, and March 31, 2001. You should read the following analysis of our
consolidated financial condition and results of operations in conjunction with
the Company's MD&A and audited Consolidated Financial Statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2001,
and unaudited interim consolidated financial statements included elsewhere in
this Quarterly Report on Form 10-Q. Effective on the date of demutualization,
the consolidated financial statements of Prudential Insurance for financial
statement periods prior to the demutualization became the historical
Consolidated Financial Statements of Prudential Financial. The Consolidated
Financial Statements have been prepared in accordance with accounting
principles generally accepted in the United States of America ("GAAP").
Demutualization and Related Transactions
On the date of demutualization, Prudential Insurance converted from a mutual
life insurance company owned by its policyholders to a stock life insurance
company and became an indirect, wholly owned subsidiary of Prudential
Financial. On that date, eligible policyholders, as defined in the Plan of
Reorganization, received shares of Prudential Financial's Common Stock or the
right to receive cash or policy credits, which are increases in policy values
or increases in other policy benefits, upon the extinguishment of all
membership interests in Prudential Insurance. In addition, two closed blocks,
as discussed below, were established for the benefit of certain participating
individual life insurance policies and annuities issued by Prudential Insurance
and its Canadian branch.
On the date of demutualization, Prudential Financial completed an initial
public offering of 110.0 million shares of its Common Stock at an initial
public offering price of $27.50 per share, and on December 21, 2001, Prudential
Financial issued an additional 16.5 million shares of Common Stock as a result
of the exercise of the over-allotment option granted to underwriters in the
initial public offering. Also on the date of demutualization, Prudential
Financial completed the sale, through a private placement, of 2.0 million
shares of Class B Stock, a separate class of common stock, at a price of $87.50
per share. The Common Stock reflects the performance of the Financial Services
Businesses, and the Class B Stock reflects the performance of the Closed Block
Business. Collectively, the Financial Services Businesses and the Closed Block
Business are referred to as the "Businesses." In addition, on the date of
demutualization, Prudential Financial issued 13.8 million 6.75% equity security
units for gross proceeds of $690 million, including as a component thereof
redeemable capital securities of Prudential Financial Capital Trust I, a
statutory business trust that is consolidated in our financial statements.
Furthermore, Prudential Holdings, LLC ("PHLLC"), a wholly owned subsidiary of
Prudential Financial that owns the capital stock of Prudential Insurance,
issued $1.75 billion in senior secured notes (the "IHC debt"), a portion of
which were insured by a bond insurer.
Concurrent with the demutualization, Prudential Insurance completed a
corporate reorganization whereby various subsidiaries (and certain related
assets and liabilities) of Prudential Insurance were dividended (or
"destacked") so that they became wholly owned subsidiaries of Prudential
Financial rather than of Prudential Insurance. The subsidiaries distributed by
Prudential Insurance to Prudential Financial included its property and casualty
insurance companies, its principal securities brokerage companies, its
international insurance companies, its principal asset management operations,
its international securities and investments operations, its domestic banking
operations and its residential real estate brokerage franchise and relocation
services operations.
The Plan of Reorganization required us to establish and operate a mechanism
known as the Closed Block. The Closed Block is designed generally to provide
for the reasonable expectations for future policy dividends
22
after demutualization of holders of policies included in the Closed Block by
allocating assets that will be used for payment of benefits, including
policyholder dividends, on these policies. See Note 3 to the Unaudited Interim
Consolidated Financial Statements for more information on the Closed Block.
On January 22, 2002, Prudential Financial's Board of Directors authorized
the repurchase of up to $1 billion of its Common Stock. The timing and amount
of any purchases of Common Stock under this authorization will be determined by
management based on market conditions and other considerations, and such
purchases may be effected by market or negotiated transactions, including
programs adopted under Rule 10b5-1 of the Securities Exchange Act of 1934.
Overview
Financial Services Businesses and Closed Block Business
Financial Services Businesses
We refer to the businesses in our four operating divisions and our Corporate
and Other operations, collectively, as our Financial Services Businesses. The
U.S. Consumer division consists of our Individual Life Insurance, Private
Client Group, Retail Investments and Property and Casualty Insurance segments.
The Employee Benefits division consists of our Group Insurance and Other
Employee Benefits segments. The International division consists of our
International Insurance and International Securities and Investments segments.
The Asset Management division consists of our Investment Management and
Advisory Services and Other Asset Management segments. We also have Corporate
and Other operations, which contain corporate items and initiatives that are
not allocated to the business segments. Corporate and Other operations also
include businesses that we have divested or placed in wind-down status. The
principal corporate items are the expense of corporate management and earnings
on equity not allocated to our businesses.
We attribute financing costs to each segment based on its use of financing
and reflect financing costs in each segment's results. The net investment
income of each segment includes earnings on the amount of equity which
management believes is necessary to support the risks of that segment.
Closed Block Business
Effective with the date of demutualization, we established the Closed Block
Business. For periods prior to the date of demutualization, the results of the
Closed Block Business are those of our former Traditional Participating
Products segment. Upon the establishment of the Closed Block Business, we
transferred $5.6 billion of net assets previously associated with the
Traditional Participating Products segment to the Financial Services
Businesses. This capital was initially allocated to our Corporate and Other
operations as of the date of demutualization. As a result, income from
operations of the Closed Block Business for the three months ended March 31,
2002 does not include returns on these net assets, which were historically
included in income from operations of the Traditional Participating Products
segment.
In connection with the demutualization, we ceased offering domestic
participating products. The liabilities for our individual in force
participating products were segregated, together with assets which will be used
exclusively for the payment of benefits and policyholder dividends, expenses
and taxes with respect to these products, in a regulatory mechanism referred to
as the "Closed Block." We selected the amount and type of Closed Block assets
and Closed Block liabilities included in the Closed Block so that the Closed
Block assets initially had a lower book value than the Closed Block
liabilities. We expect that the Closed Block assets will generate sufficient
cash flow, together with anticipated revenues from the Closed Block policies,
over the life of the Closed Block to fund payments of all expenses, taxes and
policyholder benefits to be paid to, and the reasonable dividend expectations
of, policyholders of the Closed Block policies. We also segregated for
accounting purposes the assets that we need to hold outside the Closed Block to
meet capital requirements related
23
to the policies included within the Closed Block. No policies sold after
demutualization will be added to the Closed Block and its in force business is
expected to ultimately decline as we pay policyholder benefits in full. We
expect the proportion of our business represented by the Closed Block to
decline as we grow other businesses. A minor portion of our former Traditional
Participating Products segment, which included the policies now included in the
Closed Block Business prior to our demutualization, consisted of other
traditional insurance products that were not included in the Closed Block.
The Closed Block Business consists principally of the Closed Block, assets
held outside the Closed Block that Prudential Insurance needs to hold to meet
capital requirements related to the Closed Block policies, invested assets held
outside the Closed Block that represent the difference between the Closed Block
assets and Closed Block liabilities and the interest maintenance reserve,
deferred policy acquisition costs related to Closed Block policies, the
principal amount of the IHC debt and related hedging activities and certain
other related assets and liabilities. We allocated the net proceeds from the
issuance of the Class B Stock and IHC debt, except for $72 million used to
purchase a guaranteed investment contract to fund a portion of the bond
insurance cost associated with that debt, to the Financial Services Businesses.
However, we expect that the IHC debt will be serviced by the net cash flows of
the Closed Block Business over time, and we report results of the Closed Block
Business, including interest expenses associated with the IHC debt.
Consolidated Results of Operations
In managing our business, we analyze our operating performance by separately
considering our Financial Services Businesses and our Closed Block Business. In
addition, for the Financial Services Businesses, we analyze our operating
performance using a non-GAAP measure we call "adjusted operating income." Prior
to the date of demutualization, we also analyzed results of our Traditional
Participating Products segment based on this non-GAAP measure. Beginning in
2002, management no longer uses adjusted operating income as the measure to
assess operating performance of the Closed Block Business. Consequently,
results of the Closed Block Business for all periods are presented only in
accordance with GAAP. We calculate adjusted operating income for the Financial
Services Businesses by adjusting our income from operations before income taxes
to exclude certain items. The items excluded are:
. realized investment gains, net of losses and related charges;
. sales practices remedies and costs;
. the gains, losses and contribution to income/loss of divested businesses
that we have sold but that do not qualify for "discontinued operations"
accounting treatment under GAAP; and
. demutualization costs and expenses.
Wind-down businesses that we have not divested remain in adjusted operating
income.
The excluded items are important to an understanding of our overall results
of operations. You should not view adjusted operating income as a substitute
for net income determined in accordance with GAAP, and you should note that 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. We exclude realized
investment gains, net of losses and related charges, from adjusted operating
income, because the timing of transactions resulting in recognition of gains or
losses is largely at our discretion and the amount of these gains or losses is
heavily influenced by and fluctuates in part according to the availability of
market opportunities. Including the fluctuating effects of these transactions
could distort trends in the underlying profitability of our businesses. We
exclude sales practices remedies and costs because they relate to a substantial
and identifiable non-recurring event. For the three months ended March 31, 2002
and 2001, the Company had no expense for sales practices remedies and costs. We
24
exclude the gains and losses and contribution to income/loss of divested
businesses because, as a result of our decision to dispose of these businesses,
these results are not relevant to the profitability of our ongoing operations
and could distort the trends associated with our ongoing operations. We also
exclude demutualization costs and expenses because they are directly related to
our demutualization and could distort the trends associated with our business
operations.
In the discussion below of our consolidated results of operations, we
separately discuss income from operations before income taxes and adjusted
operating income for the Financial Services Businesses, as well as the
divisions thereof and Corporate and Other operations. We also discuss the items
excluded from adjusted operating income for the periods presented, i.e.,
realized investment gains, demutualization costs and expenses and divested
businesses, as well as taxes. Realized investment gains and losses are
allocated between the Financial Services Businesses and the Closed Block
Business. Results from divested businesses are allocated entirely to the
Financial Services Businesses. For purposes of analyzing our results, taxes are
not allocated to our segments or divisions. Following this consolidated
discussion, you will find a detailed discussion of our results of operations by
division and by the segments of each division, as well as the Closed Block
Business.
Net Income and Adjusted Operating Income
Consolidated Net Income
2002 to 2001 Three Month Comparison. On a consolidated basis, net income
decreased $284 million, or 65%, from $437 million in the first three months of
2001 to $153 million in the first three months of 2002. The decrease reflects a
$479 million decline in income from operations before income taxes, partially
offset by a $195 million decrease in the related provision for income taxes as
discussed below under "--Taxes."
The $479 million decrease in income from operations before income taxes
resulted from a $230 million decrease from the Financial Services Businesses
and a $249 million decrease from the Closed Block Business. For a discussion of
the Closed Block Business, see "--Results of Operations for Financial Services
Business by Division and Closed Block Business--Closed Block Business." The
$230 million decrease from the Financial Services Businesses came primarily
from a $161 million decline from our Employee Benefits division, a $68 million
decline from our U.S. Consumer division and a $55 million decline from our
Corporate and Other operations, partially offset by increases of $43 million
from our Asset Management division and $11 million from our International
division.
The $161 million decline from our Employee Benefits division, the $68
million decline from our U.S. Consumer division and the $55 million decline
from our Corporate and Other operations came primarily from decreases in
realized investment gains, net of losses. The $43 million increase from our
Asset Management division came primarily from an increase in realized
investment gains, net of losses. The $11 million increase from our
International division came from an increase in adjusted operating income,
reflecting our acquisition of Gibraltar Life, partially offset by increased
realized investment losses.
Net income per share of Common Stock, which reflects the performance of the
Financial Services Businesses, decreased to 46 cents per Common share for the
three months ended March 31, 2002, from 69 cents per equivalent Common Share
for the three months ended March 31, 2001. Net income on an equivalent share
basis assumes that shares issued in the Company's demutualization on December
18, 2001 and the initial public offering were outstanding for the entire 2001
period and does not reflect adjustments to earnings for demutualization or
related transactions. The net loss per share of the Class B Stock, which
reflects the performance of the Closed Block Business, amounted to $58.50 per
Class B Share for the three months ended March 31, 2002, compared to net income
of $17.00 per equivalent share of Class B Stock for the three months ended
March 31, 2001, which assumes that the Class B Shares, which were issued at the
time of the demutualization, were outstanding for the entire 2001 period and
does not reflect adjustments to earnings for demutualization or related
transactions. The first quarter 2002 decrease in net income per share of the
Common
25
Stock and the loss per share of Class B Stock in comparison to results of the
year-earlier period reflect the decline in net income of the Financial Services
Businesses as discussed above and the results of the Closed Block Business as
discussed under "--Results of Operations for Financial Services Business by
Division and Closed Block Business--Closed Block Business."
See "--Financial Services Businesses Adjusted Operating Income" below for a
discussion of the adjusted operating income results of our divisions and our
Corporate and Other operations.
See "--Realized Investment Gains" below for a discussion of realized
investment gains, net of losses, and charges related to net realized investment
gains for the Financial Services Businesses.
Financial Services Businesses Adjusted Operating Income
2002 to 2001 Three Month Comparison. Adjusted operating income of our
Financial Services Businesses increased $50 million, or 11%, from the first
three months of 2001 to the first three months of 2002. The increase came
primarily from increases of $102 million from our International division and
$24 million from our Corporate and Other operations, partially offset by
decreases of $38 million from our Employee Benefits division, $23 million from
our U.S. Consumer division and $15 million from our Asset Management division.
The $102 million increase in adjusted operating income from our
International division came primarily from a $109 million increase from the
International Insurance segment, including a $104 million contribution from
Gibraltar Life.
Realized Investment Gains
We have frequently used an active management strategy for a significant
portion of our public fixed maturity investment portfolio to maximize the
overall return on our investments, subject to our adjusted operating income
objectives. When applied during a period of generally declining interest rates,
we expect that using this strategy will result in lower investment income
partially offset by realized investment gains. Conversely, when applied during
a period of generally rising interest rates, we expect that using this strategy
will result in increased investment income offset by realized investment
losses. The amount of our gains or losses also depends on relative value
opportunities and other variables. Realized investment gains, net of losses,
also includes impairments on fixed income and equity assets, which we recognize
on an ongoing basis. The level of impairments generally reflects economic
conditions, and is expected to increase when economic conditions worsen and to
decrease when economic conditions improve.
In consideration of our adjusted operating income objectives in the
Financial Services Businesses and other factors, we may choose, at times, to
constrain our active management and, therefore, the magnitude of realized
investment gains or losses.
In addition, we require most issuers of private fixed maturity securities to
pay us make-whole yield maintenance payments when they prepay the securities.
Prepayment levels are also driven by the interest rate environment and other
factors not within our control. The prepayment of private fixed maturities we
held contributed realized investment gains of $8 million in the first three
months of 2002 and $12 million in the first three months of 2001.
