Good morning. I'm Tracy Dolin-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 username, please use Barclays2. 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 of what's on your mind, and also on the left side, there's a Q&A box. 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. 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 context for you. What I want to do is emphasize a few of the comments we made on the second quarter call and amplify them. 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. The point is, we have a really strong balance sheet, and we have very good liquidity, and that risk framework has served us really well. We're in a strong capital position. What that enables us to do is to focus on our business, and that's really important.
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. COVID, so far, has turned out to be not as bad as anticipated. The recession we can talk about as we go forward, right? That's really of the credit cycle, where are we in the credit cycle and what do we expect going forward? There's lower for longer interest rates, and that obviously has a big headwind effect on us. We've said that that'll affect us sort of to the tune of $0.30 annually on an EPS basis. Finally, we're taking short and long-term actions, and we talked about some of those things on the call.
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. 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. We're using this opportunity to accelerate the changes of technology, customer service, expense savings, personnel, et cetera. We're right in the middle of that as we go forward. 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. 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 your return hurdles. Likewise, a number of years ago, you've updated your hedging strategy and moderated the richness of guarantees. At this point, Charlie, how much more work do you have to do?
I'd say there is more work to do. 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 had low interest rates for 20 years. We were either repricing products, we stopped selling products, the single premium, the yen-denominated product, effectively HDI and GUL single life. We've done a lot of that, as you said. You kind of morph into product design. 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 is creating a buffered product like FlexGuard or putting SimplyTerm on Assurance. 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. You look at the strategic asset allocation in light of the low interest rate environment for longer, and how you optimize the risk return trade-offs, if you will, and the volatility trade-off. 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. We're looking at all that in terms of the opportunities that we may have. Finally, last but not least, is business mix, right? We want to emphasize less interest rate sensitive businesses, ones with less volatility, and ones that are less capital-intensive, as I mentioned. You think about asset management, retirement assurance as we go forward.
Those are kind of the six levers, if you will, that I think we either have pulled or we are pulling as we go forward.
Excellent. Maybe I'll take you through 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 do the economics look in today's environment in doing something like that?
Well, I think there's a balance, right? We work for shareholders. 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. That may mean either selling a portion, it may mean re-insuring a portion, it may be re-insuring 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's 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? How does that relate to the amount of proceeds that you would get versus that multiple expansion?
We're weighing all these things as we go forward. Rest assured, we will do what's right for shareholders.
Okay, great. Let's talk about viability in the broader retirement and savings market. 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?
Yeah, I do. I do for a number of reasons. One, let's state that we've been operating in Japan successfully for 20 years in an extraordinarily low interest rate environment. As a result, you've seen that we've been able to operate successfully. A couple of sort of macro comments, then I'll get into some other things. 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. As an insurance company and as a diversified insurance company, we can pool risks, like longevity risks, in order to create retirement outcomes for our customers. That's really important.
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. 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 products. Despite the headwinds associated with the pandemic, the recession and low interest rate environment, I think we 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 ranked number 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. We're further building out our alternatives capability.
PGIM, we're taking advantage of things. In international, we're leveraging off of Japan and our strength in Japan to do other things. You've seen what we've done in terms of moving from developing to developed markets in terms of, or rather developed markets into developing markets, I apologize, by selling 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. We're doing things at the margin there. 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.
There's a lot we're doing in order to strengthen our overall business and be able to provide the right products to the right clients as we think about expanding our addressable universe.
Great. I think I'm going to address a lot of the other items you mentioned on PGIM and expense savings. Maybe if I could just pick on longevity, since you've mentioned that on institutional channel. Maybe we could shift gears and talk about PRT. Can you discuss your appetite for pension risk transfers and longevity reinsurance in the current economic environment? I guess I'm wondering, are there issues with the funding status of pension plans that would limit deal flow?
Yeah. If you had asked me last year as another analyst did, "What do you think the volume of PRT would be this year?" I said, I thought it would be significantly lower than it was last year. Last year was a banner year, right? In fact, if you looked in the first quarter all bets were off because of what happened. In the second quarter, the equity markets obviously bounced back and funding came up, right? Funding is back within a few points of where it was. 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. One is that 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.
That's really important. The third is PBGC fees keep going up. 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. Fourth, low interest rates enable companies to borrow to fund that last little bit that they need to. The pipeline, especially we think in the fourth quarter, is expected to recover and be reasonably robust this year. The supply side, I think, is okay.
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 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. What I'll say about Pru is we will be disciplined about our pricing, and we'll see where the market is and what competitors do. We think the supply will be there. The demand side's 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 protect against unexpected longevity, and there's limited optionality associated with this liability. Two, because the duration is much longer, for deferred lives, it's more difficult to find the assets. With retirees, the average age is ±75. It's much easier, obviously, for ALM matching. With retirees, you don't have the tail risk, such as sudden medical discoveries like a cure to cancer or diabetes or something else. We much prefer and are much more comfortable with retirees than we are with deferred.
Okay, great. Maybe you could just touch upon COVID-19 a little bit. The reason why I'm asking you this upcoming question is because Prudential is 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 that benefit from that. 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 our longstanding correlation matrices out the window.
