Prudential Financial, Inc. (PRU) Earnings Call Transcript & Summary

Good morning. I'm Tracy Benguigui. I joined Barclays recently as the new insurance analyst, and I'm pleased to kick off our insurance morning with Charlie Lowrey, Chairman and CEO of Prudential Financial. Charlie, thank you for being here with us.

Thanks, Tracy, for having me. I'm looking forward to this a lot.

Excellent. Just some housekeeping items before we kick off, there is a live polling question left side of your screen. If asked for user name, please use Barclays 2. Look for the next button to move through polling questions. We could see the results in real time. The first one is just for fun. The next question really gives me a sense what's on your mind. And also on the left side, there's a Q&A box. So today's session format is a fireside chat. I'll first go through my prepared Q&A with Charlie, and then turn over to your submitted questions.

So now with that out of the way, Charlie, can you provide us a 360 view of Prudential in this dynamic environment we're living in?

Sure. Let me just take a couple of minutes, Tracy, and provide like context for you. And what I want to do is emphasize a few of the comments we made on the second quarter call and amplify them. But the first is that we have a very strong balance sheet, right? I think the financial industry learned a lot from the great financial crisis and put into place really robust risk frameworks from which we then emphasized and put forward kind of a playbook, if you will, and we can talk about that more as we go forward. But the point is we have a really strong balance sheet, and we have very, very good liquidity. And that risk framework has served us really well. So we're in a strong capital position. What that enables us to do is to focus on our business, and that's really important. So in terms of the business, the insurance industry has really been hit by a trifecta of stuff. First, you had COVID, then you had the recession. Finally, you have low interest rates for longer. Now COVID so far has turned out to be not as bad as anticipated. The recession we can talk about as we go forward, right? And that's really the credit cycle, where are we in the credit cycle and what do we expect going forward. And then there's lower-for-longer interest rates, and that obviously has a big headwind effect on us. We've said that, that will affect us sort of to the tune of $0.30 annually on an EPS basis. And then finally, we're taking short and long-term actions, and we talked about some of those things on the call. So we're on track with our short-term actions, whether it's the repricing of products, whether it's the creation of new products, whether it's our expense savings initiatives. And then we're looking to do more on a long-term basis and accelerate that in terms of transforming the company into a less market rate-sensitive company, less interest rate-sensitive company, less capital-intensive company and a company with higher growth. So we're using this opportunity to accelerate the changes of technology, customer service, expense savings, personnel, et cetera, and we're right in the middle of that as we go forward. And to the extent you want, we can talk more about it. But that provides a little bit of context for you as we go forward.

Excellent. So reducing market sensitivity, as you mentioned, has been a key objective at Prudential. Low interest rates are not new, but it definitely feels different right now. We've seen Prudential react by repricing or completely exiting products that are not meeting the return hurdles. Likewise, a number of years ago, you've updated your hedging strategy and moderated richness of guarantees. So at this point, Charlie, how much more work do you have to do?

I'd say there is more work to do. So we are constantly repricing products. You've seen us do it before, as you said. We've been doing it for years, starting with -- in Japan, where we've been -- we've had low interest rates for 20 years. So we are either repricing products. We stopped selling products, the single premium yen-denominated product, effectively HDI and GUL single life. So we've done a lot of that, as you said. We -- you then kind of morph into product design. Now that may be what we've done reducing the retention limit on our life product from $20 million to $10 million. Something as simple as that as creating a buffered product like FlexGuard or putting simply term on assurance. So product design in this environment is a big part of that. That would be kind of the third thing. The fourth is, looking at our investment portfolio, we have a conservative investment portfolio. So you look at the strategic asset allocation in light of the low interest rate environment for longer and what are -- how do you optimize the risk/return trade-offs, if you will, and the volatility trade-off. So we're looking at that. We're looking at our existing books of business and what we've said is nothing is off the table. We're looking at either reinsuring them, potentially selling some of them, running some of them down. So we're looking at all that in terms of the opportunities that we may have. And finally, last but not least, is business mix, right? So we want to emphasize less interest rate-sensitive businesses, ones with less volatility and ones that are less capital intensive, as I mentioned. So you think about asset management, retirement, assurance, as we go forward. So those are kind of the 6 levers, if you will, but I think we either have pulled or we are pulling as we go forward.