We use derivative contracts to hedge the risk that changes in interest rates
or foreign currency exchange rates will affect the market value of certain
investments. We also use derivative contracts to mitigate the risk that
unfavorable changes in currency exchange rates will reduce U.S. dollar
equivalent earnings generated by certain of our non-U.S. businesses. The vast
majority of these derivative contracts do not qualify for hedge accounting, and
consequently we recognize the changes in fair value of such contracts from
period to period in current
26
earnings, although we do not necessarily treat underlying investments the same
way. Accordingly, our hedging activities can contribute significantly to
fluctuations in realized investment gains and losses.
The comparisons below discuss realized investment gains net of losses and
related charges. These related charges, which pertain to the Financial Services
Businesses and not to the Closed Block Business, relate to policyholder
dividends, deferred policy acquisition costs and reserves for future policy
benefits. A percentage of net realized investment gains on specified Gibraltar
Life assets is required to be paid as dividends to Gibraltar Life
policyholders. See "--Results of Operations for Financial Services Businesses
by Division and Closed Block Business" below. We amortize deferred policy
acquisition costs for interest sensitive products based on estimated gross
profits, which include net realized investment gains on the underlying invested
assets; the related charge for amortization of deferred policy acquisition
costs represents the amortization related to net realized investment gains for
the period. We adjust the reserves for some of our policies when cash flows
related to these policies are affected by net realized investment gains, and
the related charge for reserves for future policy benefits represents such an
adjustment. The changes in these related charges from one period to another may
be disproportionate to the changes in realized investment gains, net of losses,
because the indicated reserve adjustments relate to realized investment gains,
but not losses, evaluated over several periods.
2002 to 2001 Three Month Comparison. On a consolidated basis, realized
investment gains, net of losses and related charges, declined $502 million,
from a net gain of $332 million in the first three months of 2001 to a net loss
of $170 million in the first three months of 2002. Charges related to net
realized investment gains and losses, which relate only to the Financial
Services Businesses amounted to $4 million in the first three months of 2001,
compared to a credit of $5 million in the first three months of 2002. We
realized net losses of $196 million on fixed maturity investments in the first
three months of 2002, including impairments of $72 million, compared to net
gains of $190 million in the first three months of 2001. The net gains on fixed
maturities in the first three months of 2001 came primarily from fixed maturity
investment sales in an environment of lower interest rates than when the
securities were purchased, which generated realized gains of $262 million,
offset by fixed maturity impairments totaling $84 million. We realized net
losses on equity securities of $54 million in the first three months of 2002,
compared to net gains of $6 million in the first three months of 2001, as we
benefited in the first three months of 2001 from more favorable equity market
conditions. We recorded net investment gains on derivatives of $26 million in
the first three months of 2002 and $123 million in the first three months of
2001. These amounts are net of related fair value adjustments to fixed
maturities that qualify for fair value hedge accounting treatment.
Realized investment gains (losses), net also includes a gain of $59 million
from the Asset Management division's sale of a specialized asset management
subsidiary during the first three months of 2002. This subsidiary did not have
material assets or operating results in prior periods.
For the Financial Services Businesses, realized investment gains, net of
losses and related charges, decreased $339 million from a net gain of $243
million in the first three months of 2001 to a net loss of $96 million in the
first three months of 2002. Charges related to net realized investment gains
and losses for the Financial Services Businesses amounted to $4 million in the
first three months of 2001, compared to a credit of $5 million in the first
three months of 2002. These charges did not change proportionately with the
change in realized investment gains, net of losses, from the first three months
of 2001 to the first three months of 2002 for the reasons described above. We
realized net losses of $108 million on fixed maturity investments in the first
three months of 2002, including impairments of $26 million, compared to net
gains of $112 million in the first three months of 2001. The net gains on fixed
maturities in the first three months of 2001 came primarily from fixed maturity
investment sales in an environment of lower interest rates than when the
securities were purchased, which generated realized gains of $143 million
offset by fixed maturity impairments totaling $38 million. We realized net
losses on equity securities of $63 million in the first three months of 2002
compared to net gains of $46 million in the first three months of 2001. The
2002 results reflect our disposal of certain equity securities of our Gibraltar
Life operations, while the 2001 results reflect the benefit of more favorable
equity market conditions. We recorded net investment gains on derivatives of
$20 million in the first three months of
27
2002 and $68 million in the first three months of 2001. These amounts are net
of related fair value adjustments to fixed maturities that qualify for fair
value hedge accounting treatment. In addition, we recognized a gain of $59
million in the first three months of 2002 from the sale of a specialized asset
management subsidiary, as discussed above.
For the Closed Block Business, realized investment gains, net of losses,
declined $163 million, from a net gain of $89 million in the first three months
of 2001 to a net loss of $74 million in the first three months of 2002. We
realized net losses of $88 million on fixed maturity investments in the first
three months of 2002, including impairments of $46 million, compared to net
gains of $78 million in the first three months of 2001. The net gains on fixed
maturities in the first three months of 2001 came primarily from fixed maturity
investment sales in an environment of lower interest rates than when the
securities were purchased, which generated realized gains of $119 million
offset by fixed maturity impairments totaling $46 million. We realized net
gains on equity securities of $9 million in the first three months of 2002,
compared to net losses of $40 million in the first three months of 2001. We
recorded net investment gains on derivatives of $6 million in the first three
months of 2002 and $55 million in the first three months of 2001.
Divested Businesses
Our income from operations includes results from several businesses that we
have divested but that do not qualify for "discontinued operations" treatment
in our income statement under GAAP. Our results from divested businesses for
the three months ended March 31, 2002 and 2001 primarily relate to the former
lead-managed equity underwriting for corporate issuers and institutional fixed
income businesses of Prudential Securities. The lead-managed equity
underwriting for corporate issuers and institutional fixed income businesses of
Prudential Securities recorded pre-tax losses of $8 million in the first three
months of 2002 and $23 million in the first three months of 2001. The losses in
these periods came primarily from deterioration in the value of collateralized
receivables related to these businesses that we are in the process of
liquidating and wind-down costs.
Demutualization Costs and Expenses
We incurred costs and expenses related to demutualization totaling $45
million in the first three months of 2001. These costs and expenses are
reported separately in our consolidated income statements within income from
operations before income taxes. These demutualization expenses consisted
primarily of the costs of engaging independent accounting, actuarial,
investment banking, legal and other consultants that advised us and insurance
regulators in the demutualization process and related matters as well as
printing and postage for communication with policyholders.
Taxes
Our income tax provisions amounted to $91 million in the first three months
of 2002 and $286 million in the first three months of 2001. The income tax
provisions represented 37.3% of income from operations before income taxes in
the first three months of 2002 and 39.6% of income from operations before
income taxes in the first three months of 2001. The higher effective rate in
the 2001 period was primarily due to demutualization costs and expenses during
that period, which amounts were not deductible for tax purposes.
Results of Operations for Financial Services Businesses by Division and
Closed Block Business
The following table summarizes certain selected financial data for each of
our four divisions and for Corporate and Other operations, including
consolidating adjustments, which together comprise our Financial Services
Businesses, and our Closed Block Business, for the three months ended March 31,
2002 and 2001, as well as their assets as of those dates. In managing the
Financial Services Businesses, we analyze our operating
28
performance using "adjusted operating income," which is a non-GAAP measure that
excludes certain items as described above under "--Consolidated Results of
Operations." Amounts for the Financial Services Businesses presented below are
prepared on that basis.
As of or for the
Three Months Ended
March 31,
-----------------
2002 2001
------ ------
(in millions)
Revenues:
Financial Services Businesses:
Adjusted operating income basis(1):
U.S. Consumer........................................................................ $1,841 $1,948
Employee Benefits.................................................................... 1,524 1,461
International(2)..................................................................... 1,386 672
Asset Management..................................................................... 291 329
Corporate and Other.................................................................. 14 (2)
------ ------
Total............................................................................. 5,056 4,408
Other amounts included in consolidated revenues:
Realized investment gains (losses), net.............................................. (101) 247
Revenues from divested businesses.................................................... (18) 8
------ ------
Total revenues--Financial Services Businesses..................................... 4,937 4,663
Total revenues--Closed Block Business(3).................................................... 1,777 2,084
------ ------
Total consolidated revenues................................................................. $6,714 $6,747
====== ======
Adjusted operating income(4):
Financial Services Businesses:
U.S. Consumer........................................................................ $ 171 $ 194
Employee Benefits.................................................................... 66 104
International(2)..................................................................... 200 98
Asset Management..................................................................... 63 78
Corporate and Other.................................................................. 23 (1)
------ ------
Total Financial Services Businesses............................................... 523 473
Items excluded from adjusted operating income:
Realized investment gains, net of losses and related charges:
Realized investment gains (losses) net............................................ (101) 247
Related charges................................................................... 5 (4)
------ ------
Total realized investment gains, net of losses and related charges............. (96) 243
Divested businesses.................................................................. (8) (22)
Demutualization costs and expenses................................................... -- (45)
------ ------
Income from operations before income taxes--Financial Services Businesses................... 419 649
Income from operations before income taxes--Closed Block Business(3)........................ (175) 74
------ ------
Consolidated income from operations before income taxes..................................... $ 244 $ 723
====== ======
Income (loss) from operations before income taxes:
Financial Services Businesses:
U.S. Consumer........................................................................ $ 153 $ 221
Employee Benefits.................................................................... 36 197
International(2)..................................................................... 115 104
Asset Management..................................................................... 122 79
Corporate and Other.................................................................. (7) 48
------ ------
Total Financial Services Businesses............................................... 419 649
Closed Block Business(3).................................................................... (175) 74
------ ------
Total............................................................................. $ 244 $ 723
====== ======
29
As of or for the
Three Months Ended
March 31,
------------------
2002 2001
-------- --------
(in millions)
Assets:
Financial Services Businesses:
U.S. Consumer.................................. $ 70,556 $ 67,256
Employee Benefits.............................. 74,461 74,489
International(5)............................... 38,659 11,000
Asset Management............................... 33,692 34,549
Corporate and Other............................ 15,817 14,014
-------- --------
Total Financial Services Businesses......... 233,185 201,308
Closed Block Business(3).............................. 64,730 70,444
-------- --------
Total....................................... $297,915 $271,752
======== ========
--------
(1) Revenues exclude realized investment gains, net of losses, and revenues
from divested businesses.
(2) Includes the results of Gibraltar Life, which we acquired in April of 2001.
(3) Amounts shown for the Closed Block Business represent results of the
Traditional Participating Products segment for the 2001 period.
(4) Adjusted operating income equals revenues as defined above in footnote (1)
less benefits and expenses excluding (i) the impact of net realized
investment gains on deferred acquisition cost amortization, reserves and
dividends to policyholders; (ii) the benefits and expenses from divested
businesses; and (iii) demutualization costs and expenses.
(5) Assets of our International division at March 31, 2002, include assets of
Gibraltar Life stated as of February 28, 2002, amounting to $27,248 million.
Other Data:
As of March 31,
---------------
2002 2001
------ ------
(in billions)
Assets Under Management and Administration (at fair market value):
Managed by Asset Management division(1):
Retail customers(2)............................................. $ 92.3 $ 97.2
Institutional customers(3)...................................... 86.2 89.5
General account................................................. 111.7 111.0
------ ------
Total proprietary............................................ 290.2 297.7
Managed by Retail Investments or Private Client Group segments:
Non-proprietary wrap-fee and other assets under management(4)... 50.6 49.8
International(5).................................................... 38.0 8.9
------ ------
Total assets under management................................ 378.8 356.4
Client assets under administration.................................. 201.2 203.5
------ ------
Total assets under management and administration............. $580.0 $559.9
====== ======
--------
(1) Reflects reclassification of amounts by client category as of January 1,
2002, based upon internal management criteria, which reduced the amount
attributed to retail customers by $3.3 billion and increased the amounts
attributed to institutional customers and the general account by $2.8
billion and $0.5 billion, respectively.
(2) Consists of individual mutual funds, including investments in our mutual
funds through wrap-fee products, and both variable annuities and variable
life insurance assets in our separate accounts. Fixed annuities and the
fixed rate options of both variable annuities and variable life insurance
are included in general account.
(3) Consists of third-party institutional assets and group insurance contracts.
(4) Consists of wrap-fee assets gathered by the Private Client Group and Retail
Investments segments and funds invested in the non-proprietary options of
our investment products other than wrap-fee products.
(5) Consists primarily of general account assets supporting our International
Insurance segment, assets gathered by the International Securities and
Investments segment and wind-down Canadian operations. International assets
under management as of March 31, 2002 includes invested assets, stated as
of February 28, 2002, of $26.1 billion of Gibraltar Life, which we acquired
in April 2001.
30
As of March 31,
---------------
2002 2001
----- -----
Distribution Representatives:
Prudential Agents.................................. 4,469 5,382
Financial Advisors (domestic and international).... 5,859 6,628
International Life Planners........................ 4,098 3,434
Gibraltar Life Advisors (as of February 28, 2002).. 5,726 --
U.S. Consumer Division
Division Results
The following table and discussion present the U.S. Consumer division's
results based on our definition of adjusted operating income, which is a
non-GAAP measure, as well as income from operations before income taxes, which
is prepared in accordance with GAAP. See "--Consolidated Results of Operations"
for a definition of adjusted operating income.
Three Months Ended
March 31,
-----------------
2002 2001
------ ------
(in millions)
Division operating results:
Revenues(1)............................................................................ $1,841 $1,948
Benefits and expenses(2)............................................................... 1,670 1,754
------ ------
Adjusted operating income.............................................................. $ 171 $ 194
====== ======
Adjusted operating income by segment:
Individual Life Insurance........................................................... $ 117 $ 79
Private Client Group................................................................ (19) (6)
Retail Investments.................................................................. 51 61
Property and Casualty Insurance..................................................... 22 60
------ ------
Total............................................................................ 171 194
Items excluded from adjusted operating income:
Realized investment gains, net of losses and related charges:
Realized investment gains (losses), net.......................................... (19) 29
Related charges(3)............................................................... 1 (2)
------ ------
Total realized investment gains, net of losses and related charges............ (18) 27
------ ------
Income from operations before income taxes................................................ $ 153 $ 221
====== ======
--------
(1) Revenues exclude realized investment gains, net of losses.
(2) Benefits and expenses exclude the impact of net realized investment gains
on deferred acquisition cost amortization and reserves.
(3) Related charges consist of the following:
Three Months Ended
March 31,
-----------------
2002 2001
---- ----
(in millions)
Reserves for future policy benefits.............. $-- $(1)
Amortization of deferred policy acquisition costs 1 (1)
--- ---
Total......................................... $ 1 $(2)
=== ===
2002 to 2001 Three Month Comparison. Adjusted operating income of our U.S.
Consumer division decreased $23 million, or 12%, in the first three months of
2002 from the first three months of 2001. The decline resulted primarily from a
decrease in adjusted operating income in our Property and Casualty Insurance
segment. Income from operations before income taxes decreased $68 million, or
31%, as a result of a $45 million decrease
31
in realized investment gains, net of losses and related charges, as well as the
decrease in adjusted operating income. For a discussion of realized investment
gains and losses and charges related to realized investment gains and losses,
see "--Consolidated Results of Operations--Realized Investment Gains."
