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WIKI ANALYSIS
Prudential Financial Inc. (Public NYSE: PRU) is one of the largest group and individual life insurance providers and variable annuity distributors in the United States. Recording net income of $3.7 billion in FY2007, Prudential's Investment, Insurance, and International business segments contribute nearly the same amount to total net revenue. Within the investment segment, Prudential operates an asset management branch with over $498 billion in managed assets in addition to financial advisory and retirement services. The Insurance segment deals group and individual life insurance policies in addition to distributing various types of annuities. Prudential’s international business is mainly focused in Korea and Japan, providing life insurance through “life planner” agents and managing $13 billion in foreign equity and debt. All of this has afforded Prudential excess capital inflow. However, with domestic insurance opportunities few and far between, Prudential has authorized the buyback of up to $3 billion in currently floating common shares until 2008.
Domestically, Prudential’s investment segment contributed to earnings steadily throughout 2008. Within the Retirement sub-segment however, things are looking a little brighter. While baby boomers beginning to hit the retirement age, Prudential has positioned itself to close the gap between the inefficiencies in the social security and corporate pension plans by providing its own retirement products to this aging demographic. Last year, the Retirement sub-segment contributed to 64% of Prudential’s Investment segment total revenue.
Internationally, Prudential is looking to expand its successful “life planner” model currently active in Korea and Japan. Since the domestic insurance market is well saturated, Prudential is cautiously exploring expansion of its international insurance products in Mexico, China, and India. With the sudden and catastrophic fall of AIG, Prudential has sought out two new investors to take a 20% stake in the company and help finance a $15 billion purchase of AIG's Asian business unit.[1]
History
The Prudential Friendly Society was founded by Senator John Dryden in 1875 and sold burial insurance and burial financing to low income households. Today called Prudential Insurance Company of America, the company has expanded its offerings to various insurance and financial products. Prudential began trading its common stock on the New York Stock Exchange in 2001.
Business Segments
Prudential Financial operates a highly diversified business platform within the insurance industry. The company earns revenue through product sales of life insurance and annuities as well as asset management. It operates both domestically and in Korean and Japan, targeting both individual households and groups. Its product offerings, geographic footprint and customer mix allows Prudential to spread exposure across a wide base of operations.
Keeping this in mind, each of the business segments operating within Prudential (Investment; Insurance; and International Investment and Insurance) contribute nearly the same proportion to Prudential’s total net income.
Investment
Prudential’s Investment segment accounted for $7.32 billion or 27.4% percent of the total revenue in 2007. Investments is divided into three sub-segments: Asset Management; Financial Advisory; and Retirement.
- Asset Management: Asset Management accounted for 31% of total revenue contribution by the Investment segment. As of the end of 2007, Prudential's Investment segment held over $498 billion in managed assets. The products provided by the Asset Management sub-segment include private individual and mutual fund investment management and financial advisory through structured distribution. In addition to private individual and mutual fund clients, Prudential markets its products in public and private marketplaces, utilizing the Financial Advisory and Retirement sub-segments in addition to the Insurance, and International Investment and Insurance segments as cross selling opportunities. Other products that Prudential’s Asset Management sub-segment deals in are public and private fixed income, public and private equity, commercial mortgage origination, servicing and securitization, and proprietary investments.
- Financial Advisory: Financial Advisory accounted 5.1% of total net revenue for the Investment business segment in 2007. Combined with the retail brokerage and clearing services of the former Prudential Securities (currently Prudential Equity Group), the Financial Advisory sub-segment conducts and services most of Prudential’s equity sales, trading, and research operations. This sub-segment of Prudential has been subject to transition and regularity which have restricted its earnings capacity.
