Ladies and gentlemen, thank you for standing by. Welcome to the Prudential quarterly earnings call. At this time, all lines are in a listen-only mode. Later, we'll conduct the question and answer session. Instructions will be given to you at that time. If you need assistance during the call today, press star and then zero, and an operator will assist you offline. As a reminder, today's conference call is being recorded. I would now like to turn the conference over to Mr. Mark Finkelstein. Please go ahead.
Thank you, Cynthia. Good morning. Thank you for joining our call. Representing Prudential on today's call are John Strangfeld, CEO, Mark Grier, Vice Chairman, Charlie Lowrey, Head of International Businesses, Steve Pelletier, Head of Domestic Businesses, Rob Falzon, Chief Financial Officer, and Rob Axel, Principal Accounting Officer. We will start with prepared comments by John and Rob. Then we will answer your questions. Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures. For a reconciliation of such measures to the comparable GAAP measures and a discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the section titled Forward-Looking Statements & Non-GAAP Measures of our earnings press release, which can be found on our website at www.investor.prudential.com.
With that, I will hand it over to John.
Thank you, Mark. Good morning, everyone. Thank you for joining us. 2016 was a solid year for Prudential. We continue to show good momentum across our businesses. I will provide you some higher-level observations on our results for the fourth quarter and full year, the underlying fundamental trends in our businesses, capital deployment, and regulation. I'll then hand it over to Mark and Rob to go through the specifics. Fourth quarter operating earnings of $2.43 per share, which excludes a $0.03 benefit from market-driven and discrete items, exceeded the $2.07 we reported a year ago. Recall that we typically experience elevated expenses in the fourth quarter, which we estimate to be $0.21 per share in this year's quarter.
Otherwise, results for the current quarter benefited from solid core growth across our businesses, good underwriting experience, and favorable spread income, including higher than expected non-coupon investment returns and prepayment income. Net income was $0.65 per share in the quarter. We're about $1.80 per share below core operating income. A closer alignment of our operating and net income and reducing overall volatility have been key strategic focuses for us over the last couple of years. With the election, we experienced significant movements in treasury rates, credit spreads, and currencies, which resulted in mark-to-market accounting net losses for the quarter. However, the vast majority of these losses were driven by the component of our variable annuity reserve that we don't deem economic and therefore don't hedge. The net impact to earnings from other derivatives was fairly modest. I will now briefly discuss full-year results.
Operating earnings, excluding market-driven and discrete items, was $9.65 per share for the year. We're slightly below the 2016 guidance range, which we established in December of 2015. ROE for the full year was 12.7%. While our segment core operating results were consistent with guidance, we did experience higher corporate expenses than we had anticipated, in part due to a number of inherently variable or episodic items. Examples of this include higher long-term and deferred compensation expenses related to stronger than expected equity returns, including our share price, higher legal costs, and losses on a tax-advantaged investment. Net income for the year was $9.71 per share, which is in line with adjusted operating income excluding market-driven and discrete items. While there are moving parts from quarter to quarter, we are pleased to see the consistency of these two measures on a full-year basis.
Adjusted book value per share growth was a solid 7.3% for the year, which is after paying $2.80 in dividends. I will now touch on key fundamental trends in our businesses, starting with our international businesses. Our international operations experienced strong sales growth in 2016. Constant U.S. dollar sales grew 8% for the full year and 5% for the fourth quarter, despite a challenging interest rate environment, most notably in Japan, our largest overseas market. We have been able to leverage a broad U.S. dollar product portfolio that more than mitigated pricing and product actions taken on yen-based products in response to the lower interest rate environment. For the year, our U.S. dollar product sales in Japan increased 53%, which contrasts with a 12% decline in yen-based products. In addition, we saw growth in both our Life Planner and life consultant field forces while maintaining strong productivity levels.