Excellent. I think one of the things that you've mentioned, on a balance sheet perspective, how open are you to pursue reinsurance or sales of businesses or blocks, particularly? How does the economics look in today's environment in doing something like that?

Well, I think there's a balance, right? We work for shareholders. And so what we're going to do is look at -- if we make a decision to do something, look at the long-term benefit to shareholders. So that may mean either selling a portion, it may mean reinsuring a portion, it may mean reinsuring the entire block if we can get a good price. It may be if the prices aren't great that we see out there and we think there is far more value to shareholders in holding it and running it off, we might do that. The other aspect of this is if you were to sell a business, would you get a multiple expansion? How much would that multiple expansion be? And how does that relate to the amount of proceeds that you would get versus that multiple expansion? So we're weighing all of these things as we go forward. But rest assured, we will do what's right for shareholders.

Okay. Great. Let's talk about the product liability in the broader retirement and savings market. I mean you've mentioned repricing, moderation of the benefits, redesign. Do you feel we could still offer competitive products relative to, let's say, a plain vanilla mutual fund?

Yes, I do, and I do for a number of reasons. One, let's state that we've been operating in Japan successfully for 20 years in an extraordinary healthy low investment rate -- investment -- or excuse me, interest rate environment. And as a result, you've seen that we've been able to operate successfully. So a couple of sort of macro comments, and then I'll get into some other things. But in times like this, what we've experienced before, we've experienced in Japan, we've experienced here, is the value of our products and what we do are even more apparent and more important to people in the kind of volatile and low interest rate environment we're in today. And as an insurance company and as a diversified insurance company, we can pull risk, like longevity risk, in order to create retirement outcomes for our customers. So that's really important. So when you look at Prudential and our complementary business mix, it provides diversification and capital benefits, which can reduce the sensitivity of market movements, which helps clients. So we've taken actions to lower market sensitivity. We manage interest rate exposure very carefully. And we've accelerated expense actions, which will help us in terms of pricing our clients -- our products. And despite the headwinds associated with the pandemic, the recession and the low interest rate environment, I think, we've made some pretty good progress. We have record levels of AUM and PGIM, right? We've really expanded internationally. Now 35% of our AUM is from international clients. Our retail expansion has been very good. In fact, we were ranked #1 in the U.S. mutual fund franchise across active and passive asset managers on a net year-to-date basis, which kind of surprised us actually, but we were. And we're further building out our alternatives capability. So PGIM, we're taking advantage of things. In the international, we're leveraging off of Japan and our strength in Japan to do other things. You've seen us -- what we've done in terms of moving from developing to developed markets in terms -- or rather developed markets into developing markets, I apologize, by selling in Poland, Italy, Korea and now announcing Taiwan. We've expanded in Brazil in our bank distribution, and we've expanded through Habitat, our Chilean pension fund business, into Colombia and Peru. So we're doing things at the margin there. And in the U.S. Business, obviously, we bought assurance in order to expand our digital distribution. And we're accelerating our future work initiatives, our expense initiatives as we go forward, and we may even expand them. So there's a lot we're doing in order to strengthen our overall business, and we're able to provide the right clients to -- the right products to the right clients as we think about expanding our addressable universe.

Great. In fact, I'm going to address a lot of the other items you mentioned on PGIM and expense savings. But maybe if I could just pick on longevity since you've mentioned that on the institutional channel. Maybe we could shift gears and talk about PRT. Can you discuss your appetite for pension risk transfer and longevity reinsurance in the current economic environment? And I guess I'm wondering, are there issues with the funding status of pension plans that would limit deal flow?