- Retirement: Retirement accounted for 64% of total revenue contribution by the Investment segment. The Retirement sub-segment provides retirement-plan products and services such as record keeping, plan administration, actuarial advisory services, tailored participant education institutional and retail investment funds to public, private, and nonprofit organizations. Through the acquisition of the CIGNA retirement business in 2003 for $2.1 billion, Prudential Retirement has boosted its competitive position within the retirement market and increased its retirement account value roughly 75% by 2005. Management has positioned Prudential to benefit from aiding baby boomers transition from the workforce to retirement. To close the gap between retirees and inefficiencies in pension plans provided by the government and corporations, Prudential will be able to provide annuities and other payout options. In addition, Prudential’s Asset Management and Financial Advisory will benefit from retiree’s rising propensity to save.
Insurance
The Insurance segment recorded $9.9 billion in revenue and accounted for 65% of total revenue in 2007. Prudential’s Insurance segment can be divided into these two respective sub-segments: individual insurance and annuities; and group insurance.
- Individual Life and Annuities: The products available from Prudential’s Individual Life and Annuities sub-segment are variable, term, and universal life insurance, in addition to variable and fixed annuities. Both products are issued by Prudential agents, but the life products are being sold more often through third party avenues and the annuities through various financial planners, brokers, and banks. In 2003, Prudential acquired American Skandia, one of the United State’s largest distributors of variable annuities through individual financial planners. Subsequently, Prudential went on to become of the top 10 annuity distributors within the United States. The additional acquisition of Allstate’s variable annuity business helped propel Prudential to become the fourth largest distributor of advisor-sold variable annuities in the United States. Individual Life and Annuities accounted for 51.5% of total revenue contribution by the Insurance segment in 2007.
- Group Insurance: Prudential is the second largest group provider in the United States, with a market share of 12%. The Group Insurance sub-segment provides products to institutional clients such as group life, long and short term group disability, long-term care, and corporate/trust owned life insurance for use with employee and membership benefits. The growth this sub-segment is driven by management’s concerted effort to bring in new business – growth through expanding existing client’s balance sheet contribution is of secondary importance. Group Life Insurance accounted for 48.5% of total net revenue contribution by the Insurance segment in 2005.
International Investment and Insurance
The two sub-segments in this business segment are International Insurance and International Investment.
- International Insurance: Prudential’s International Insurance sub-segment runs similarly to the individual insurance sub-segment in the United States, providing much of the same services through agents called “life planners” to Korea and Japan. Primarily marketed towards highly affluent markets, Prudential’s independently operated Gibraltar Life was supplemented by the purchase of Japanese insurance company Kyoei Life in 2001, allowing for customer base expansion to include those considered middle affluent. Prudential’s management is optimistic about pursuing additional opportunities abroad in Mexico, India, and China to replicate the success of “life planners” in Japan and Korea. Looking to enter these markets starting with small capital contributions, Prudential has been weary in making any international acquisitions, with the exception of Kyoei Life in Japan.
- International Investment: The international investments sub-segment manages a significant portion of Prudential’s insurance operations in Japan. In 2004, Prudential’s acquisition of Korea’s Hyundai Investments and Securities Co., Ltd. increased assets managed in this sub-segments portfolio to $13 billion.
Business Drivers
Robustness and Accuracy of Insurance Models
Perhaps more so than other industries, the insurance industry is extremely sensitive to how accurately a model can forecast risk. Insurance itself is a premium that an individual pays to guard against risks and potentially unfavorable outcomes. Companies create models to determine a particular client's or scenario’s level of risk. These models can use extremely simple algorithms to determine risk or extremely complex algorithms, but all models are ultimately subject to the same scrutiny: limited scope.
It is difficult to build parameters in these risk models for natural disasters, terrorist attacks, spread of disease, and other events are not always able to be predicted accurately and as a result, insurance companies will always run the risk of defaulting on its claims. In most cases, however, models are made robust to account for these unforeseen incidences through higher premiums. Additionally, how accurately a company is able to profile a client’s risk to the company through the modeling will determine the financial health of the company; for instance, if low premiums are offered to a high risk life insurance clients, the mortality rate will cause more claims to be made than the income of premiums can support. Therefore, as long as the companies can identify high risk clients from low risk clients and assign sliding menu costs accordingly, the company will receive efficient net revenue from its premium payments.