The environment is challenging. We continue to expect solid core growth, earnings, and cash flow out of our international businesses. Moving on to our domestic businesses. While growth and earnings trends differ across our asset management, retirement, and protection businesses, at an overall level, we continue to see good momentum. Asset management has been a particular highlight, generating positive net flows from unaffiliated third parties of $5.7 billion for 2016, including $900 million in the fourth quarter. Our net flows are benefiting from our initiatives to expand distribution and product offerings and our solid overall investment performance. While we're not immune to the industry net flow challenges affecting active equity strategies, we benefit from our diversified platform and scale with over $1 trillion of assets under management. 2016 also marks our 14th consecutive year of positive institutional flows.
Retirement also had a strong year, with net flows of $5.8 billion and 5% account value growth over the year-end 2015. We continue to see favorable long-term growth prospects. We are also pleased with the strong underwriting performance we've experienced, particularly in our pension risk transfer business. Annuity sales and net flows are showing pressure, as evidenced by lower sales in both the fourth quarter and the full year. Our product diversification efforts enabled us to show smaller year-over-year variable annuity sales declines than peers in 2016. We're not immune to broader industry pressures, including the impact of regulatory uncertainty. Having said that, we continue to believe in the long-term value proposition and return potential of annuities. We believe the actions we are taking to restructure our annuities business during 2016 will substantially reduce the capital volatility and improve the earnings and cash flow prospects for this business.
To round out our businesses, our individual life and group insurance protection businesses are showing positive sales and top-line growth trends. We are pleased to see favorable mortality in our individual life business in the fourth quarter, following adverse experiences in the first three quarters. As we commented, mortality experience can fluctuate over shorter time periods. Our overall underwriting experience has been positive over a multi-year period. Group insurance had a good year, producing benefit ratios at the lower end of our expected range and has started to show top-line momentum after a period of declines, which followed pricing and underwriting actions. I will now turn to capital deployment. We returned over $900 million of capital to shareholders in the fourth quarter through dividends and share repurchases, which brings our full-year shareholder return to $3.2 billion.
This is on top of the roughly $530 million spent on our investment in AFP Habitat, a Chilean retirement services provider. 2016 was a particularly strong year for share repurchases, benefiting from capital freed up from our annuity restructuring, as well as gains from our Japan capital hedge to supplement the strong cash generation in our businesses. We believe in a balanced approach to capital deployment, including returning capital to shareholders and investing in our businesses. For 2017, the board has authorized $1.25 billion of share repurchases. Yesterday we announced a 7% increase in our quarterly dividend. Our annualized dividend has nearly doubled over the last five years, growing at an annual rate of 13%, reflecting our stronger and more consistent cash generation.
Finally, it's been an eventful couple of weeks in respect to regulation, with directives from President Trump requesting the DOL to examine the Fiduciary Rule and the Department of the Treasury to review the current regulatory oversight of the financial system more broadly. We strongly support an effective regulatory environment and the protections it provides. However, we also believe a reevaluation of both standards is appropriate in order to address, among other factors, any unintended consequences. Therefore, we support these actions taken by the new administration. In the meantime, there is considerable uncertainty on where both of those directives will ultimately land. As a consequence, we continue to manage our business following the current framework. With that, I'll hand it over to Mark.
Excuse me. Thank you, John. Good morning, good afternoon, or good evening, Thank you for joining our call today. I'll take you through our results, I'll turn it over to Rob Falzon, who will cover liquidity, leverage, and capital highlights. I'll start on slide two. After-tax adjusted operating income amounted to $2.46 per share for the quarter, compared to $1.94 a year ago. After adjusting for a $0.03 per share discrete item, EPS amounted to $2.43 for the quarter, up from $2.07 a year ago. Core performance of our businesses was solid in the quarter, with results benefiting from higher fees in our asset management and annuities businesses, greater spread margins, and continued business growth in international insurance on a constant currency basis. Non-coupon investment returns and prepayment income were about $65 million above our average expectations in the quarter.