Yes. And if you would ask me, last year, as another analyst did, what did you -- what do you think the volume of PRT would be this year? I would say -- I said I thought it would be significantly lower than it was last year. Last year was a banner year, right? And in fact, if you looked in the first quarter, all bets were off because of what happened. But in the second quarter, the equity markets obviously bounced back and funding came up, right? So funding is back within a few points of where it was. So a few points in terms of the supply, the willingness of corporations to actually transact, and then I'll get into sort of the demand. But one is that the funding is back up to kind of almost previous levels. Two, the volatility that we've seen, it reminds corporations of the value of pension risk transfer. So that's really important. The third is PBGC fees keep going up. So if you're a pension fund and you have a high number of potential retirees with low balances, you're getting crushed by the PBGC fees, and therefore, it would be good to transact to get out from under those. And then fourth, low interest rates enable companies to borrow to fund that last little bit that they need to. So the pipeline, especially, we think, in the fourth quarter, is expected to recover and be reasonably robust this year. So the supply side, I think, is okay. Now on the demand side, low interest rates, frankly, make it a challenge for people looking to assume these assets because obviously, we have to reinvest the proceeds and -- that we receive. And if it's at a low interest rate environment, especially if you're focused on retirees, and therefore, you have a shorter duration, is a challenge. So what I'll say about PRU is that we have been -- we will be disciplined about our pricing, and we'll see where the market is and what competitors do. But we think the supply will be there, but the demand side is going to be a little bit challenging, I think.

Maybe just staying on the demand side a little bit in your discipline and risk appetite. Just remind us, what's your appetite for deferred lives transactions?

Limited. It is quite limited. One, you have to have additional capital to predict against unexpected longevity, and there's limited optionality associated with this liability. Two, it's -- because the duration is much longer for deferred lives, it's more difficult to find the assets. With retirees, the average age is plus or minus 75, it's much easier, obviously, for ALM matching. And then you don't -- with retirees, you don't have the tail risk, such as sudden medical discoveries like a cure to cancer or diabetes or something else. So we much prefer and are much more comfortable with retirees than we are with deferred.

Okay. Great. Maybe want to touch upon COVID-19 a little bit. And the reason why I'm asking you this question -- upcoming question is because Prudential is like really one of the few companies that really talk about a longevity risk, a mortality risk, you even have a percentage you put into earnings, a benefit from that. So just taking that to another level. COVID-19 could be described in a way as a black swan event. We saw the emergence of mortality, morbidity, credit, interest rate and equity risk, all in one. And the pandemic angle makes this crisis feel a little bit different than in the financial crisis. So I'm wondering if these scenarios were built into your internal models, and if we should throw any -- our long-standing correlation matrixes out the window.

Well, I hope not, to the latter question. And to the former question, absolutely. So when I talked about what we learned coming out of the great financial crisis, it was that we had to have an even stronger risk framework. And as we built that up over the years, we, in fact, had a pandemic playbook, which some of us honestly kind of thought really, why do we need this? But thank goodness, we had it. And you actually saw us put it to use in March. Before everything became what it is, we went out and issued $1.5 billion of debt. Now we were going to do a $500 green bond, which we did. But we added $1 billion to it because some of the signals were kind of flashing red, and our CFO, Ken Tanji said, "You know what? I just want some more. I want to be safe. I want to make sure we have a robust capital framework. And we're going to go out early, and we're going to do an additional $1 billion." That was specifically because of the risk process that we put into place. So we have this framework, and we have been using it and continue to use it as we monitor what's going on. There's a dashboard that we use, and we analyze potential scenarios for each business and then for the company as a whole. The other thing I would say, and the second quarter really highlights this, is the diversification we have, right? So there is an inherent diversification in our businesses. And you saw that with the net impact of mortality, which was actually favorable by $100 million across our businesses in the second quarter. And you're like, well, how is that possible? The reason was because the deaths in the U.K. were higher than estimated, and that's where we have a lot of our longevity exposure. And therefore, that offset what turned out to be less than estimated impacts to our U.S. and group business and very limited deaths, and as a result, ramifications in Japan. So I think this particular example highlights the complementary nature of our business mix and in particular, our retirement longevity business with regard to the life insurance mortality business. So there are a couple of things going on. One is a robust risk framework, and the other is just the inherent diversification of the business.

Well, I guess [indiscernible] building your point, I'm wondering if you considered any other type of silver lining from this opportunity with disruption-led opportunities. I mean, for instance, life insurance still is sold for the most part at the kitchen table. And I'm wondering how successful your digital and hybrid effort has been to overcome these few and far between kitchen table discussions?