Interest Rates
Generally speaking, interest rates will affect any firm involved in any type of investment or firm that issues corporate debt or equity. Changes in the interest rate will invariably change the fundamental values of both equity and debt, since the fundamental value of debt is determined by the time weighted average of payments discounted by current short or long interest rates, and the fundamental value of equity is determined by the value of a firm today along with any projects in the future discounted by some factor over the risk free interest rate.
Systematically, the interest rates are roughly set through the supply and demand of money in the economy, most of the time with help from the Federal Reserves’ monetary policy. Specifically for Prudential, with over $250 billion dollars in domestically managed assets and a large stake in the variable annuities market, changes in short and long term interest rates will surely influence the bottom line (see Yield Curve).
Aging Baby Boomers
As the first of the baby boomers are set to retire within the next few years, financial and insurance firms remain pitted in a battle to provide them with financial funds to fuel their retirement. The traditional methods of retirement finance such as social security, 401ks, and corporate pension plans are becoming increasingly riskier as government legislature struggles to find a solution to social security deficits and companies find it harder and harder to meet the promises of current pension plans. Since the lines between financial institutions and insurance institutions has been blurred with the repeal of the 1999 repeal of the Glass-Steagall Act, which restricted the ability of insurance companies to provide financial services, aging baby boomers have become an increasingly attractive market to insurance companies.
To compete with the corporate pensions plans provided by the company, insurance companies are offering annuities to retirees. Annuities come in many, often complex, forms and packages. However, the underlying concept remains the same: purchase of the annuity is made with an upfront lump sum, with the promise of a steady periodic income as long as the contract requires. Prudential has moved forward since 2003, with the acquisition of American Skandia, to capitalize on the opportunity. Now one of the largest originators of variable annuities, Prudential stands well to profit from the inefficiencies in the current retirement financial landscape.
Competition
Prudential operates primarily within the insurance industry and is the third largest life insurance company in the United States by market share. The company operates an extremely diverse business platform to abate risks inherent in the insurance market. Prudential offers primarily group and individual life insurance polices within the United States and abroad, Prudential’s insurance earnings are highly sensitive to mortality rates.
Prudential’s focus on life insurance is balanced by Prudential’s positions domestically and internationally. Since mortality rates in Japan and Korea have little correlation with mortality rates in the United States, Prudential has spread mortality rate shift risks over the globe. Unlike most insurance companies, Prudential’s business segment diversity creates low correlation across business segments, allowing for income that is more risk neutral. Prudential’s main competitors within the Insurance industry in the United States are American International Group (AIG), MetLife (MET), Northwestern Mutual, and ING America INS Holdings.
Prudential distinguishes itself within the life insurance industry’s top five companies by maintaining the most diversified business platform. Maintaining nearly equal positions in asset management, life insurance origination, and annuity sales, Prudential is the most able to handle aggregate risk in and of these three markets. Northwestern Mutual has been primarily focused on providing life insurance since filling its corporate institutionalization papers 150 years ago and has just now begun to integrate itself within the annuities market. AIG, MetLife, and ING all handle life insurance heavy business platforms with segments in asset management and annuity sales proportionally smaller, exposing themselves more so to mortality rate risk than Prudential.
| ' | Premium Income ($USD, Millions) | Annualized Premiums | Assets Under Mgmt. ($USD, Billions) | Operating Margin | Return on Avg. Equity |
| Prudential | 14,351 | 197 | 438 | 13.62% | 15.32% |
| ING | 32,292 | 223.6 | 803.4 | 14.50% | 24.02% |
| MetLife | 27,895 | 521 | -- | 11.39% | 12.01% |
| AIG | 79,320 | -- | 862 | -45.77% | 6.28% |
| Northwestern Mutual | 13,242 | 381 | -- | -- | -- |
All figures are for FY2007.
References
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