We estimate that this tailwind, along with the net impact of favorable underwriting results relative to expectations in our retirement and life insurance protection businesses, and updates of reserves and related items in individual life, benefited current quarter results by about $0.12 per share. In the comparison of results to a year ago, the contribution of these variable items, together with less favorable currency exchange rates, had a net favorable impact of about $0.08 per share. In thinking about our earnings pattern, I would also note that we estimate current quarter expenses for items such as technology and business development, annual policyholder communications, advertising, and other variable costs were about $140 million or $0.21 per share above our quarterly average for the year, consistent with the historical pattern we mentioned when we discussed our third quarter results.
On a GAAP basis, including amounts categorized as realized investment gains or losses and results from divested businesses, we reported net income of $284 million for the current quarter, about $800 million below our after-tax adjusted operating income. This was mainly driven by a negative impact from product derivatives, which I will discuss shortly. Slide three shows financial highlights for the year. EPS for the year amounted to $9.65 after adjusting for market-driven and discrete items, which implies an ROE of 12.7%. We mentioned in our outlook call in December, we are not immune to the multi-year impact of low interest rates in our two primary markets, the U.S. and Japan, we continue to make strategic investments in our businesses that have longer-term paybacks. A consequence, in December, we moderated our ROE expectations to a 12%-13% range in the near to intermediate term.
The full-year EPS comparison reflects less favorable currency exchange rates in 2016, along with a greater tailwind benefit in 2015 from underwriting experience that was more favorable than our average expectations. Underwriting results, plus the net impact of other variable items we called out, had a negative impact of about $0.55 per share on the comparison of results year-over-year. Moving to slide four. Results for the quarter include a single market-driven and discrete item from the settlement of legal matters in the retirement business. Our quarterly market and experience unlocking in the annuities business was insignificant. Moving to slide five. Our GAAP net income of $284 million in the current quarter includes amounts characterized as pre-tax net realized investment losses of $824 million and divested business results and other items outside of adjusted operating income amounting to net pre-tax losses of $313 million.
Of note, product-related embedded derivatives and hedging had a negative impact of $1.3 billion. The largest single driver was the impact on non-performance risk, or NPR, from applying tighter credit spreads to a smaller gross GAAP liability for annuities living benefit, which decreased due to rising interest rates in the quarter. Essentially, the reduction in NPR was greater than the decrease in the GAAP gross reserve that we consider non-economic and don't hedge, driving the loss. We did also see some modest net hedge breakage of roughly $200 million in the quarter due to the volatility in the post-election period. Our hedging program was 95% effective in the quarter. The current quarter pre-tax loss from divested businesses was mainly a result of negative mark-to-market on duration management derivatives in long-term care.
Moving to our business results and starting on slide six, I'll discuss the comparative results excluding the market-driven and discrete items I've mentioned. Annuities earnings were $422 million for the quarter, up by $19 million from a year ago. The increase was mainly driven by more favorable net investment results, including current quarter earnings from non-coupon investments and prepayment fees about $10 million above our average expectations. In addition, results benefited from a greater net fee contribution due to our recent risk management refinements. Higher expenses, including business development costs, were a partial offset. The sequential quarter decline in earnings was mainly driven by seasonally higher expenses, which for annuities were about $10 million greater in the fourth quarter than the quarterly average for the year, and by lower fees, mainly driven by lower average account values.
The increase in return on assets, or ROA, from a year ago to 107 basis points reflects the benefit of our changes in risk management strategy. Quarterly return on assets can vary from a baseline, and as we had noted in the third quarter, benefited from some items that were stronger than we would expect as a base case. Slide seven presents our annuity sales. Total sales in the quarter are down roughly $400 million from a year ago, mainly from HDI, which represented about half of current quarter sales. The decline is directionally consistent with the lower levels of variable annuity sales across the industry, and we believe the continuing uncertainty associated with distributors adapting to the new DOL regulations was a contributor. Sales of our fixed income-based PDI product are also down from a year ago and sequentially, reflecting a repricing action in September.