Individual Life Insurance
Operating Results
The following table sets forth the Individual Life Insurance segment's
operating results for the periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
---- ----
(in millions)
Operating results:
Revenues(1)............... $443 $467
Benefits and expenses..... 326 388
---- ----
Adjusted operating income. $117 $ 79
==== ====
--------
(1) Revenues exclude realized investment gains, net of losses.
Adjusted Operating Income
2002 to 2001 Three Month Comparison. Adjusted operating income increased
$38 million, or 48%, from the three months ended March 31, 2001 to the three
months ended March 31, 2002. The increase came primarily from a decline in
operating expenses, reflecting savings that we have begun to realize from our
field management and agency restructuring program implemented in 2001, as well
as more favorable mortality experience, net of reinsurance, in the first three
months of 2002.
Revenues
2002 to 2001 Three Month Comparison. Revenues, as shown in the table above
under "--Operating Results," decreased $24 million, or 5%, from the first three
months of 2001 to the first three months of 2002.
Premiums decreased $31 million, or 36%, from $87 million in the first three
months of 2001 to $56 million in the first three months of 2002, reflecting
decreased premiums on term insurance we issued under policy provisions to
customers who previously had lapsing variable life insurance with us.
Policy charges and fees amounted to $250 million in the first three months
of 2002, essentially unchanged from $251 million in the first three months of
2001.
Net investment income increased $6 million, or 6%, from $99 million in the
first three months of 2001 to $105 million in the first three months of 2002,
primarily from an increase in the level of invested assets.
Benefits and Expenses
2002 to 2001 Three Month Comparison. Benefits and expenses, as shown in the
table above under "--Operating Results," decreased $62 million, or 16%, from
the first three months of 2001 to the first three months of 2002. Operating
expenses, including distribution costs that we charge to expense, declined $23
million reflecting savings from our program to restructure our field management
and agency structure. In addition, policyholder benefits and related changes in
reserves decreased $29 million, from $154 million in the first three months of
2001 to $125 million in the first three months of 2002, primarily as a result
of the lower amount of term insurance we issued in the 2002 period under policy
provisions to customers who previously had lapsing
32
variable life insurance with us, as well as more favorable mortality
experience, net of reinsurance, in the current period.
Sales Results
The following table sets forth the Individual Life Insurance segment's
sales, as measured by statutory first year premiums and deposits for the
periods indicated. These amounts do not correspond to revenues under GAAP. In
managing our individual life insurance business, we analyze statutory first
year premiums and deposits as well as revenues because statutory first year
premiums and deposits measure the current sales performance of the business
unit, while revenues reflect, predominantly in our case, the renewal
persistency and aging of in force policies written in prior years and net
investment income, as well as current sales.
Three Months
Ended March 31,
---------------
2002 2001
----- -----
(in millions)
Sales(1):
Variable and universal life........................ $55 $ 65
Corporate-owned life insurance..................... 10 37
Term life.......................................... 13 10
--- ----
Total.......................................... $78 $112
=== ====
Sales by distribution channel(1):
Prudential Agents.................................. $53 $ 57
Third-party and other distributors................. 25 55
--- ----
Total.......................................... $78 $112
=== ====
--------
(1) Statutory first year premiums and deposits.
2002 to 2001 Three Month Comparison. Sales of new life insurance, as
measured by statutory first year premiums and deposits, decreased $34 million,
or 30%, from the first three months of 2001 to the first three months of 2002.
The decline came primarily from a $27 million decrease in the segment's sales
of corporate-owned life insurance products, substantially all of which is sold
by the PruSelect third-party distribution channel. A decrease of $21 million in
sales of variable life insurance was partially offset by $11 million of sales
of our universal life insurance products, which we introduced in late 2001. In
2001 we also repriced certain of our term insurance products. Inclusive of
corporate-owned life insurance sales, which tend to emerge unevenly over the
course of the year due to typically large case size, PruSelect accounted for
32% of the Individual Life Insurance segment's sales in the first three months
of 2002, compared to 49% in the first three months of 2001. Sales by the
PruSelect channel, other than corporate-owned life insurance, decreased $3
million, or 17%, in the first three months of 2002 from the first three months
of 2001. During 2001, we began to expand the focus of PruSelect, which has
historically served intermediaries who provide insurance solutions in support
of estate and wealth transfer planning for affluent individuals and
corporate-owned life insurance for businesses, toward the mass affluent market.
We believe that the decrease in PruSelect channel sales for products other than
corporate-owned life insurance reflects a continued decline in demand for
individual variable life insurance products and our transition to the new
focus, which included changes in our underwriting classifications and a
reduction in our maximum insurance coverage on a single life.
Sales from Prudential Agents declined by $4 million from the first three
months of 2001 to the first three months of 2002, as the decline in agents was
largely offset by an increase in productivity. The number of Prudential Agents
declined to approximately 4,500 at March 31, 2002, down from approximately
5,400 at March 31, 2001, but increased slightly from December 31, 2001. The
decline in agents from March 31, 2001 reflected actions we took in 2001 to
increase the productivity standards required to continue agents' contracts.
Prudential Agent productivity increased to $34,000 in the first three months of
2002 from $25,000 from the first three months of 2001. We have not implemented
further increases in these productivity standards for periods current
33
level will contribute to stabilization in the number of Prudential Agents. We
measure Prudential Agent productivity as commissions on new sales of all
products, not only life insurance, by Prudential Agents with us for the entire
period, divided by the number of those Prudential Agents.
Policy Surrender Experience
The following table sets forth the Individual Life Insurance segment's
policy surrender experience for variable life insurance, measured by cash value
of surrenders, for the periods indicated. These amounts do not correspond to
expenses under GAAP. In managing this business, we analyze the cash value of
surrenders because it is a measure of the degree to which policyholders are
maintaining their in force business with us, a driver of future profitability.
Our term life insurance products do not provide for cash surrender values.
Three Months
Ended
March 31,
--------------
2002 2001
------ ------
($ in millions)
Cash value of surrenders....................................................................... $162 $180
====== ======
Cash value of surrenders as a percentage of mean future policy benefit reserves, policyholders'
account balances, and separate account balances.............................................. 3.9% 4.3%
====== ======
2002 to 2001 Three Month Comparison. The total cash value of surrenders and
the level of surrenders as a percentage of mean future policy benefit reserves,
policyholders' account balances and separate account balances decreased in the
first three months of 2002 from the first three months of 2001, as the 2001
period was affected by a single large surrender.
Private Client Group
Operating Results
The following table sets forth the Private Client Group segment's operating
results for the periods indicated.
Three Months
Ended
March 31,
------------
2002 2001
----- -----
(in millions)
Operating results:
Non-interest revenues........................... $482 $536
Net interest revenues........................... 45 70
---- ----
Total revenues, net of interest expense..... 527 606
---- ----
Total non-interest expenses..................... 546 612
---- ----
Adjusted operating income....................... $(19) $ (6)
==== ====
Adjusted Operating Income
2002 to 2001 Three Month Comparison. The Private Client Group segment
reported pre-tax losses, on an adjusted operating income basis, of $19 million
for the first three months of 2002 and $6 million for the first three months of
2001. The $13 million increase in the segment's loss came primarily from an $11
million greater loss from our domestic securities brokerage operations, which
reported losses of $19 million for the first three months of 2002 and $8
million for the first three months of 2001. These operations were adversely
affected by a decline in revenues from retail investor transaction volume and
margin loan and other customer balances, which resulted in decreased commission
and net interest revenues. Partially offsetting these declines was a decrease in
34
non-interest expenses reflecting actions taken in 2001 to reduce staffing
levels, occupancy costs and other overhead costs.
Revenues
The following table sets forth the Private Client Group segment's revenues,
as shown in the table above under "--Operating Results," by source for the
periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
----- -----
(in millions)
Commissions...................................... $270 $320
Fees............................................. 177 182
Other............................................ 35 34
---- ----
Total non-interest revenues................... 482 536
Net interest revenues............................ 45 70
---- ----
Total revenues, net of interest expense....... $527 $606
==== ====
2002 to 2001 Three Month Comparison. Total revenues, net of interest
expense, as shown in the table above under "--Operating Results," decreased $79
million, or 13%, from the first three months of 2001 to the first three months
of 2002. The decrease came primarily from a $75 million decline in revenues
from our domestic securities brokerage operations, from $595 million in the
first three months of 2001 to $520 million in the first three months of 2002.
Commission revenues decreased $50 million, or 16%, from the first three
months of 2001 to the first three months of 2002. The decrease came primarily
from a $42 million decline in commissions from over-the-counter and listed
equity securities transactions. Commission revenues have been negatively
affected by less active securities markets and reduced retail transaction
volume. Commission revenues accounted for 56% of total segment non-interest
revenues for the first three months of 2002. Accordingly, we expect that a
continuation of the level of securities market activity experienced in the
first three months of 2002, or a further downtrend in this activity, would
continue to have a negative impact on our revenues and on the segment's
adjusted operating income, partially offset by lower expenses resulting from
actions we have taken to reduce the cost structure of our domestic securities
brokerage operations.
Fee revenues, which include asset management and account service fees,
declined $5 million, or 3%, from the first three months of 2001 to the first
three months of 2002. The decline came from a decrease in revenues from
wrap-fee products, reflecting competitive pricing pressures and changes in
product mix, as well as the negative impact of market value declines. The
negative impact of market value declines on wrap-fee and managed account assets
under management essentially offset the benefit of new assets gathered in these
accounts. Additionally, the negative impact of market value declines on
clients' mutual funds, on which a portion of our fees are based, contributed to
the decline in fee revenues. Fee revenues accounted for 37% of total
non-interest revenues in the first three months of 2002, compared to 34% in the
first three months of 2001, reflecting the decrease in commission revenues and
actions we have taken to increase the contribution of recurring revenues. These
actions included enhanced marketing of fee-based products and compensation
incentives to Financial Advisors for sales of these products, as well as
emphasis on financial planning in recruiting and training of Financial Advisors.
Net interest revenues decreased $25 million, or 36%, from the first three
months of 2001 to the first three months of 2002, primarily as a result of a
decrease in average customer margin lending and other customer related balances
of our domestic securities brokerage operations, reflecting the reduced level
of individual investor activity. Average customer margin lending balances were
$3.26 billion in the first three months of 2002 compared to $5.22 billion in
the first three months of 2001.
35
The number of domestic retail Financial Advisors was 5,085 at March 31,
2002, a decrease of 6% from 5,383 at December 31, 2001. The majority of the
decline came from Financial Advisors with less than 4 years of industry
experience and reflects a decrease in our recruiting of inexperienced Financial
Advisors to be trained by us.
Assets under management and client assets were $250 billion at March 31,
2002, essentially unchanged from December 31, 2001.
Non-Interest Expenses
2002 to 2001 Three Month Comparison. Total non-interest expenses, as shown
in the table above under "--Operating Results," decreased $66 million, or 11%,
from the first three months of 2001 to the first three months of 2002. The
decrease came primarily from a $64 million decline in non-interest expenses at
our domestic securities brokerage operations. Our domestic securities brokerage
operations have begun to reflect the benefit of actions taken in 2001 to reduce
staffing levels, occupancy costs and other overhead costs. Additionally, costs
associated with formula based and discretionary incentive compensation programs
decreased due to the lower level of revenues and earnings in the first three
months of 2002.
Retail Investments
Operating Results
The following table sets forth the Retail Investments segment's operating
results for the periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
----- -----
(in millions)
Operating results:
Revenues(1)........................................ $340 $386
Benefits and expenses(2)........................... 289 325
---- ----
Adjusted operating income.......................... $ 51 $ 61
==== ====
--------
(1) Revenues exclude realized investment gains, net of losses.
(2) Benefits and expenses exclude the impact of net realized investment gains
on deferred acquisition cost amortization and reserves.
Adjusted Operating Income
2002 to 2001 Three Month Comparison. Adjusted operating income decreased
$10 million, or 16%, from the first three months of 2001 to the first three
months of 2002. Approximately $6 million of the $10 million decrease came from
our annuity business, reflecting lower fee revenues from variable annuities due
to a decrease in average account values, as well as a decline in yields on
assets supporting our annuity products. Partially offsetting these revenue
declines was a decrease in amortization of deferred policy acquisition costs.
The remainder of the decrease came from our mutual funds and wrap-fee products
business, primarily due to lower asset-based distribution revenues.
Revenues
2002 to 2001 Three Month Comparison. Revenues, as shown in the table above
under "--Operating Results," decreased $46 million, or 12%, from the first
three months of 2001 to the first three months of 2002. Fee-based revenue
decreased $23 million, from $253 million in the first three months of 2001 to
$230 million in the first three months of 2002. The decrease came primarily
from our mutual funds and wrap-fee products and from our variable annuity
products, reflecting a decline in the average market value of customer accounts
on
36
which our fees are based. The remainder of the decrease in revenues came
primarily from lower investment income in the 2002 period, reflecting lower
yields on our investment portfolio.
Benefits and Expenses
2002 to 2001 Three Month Comparison. Benefits and expenses, as shown in the
table above under "--Operating Results," decreased $36 million, or 11%, from
the first three months of 2001 to the first three months of 2002. Amortization
of deferred policy acquisition costs decreased $18 million, or 30%, from $60
million in the first three months of 2001 to $42 million in the first three
months of 2002, primarily as a result of decreased amortization of deferred
policy acquisition costs associated with lower fee income. Additionally,
amortization of deferred policy acquisition costs included $9 million in the
first three months of 2001 to reflect decreases in expected future gross
profits on our annuity products primarily due to declines in market values of
the underlying assets on which our fees are based. Commissions and other
general expenses decreased $12 million, or 7%, primarily due to lower asset
management expense on our mutual fund and wrap-fee products and from our
variable annuity products and, to a lesser extent, a decrease in general and
administrative expenses reflecting our expense management efforts.
Sales Results and Assets Under Management
The following table sets forth the changes in the total mutual fund assets
and annuities, excluding wrap-fee products, the balance of wrap-fee product
assets and net sales of our Retail Investments mutual fund and annuity products
for the periods indicated. Assets are reported at fair market value for mutual
funds and wrap-fee products and account value for annuities. Net sales
(redemptions) are gross sales minus redemptions or surrenders and withdrawals,
as applicable. Neither sales nor net sales are revenues under GAAP; they are,
however, relevant measures of business activity. Revenues are derived from fees
and interest spread income as discussed above.