Well, I hope not to the latter question, to the former question, absolutely. 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. 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. 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, Kenneth 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. 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. We analyze potential scenarios for each business and then for the company as a whole. The other thing I would say, the second quarter really highlights this, is the diversification we have. Right? 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.
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. 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. 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. 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, building your playbook, I'm wondering if you considered any other type of silver lining from this opportunity with disruption-led opportunities. For instance, life insurance still is sold for the most part, at the kitchen table.
Yeah.
I'm wondering how successful your digital and hybrid effort's been to overcome these few and far between kitchen table discussions.
I think the silver lining is that we are accelerating a lot of what we were already doing, and we've had to do that. Just as an example, we went 100% remote in 48 hours, right? If you had asked us beforehand whether we could have done that, we would've put together a committee, we would've studied it for two years and said it was impossible. Yet we did it in 48 hours. That proved to us that we can operate at a completely different speed than we had before. 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 SimplyTerm 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 advisors before. You've also seen a 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 acknowledgement 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. That's the second thing, is we think there will be a greater recognition of what we have to offer. 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. With our retirement clients doing more online, and we've been doing that, introducing more chatbots, introducing all sorts of things, and we've done that throughout COVID at a pace that frankly, we wouldn't have done before. 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. 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. We've been speeding up, frankly, the product development process as well. That's it 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. I'm just wondering, any early learnings you can gauge from your Asian sales efforts, which may have been ahead of the curve, the COVID-19 curve, relative to the U.S.?
Yeah. I think there is, and our Japan business in particular, has really strong relationships. The life planners and life plan consultants have extraordinarily strong relationships. 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. 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. That's something we were a little nervous about. Could they make that transition? And they really have. The other thing is, I think just the needs-based approach we have to selling a 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 begin to open up a bit. 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 PGIM. These days, people with life insurance are gravitating to more fee-based business from spread business.
On an 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? 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. PGIM has performed very, very well. In fact, 85% of its assets under management are outperforming their benchmarks over a three, five, and 10-year period. They're performing well. That performance and their ability to create alpha enhances the competitiveness of the U.S. businesses, right? The U.S. businesses, which obviously give them their balances, do better, and that then leads 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.
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. Our retail clients and some of our institutional clients. There are many ways in which PGIM helps PRU as a whole and Prudential helps PGIM. It works quite well.
Maybe one thing you didn't talk about there are you offering proprietary PGIM funds in your VA sub-accounts, for instance?
Yeah, absolutely. It is over 50% of our VA funds are proprietary PGIM funds. The VA goes through a very robust process. We have loads of external managers, PGIM competes for those. To the extent that an objective group looks at these and says, "Yeah, PGIM's best," then they get the assets. They compete for them.
Just recognizing that Prudential is actually the biggest client of PGIM. How has PGIM influenced your total return on your general account?
It produces significant alpha. Every quarter, we look at the performance of PGIM relative to the benchmarks and see what has happened and what is there. It has created significant alpha over time. As I said, the performance has been really good, and it really remains a key driver to the success of the businesses by virtue of its performance in the general account. We've been very pleased with PGIM's performance.
Great. We have about 10 minutes left. I'll remind folks to submit questions in the Q&A box, which will be emailed to me. Just a reminder there. Maybe shifting gears and talking about capital management. Has COVID-19 reshaped your desired capital deployment measures upon your menu of choices, either M&A, share buybacks, or reinvestment back into the business?
Not really. We have a playbook. We're following that playbook, our capital deployment approach really hasn't changed at all. We paused our share repurchases in the second quarter in line with our risk framework and the playbook that we had in place. Until we get better visibility about the depth and duration of the pandemic and the possible recession that may still come, as well as the length of the credit cycle, because the credit cycle has been more benign in the first half than we thought. We think that the duration of it may continue for quite some time as furloughs turn into layoffs, as other things happen. We're watching that very closely, and we'll focus on maintaining our financial strength, our flexibility, and frankly, our resiliency over time. We'll continue to evaluate the kind of macro environment, if you will.
As conditions evolve, we'll continue to assess the appropriate time and the amount for the resumption of share repurchases. Until then, they're going to remain on pause. What we don't want to do, Tracy, is to start them and then stop them again, right? Dividends are the most important thing. We've said that. We will continue to prioritize dividends and seek to maintain them through the cycles, stock buybacks, when we feel we can start the program again, we will. We're going to be cautious because we're concerned about the credit cycle, especially in the second half.
Got it. As you are chomping at the bit on augmenting capital light businesses in your mix, how does that position PRU on an ROE perspective in light of this new era of ultra-low interest rates?
Yeah. Would that we could go back to the 3% 10-year. That would be kind of nice. We'll continue to be very disciplined about our pricing and have taken steps, as you know, to reprice our products and emphasize new products that are less market sensitive. Our annual ROE on an adjusted basis, in the second quarter was about 12%, if you were adjusting for unique items, the puts and takes that came out of that, such as annual assumption updates and things like that. Looking forward, there are two things. There's a plus and there's a minus to the ROE. The minus is obviously the sustained low interest rates, which are a headwind. We quantify that, as I said in the beginning, about $0.03 a quarter, which is cumulative. Over a year, that's about $0.30. That's a big headwind.