For the year, more than two-thirds of our gross sales represented new business without retained exposure to equity market-linked living benefit guarantees, reflecting our successful product diversification efforts and external reinsurance for new business through the end of 2016, sharing HDI rider risks. Turning to slide eight. Retirement earnings were $298 million for the quarter, up $130 million from a year ago. The increase was driven by a greater contribution from net investment results, more favorable case experience, and lower expenses. The contribution from net investment results was up $98 million from a year ago. Current quarter earnings from non-coupon investments and prepayment fees were about $30 million above our average expectations, compared to a contribution about $20 million below expectations a year ago. Higher spread-based account values and our ALM strategies also contributed to the stronger net investment results.
Current quarter case experience was about $10 million more favorable than our average expectations. Our pension risk transfer business continues to perform well, and we've benefited from over $100 million of favorable case experience over the past 2 years. The sequential quarter increase in earnings included the contribution from about $3 billion of new funded pension risk transfer business that closed late in the third quarter. Turning to slide 9. Total retirement gross deposits and sales were $8.9 billion for the current quarter compared to $8.3 billion a year ago. Gross sales of institutional investment products in the current quarter amounted to about $4 billion, including roughly $2 billion of mainly funded new pension risk transfer cases and $1 billion of stable value wraps.
The modest negative net flows in the quarter reflect the episodic nature of the large case business, both in pension risk transfer and full service, as you can see looking over the full year results. Net flows for the year were about $6 billion, including about $4 billion for standalone institutional products and $2 billion in full service. The institutional net flows included about $5 billion of new funded pension risk transfer cases, which more than offset our runoff of the in-force business. Turning to slide 10. Asset management earnings were $224 million for the quarter, compared to $198 million a year ago. The increase was driven by higher asset management fees, partly offset by a $15 million lower contribution from other related revenues, which included a $10 million gain in the year-ago quarter from a legacy portfolio disposition.
The increase in asset management fees reflected greater fees from management of fixed income assets, driven by growth in average assets under management, and also reflected the benefit of a fee rate restructuring in real estate in mid-2016, both partially offset by lower fees tied to equities. The asset management business reported about $900 million of net positive unaffiliated third-party flows in the quarter, excluding money market activity. Net institutional flows of $2.5 billion, driven by fixed income strategies, were partly offset by retail outflows driven by equities. For the year, we reported $5.7 billion of positive unaffiliated third-party net flows, another strong year for our important asset management business. Turning to slide 11. Individual life earnings were $138 million for the quarter, compared to $119 million a year ago.
The increase in earnings was driven by a greater contribution from net investment results and more favorable claims experience, which together had a favorable impact of about $50 million on the comparison of results. Earnings for the current quarter included income from non-coupon investments and prepayment fees about $15 million above our average expectations, and a contribution from claims experience also about $15 million more favorable than average expectations. Going the other way, current quarter results included a negative impact of about $25 million from updates of reserves and related items, including an unusually large impact from periodic true-ups, such as actual to expected in-force business. Expenses were also modestly higher in the current quarter than a year ago. Turning to slide 12. Individual life sales, based on annualized new business premiums, were essentially unchanged from a year ago, but up by $40 million from the third quarter.
The sequential quarter increase came mainly from guaranteed and other universal life, including tax and estate planning sales that tend to peak in the fourth quarter. In addition, the current quarter reflected accelerated purchases in advance of price increases and face amount limits we recently implemented for our guaranteed universal life products. Turning to slide 13. Group insurance earnings were $43 million for the quarter, up by $16 million from a year ago. Current quarter results benefited from lower expenses, including the impact of nonlinear items such as premium taxes, and a greater contribution from net investment results, including current quarter earnings from non-coupon investments and prepayment fees, slightly more favorable than our average expectations. Underwriting results were solid but less favorable than a year ago. The total benefits ratio remained at the favorable end of our targeted range of 87%-91%.