Three Months Ended
March 31,
-----------------
2002 2001
------- -------
(in millions)
Mutual Funds(1) and Wrap-fee Products(2):
Mutual fund assets, excluding wrap-fee products:
Beginning total mutual fund assets................................. $57,809 $57,764
Sales (other than money market).................................... 914 1,324
Redemptions (other than money market).............................. (1,116) (1,202)
Reinvestment of distributions and change in market value........... 32 (1,254)
Net money market sales............................................. (896) 1,536
------- -------
Ending total mutual fund assets................................ 56,743 58,168
Wrap-fee product assets at end of period.............................. 18,192 17,335
------- -------
Total mutual fund and wrap-fee product assets at end of period........ $74,935 $75,503
======= =======
Net mutual fund sales (redemptions) other than money market(3)........ $ (202) $ 122
======= =======
Variable Annuities(1):
Beginning total account value...................................... $18,689 $21,059
Sales.............................................................. 374 339
Surrenders and withdrawals......................................... (597) (665)
Change in market value, interest credited and other activity(4)(5). (31) (1,615)
------- -------
Ending total account value..................................... $18,435 $19,118
======= =======
Net sales (redemptions)............................................... $ (223) $ (326)
======= =======
Fixed Annuities
Beginning total account value...................................... $ 2,975 $ 2,926
Sales.............................................................. 37 30
Surrenders and withdrawals......................................... (50) (69)
Interest credited and other activity(4)............................ (53) 2
------- -------
Ending total account value..................................... $ 2,909 $ 2,889
======= =======
Net sales (redemptions)............................................... $ (13) $ (39)
======= =======
37
--------
(1) Mutual funds and variable annuities include only those sold as retail
investment products. Investments through defined contribution plan products
are included with such products.
(2) Wrap-fee product assets include proprietary assets of $3.2 billion at March
31, 2002 and 2001.
(3) Excludes wrap-fee products.
(4) Includes maintenance and insurance charges assessed, net bonus payments
credited to contract holder accounts, annuity benefits and other
adjustments.
(5) Includes decreases in policyholder account balances during the first three
months of 2002 of $45 million for variable annuities and $56 million for
fixed annuities due to the distribution of policy credits, subsequently
paid out in cash, as demutualization consideration in connection with the
Company's demutualization.
2002 to 2001 Three Month Comparison. Mutual fund and wrap-fee product
assets under management amounted to $74.9 billion at March 31, 2002, a decrease
of $829 million, or 1%, from December 31, 2001. Mutual fund assets under
management at March 31, 2002 amounted to $56.7 billion, a decrease of $1.1
billion, or 2%, from December 31, 2001. Wrap-fee assets amounted to $18.2
billion at March 31, 2002, essentially unchanged from December 31, 2001.
The decrease in mutual fund assets under management in the first three
months of 2002 came from net money market outflows of $896 million and net
redemptions of non-money market mutual funds of $202 million. The increase in
mutual fund assets under management in the first three months of 2001 came
primarily from $1.536 billion of net sales of money market mutual funds and
$122 million of net sales of non-money market mutual funds. We believe the net
money market mutual fund outflows during the first quarter of 2002 reflect
seasonal withdrawals by our customers and that these seasonal withdrawals were
more than offset during the first quarter of 2001 by customer response to
unfavorable securities market conditions leading to increased money market fund
investments. The net redemptions of non-money market funds in the first quarter
of 2002 reflect the continued difficult equity securities market conditions,
while the net sales of non-money market funds in the first quarter of 2001 came
primarily from gross sales of $216 million from the launch of a new mutual
fund, which more than offset customer withdrawal activity. Net sales of mutual
funds from sub-advised relationships, funds that we manage in third party
products, amounted to $64 million in the first three months of 2002 and $131
million in the first three months of 2001.
Total account values for fixed and variable annuities amounted to $21.3
billion as of March 31, 2002, a decrease of $320 million from December 31,
2001. This decrease resulted primarily from net redemptions of variable
annuities of $223 million in the first three months of 2002. The decrease in
net redemptions, from $326 million in the first three months of 2001 to $223
million in the first three months of 2002, came primarily from a lower level of
surrenders and an increase in gross sales.
Property and Casualty Insurance
Operating Results
The following table sets forth the Property and Casualty Insurance segment's
operating results for the periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
----- ----
(in millions)
Operating results:
Revenues(1)........................................ $531 $489
Benefits and expenses.............................. 509 429
----- ----
Adjusted operating income.......................... $ 22 $ 60
===== ====
--------
(1) Revenues exclude realized investment gains, net of losses.
38
Adjusted Operating Income
2002 to 2001 Three Month Comparison. Adjusted operating income decreased
$38 million, or 63%, from the first three months of 2001 to the first three
months of 2002. Results for 2002 reflected a $45 million lower net benefit from
prior accident year development. Partially offsetting this was a $13 million
reduction in expenses, driven largely by our cost reduction initiatives and our
discontinuation of certain distribution channels.
We released prior year reserves of $2 million in the first three months of
2002 and $47 million in the first three months of 2001 because our automobile
casualty claims experience for prior years was more favorable than we
previously estimated in establishing reserves for these accident years.
Additionally, we benefited $20 million in the first three months of 2002 and
$24 million the first three months of 2001 under stop-loss reinsurance
contracts, which are based on current accident year results. The stop-loss
recoveries during the first quarter of 2002 represent about half of the maximum
amount that we can recover for the entire year, due to current contractual
limitations. Absent a change in the accident year experience in the first three
months of 2002, recoveries under this contract would be exhausted in the second
quarter, which would result in a decline in results later in 2002. However, as
discussed under "--Benefits and Expenses," we are in process of re-underwriting
and non-renewing business that has produced adverse loss experience and
implementing rate increases for certain business. While there can be no
assurance, we believe that these actions, together with our cost reduction
measures, will contribute to improvement of accident year experience.
Revenues
The following table sets forth the Property and Casualty Insurance segment's
earned premiums, which are net of reinsurance ceded, for the periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
----- ----
(in millions)
Automobile............... $372 $328
Homeowners............... 113 109
Other.................... 8 8
---- ----
Total earned premiums. $493 $445
==== ====
2002 to 2001 Three Month Comparison. Revenues, as shown in the table above
under "--Operating Results," increased $42 million, or 9%, from the first three
months of 2001 to the first three months of 2002.
Total earned premiums, as shown in the immediately preceding table,
increased by $48 million, or 11%, from the first three months of 2001 to the
first three months of 2002.
Automobile earned premiums increased by $44 million, or 13%, from the first
three months of 2001 to the first three months of 2002, primarily from the
retail, independent agent and non-standard auto distribution channels.
Homeowners earned premiums increased $4 million, or 4%, from the first three
months of 2001 to the first three months of 2002 as a result of rate increases
implemented during 2001.
39
Benefits and Expenses
The following table shows our calendar year loss, expense and combined
ratios, the impact on these calendar year ratios of current accident year
catastrophe losses and our accident year combined ratios based on loss
experience for the periods indicated (all based on statutory accounting
principles).
Three Months Ended
March 31,
-----------------
2002 2001
----- -----
Loss ratio(1):
Automobile......................................... 75.8 % 56.9 %
Homeowners......................................... 72.1 79.5
Overall........................................ 74.8 61.8
Expense ratio(2):
Automobile......................................... 28.5 32.0
Homeowners......................................... 35.3 43.3
Overall........................................ 29.8 34.3
Combined ratio(3):
Automobile......................................... 104.3 88.9
Homeowners......................................... 107.4 122.8
Overall........................................ 104.6 96.1
Effect of catastrophic losses included in combined
ratio(4):........................................... 0.9 0.2
Accident year combined ratio(5):...................... 105.0 108.9
--------
(1) Represents ratio of incurred losses and loss adjustment expenses to earned
premiums. Ratios reflect the net favorable development in the calendar
period from prior accident year reserves, of $2 million in the first three
months of 2002 and $47 million in the first three months of 2001. Ratios
also reflect recoveries from current accident year stop-loss reinsurance
contracts of $20 million for the first three months of 2002 and $24 million
for the first three months of 2001.
(2) Represents ratio of operating expenses to net written premiums.
(3) Represents the sum of (1) and (2).
(4) Represents losses and loss adjustment expenses attributable to catastrophes
that are included in the combined ratio. This ratio includes current
accident year catastrophes and excludes current calendar year development
on catastrophe losses occurring in prior accident years. We classify as
catastrophes those events that are declared catastrophes by Property Claims
Services, which is an industry organization that declares and tracks all
property-related catastrophes causing insured property damage in the United
States. Property Claims Services declares an event a catastrophe if it
causes in excess of a specified dollar amount of insured property damage,
which was $25 million throughout the periods presented, and affects a
significant number of policyholders and insurance companies.
(5) Accident year combined ratios reflect the combined ratios for accidents
that occur in the indicated period, restated to reflect subsequent changes
in loss estimates for those claims based on cumulative loss data through
March 31, 2002. These ratios reflect the recoveries from stop-loss
reinsurance contracts as noted above. We analyze accident year combined
ratios because they reflect the actual loss experience of events that occur
in a given period excluding the effect of events that occur in other
periods.
2002 to 2001 Three Month Comparison. Our automobile loss ratio, as shown in
the table immediately above, increased from the first three months of 2001 to
the first three months of 2002 primarily due to the lower net benefit from
prior accident year reserve development in 2002. We added significant new
automobile business during 2001, primarily in the first half of the year, which
we expected would produce less favorable experience in its initial year than
similarly priced seasoned business. However, based on our evaluation of the
quality of the new business produced, particularly the major portion of the
business which was sold through distribution channels we implemented in 1999
and 2000, we suspended our mailing solicitations for the direct distribution
channel and limited the growth of business from some of our other distribution
channels, commencing in the third quarter of 2001. In October 2001, we
announced that we would no longer write business through our property and
casualty insurance career agency channel except in a few selected markets. As
indicated above, we are also in process of re-underwriting and non-renewing
business that has produced adverse loss experience, to
40
the extent permitted contractually and by state insurance regulations, and
pursuing rate increases across our business. These efforts have not yet
affected the loss ratio significantly, as the business produced prior to their
implementation will continue to affect the accident year results until the
associated premiums are fully earned and the business is fully re-underwritten
or non-renewed.
The decrease in the homeowners' loss ratio was the result of a milder than
normal winter and rate increases implemented in 2001. Our stop-loss reinsurance
recoveries resulted in decreases in the homeowners' combined ratio of 7.1
percentage points in the first three months of 2002 and 14.7 percentage points
in the first three months of 2001.
Our accident year catastrophe losses, net of reinsurance, amounted to $4
million for the first three months of 2002, compared to $1 million for the
first three months of 2001.
Losses that we ceded through reinsurance, including stop-loss reinsurance,
as well as involuntary reinsurance pool mechanisms, resulted in decreases in
the total combined ratio of 4.7 percentage points for the first three months of
2002 and 10.3 percentage points for the first three months of 2001.
Our overall expense ratio decreased from 34.3% in the first three months of
2001 to 29.8% for the first three months of 2002, as we incurred costs in 2001
to develop our distribution channels and benefited in 2002 from cost reduction
initiatives and the favorable impact of the increased premium base.
The decrease in the accident year combined ratio resulted primarily from the
decline in the expense ratio. Recoveries from stop-loss reinsurance resulted in
decreases in the accident year combined ratio of 4.1 percentage points in the
first three months of 2002 and 5.4 percentage points in the first three months
of 2001.
Employee Benefits Division
Division Results
The following table and discussion present the Employee Benefits division's
results based on our definition of adjusted operating income, which is a
non-GAAP measure, as well as income from operations before income taxes, which
is prepared in accordance with GAAP. See "--Consolidated Results of Operations"
for a definition of adjusted operating income.
Three Months
Ended March 31,
--------------
2002 2001
------ ------
(in millions)
Division operating results:
Revenues(1)................................................ $1,524 $1,461
Benefits and expenses(2)................................... 1,458 1,357
------ ------
Adjusted operating income.................................. $ 66 $ 104
====== ======
Adjusted operating income by segment:
Group Insurance........................................ $ 37 $ 47
Other Employee Benefits................................ 29 57
------ ------
Total............................................... 66 104
Items excluded from adjusted operating income:
Realized investment gains, net of losses
and related charges:
Realized investment gains (losses), net............. (33) 95
Related charges(3).................................. 3 (2)
------ ------
Total realized investment gains, net
of losses and related charges.................... (30) 93
------ ------
Income from operations before income taxes.................... $ 36 $ 197
====== ======
41
--------
(1) Revenues exclude realized investment gains, net of losses.
(2) Benefits and expenses exclude the impact of net realized investment gains
on deferred acquisition cost amortization and reserves.
(3) Related charges consist of the following:
Three Months
Ended
March 31,
-------------
2002 2001
----- -----
(in millions)
Reserves for future policy benefits................... $2 $--
Amortization of deferred policy acquisition costs..... 1 (2)
-- ---
Total.............................................. $3 $(2)
== ===
2002 to 2001 Three Month Comparison. Adjusted operating income of our
Employee Benefits division decreased $38 million, or 37%, from the first three
months of 2001 to the first three months of 2002 as a result of a $28 million
decrease in adjusted operating income from our Other Employee Benefits segment
and a $10 million decrease from our Group Insurance segment. Income from
operations before income taxes decreased $161 million, or 82%, from the first
three months of 2001 to the first three months of 2002, reflecting a $123
million decrease in realized investment gains, net of losses and related
charges as well as the decrease in adjusted operating income. For a discussion
of realized investment gains and losses, and charges related to realized
investment gains and losses, see "--Consolidated Results of
Operations--Realized Investment Gains."
Group Insurance
Operating Results
The following table sets forth the Group Insurance segment's operating
results for the periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
----- -----
(in millions)
Operating results:
Revenues(1)........................................ $890 $768
Benefits and expenses.............................. 853 721
---- ----
Adjusted operating income.......................... $ 37 $ 47
==== ====
--------
(1) Revenues exclude realized investment gains, net of losses.
Adjusted Operating Income
2002 to 2001 Three Month Comparison. Adjusted operating income decreased
$10 million, or 21%, from the first three months of 2001 to the first three
months of 2002. The decrease came from the benefit to first quarter 2001
results from refinements we made to our group life insurance reserves and our
favorable estimates at that time of life claims development. Group disability
experience improved in the first quarter of 2002, but the effect on adjusted
operating income was essentially offset by higher sales-based compensation
costs and lower interest spreads.
Revenues
2002 to 2001 Three Month Comparison. Revenues, as shown in the table above
under "--Operating Results," increased by $122 million, or 16%, from the first
three months of 2001 to the first three months of
42
2002. Group life insurance premiums increased by $84 million, or 18%, to $554
million primarily due to growth in business in force resulting from new sales
and continued strong persistency, which decreased modestly from 99% in the
first three months of 2001 to 97% in the first three months of 2002, reflecting
a limited impact from the commencement of pricing adjustments in 2002 discussed
below. Group disability premiums, which include long-term care products,
increased by $18 million, also reflecting the growth in business in force.
Persistency increased from 92% in the first three months of 2001 to 95% in the
first three months of 2002, primarily due to the cancellation of a large case
in the first three months of 2001. The remainder of the increase in revenues
came primarily from higher fees on products sold to employers for funding of
employee benefit programs and retirement arrangements, reflecting growth in
this business.
Benefits and Expenses
The following table sets forth the Group Insurance segment's benefits and
administrative operating expense ratios for the periods indicated.
Three Months
Ended March 31,
--------------
2002 2001
----- -----
Benefits ratio(1):
Group life......................................... 91.8% 90.0%
Group disability................................... 84.6 88.5
Administrative operating expense ratio(2):
Group life......................................... 10.0 10.4
Group disability................................... 22.7 23.3
--------
(1) Ratio of policyholder benefits to earned premiums, policy charges and fee
income. Group disability ratios include long-term care products.