I think it is -- the silver lining is that we are accelerating a lot of what we were already doing, and we've had to do that. So just as an example, I mean, we went 100% remote in 48 hours, right? If you would've asked us beforehand whether we could have done that, we would have put together a committee, we would have studied it for 2 years and said it was impossible. And yet, we did it in 48 hours. That proved to us that we can operate at a completely different speed than we had before. So when you think about silver linings, one is the acceleration of many of the initiatives we already had outstanding. The second is our ability through that to expand, I think, our addressable universe and serving more of the needs of society, and you've seen us do that through assurance and putting the simply term product on there. You've seen us do it with the group business in terms of the digitization of all our online education, which was done in person by advisers before. You've also seen the silver lining, I think, and we saw this in Japan in 2011 after the earthquake, where although there was a decrease in activity, there was an increase in the acknowledgment of the importance of what we offer, whether it is life insurance, emergency savings, retirement, all the products that can provide people with peace of mind and financial wellness. So that's the second thing as we think there will be a greater recognition of what we have to offer. And I think, the third is accelerating how we feel like we're doing in terms of distribution. In that, I think, we feel we're well positioned, but we needed to do more. We needed to do more revamping the front end of our systems. So with our retirement clients doing more online, and we've been doing that, introducing more chat bots, introducing all sorts of things. And we've done that throughout COVID at a pace that we would -- frankly, we wouldn't have done before. And to expand and strengthen the full array of distribution models we have, right? Because I think we have an omni-channel distribution, whether it's direct-to-consumer, whether it's hybrid, whether it's digital or whether it's face-to-face. And so we have been strengthening each of those and focusing on each of those during this time. The final thing is just -- I think we also -- during these times, you think about the solutions that clients need, and we've been broadening that set of solutions. Again, whether it's putting on a very simple term product on assurance, whether it's introducing a buffered product called FlexGuard to take the place of HDI, that kind of thing. So we've been speeding up, frankly, the product development process as well. So that's -- in a nutshell, it's the acceleration of many of the things we were doing, but doing them faster and hopefully doing them better.

Excellent. And I'm just wondering, any early learnings you can gauge from your Asian sales efforts, which may be been ahead of the curve, the COVID-19 curve, relative to the U.S.?

Yes, I think there is. And our Japan business, in particular, has really, really strong relationships. The Life Planners and life plan consultants have extraordinarily strong relationships. And what has been, I think, I won't say surprising, but pleasing to us is how those relationships, which normally have been face-to-face, because that's the way you do business in Japan mostly, have transformed to a digital nature. And the Life Planners and life plan consultants have adapted to increase the use of virtual tools, including online consulting and digital solutions, to connect to customers. And that's something we were a little nervous about, could they make that transition? And they really have. The other thing is, I think, the -- just the needs-based approach we have to selling of death protection products continues to be of real value to our customers. There, they get it. They see what's happening. They want these products. And if they can only get it digitally, they will. As it turns out, Japan obviously hasn't been hit as hard. They've begin to open up a bit. So that's alleviated some of this. But we've been really pleased with the pivot that the Life Planners and Life Consultants have been able to do.

Great. In your opening remarks, you talked about [indiscernible]. So these days, more private insurers are gravitating to fee-based business from spread business [indiscernible] interest rate environment. How would you describe the symbiotic benefits of PGIM upon your U.S. Financial Wellness and International Insurance businesses?

There's kind of a virtuous circle, right? So the thing I love about the asset management business is it is a ruthless business. Either you perform and you gain assets or you don't perform and you lose assets. It's as simple as that. And PGIM has performed very, very well. In fact, 85% of its assets under management are outperforming their benchmarks over a 3-, 5- and 10-year period. So they're performing well. That performance and their ability to create alpha enhances the competitiveness of the U.S. Businesses, right? So the U.S. Businesses, which obviously give them their balances, do better. And that then leads the U.S. Businesses to do better, which then gives PGIM more business and increases the scale of PGIM. In addition to that, and we can get into this at some point, if you want, on the retail side, but PRU has the ability and does seed funds to create track records by which then PGIM can go out and raise money and then use that in various ways, including helping our clients, so our retail clients and some of our institutional clients. So there are many ways in which PGIM helps PRU as a whole and Prudential helps PGIM. It's actually -- it works quite well.