Moving to international insurance and turning to slide 14. Earnings for our Life Planner business were $395 million for the quarter compared to $367 million a year ago. Excluding a $22 million negative impact of foreign currency exchange rates, earnings increased by $50 million from a year ago. Current quarter results benefited from continued business growth, with constant dollar insurance revenues up 6% from a year ago, lower expenses, and more favorable policy benefits experience, with mortality about $15 million more favorable than our average expectations. Turning to slide 15. Gibraltar Life earnings were $360 million for the quarter compared to $371 million a year ago. Excluding a negative impact of $26 million on the comparison from foreign currency exchange rates, earnings are up by $15 million from a year ago.
Current quarter results benefited from business growth, including the contribution from our investment in AFP Habitat in Chile, and stronger net investment results, driven mainly by increased portfolio size. Mortality in the quarter was roughly consistent with our average expectations versus about $15 million more favorable than expected a year ago. Turning to slide 16. International insurance sales on a constant dollar basis were $727 million for the current quarter, up $35 million or 5% from a year ago. This sales growth was driven by a 41% increase in our sales of U.S. dollar products in Japan, which more than offset lower yen-based sales. U.S. dollar products comprised more than half of our sales in Japan for each of the past three quarters and the year, compared to just over one-third of our sales in 2015.
This change in mix reflects our adaptation of the product portfolio to the current environment, including reductions in crediting rates and commissions, and in some cases, sales suspensions for yen products that are most affected by interest rates. We are continuing to benefit from our longstanding competitive advantage in distribution of U.S. dollar products in Japan, emphasizing recurring premium death protection products with returns mainly based on mortality and expense margins. Life Planner sales in Japan were up 15% from a year ago, reflecting an 8% increase in agent count, driven mainly by recent sales manager appointments together with higher average premium size. Gibraltar sales were essentially unchanged from a year ago. An 8% sales increase from our life consultants, driven mainly by higher average premium size, was offset by lower bank channel sales.
The decline in bank channel sales included the effects of terminating sales of single premium JPY-based products. Sales outside Japan are up 3% from a year ago, driven by continued growth in Brazil. Turning to slide 17. The corporate and other loss was $441 million for the current quarter compared to a $378 million loss a year ago. The increased loss was driven by higher expenses, including variable items such as initiative costs and compensation programs that are linked to equity returns, including our share price. Lower interest expense, reflecting our paydowns of debt over the past year, was a partial offset. Higher expenses drove the sequential quarter increase in the loss. Of the company's $140 million overall excess to fourth quarter expenses in relation to the quarterly average for the year that I mentioned earlier, about $80 million resides in corporate and other.
Now I'll turn it over to Rob Falzon.
Thanks, Mark. I'm going to provide an update on key balance sheet items and financial measures starting on slide 18. While statutory results are not yet final, we estimate that our composite RBC for our U.S. insurance subsidiaries on a comprehensive basis will be well above our 400% target as of year-end. Following the recapture of our living benefit risks and the refinements we made to our risk management strategies, most of the contract risks and supporting capital for annuities reside in our PALAC statutory entity. Therefore, we view this composite RBC position as a primary measure of our financial strength. We expect both PALAC and Prudential Insurance to separately report strong RBC positions in relation to our target as well. In Japan, Prudential of Japan and Gibraltar Life reported strong solvency margins of 858% and 975% respectively as of September 30th. These solvency margins are comfortably above our targets.
Looking at liquidity, leverage, and capital deployment highlights on slide 19. Cash and liquid assets at the parent company amounted to $4.5 billion at the end of the quarter, an increase of about $1 billion from September 30th. This reflects cash inflows during the quarter, net of the impact of about $900 million returned to shareholders, including dividends and $625 million of share repurchases. Capital flows to the parent company in the quarter included roughly $1 billion from PALAC, driven by earnings from the annuities business over the past year. We are continuing to manage the product risks on an economic basis, including the ability to maintain a CTE 97 threshold through moderate stress scenarios, and we are benefiting from greater certainty of cash flows and reduced capital volatility as outcomes of the risk management refinements we implemented.
We expect the more stable earnings and capital in our annuities business to support ongoing distributions. Our financial leverage and total leverage ratios as of year-end remained within our targets. As John noted, we returned $3.2 billion to shareholders during the year through dividends and share repurchases and announced a 7% increase in our quarterly dividend yesterday. I'll turn it back over to John.