(2) Ratio of administrative operating expenses (excluding commissions) to gross
premiums, policy charges and fee income.
2002 to 2001 Three Month Comparison. Benefits and expenses, as shown in the
table above under "--Operating Results," increased by $132 million, or 18%,
from the first three months of 2001 to the first three months of 2002. The
increase resulted in large part from an increase of $112 million, or 20%, in
policyholders' benefits, including the change in policy reserves, reflecting
the growth of business in force. Based on our evaluation of mortality
experience during 2001, we reviewed our pricing policies to determine whether
our pricing structure provides for adequate margins and returns on all of our
group insurance products. As a result of this review, in the fourth quarter of
2001, we commenced pricing adjustments, when contractually permitted, which
consider the deterioration of the benefits ratio on our group life insurance
products since 2000. During the first three months of 2002, we implemented
pricing adjustments on group life insurance business representing about 28% of
our premiums in force, and we expect to have implemented pricing adjustments on
business representing about half of our 2001 premiums in force by the end of
the year 2002. While there can be no assurance, we expect these actions to
result, over time, in a return to benefits ratios consistent with our
profitability objectives. The implementation of these actions resulted in a
modest decline in persistency on our group life insurance business in force
and, consistent with our expectations, some slowing of our sales. An increase
of $16 million, or 15%, in operating expenses also contributed to the increase
in benefits and expenses. The increase in operating expenses, from $109 million
in the first three months of 2001 to $125 million in the first three months of
2002, resulted primarily from the growth in business in force and related
sales-based compensation costs as well as continued business process
improvement costs.
The group life benefits ratio for the first three months of 2002 increased
1.8 percentage points from the first three months of 2001 primarily as a result
of the refinements in our calculations of reserves in the first three months of
2001 and our favorable estimates of life claims development at that time. We
estimate that these items,
43
collectively, reduced our first quarter 2001 group life benefits ratio by about
2.1 percentage points. We further estimate that our first quarter 2002 pricing
adjustments reduced the period's group life benefits ratio by 0.6 percentage
points. The group disability benefits ratio improved by 3.9 percentage points
from the first three months of 2001 to the first three months of 2002
reflecting better morbidity experience, which we attribute to accelerated case
resolution and our ongoing efforts to improve the quality of our underwriting
and claims management processes. The group life and group disability insurance
administrative operating expense ratios improved 0.4 percentage points and 0.6
percentage points, respectively, reflecting the impact of our efforts to
improve operational efficiencies.
Sales Results
The following table sets forth the Group Insurance segment's new annualized
premiums for the periods indicated. In managing our group insurance business,
we analyze new annualized premiums, which do not correspond to revenues under
GAAP, as well as revenues, because new annualized premiums measure the current
sales performance of the business unit, while revenues reflect the renewal
persistency and aging of in force policies written in prior years and net
investment income in addition to current sales.
Three Months
Ended
March 31,
-------------
2002 2001
----- -----
(in millions)
New annualized premiums:(1)
Group life......................................... $162 $288
Group disability(2)................................ 53 69
---- ----
Total.......................................... $215 $357
==== ====
--------
(1) Amounts exclude new premiums resulting from rate changes on existing
policies, from additional coverage issued under our Servicemembers' Group
Life Insurance contract and from excess premiums on group universal life
insurance that build cash value but do not purchase face amounts. Sales
results for the 2001 period give effect to quarterly allocation consistent
with our current reporting practices.
(2) Includes long-term care products.
2002 to 2001 Three Month Comparison. Total new annualized premiums
decreased $142 million, or 40%, from the first three months of 2001 to the
first three months of 2002, due to decreases in both group life and group
disability sales. The group life sales decrease came from a decrease of $151
million in sales to new customers reflecting a sale of $99 million to one large
customer in the first three months of 2001 and the expected slowing of our
sales due to the commencement of pricing adjustments in 2002, partially offset
by increased sales to existing customers. Group disability sales decreased
primarily due to the impact of pricing adjustments on group life insurance on
bundled group life and disability products.
44
Other Employee Benefits
Operating Results
The following table sets forth the Other Employee Benefits segment's
operating results for the periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
----- -----
(in millions)
Operating results:
Revenues(1)........................................ $634 $693
Benefits and expenses(2)........................... 605 636
---- ----
Adjusted operating income.......................... $ 29 $ 57
==== ====
--------
(1) Revenues exclude realized investment gains, net of losses.
(2) Benefits and expenses exclude the impact of net realized investment gains
on reserves and deferred acquisition cost amortization.
Adjusted Operating Income
2002 to 2001 Three Month Comparison. Adjusted operating income decreased
$28 million, or 49%, from the first three months of 2001 to the first three
months of 2002. The $28 million decrease came primarily from a decrease in
adjusted operating income of $27 million from our guaranteed products business.
Our real estate and relocation business, which is expected to result in a first
quarter loss due to its seasonal nature, produced a slightly lower loss in the
first quarter of 2002 than the year-ago quarter. Results of our full service
defined contribution business were essentially unchanged from the first three
months of 2001 to the first three months of 2002.
Our guaranteed products business reported adjusted operating income of $38
million in the first three months of 2002, a decrease of $27 million from the
first three months of 2001. The decrease of $27 million is primarily due to
lower investment income margins in the first quarter of 2002, reflecting a
decline in yields on invested assets.
Revenues
2002 to 2001 Three Month Comparison. Revenues, as shown in the table above
under "--Operating Results," decreased $59 million, or 9%, from the first three
months of 2001 to the first three months of 2002. Net investment income
decreased $60 million, or 11%, from $569 million in the first three months of
2001 to $509 in the first three months of 2002 reflecting lower yields.
Benefits and Expenses
2002 to 2001 Three Month Comparison. Benefits and expenses, as shown in the
table above under "--Operating Results," decreased $31 million, or 5%, from the
first three months of 2001 to the first three months of 2002. Policyholders'
benefits, together with the change in policy reserves and interest credited to
policyholders, decreased $35 million from the first three months of 2001 to the
first three months of 2002. The decrease reflected our maturing block of group
annuity business.
45
Sales Results and Assets Under Management
The following table shows the changes in the account values and net sales of
Other Employee Benefits segment products for the periods indicated. Net sales
are total sales minus withdrawals or withdrawals and benefits, as applicable.
As noted above under "--U.S. Consumer Division--Retail Investments--Sales
Results and Assets Under Management," neither sales nor net sales are revenues
under GAAP.
Three Months Ended
March 31,
-----------------
2002 2001
------- -------
(in millions)
Defined Contribution:
Beginning total account value....................... $24,640 $26,046
Sales............................................... 1,010 1,255
Withdrawals......................................... (817) (1,035)
Change in market value, interest credited and other
activity(1)....................................... 504 (1,793)
------- -------
Ending total account value...................... $25,337 $24,473
======= =======
Net sales.............................................. $ 193 $ 220
======= =======
Guaranteed Products(2):
Beginning total account value....................... $39,825 $41,577
Sales............................................... 259 400
Withdrawals and benefits............................ (864) (1,569)
Change in market value, interest income............. 355 326
Other(3)............................................ (175) (273)
------- -------
Ending total account value...................... $39,400 $40,461
======= =======
Net sales.............................................. $ (605) $(1,169)
======= =======
--------
(1) Includes increases to account values during the first quarter of 2002 of
$101 million added to customer accounts due to Common Stock received as
demutualization consideration and $448 million added to customer accounts
from inclusion of amounts not previously reflected in this segment.
(2) Prudential's retirement plan accounted for 39% of sales in the three months
ended March 31, 2002, and 64% of sales for the three months ended March 31,
2001. Ending total account value includes assets of Prudential's retirement
plan of $9.2 billion at March 31, 2002, and $7.8 billion at March 31, 2001.
(3) Represents changes in asset balances for externally managed accounts.
2002 to 2001 Three Month Comparison. Assets under management in our full
service defined contribution business amounted to $25.3 billion at March 31,
2002, an increase of $697 million, or 3%, from December 31, 2001. The increase
came primarily from $549 million added to customer accounts from inclusion of
amounts not previously reflected in this segment and Common Stock received as
demutualization consideration as well as net sales of $193 million, which were
approximately equal to the year-ago quarter. Assets under management decreased
$1.573 billion, or 6%, in the first quarter of 2001, primarily due to a decline
in market value of mutual funds reflecting the general downturn of the equity
markets.
46
International Division
Division Results
The following table and discussion present the International division's
results based on our definition of adjusted operating income, which is a
non-GAAP measure, as well as income from operations before income taxes, which
is prepared in accordance with GAAP. See "--Consolidated Results of Operations"
for a definition of adjusted operating income.
Three Months Ended
March 31,
------------------
2002 2001
------ ----
(in millions)
Division operating results:
Revenues(1)................................................................................ $1,386 $672
Benefits and expenses(2)................................................................... 1,186 574
------ ----
Adjusted operating income.................................................................. $ 200 $ 98
====== ====
Adjusted operating income by segment:
International Insurance................................................................ $ 204 $ 95
International Securities and Investments............................................... (4) 3
------ ----
Total............................................................................... 200 98
Items excluded from adjusted operating income:
Realized investment gains (losses), net................................................ (86) 6
Related charges(3).................................................................. 1 --
------ ----
Total realized investment gains, net of losses and related charges.............. (85) 6
------ ----
Income from operations before income taxes.................................................... $ 115 $104
====== ====
--------
(1) Revenues exclude realized investment gains, net of losses.
(2) Benefits and expenses excluded the impact of realized investment gains, net
of losses, on dividends to policyholders.
(3) Related charges consist of the portion of dividends to policyholders
attributable to realized investment gains, net of losses.
2002 to 2001 Three Month Comparison. Adjusted operating income of our
International division increased $102 million from the first three months of
2001 to the first three months of 2002. The increase came from an increase of
$109 million in adjusted operating income from our International Insurance
segment, including $104 million from Gibraltar Life, which we acquired in April
2001, as discussed below. This increase was partially offset by a $7 million
decline in adjusted operating income from our International Securities and
Investments segment. Income from operations before income taxes increased by
$11 million, or 11%, from the first three months of 2001 to the first three
months of 2002 as the increase in adjusted operating income was largely offset
by a $91 million decrease in realized investment gains, net of losses and
related charges. For a discussion of realized investment gains and losses, and
charges related to realized investment gains and losses, see "--Consolidated
Results of Operations--Realized Investment Gains."
International Insurance
Our international insurance operations are subject to currency fluctuations
that can materially affect the U.S. dollar results of our international
insurance operations from period to period even if results on a local currency
basis are relatively constant. Exchange rates fluctuated significantly in the
first three months of 2002 and 2001. The financial results of our International
Insurance segment reflect the impact of forward currency transactions designed
to mitigate the risks of adverse changes in currency exchange rates. We have
translated all information
47
in this section on the basis of actual exchange rates, including the impact of
the forward currency transactions. To achieve a better understanding of local
operating performance, where indicated below, we analyze results both on the
basis of translated results based on actual exchange rates and on the basis of
local results translated at a constant exchange rate. When we discuss constant
exchange rate information below, we translated on the basis of the average
exchange rates for the year ended December 31, 2001.
Operating Results
The following table sets forth the International Insurance segment's
operating results for the periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
------ -----
(in millions)
Operating results:
Revenues(1)
International Insurance, excluding Gibraltar Life..... $ 566 $521
Gibraltar Life........................................ 683 --
------ ----
1,249 521
------ ----
Benefits and expenses
International Insurance, excluding Gibraltar Life......... 466 426
Gibraltar Life............................................ 579 --
------ ----
1,045 426
------ ----
Adjusted operating income.................................... $ 204 $ 95
====== ====
--------
(1) Revenues exclude realized investment gains, net of losses.
Adjusted Operating Income
2002 to 2001 Three Month Comparison. Adjusted operating income increased
$109 million from the first three months of 2001 to the first three months of
2002. Results of Gibraltar Life, which are included in our results from the
April 2, 2001 date of reorganization and therefore are not reflected in first
quarter 2001 adjusted operating income, contributed $104 million to the
increase.
The $104 million adjusted operating income reported by Gibraltar Life
reflected revenues of $683 million and benefits and expenses of $579 million.
Gibraltar Life's revenues were comprised primarily of $558 million of premiums,
policy charges and fees and $110 million net investment income, and its
benefits and expenses were comprised of $450 million of policy benefits,
including changes in reserves, and $129 million of operating expenses.
Gibraltar Life's results in the first three months of 2002 reflect favorable
mortality experience. As a result of Gibraltar Life's emergence from
reorganization proceedings in April 2001 and the reduction in benefits for in
force policies, when we established Gibraltar Life's initial liability for
future policy benefits, we assumed a higher than normal level of policy
surrenders for the near term. Our surrender rate assumptions for Gibraltar
Life's years of operations, commencing at the date of reorganization, are 6% in
the first year and 4% thereafter for paid-up policies and 2% to 38% in the
first year, 3% to 14% in the second year and 6% to 10% thereafter for premium
paying policies, although the actual surrender rates we experience may differ
materially from our assumptions. Gibraltar Life's adjusted operating income
included in our results for the three months ended March 31, 2002 was not
affected significantly by the deviation of policy surrenders from our initial
assumptions. Future surrender experience in the near term may be significantly
different from the levels we assumed, and our future adjusted operating income
will be sensitive to differences in actual surrender experience from our
assumptions,
48
particularly during an initial period of about two years from the date of
reorganization. We estimate that every 1% of in force policies that surrender
in excess of our assumed level would contribute $40 to $50 million to our
adjusted operating income for the period of the surrenders, and conversely that
for every 1% of in force policies that surrender below our assumed level, our
reported adjusted operating income would be negatively affected by $40 to $50
million.
Adjusted operating income, excluding the impact of the Gibraltar Life
acquisition discussed above, increased $5 million, or 5%, from the first three
months of 2001 to the first three months of 2002. The increase came from
improved results from our operations in countries other than Japan. The
contribution from continued growth of our existing Japanese insurance
operations was more than offset in the current quarter by the negative impact
of currency exchange rates, including the impact of our currency hedging, and a
loss from the termination of a large case that provided individual life
insurance coverage to multiple employees of an organization. Our operations in
countries other than Japan resulted in an approximate break-even for the first
quarter of 2002, compared to a loss, on an adjusted operating income basis, of
$9 million for the first quarter of 2001, as increased profits from our
operations in Korea, reflecting strong sales and continued favorable
persistency offset continued costs of expansion into other countries. Our
Japanese insurance operations, excluding Gibraltar Life, reported adjusted
operating income of $101 million in the first three months of 2002, compared to
$104 million in the first three months of 2001. First quarter 2002 results for
our Japanese insurance operations reflect a negative impact of about $7 million
from currency fluctuations, including the effect of our currency hedging, as
well as a $6 million loss from termination of a large case that provided
individual life insurance coverage to multiple employees of an organization.
Additionally, first quarter 2001 results from these operations benefited from
exceptionally strong sales in anticipation of a premium rate increase taking
effect April 1, 2001.
