EUR 850.00 For Business Accounts Only

Morningstar | Prudential Financial's 2Q Marred by Reserve Charge, but Underlying Results Solid

A charge to boost reserves in Prudential Financial's discontinued long-term care business largely wiped out the company's reported profitability during the second quarter, but underlying results remained solid with an annualized operating return on equity of 13% for the quarter, roughly in line with recent results. We will maintain our $118 fair value estimate and no-moat rating.

Results across Prudential's segments were something of a mixed bag. Domestically, retirement, group insurance, and individual solutions all saw adjusted operating income decline modestly year over year, while individual life’s year-over-year comparison benefited from the adverse development this segment saw last year. Internationally, Life Planner saw a solid increase in adjusted operating income, while Gibraltar saw a decline.

The ongoing bright spot for Prudential has been its investment management business. This segment saw a 17% year-over-year increase in adjusted operating income, driven in part by $7.3 billion in third-party net inflows, mainly from institutional clients. With 95% of fund assets under management outperforming the benchmark on a three-year basis, Prudential looks poised to maintain this trend of positive flows. While this is one area of the company's overall business that might have an economic moat, it represents just 13% of earnings, so we think the competitive dynamics of the life insurance industry will continue to dominate overall results in the near to medium term.

During the June quarter, Prudential took a $1.5 billion pretax charge to boost reserves in its long-term care business. The company ceased writing new policies in this business in 2012. The charge was not a major surprise to us, as this line historically has been characterized by reserve increases for participants, which was the prompt for Prudential and others to exit the business (while General Electric recently took a large hit on this same business).

The amount of the charge is not sufficient to materially alter our valuation of the firm as a whole, and with only $6.6 billion in GAAP reserves related to the business, Prudential's exposure looks quite manageable to us. However, we would note that charges such as this, and the uncertainty around long-tail liabilities, fundamentally contribute to the lack of transparency in the life insurance industry, which is a key contributor to our generally cautious view of the space and our high uncertainty rating for Prudential.