Thank you, Rob. Thank you, Mark. We'd like to open it up to questions.
Certainly, ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touch tone phone. You will hear a tone indicating that you have been placed in queue. You may remove yourself from queue by pressing the pound key. If you are using a speakerphone, please pick up your handset before pressing the numbers. Once again, press star and then one for any questions or comments. Our first question will come from Erik Bass with Autonomous Research. Your line is open.
Hi, thank you. John, just a question for you. You've talked about the steps taken to reduce reported volatility, including the changes to yen accounting and the VA captive. I think with the market moves this past quarter below the line noise has reemerged as a concern for some insurance investors. Are there any other initiatives you're contemplating to kind of further reduce some of the non-economic noise in Pru's results?
Yeah. I think I'm going to suggest Erik that Rob take that question. Rob?
Erik, this is an ongoing initiative for us. When we look back over the last four, five, six years, we identified that the two primary sources of breakage for us between our reported GAAP results and the operating earnings that we share with you came from the FX remeasurement issue that you alluded to, and then from our annuities business. We've undertaken initiatives to solve for the, I'll say the 80%-85% of the noise that's been created over the last couple of years. Within our annuities business, we haven't finished, but we've gotten substantially there, so we're continuing to do some work in order to take out some of the remaining volatility, some of which you saw this quarter. There's the remaining 15%-20%, and yes, we've identified initiatives there that we think may help to eliminate that.
We care a lot about cash flow, but we also recognize that GAAP matters to investors, and it matters to the creation of book value growth, and so we continue to stay on that.
Thank you. I think you've also recently made some pricing changes to both the PDI product in VAs and then some individual life products. With interest rates now moving somewhat higher, how do you think about the trade-off between higher new business margins and adjusting pricing to make the products more attractive to consumers and drive more sales?
Erik, it's Stephen. I'll take that part of your question. We're always looking to strike the right balance between the factors that you mentioned. For example, this quarter's sales in annuities reflected the factor that Mark spoke about. At the end of the third quarter, we had a trimming of the benefit in our PDI product. That resulted from reduced sales throughout the quarter. However, we have a highly distinctive capability, distinctive in the industry, in our annuities business to reprice both PDI and HDI as often as monthly. We do have the ability to respond to market developments and to act nimbly in our balancing of the factors you mentioned. In fact, on PDI, we already took a modest step in that direction at the very end of the year, increasing some of the payout rates.
As and when market conditions allow us to continue that path, we will do so. We're always looking to write business on a sustainable and profitable basis.
Got it. Thank you.
Thank you. Our next question comes from the line of John Nadel with Credit Suisse. Your line is open.
Good morning, everybody. I guess a broad question, but with the move higher in rates, and I realize we're sort of flat year-over-year, but certainly higher since the election, as you think about how much more do we need to go, I guess globally, to get to sort of a blended stability on your portfolio yield?
John, it's Rob. Let me take a stab at that. The way I would think about it is, I'd look at the comparison of our portfolio yield to new money rates, use that as sort of a metric for where we want to get to the point where the roll-off in the portfolio is not creating further drag on the overall yield by virtue of where we can invest. In the U.S., our new money rates are around 3.5%. The portfolio roll-off in the course of the next couple of years is going to be 4%- 4.25%, somewhere in that order of magnitude.
We've got about another, call it 75 basis points of interest rate rise between a combination of underlying treasuries and credit spreads in order to close the gap between where we're putting new investments on the books and where old investments are rolling off the books. If you look at the Japan portfolio, recognizing that that is a mix of both U.S. and yen liabilities, the portfolio yield there is around 3% and our new money rates are around 2.5%. We've got a little over 50 basis points of negative yield there that we have to make up. That would come from a combination of both rising rates in the U.S. and rising rates in Japan.
That's really helpful. Thank you. I guess my follow-up question is, focusing on a couple of the below the line items, the impact from the divested businesses this quarter, would you characterize that impact running through net income as also largely non-economic? If so, what drove that?