The segment's increase in adjusted operating income includes the unfavorable
effect of year over year fluctuations in currency exchange rates as well as the
impact of our hedging at expected exchange rates. On a constant exchange rate
basis and excluding the impact of currency hedging, adjusted operating income,
including results of Gibraltar Life, increased $113 million.
Revenues
2002 to 2001 Three Month Comparison. Revenues, as shown in the table above
under "--Operating Results," increased $728 million from the first three months
of 2001 to the first three months of 2002, including $683 million from
Gibraltar Life. Excluding the impact of the Gibraltar Life acquisition,
revenues increased $45 million, or 9%, from the first three months of 2001 to
the first three months of 2002. The $45 million increase in revenues came
primarily from an increase in premium income of $32 million, or 7%, from $454
million in the first three months of 2001 to $486 million in the first three
months of 2002. Premiums from our Korean operations increased $32 million, from
$58 million in the first three months of 2001 to $90 million in the first three
months of 2002, as a result of increased sales and strong persistency. Premiums
in all other countries remained essentially unchanged from the first three
months of 2001 as compared to the first three months of 2002, primarily as a
result of the negative impact of currency exchange rate fluctuations on our
existing business in Japan, for which premiums increased 11% over the year-ago
quarter absent the impact of these fluctuations. On a constant exchange rate
basis and excluding the impact of currency hedging, total segment revenues
increased $830 million, from the first three months of 2001 to the first three
months of 2002.
Benefits and Expenses
2002 to 2001 Three Month Comparison. Benefits and expenses, as shown in the
table above under "--Operating Results," increased $619 million from the first
three months of 2001 to the first three months of 2002, including $579 million
from Gibraltar Life. Excluding the impact of the Gibraltar Life acquisition,
benefits and expenses increased $40 million, or 9%, from the first three months
of 2001 to the first three months of 2002. The $40 million increase in benefits
and expenses came primarily from an increase of $19 million in policyholders'
49
benefits, which includes the change in reserves for future policy benefits.
Policyholders' benefits increased from $337 million in the first three months
of 2001 to $356 million in the first three months of 2002. The increase
resulted primarily from the greater volume of business in force, which was
driven by new sales, continued strong persistency and the aging of business in
force in markets where our operations are more mature, partially offset by the
impact of currency exchange rate fluctuations. On a constant exchange rate
basis, total segment benefits and expenses increased $716 million.
Sales Results
In managing our international insurance business, we analyze new annualized
premiums, which do not correspond to revenues under GAAP, as well as revenues,
because new annualized premiums measure the current sales performance of the
business unit, while revenues reflect the renewal persistency and aging of in
force policies written in prior years and net investment income in addition to
current sales.
2002 to 2001 Three Month Comparison. New annualized premiums increased $17
million, or 11%, from $162 million in the first three months of 2001 to $179
million in the first three months of 2002, including $49 million from Gibraltar
Life and reflecting the unfavorable impact of currency exchange rate
fluctuations. On a constant exchange rate basis, new annualized premiums
increased $34 million, or 22%, from the first three months of 2001 to the first
three months of 2002, including $53 million from Gibraltar Life. On that basis,
new annualized premiums from our operations in Japan were $137 million in the
three months ended March 31, 2002, including $53 million from Gibraltar Life,
compared to $111 million in the year-ago quarter when Gibraltar Life's sales
force sold policies for our existing Japanese insurance operation pending the
completion of Gibraltar Life's reorganization, accounting for $19 million of
that quarter's sales. Since the first quarter of 2001, the Gibraltar Life sales
force has distributed only Gibraltar Life products. Sales in Japan during the
year-ago quarter were particularly strong due to anticipated premium rate
increases that took effect on April 1, 2001. Sales in all other countries, also
on a constant exchange rate basis, increased $8 million as a result of an
increase from our operations in Korea.
Investment Margins and Other Profitability Factors
Many of our insurance products sold in international markets provide for the
buildup of cash values for the policyholder at mandated guaranteed interest
rates. The spread between the actual investment returns and these guaranteed
rates of return to the policyholder is an element of the profit or loss that we
will experience on these products. Interest rates guaranteed in our Japanese
insurance contracts are regulated by Japanese authorities. Between July 1, 1996
and April 1, 1999, we guaranteed premium rates using an interest rate of 3.1%
on most of the products we sold even though the yield on Japanese government
and high-quality corporate bonds was less than that much of this time. This
resulted in some negative investment spreads over this period. As a
consequence, our profitability with respect to these products in Japan during
that period resulted primarily from margins on mortality charges and expenses.
In response to the low interest rate environment, Japanese regulators approved
a reduction in the required rates for most of the products we sell to 2.35% in
April of 1999, which has allowed us to charge higher premiums on new business
for the same amount of insurance. While this has also resulted in an
improvement in investment spreads, these spreads had a negative impact on
adjusted operating income from our Japanese insurance operations other than
Gibraltar Life in the three months ended March 31, 2002 and 2001 and the
profitability of these products in Japan continues to result primarily from
margins on mortality charges and expenses. In 2001, Japanese regulators
approved further reductions in the required interest rates applicable to most
of the products we sell. As a result, we increased premium rates on most of our
products sold in Japan when the new rates were implemented, in April 2001 for
some products and in October 2001 for other products. Additionally, interest
rates on our guaranteed products sold in Korea are regulated by Korean
authorities, who approved, in April 2001, a reduction in the required rates for
most of the products we sell, allowing us to charge higher premiums on new
business for the same amount of insurance. While these actions enhance our
ability to set rates commensurate with available investment returns, the major
sources of profitability
50
on our products in Korea, as in Japan, are margins on mortality and expense
charges rather than investment spreads.
We base premiums and cash values in the countries in which we operate on
mandated mortality tables. Our mortality experience in the International
Insurance segment on an overall basis for the three months ended March 31, 2002
and 2001 was well within our pricing assumptions and below the guaranteed
levels reflected in the premiums we charge.
International Securities and Investments
Operating Results
The following table sets forth the International Securities and Investments
segment's operating results for the periods indicated.
Three Months
Ended March 31,
---------------
2002 2001
----- -----
(in millions)
Operating results:
Revenues.................. $137 $151
Expenses.................. 141 148
---- ----
Adjusted operating income. $ (4) $ 3
==== ====
Adjusted Operating Income
2002 to 2001 Three Month Comparison. The International Securities and
Investments segment reported a loss, on an adjusted operating income basis, of
$4 million for the first three months of 2002 compared to adjusted operating
income of $3 million for the first three months of 2001. The $7 million
decrease came from our international securities operations, including our
futures operations, reflecting a decline in transaction volume. Losses from our
international investments operations amounted to $6 million in the first three
months of 2002, unchanged from the first three months of 2001, as increased
expenses from the expansion of this developing business offset its revenue
growth.
Revenues
2002 to 2001 Three Month Comparison. Revenues, as shown in the table above
under "--Operating Results," decreased $14 million, or 9%, from the first three
months of 2001 to the first three months of 2002. The decrease came from a $20
million decrease in revenues from our international securities operations,
which include our futures operations. The $20 million decrease came primarily
from lower commission revenues associated with less active U.S. equity markets
and reduced retail and institutional transactional volumes. Revenues from our
international investments operations increased $6 million, primarily from asset
management fees and commissions earned by recently acquired units.
Expenses
2002 to 2001 Three Month Comparison. Expenses, as shown in the table above
under "--Operating Results," decreased $7 million, or 5%, from the first three
months of 2001 to the first three months of 2002. Expenses of our international
securities operations decreased $13 million, due primarily to decreases in
revenue-based compensation costs. Expenses of our international investments
operations increased $6 million, reflecting expenses from recently acquired
units.
51
Asset Management Division
The following table and discussion present the Asset Management division's
results based on our definition of adjusted operating income, which is a
non-GAAP measure, as well as income from operations before income taxes, which
is prepared in accordance with GAAP. See "--Consolidated Results of Operations"
for a definition of adjusted operating income.
Division Results
The following table sets forth the Asset Management division's results for
the periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
----- -----
(in millions)
Division operating results:
Revenues(1)......................................... $291 $329
Expenses............................................ 228 251
---- ----
Adjusted operating income........................... $ 63 $ 78
==== ====
Adjusted operating income by segment:
Investment Management and Advisory Services..... $ 39 $ 34
Other Asset Management.......................... 24 44
---- ----
Total........................................ 63 78
Items excluded from adjusted operating income:
Realized investment gains (losses), net......... 59 1
---- ----
Income from operations before income taxes............. $122 $ 79
==== ====
--------
(1) Revenues exclude realized investment gains, net of losses.
2002 to 2001 Three Month Comparison. Adjusted operating income of our Asset
Management division decreased $15 million, or 19%, in the first three months of
2002 from the first three months of 2001, as a result of a decrease in adjusted
operating income from our Other Asset Management segment, partially offset by
an increase in adjusted operating income from our Investment Management and
Advisory Services segment. Income from operations before income taxes increased
$43 million, or 54%, primarily as a result of the increase in realized
investment gains. For a discussion of realized investment gains and losses, and
charges related to realized investment gains and losses, see "--Consolidated
Results of Operations--Realized Investment Gains."
Investment Management and Advisory Services
Operating Results
The following table sets forth the Investment Management and Advisory
Services segment's operating results for the periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
----- -----
(in millions)
Operating results:
Revenues(1)............... $198 $205
Expenses.................. 159 171
---- ----
Adjusted operating income. $ 39 $ 34
==== ====
--------
(1) Revenues exclude realized investment gains, net of losses.
52
Adjusted Operating Income
2002 to 2001 Three Month Comparison. Adjusted operating income increased $5
million, or 15%, from the first three months of 2001 to the first three months
of 2002, reflecting decreased expenses from cost saving measures implemented in
2001. The segment's decrease in revenues was primarily due to lower asset
management revenues resulting from declines in market value of the underlying
assets on which our fees are based.
Revenues
The following table sets forth the Investment Management and Advisory
Services segment's revenues, as shown in the table above under "--Operating
Results," by source for the periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
----- -----
(in millions)
Revenues:
Retail customers(1)..... $ 49 $ 53
Institutional customers. 84 97
General account......... 65 55
---- ----
Total revenue....... $198 $205
==== ====
--------
(1) Consists of individual mutual funds and both variable annuities and
variable life insurance in our separate accounts. Fixed annuities and the
fixed rate options of both variable annuities and variable life insurance
are included in general account. Also includes funds invested in
proprietary mutual funds through our defined contribution plan products.
2002 to 2001 Three Month Comparison. Revenues, as shown in the table above
under "--Operating Results," decreased $7 million, or 3%, from the first three
months of 2001 to the first three months of 2002. The decrease came from
declines of $13 million, or 13%, in revenues from management of institutional
customer assets and $4 million, or 8% from management of retail customer
assets. The decrease in revenues from management of institutional and retail
customer assets came primarily from market value declines on publicly traded
equity securities, which resulted in a lower level of average assets under
management. Revenues from management of general account assets increased $10
million, or 18%, reflecting higher revenues generated from our proprietary
investment and syndication activities.
Expenses
2002 to 2001 Three Month Comparison. Expenses, as shown in the table above
under "--Operating Results," decreased $12 million, or 7%, from the first three
months of 2001 to the first three months of 2002. The decrease primarily
reflects decreases in compensation expenses, driven by cost saving measures
implemented in 2001 and market value declines on publicly traded equity
securities on which compensation is based. In light of the current business
environment we continue to evaluate our asset management operations for
consolidation or other opportunities, which, if implemented, could result in
implementation costs in future periods with anticipated savings from a lower
cost structure thereafter.
53
Other Asset Management
Operating Results
The following table sets forth the Other Asset Management segment's
operating results for the periods indicated.
Three Months
Ended
March 31,
-------------
2002 2001
----- -----
(in millions)
Operating results:
Revenues.................. $93 $124
Expenses.................. 69 80
--- ----
Adjusted operating income. $24 $ 44
=== ====
Adjusted Operating Income
2002 to 2001 Three Month Comparison. Adjusted operating income decreased
$20 million, or 45%, in the first three months of 2002 from the first three
months of 2001. The decrease came from a $16 million decline in adjusted
operating income from our equity sales and trading operations and a $4 million
decrease from our commercial mortgage securitization operations and hedge
portfolios. Adjusted operating income from our equity sales and trading
operations in the first three months of 2002 was $11 million, a decrease of $16
million or 59% from the first three months of 2001. This decrease reflected a
decline in our revenues from trading activities supporting retail and
institutional customers partially offset by decreased employee related costs
reflecting the benefit of staff reductions completed in the latter part of 2001.
Adjusted operating income from our commercial mortgage securitization
operations and hedge portfolios decreased $4 million to $13 million in the
first three months of 2002 from $17 million in the first three months of 2001.
The decrease came primarily from our hedge portfolios.
Revenues
2002 to 2001 Three Month Comparison. Revenues, as shown in the table above
under "--Operating Results," decreased $31 million, or 25%, from the first
three months of 2001 to the first three months of 2002. The decrease came from
a decline in revenues from our equity sales and trading operations, from $100
million in the first three months of 2001 to $74 million in the first three
months of 2002. Revenues in the first three months of 2002 were negatively
affected by reduced revenues from trading supporting retail and institutional
customers. The reduced trading revenues we experienced in the first three
months of 2002 reflected lower transaction volume in the equity securities
markets resulting from decreased investor trading activity, as well as reduced
securities trading spreads. Revenues from our hedge portfolios decreased $7
million.
Expenses
2002 to 2001 Three Month Comparison. Expenses, as shown in the table above
under "--Operating Results," decreased $11 million, or 14%, from the first
three months of 2001 to the first three months of 2002 due to decreased
employee related costs reflecting the benefit of staff reductions completed in
the latter part of 2001 in our equity sales and trading operations.
Corporate and Other Operations
Corporate and Other operations includes corporate-level activities that we
do not allocate to our business segments. It also consists of international
ventures, divested businesses and businesses that we place in wind-down status
but that we have not divested.
54
Corporate-level activities consist primarily of corporate-level income and
expenses not allocated to any of our business segments, including costs for
company-wide initiatives such as enhancement of our Internet capabilities and
income from our qualified pension plans, as well as investment returns on our
unallocated equity, which is capital that is not deployed in any of our
segments. Corporate-level activities also include returns from investments that
we do not allocate to any of our business segments, including a debt-financed
investment portfolio, which has been substantially reduced, and transactions
with other segments.
The following table and discussion present results of these activities based
on our definition of adjusted operating income, which is a non-GAAP measure, as
well as income from operations before income taxes, which is prepared in
accordance with GAAP. See "--Consolidated Results of Operations" for a
definition of adjusted operating income.
Three Months
Ended
March 31,
------------
2002 2001
----- -----
(in millions)
Adjusted operating income:
Corporate-level activities(1)................... $ 27 $ 4
Other businesses:
International ventures...................... (1) (8)
Other....................................... (3) 3
---- ----
Total.................................... 23 (1)
Items excluded from adjusted operating income:
Realized investment gains (losses), net..... (22) 116
Divested businesses......................... (8) (22)
Demutualization costs and expenses.......... -- (45)
---- ----
Income (loss) from operations before income taxes.. $ (7) $ 48
==== ====
--------
(1) Includes consolidating adjustments.