The positive is that we have net business growth and that we have initiated a strong expense savings and efficiency effort, right? To improve our efficiency, to improve customer experience initiatives. We've stated to you all that we're looking for $500 million of run rate improvement by the end of 2022. That's to mitigate some of the headwinds and to add to our run rate earnings. That in combination with all the other things we're doing, hopefully offsets or more than offsets the headwinds that are out there. We're actively managing this. We have a headwind, which is called low interest rates.
Okay, great. I want to circle back on interest rates, before I do, staying on the theme of capital-light business. Last September, Prudential paid $2.4 billion on a bet on Insurtech platform, Assurance IQ. One year later, are you happy you've made this bet?
Yes. We are very happy. We better be. We paid a lot of money for it. We are happy with it. We think it is doing what we wanted it to do. If you look at many of the metrics of the transaction, they are actually doing quite well in terms of the number of customers, in terms of the number of products, in terms of all sorts of things that are going in the right direction. This is very much of a fourth quarter business, we're anxiously awaiting the fourth quarter. They've been preparing for it for a year for Medicaid, Medicare Advantage, Medicare. We'll see what happens there. In terms of the synergies between the businesses, what they have taught us, what they're giving us, and hopefully what we are giving them is on track.
We thought we'd get a SimplyTerm product on by the end of, I think, the third quarter. We bumped that up a quarter, we're on track there. They put other things on the site, there is a tremendous amount of interest by insurers to get onto the site to begin to sell their product too, because it's open architecture. Yeah, we're quite pleased with where it is. Obviously, COVID has affected this to a certain extent because everybody left, and in that environment, especially with a company like Assurance, the benefits of being together are great. They're managing through that. They're managing well, we continue to be extremely excited about the potential that we have there.
Excellent. Low interest rates has always been a double-edged sword, right? You did talk a little bit earlier about the ability to raise capital with some debt issuances. I'm wondering what opportunities in the market for possible further refinancing or pre-funding of upcoming maturities.
Yeah. We have done three debt issues. We did the first one in March, we did another pre-funding for a transaction in 2023, we recently did one. Better to be lucky than smart. There was, I think, great execution, we really timed it in terms of some of the interest rates and the execution on this. The third transaction actually is going to replace a transaction that existed, it's going to be extremely accretive to the company and for shareholders. We were able to take advantage of that. We will look for other opportunities to do that. Obviously, it is an extraordinarily good environment, I think we have been quite aggressive in taking advantage of that so far with these three debt issues, including the first ever green bond that was done by an insurance company in the U.S.
We were very excited about that. As I said, that was done in March, we added $1 billion to that opportunistically just to make sure that we were in a fortress-like position, if you will, with our balance sheet going into something we didn't know what it was going to be. Again, our risk framework started flashing red, we said we better raise more capital. We did in an opportune time, we've done twice since then. If there are other opportunities to do that, we will absolutely take advantage of them.
Great. I'm going to have to move on. We have about two minutes left, let's call this rapid fire session, okay? I've got two quick questions for you.
Yeah.
It appears actually that your expense savings have materialized better than expectations. What does the rest of the year look like?
I think the rest of the year looks pretty good. We expect to incur some operating costs of approximately $60 million for COVID, that'll be offset a little bit by lower travel and entertainment expenses in the second half of about $30 million. We feel good about what we've put into place, and we feel good about what we're predicting for the second half of the year.
Okay. Just in time, I got one question in. That has to do with your commercial real estate offices. What are the longer term implications for your own needs and for the properties held in your investment portfolio?
Yeah. Two different questions, very quickly. Properties held in investment portfolio, I think we're in reasonable shape. We're underweight and have been underweight hotels and office and retail. We're overweight in terms of industrial and apartments. I think we're in reasonable shape there. In terms of our own space, we're rethinking that. We've told people they're not coming back to work. Most people aren't coming back to work until 2021. Only then if they feel comfortable. I think it's fair to say we will over time shrink our real estate space. We're looking at ways to do that and locations by which to do that.
Excellent. I think we're just out of time. Maybe the last rapid fire question I would have for you is any kind of bold prediction for 2021? It could be.
Wow. That is tough. What I would say is that, this is just a personal view, I think a vaccine will be a longer time in coming. One of the reasons they may have one, the distribution of it is going to be very difficult. I think we're going to be in the environment we're in for quite a while. We're just going to have to get used to a new normal. As companies, we will have to respond to that new normal. Not as much a prediction as a resignation that we're in this for the long term. It wouldn't surprise me, Tracy, if we do this next year, that I'd almost anticipate we'd be doing it virtually again.
Okay. I had a lot of fun talking with you.
Thank you.
I'd like to thank you so much for participating in today's session.
Great. Well, thank you for having me. It's an honor and a great opportunity for us, so thank you.
Okay. Bye.
See you.