2002 to 2001 Three Month Comparison. Corporate and Other operations
resulted in adjusted operating income of $23 million in the first three months
of 2002 and a $1 million loss, on an adjusted operating income basis, in the
first three months of 2001.
Corporate-level activities resulted in adjusted operating income of $27
million in the first three months of 2002 and $4 million in the first three
months of 2001. The increase was largely the result of inter-company
arrangements with other segments whereby the impact of certain market
fluctuations in interest rates, currency exchange rates and equity price levels
is assumed by Corporate and Other operations. These arrangements resulted in
losses of $47 million in the first three months of 2001 and gains of $4 million
in the first three months of 2002. About half of the change was attributable to
losses incurred last year from arrangements connection with the Other Asset
Management segment's mortgage securitization operations during a period of
rising interest rates. The remaining variance was attributable largely to
losses incurred last year in connection with deferred compensation arrangements
during a period of weakening equity markets. Both of these activities resulted
in modest gains this year.
The favorable impact of the hedging activity discussed above was offset in
part by a higher level of general and administrative expenses at the corporate
level, which totaled $149 million this year on a gross basis before qualified
pension income, compared with $125 million in last year's first quarter. Costs
for non-pension postretirement benefits increased $7 million this year as a
result of a decrease in the value of plan assets, which will continue to affect
plan costs for the remainder of the year. In addition, higher employee
termination costs of $7 million were incurred primarily in connection with our
outsourcing of certain human resources support functions to a third party.
Income from our own qualified pension plan amounted to $126 million in the
first three
55
months of 2002, compared to $135 million in the first three months of 2001. The
$9 million decline reflected changes in pension plan obligation assumptions.
For each of the remaining quarters of 2002, we expect income from our own
qualified pension plan to be approximately the same as that of the first
quarter.
Investment income, net of interest expense, in corporate-level activities
increased by $7 million in the first quarter of 2002 over last year's first
quarter. The benefit resulting from the transfer of net assets from the
Traditional Participating Products business at the date of our demutualization
and from cash held for distribution to policyholders was largely offset by
lower returns from joint venture and limited partnership investments, reduced
investment income, net of interest expense from the wind-down of a
debt-financed portfolio, and lower yields on corporate-level invested assets.
Income from operations before income taxes amounted to a loss of $7 million
in the first three months of 2002, compared to income of $48 million in the
first three months of 2001. The decrease was attributable to a change in net
realized investment gains (losses), from gains of $116 million last year to
losses of $22 million this year. The impact of this change was offset in part
by a $45 million reduction of costs and expenses related to our
demutualization, the $24 million increase in adjusted operating income
discussed above and a $14 million reduction in the losses from divested
businesses, primarily the former lead-managed equity underwriting for corporate
issuers and institutional fixed income businesses of Prudential Securities.
For a discussion of realized investment gains, net of losses, divested
businesses and demutualization costs and expenses, see "--Consolidated Results
of Operation--Realized Investment Gains," "--Divested Businesses" and
"--Demutualization Costs and Expenses."
Closed Block Business
Operating Results
Beginning in 2002, management no longer uses adjusted operating income as
the measure to assess operating performance of the Closed Block Business.
Consequently, results of the Closed Block Business for all periods are
presented only in accordance with GAAP. The following table sets forth the
Closed Block Business's GAAP results for the periods indicated.
Three Months Ended
March 31,
------------------
2002 2001
------ ------
(in millions)
GAAP results:
Revenues...................................... $1,777 $2,084
Benefits and expenses......................... 1,952 2,010
------ ------
Income (loss) from operations before income taxes $ (175) $ 74
====== ======
Income from Operations Before Income Taxes
2002 to 2001 Three Month Comparison. Income from operations before income
taxes decreased $249 million, to a loss of $175 million for the three months
ended March 31, 2002. Income from operations before income taxes reflects a
decline in revenues of $307 million, from $2.084 billion in the first three
months of 2001 to $1.777 billion in the first three months of 2002, primarily
from a $163 million decrease in realized investment gains, net of losses, a
decrease in net investment income and increased debt service costs associated
with the IHC debt. For a discussion of Closed Block Business realized
investment gains (losses), net, see "--Consolidated Results of
Operations--Realized Investment Gains." Partially offsetting the revenue
decline was a decrease in total benefits and expenses, as we began to realize
the benefit of staff reductions and office consolidations implemented in 2001.
56
Revenues
2002 to 2001 Three Month Comparison. Revenues, as shown in the table above
under "--Operating Results," decreased $307 million, or 15%, from the first
three months of 2001 to the first three months of 2002. Realized investment
gains, net of losses, amounted to a net realized loss of $74 million in the
first quarter of 2002 and a net realized gain of $89 million in the year-ago
quarter, a decrease of $163 million. Additionally, net investment income
declined $92 million, from $978 million for the three months ended March 31,
2001 to $886 million for the three months ended March 31, 2002. The decline
reflects our transfer of $5.6 billion of net assets previously associated with
the Traditional Participating Products segment to the Financial Services
Businesses at the date of demutualization as well as a lower investment yield
on the assets remaining in the Closed Block Business. Premiums decreased $47
million, or 5%, from $991 million in the first three months of 2001 to $944
million in the first three months of 2002, reflecting the gradual and expected
runoff of this business. We expect the decline in premiums for this business to
continue as the policies in force mature or terminate over time, as we have
discontinued sales of traditional participating products in connection with our
demutualization.
Benefits and Expenses
2002 to 2001 Three Month Comparison. Benefits and expenses, as shown in the
table above under "--Operating Results," decreased $58 million, or 3%, from the
first three months of 2001 to the first three months of 2002. Operating
expenses, including distribution costs that we charge to expense, decreased $10
million, or 6%, from the first three months of 2001 to the first three months
of 2002 as a result of our continued efforts to reduce operating cost levels.
Policyholder benefits and related changes in reserves, including interest
credited to policyholders, decreased $18 million, from $1.082 billion in the
first three months of 2001 to $1.064 billion in the first three months of 2002,
reflecting an expected reduction in the amount of reserves established for new
and renewal business, consistent with our discontinuation of sales of
traditional products discussed above.
Dividends to policyholders amounted to $643 million in the first three
months of 2002, a decrease of $48 million, or 7%, from $691 million in the
first three months of 2001. The decrease reflects a dividend scale changes for
2002 based on evaluation of the experience underlying the dividend scale.
Sales Results
New statutory premiums from sales of traditional participating individual
life insurance products amounted to $7 million for the three months ended March
31, 2002, representing first year premiums on business sold but not issued
prior to demutualization, and $9 million for the three months ended March 31,
2001. We ceased sales of traditional participating products in connection with
our demutualization.
Policy Surrender Experience
The following table sets forth policy surrender experience for the Closed
Block Business, measured by cash value of surrenders, for the periods
indicated. These amounts do not correspond to the income statement impact of
surrenders under GAAP. In managing this business, we analyze the cash value of
surrenders because it is a measure of the degree to which policyholders are
maintaining their in force business with us, a driver of future profitability.
Three Months Ended
March 31,
-----------------
2002 2001
----- -----
($ in millions)
Cash value of surrenders....................................................... $ 302 $ 316
===== =====
Cash value of surrenders as a percentage of mean future policy benefit reserves 2.6 % 2.8 %
===== =====
57
2002 to 2001 Three Month Comparison. The total cash value of surrenders
decreased $14 million, or 4%, in the first three months of 2002 from the first
three months of 2001, primarily as a result of our efforts during 2001 to
locate policyholders in connection with our demutualization. The level of
surrenders as a percentage of mean future policy benefit reserves was
relatively unchanged in the current quarter from the year-ago quarter.
Liquidity and Capital Resources
Prudential Financial
Prudential Financial's principal source of funds to meet its obligations,
including the payment of shareholder dividends, debt service, capital
contributions to subsidiaries as may be required and operating expenses, are
cash and short-term investments, borrowings and dividends and interest income
from its direct and indirect subsidiaries. As of March 31, 2002, Prudential
Financial had cash liquidity, including cash and short-term investments of
approximately $2.9 billion, a decrease of $1.5 billion, or 34%, from December
31, 2001. The decrease of $1.5 billion was due to the payment of approximately
$1.9 billion for demutualization consideration to eligible policyholders in our
2001 demutualization offset by net funds of $400 million, including settlement
of inter-company activity, received from subsidiaries. We estimate that
demutualization consideration to eligible policyholders of approximately $400
million will be paid in the remainder of 2002. Prudential Financial remains
obligated to disburse further payments of approximately $800 million,
representing demutualization consideration for eligible policyholders we were
unable to locate. To the extent we are unable to locate these policyholders
within a prescribed period of time specified by state escheat laws, typically
three to seven years, the funds must be remitted to governmental authorities.
Liabilities relating to demutualization consideration payments were established
on the date of demutualization.
On January 22, 2002, Prudential Financial's Board of Directors authorized
the purchase of up to $1 billion of its Common Stock. The timing and amount of
any purchases of Common Stock under the authorization will be determined by
management based on market condition and other considerations, and such
purchases may be effected by market or negotiated transactions, including
programs adopted under Rule 10b5-1 of the Securities Exchange Act of 1934.
There were no such purchases during the first three months of 2002.
Our insurance, broker-dealer and various other companies are subject to
regulatory limitations on the payment of dividends and on other transfers of
funds to affiliates. The ability of Prudential Insurance to pay stockholder
dividends will be constrained in the initial years following demutualization.
New Jersey insurance law provides that, except in the case of extraordinary
dividends or distributions, all dividends or distributions paid by Prudential
Insurance may be declared or paid only from unassigned surplus, as determined
pursuant to statutory accounting principles, less unrealized investment gains
and revaluation of assets. Upon demutualization, unassigned surplus was reduced
to zero, thereby limiting Prudential Insurance's ability to pay a dividend
immediately following demutualization. As of March 31, 2002 and December 31,
2001, Prudential Insurance's unassigned surplus was $190 million and $228
million, respectively, and there were no applicable adjustments for unrealized
investment gains or revaluation of assets for purposes of the foregoing law
regarding dividends and distributions. Prudential Insurance also must notify
the New Jersey insurance regulator of its intent to pay a dividend, if the
dividend, together with other dividends or distributions made within the
preceding twelve months, would exceed a specified statutory limit and obtain a
non-disapproval from the New Jersey insurance regulator. The current statutory
limitation applicable to New Jersey life insurers generally is the greater of:
(1) 10% of such insurer's surplus as regards policyholders as of the
December 31 next preceding the date of the proposed dividend or distribution or
(2) the net gain from operations of such insurer, not including realized
investment gains, for the 12-month period ending the December 31 next preceding
the date of the proposed dividend or distribution,
in each case determined under statutory accounting principles. Statutory
accounting principles differ from GAAP primarily in relation to deferred policy
acquisition costs, deferred taxes, reserve calculation assumptions and required
investment reserves, including the asset valuation reserve and the interest
maintenance reserve. The
58
New Jersey insurance regulator is also authorized to disallow the payment of
any dividend or distribution that would otherwise be permitted under the
statutory limit if it determines that a company does not have a reasonable
surplus as to policyholders relative to its outstanding liabilities and
adequate to its financial needs or if it finds such company to be in a
hazardous financial condition. The terms of the IHC debt also contain
restrictions potentially limiting dividends by Prudential Insurance applicable
to the Financial Services Businesses in the event the Closed Block Business is
in financial distress and other circumstances.
Other states and foreign jurisdictions have similar regulations to those of
New Jersey which affect the ability of our other insurance companies to pay
dividends. The laws regulating dividends of the other states and foreign
jurisdictions where our other insurance companies are domiciled are similar,
but not identical, to New Jersey's. In addition, the net capital rules to which
our broker-dealer subsidiaries are subject may limit their ability to pay
dividends to Prudential Financial.
Financing Activities
Prudential Insurance and Prudential Funding, LLC ("Prudential Funding"), a
wholly owned subsidiary of Prudential Insurance, have unsecured committed lines
of credit totaling $4.1 billion, of which $1.5 billion expires in October 2002,
$0.1 billion expires during 2003, $1.0 billion expires in May 2004, and the
remaining $1.5 billion expires in October 2006. Borrowings under the facility
expiring in October 2002 must mature no later than October 2003, and borrowings
under the other facilities must mature no later than the respective expiration
dates of the facilities. The facility expiring in May 2004 includes 33
financial institutions, many of which are also among the 27 financial
institutions participating in the other facilities. Up to $2.5 billion of the
amount available under these facilities can be utilized by Prudential
Financial. The $2.5 billion consists of $500 million, $1.0 billion and $1.0
billion made available under the facilities expiring in October 2002, May 2004
and October 2006, respectively. We use these facilities primarily as back-up
liquidity lines for our commercial paper programs. Our ability to borrow under
these facilities is conditioned on our continued satisfaction of customary
conditions, including maintenance at all times by Prudential Insurance of total
adjusted capital of at least $5.5 billion based on statutory accounting
principles prescribed under New Jersey law. Prudential Insurance's total
adjusted capital as of March 31, 2002 and December 31, 2001 was $10.1 billion
and $10.0 billion, respectively. The ability of Prudential Financial to borrow
under these facilities is conditioned on its maintenance of consolidated net
worth of at least $12.5 billion, based on GAAP. Prudential Financial's
consolidated net worth totaled $19.8 billion and $20.5 billion as of March 31,
2002 and December 31, 2001, respectively. In addition, we have an uncommitted
credit facility utilizing a third-party-sponsored, asset-backed commercial
paper conduit, under which we can borrow up to $1.0 billion. Our actual ability
to borrow under this facility depends on market conditions. This facility,
which we intend to renew or replace with a similar facility, expires in June
2002. We also use uncommitted lines of credit from banks and other financial
institutions.
The following table sets forth our outstanding financing as of the dates
indicated:
March 31, December 31,
--------- ------------
2002 2001
--------- ------------
(in millions)
Borrowings:
General obligation short-term debt..................... $ 6,488 $ 5,334
General obligation long-term debt:
Senior debt......................................... 1,831 2,042
Surplus notes....................................... 990 989
------- -------
Total general obligation long-term debt............. 2,821 3,031
------- -------
Total general obligations....................... 9,309 8,365
------- -------
Total limited and non-recourse borrowing(1)......... 2,306 2,344
------- -------
Total borrowings................................ 11,615 10,709
------- -------
Total asset-based financing......................... 32,129 24,683
------- -------
Total borrowings and asset-based financings..... $43,744 $35,392
======= =======
--------
(1) As of March 31, 2002 and December 31, 2001, $1.75 billion of limited and
non-recourse debt is within the Closed Block Business.
59
Total borrowings and asset-based financing as of March 31, 2002 increased
approximately $8.4 billion, or 24%, from December 31, 2001, reflecting a $1.1
billion increase in short-term debt and a $7.4 billion increase in asset-based
financing. The increase in short-term debt resulted from a $600 million
increase in discretionary borrowing to fund arbitrage portfolios and a $500
million increase to fund our security operations. The increase in asset-based
financing relates primarily to our taking advantage of market opportunities in
our spread and hedge portfolios.
Our total borrowings consist of amounts used for general corporate purposes,
investment related debt, securities business related debt and debt related to
specified other businesses. Borrowings used for general corporate purposes
include those used for cash flow timing mismatches and investments in equity
and debt securities of subsidiaries including amounts needed for regulatory
capital purposes. Investment related borrowings consist of debt issued to
finance specific investment assets or portfolios of investment assets,
including real estate, real estate related investments held in consolidated
joint ventures, and institutional spread lending investment portfolios.
Securities business related debt consists of debt issued to finance primarily
the liquidity of our broker-dealers and our capital markets and other
securities business related operations. Debt related to specified other
businesses consists of borrowings associated with consumer banking activities,
real estate franchises and relocation services. Borrowings under which either
the holder is entitled to collect only against the assets pledged to the debt
as collateral, or has only very limited rights to collect against other assets,
have been classified as limited and non-recourse debt.
Our borrowing as of March 31, 2002 and December 31, 2001, categorized by use
of proceeds, are summerized below:
March 31, December 31,
2002 2001
--------- ------------
(in millions)
General obligations:
General corporate purposes............. $ 2,639 $ 2,667
Investment related..................... 2,226 1,420
Securities business related............ 3,471 3,123
Specified other businesses............. 973 1,155
------- -------
Total general obligations........... 9,309 8,365
Limited and non-recourse debt.............. 2,306 2,344
------- -------
Total borrowings.................... $11,615 $10,709
======= =======
Long-term debt............................. $ 5,100 $ 5,304
Short-term debt............................ 6,515 5,405
------- -------
Total borrowings.................... $11,615 $10,709
======= =======
Borrowings of Financial Services Businesses $ 9,865 $ 8,959
Borrowings of Closed Block Business........ 1,750 1,750
------- -------
Total borrowings.................... $11,615 $10,709
======= =======
Our short-term debt includes bank borrowings and commercial paper
outstanding under Prudential Funding's domestic and European commercial paper
programs. Prudential Funding's commercial paper borrowings as of March 31, 2002
and December 31, 2001 were $3.8 billion and $3.0 billion, respectively. The
weighted average interest rates on the commercial paper borrowings under these
programs were 1.79% for the first three months of 2002 and 5.73% for the first
three months of 2001. The total principal amount of debt outstanding under
Prudential Funding's medium-term note programs was $1.6 billion as of March 31,
2002 and $2.0 billion as of December 31, 2001. The weighted average interest
rates on Prudential Funding's long-term debt, in the aggregate, were 2.40% for
the first three months of 2002 and 6.13% for the first three months of 2001.
We had outstanding surplus notes totaling $990 million and $989 million as
of March 31, 2002 and December 31, 2001, respectively. These debt securities,
which are included as surplus of Prudential Insurance on
60
a statutory accounting basis, are subordinate to other borrowings and to
policyholder obligations and are subject to regulatory approvals for principal
and interest payments.
Insurance, Annuities and Guaranteed Products Liquidity
Our principal cash flow sources from insurance, annuities and guaranteed
products are premiums and annuity considerations, investment and fee income,
and investment maturities and sales. We supplement these cash inflows with
financing activities. We actively use our balance sheet capacity for financing
activities on a secured basis through securities lending, repurchase and dollar
roll transactions and on an unsecured basis for temporary cash flow mismatch
coverage. Historically, we have also used our balance sheet capacity to earn
additional spread income, primarily through our debt-financed investment
portfolio included in Corporate and Other operations, although this portfolio
was substantially reduced in 2001.
Cash outflow requirements principally relate to benefits, claims, dividends
paid to policyholders, and payments to contract holders as well as amounts paid
to policyholders and contract holders in connection with surrenders,
withdrawals and net policy loan activity. Uses of cash also include
commissions, general and administrative expenses, purchases of investments, and
debt service and repayments in connection with financing activities. Some of
our products, such as guaranteed products offered to institutional customers of
the Employee Benefits division, provide for payment of accumulated funds to the
contract holder at a specified maturity date unless the contract holder elects
to roll over the funds into another contract with us. We regularly monitor our
liquidity requirements associated with policyholder and contractholder
obligations so that we can manage cash inflows to match anticipated cash
outflow requirements.
Gross account withdrawals amounted to $1.996 billion in the first three
months of 2002. Gross account withdrawals for the first three months of 2002
include those relating to Gibraltar Life, which we acquired in April 2001.
These withdrawals include contractually scheduled maturities of traditional
guaranteed investment contracts totaling $178 million in the first three months
of 2002. We experienced these withdrawals on guaranteed products as a result of
contractual expirations of products sold in the late 1980s and early 1990s.
Since these contractual withdrawals, as well as the level of surrenders
experienced, were consistent with our assumptions in asset liability
management, the associated cash outflows did not have an adverse impact on our
overall liquidity.
We use surrender charges and other contract provisions to mitigate the
extent, timing and profitability impact of withdrawals of funds by customers
from annuity contracts. The following table sets forth withdrawal
characteristics of our annuity reserves and deposit liabilities (based on
statutory liability values) as of the dates indicated.
March 31, 2002 December 31, 2001
------------- ----------------
% of % of
Amount Total Amount Total
------- ----- ------- -----
($ in millions)
Not subject to discretionary withdrawal provisions..................... $36,220 38 % $36,935 38 %
Subject to discretionary withdrawal, with adjustment:
With market value adjustment........................................ 25,395 26 % 19,727 21 %
At market value..................................................... 25,678 27 % 24,906 26 %
At contract value, less surrender charge of 5% or more.............. 1,387 1 % 7,166 7 %
------- ---- ------- ----
Subtotal........................................................ 88,680 92 % 88,734 92 %
Subject to discretionary withdrawal at contract value with no surrender
charge or surrender charge of less than 5%........................... 7,529 8 % 7,224 8 %
------- ---- ------- ----
Total annuity reserves and deposit liabilities......................... $96,209 100 % $95,958 100 %
======= ==== ======= ====
As of March 31, 2002 and December 31, 2001, general account balances for
variable life insurance products other than single-payment life were $1.9
billion and $1.9 billion, respectively, while separate account balances were
$13.1 billion and $13.0 billion, respectively. The table above includes $5.361
billion and $5.881 billion as
61
of March 31, 2002 and December 31, 2001, respectively, of annuity reserves and
deposit liabilities of Gibraltar Life, which we acquired in April 2001.
Gibraltar Life's assets and liabilities were substantially restructured under a
reorganization concurrent with our acquisition, which included the imposition
of special surrender penalties on existing policies according to the following
schedule (for each year ending March 31):
2002 2003 2004 2005 2006 2007 2008 2009
--------------- --------------- --------------- --------------- --------------- --------------- --------------- ---------------
15% 14% 12% 10% 8% 6% 4% 2%
We believe that cash flows from operating and investing activities of our
insurance, annuity and guaranteed products operations are adequate to satisfy
liquidity requirements of these operations based on our current liability
structure and considering a variety of reasonably foreseeable stress scenarios.
The continued adequacy of this liquidity will depend upon factors including
future securities market conditions, changes in interest rate levels and
policyholder perceptions of our financial strength, which could lead to reduced
cash inflows or increased cash outflows. As of March 31, 2002 and December 31,
2001, on a consolidated basis, we had short-term investments of approximately
$5.2 billion and $4.9 billion, respectively, and fixed maturity investments
classified as "available for sale" with fair values of $112.4 billion and
$109.9 billion at those dates, respectively.
Securities Operations Liquidity
Prudential Securities Group Inc. maintains a highly liquid balance sheet
with substantially all of its assets consisting of securities purchased under
agreements to resell, short-term collateralized receivables from clients and
broker-dealers arising from securities transactions, marketable securities,
securities borrowed and cash equivalents. Prudential Securities Group's assets
totaled $22.1 billion and $22.8 billion as of March 31, 2002 and December 31,
2001, respectively. Prudential Securities Group's total capitalization,
including equity, subordinated debt and long-term debt, was $3.0 billion and
$3.3 billion as of March 31, 2002 and December 31, 2001, respectively. In
October 2000, we announced that we would terminate our institutional fixed
income activities that constituted the major portion of the debt capital
markets operations of Prudential Securities Group. Our continuing wind-down of
positions related to these activities resulted in a reduced level of
asset-based financing at Prudential Securities Group during the first quarter
of 2002. As of March 31, 2002, Prudential Securities Group had remaining assets
amounting to approximately $1.2 billion related to its institutional fixed
income activities, as compared to $1.7 billion as of December 31, 2001.
Substantially all of these assets were financed by means of asset-based
borrowings.
Non-Insurance Contractual Obligations
The following table presents our contractual cash flow commitments on
short-term and long-term debt and equity security units as of March 31, 2002.
This table does not reflect our obligations under our insurance, annuity and
guaranteed products contracts.
Payment Due by Period
-----------------------------------
Less
than 1-3 4-5 After 5
Total 1 Year Years Years Years
------- ------ ----- ------ -------
(in millions)
Short-term and long-term debt $11,615 $6,515 $993 $ 327 $3,780
Equity security units........ 690 -- -- 690 --
------- ------ ---- ------ ------
Total........................ $12,305 $6,515 $993 $1,017 $3,780
======= ====== ==== ====== ======
In addition to the amounts above, we are party to operating leases for which
our future minimum lease payments under non-cancelable operating leases were
$1.9 billion as of December 31, 2001. Our use of operating leases has not
changed significantly from December 31, 2001.
During the normal course of our business, we utilize financial instruments
with off-balance sheet credit risk such as commitments, financial guarantees
and letters of credit. Commitments include commitments to purchase
62
and sell mortgage loans, the underfunded portion of commitments to fund
investments in private placement securities and unused credit card and home
equity lines.
In connection with our consumer banking business, loan commitments for
credit cards, home equity lines of credit and other lines of credit include
agreements to lend up to specified limits to customers. It is anticipated that
commitment amounts will only be partially drawn down based on overall customer
usage patterns and, therefore, do not necessarily represent future cash
requirements. We evaluate each credit decision on such commitments at least
annually and have the ability to cancel or suspend such lines at our option.
The total available lines of credit card, home equity and other commitments
were $1.659 billion, of which $705 million remains available as of March 31,
2002.
Other commitments primarily include commitments to purchase and sell
mortgage loans and the unfunded portion of commitments to fund investments in
private placement securities. These mortgage loans and private placement
commitments were $2.079 billion, of which $1.349 billion remain available as of
March 31, 2002.
We also provide financial guarantees incidental to other transactions and
letters of credit that guarantee the performance of customers to third parties.
These credit-related financial instruments have off-balance sheet credit risk
because only their origination fees, if any, and accruals for probable losses,
if any, are recognized until the obligation under the instrument is fulfilled
or expires. These instruments can extend for several years and expirations are
not concentrated in any period. We seek to control credit risk associated with
these instruments by limiting credit, maintaining collateral where customary
and appropriate and performing other monitoring procedures. As of March 31,
2002, financial guarantees and letters of credit issued were $288 million.
The following table presents the expirations of our financial instruments
with off-balance sheet credit risk as of March 31, 2002.
Expirations by Period
---------------------------------
Less
than 1-3 4-5 After 5
Total 1 Year Years Years Years
------ ------ ----- ----- -------
(in millions)
Available lines of credit card, home equity and other commitments.. $ 705 $ 65 $ 2 $ 4 $ 634
Commitments to purchase and sell mortgage loans and the underfunded
portion of commitments to fund investments in private placement
securities....................................................... 1,349 117 264 137 831
Financial guarantees and letters of credit......................... 288 239 30 1 18
------ ---- ---- ---- ------
Total.............................................................. $2,342 $421 $296 $142 $1,483
====== ==== ==== ==== ======
Recent Accounting Pronouncements
See Note 2 to the Unaudited Interim Consolidated Financial Statements for a
discussion of recently issued accounting pronouncements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Risk Management, Market Risk and Derivative Instruments
The primary risks in our operations are market risk, product risk, credit
risk and operating risk. Market risk is the risk of change in the value of
financial instruments as a result of absolute or relative changes in interest
rates, foreign currency exchange rates or equity or commodity prices. To
varying degrees, the investment and trading activities supporting all of our
products and services generate market risks. There have been no material
changes in our market risk exposures from December 31, 2001, a description of
which may be found in our December 31, 2001, Annual Report on Form 10-K, Item
7A. "Quantitative and Quantitative Disclosures About Market Risk," filed with
the SEC.
63
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
We are subject to legal and regulatory actions in the ordinary course of our
businesses, including class action lawsuits. Our pending legal and regulatory
actions include proceedings specific to us and proceedings generally applicable
to business practices in the industries in which we operate. We are also
subject to litigation arising out of our general business activities, such as
our investments, contracts, leases and labor and employment relationships,
including claims of discrimination and harassment. In some of our pending legal
and regulatory actions, parties are seeking large and/or indeterminate amounts,
including punitive or exemplary damages.
Our litigation is subject to many uncertainties, and given its complexity
and scope, the outcomes cannot be predicted. It is possible that our results of
operations or cash flow in a particular quarterly or annual period could be
materially affected by an ultimate unfavorable resolution of pending litigation
and regulatory matters depending, in part, upon the results of operations or
cash flow for such period. Management believes, however, that the ultimate
outcome of all pending litigation and regulatory matters, after consideration
of applicable reserves, should not have a material adverse effect on our
financial position. See our Annual Report on Form 10-K for the year ended
December 31, 2001, for a discussion of our litigation.
Item 5. Other Information-Employees
On January 30, 2002, the Office and Professional Employees International
Union ("OPEIU"), Local 153, AFL-CIO, filed petitions with the National Labor
Relations Board ("NLRB") seeking representation of approximately 2,000
Prudential Agents who had formerly been covered by the terms of now expired
collective bargaining agreements. An election to determine whether this union
would represent these Agents was administered by the NLRB, and the Prudential
Agents voted against union representation. On May 6, 2002, the OPEIU filed
objections with the NLRB challenging the election result. If the NLRB overrules
the objections, the election results will be certified and finalized. If it
upholds the objections, the NLRB could order a new election.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) Reports on Form 8-K
During the three months ended March 31, 2002, the following Current
Reports on Form 8-K were filed or furnished by the Company:
1. Current Report on Form 8-K, January 3, 2002, attaching the Quarterly
Financial Supplement for its Financial Services Businesses for the
quarterly period ended September 30, 2001.
2. Current Report on Form 8-K, February 13, 2002, attaching (i) press
release announcing fourth quarter 2001 results and (ii) the Quarterly
Financial Supplement for its Financial Services Businesses for the
quarterly period ended December 31, 2001.
64
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PRUDENTIAL FINANCIAL, INC.
By: /s/ RICHARD J. CARBONE
----------------------------------
Richard J. Carbone
Senior Vice President and Chief
Financial Officer
(Authorized signatory
and principal financial officer)
Date: May 15, 2002
65