Yeah. We would think of that as being entirely non-economic. The divested businesses, with the primary drivers of that are going to be two things. One, our closed block business. That is entirely non-economic in that the results of that business over time are passed through to the policy holders. It has no economic impact to the shareholders of the company. The second item in there is our long-term care business, and what you saw in there was actually from an operating standpoint, it's generating modest profits, as you would expect, given when we wrote down the book. It's generating profits that from an underwriting standpoint and from the earnings that we get off our surplus that we have in that business. There are a certain number of derivatives that are helping us to manage the portfolio there because it's a very long liability.
You've got to mark-to-market on those derivatives as interest rates rose. The entire loss you saw within long-term care, in fact, is more than attributed to the mark on that derivative offsetting the modest level of profits we were otherwise getting out of it. We would consider that to be non-economic, therefore, as well.
Yeah, with no corresponding mark on the liabilities.
Yes, sorry. Thanks, Mark.
Yeah. Understood. I understand that there's some work going on at FASB around that. Is that your understanding as well? If so, any guess on how long it takes to get to the point where we get a little bit closer to matching up the impact on the left versus the right side of the balance sheet?
Well, FASB has a proposal out which would go in the right direction. The initial proposal out by FASB would now include a mark-to-market concept on both the left and the right-hand side of the balance sheet, which I think would be helpful and, as I said, a step in the right direction. The concern that we have is that the details matter on how you go about doing that. You don't want to solve for that problem and then create other volatility and noneconomic outcomes by virtue of getting the discount rates wrong that you're using on the asset side and the liability side. There are a number of issues that we have with the FASB proposal.
While we think it's generally headed in the right direction, we think it needs some fine-tuning in order to get it quite right so that, in fact, the new proposal is a net good as opposed to just trading one level of noise for a different level of noise.
Thanks very much. I appreciate it.
Thank you. Our next question comes from the line of Suneet Kamath at Citigroup. Your line is open.
Thanks. Good morning. I just wanted to start with the ROE, going back to the outlook call where you took the guidance for the near term down from 13-14 to 12-13. I think you'd said that the primary driver of that was rates, although there were some other factors. I'm trying to reconcile that 100 basis point reduction in ROE guidance to the interest rate sensitivity that you show in the same deck where I think you said a 100 basis point increase or swing in 10-year Treasuries is only $0.15-$0.20. That's a pretty modest impact on ROE. I'm just trying to reconcile the two.
Let me take a stab at that, Suneet. The effect of interest rates is a compounding effect. When we first established our 13%-14% outlook for ROE, it was a point in time where our outlook for interest rates were about 100 basis points higher than they are today. We've had several years now of rates being below that expectation, and it's the compounding effect of that every year as the portfolio rolls and as we're putting on new business and making new investments that created the drag on the ROE. By contrast, it will then therefore take us a couple of years of interest rates being back up at 100 basis points in order to build back toward what we think is that longer-term sustainable ROE of 13%-14%. Does that help?
Yeah, that does. I just was wondering, is another factor in there this recurring premium that products that you sell in Japan, just given that rates have had such a big move to the downside in that country?
Let me take one stab at that, and then if Charlie wants to add any commentary, he can. Obviously, the impact on our returns are felt both in the U.S. and in Japan. Yes, we are seeing lower rates in Japan in all across our products. Those products where we were more rate sensitive, we've either done pricing adjustment or we've discontinued sales of those products. I would note, however, that our returns in Japan are actually quite competitive, so we have a very high ROE out of our Japan business. Therefore, the compression that we felt as a result of lower rates in Japan, while it's had a negative impact, we still produce very attractive returns there. Charlie, I don't know if you wanted to elaborate on that.
No, I think you did. I guess the only thing I'd add two points to this. I think the real driver of our ROE is our business mix. There are some factors, interest rate, et cetera, that have some effect over time. You've seen us when we came out of the financial crisis articulating 13%-14% and then exceeding that when we had the wind at our backs. We also would never raise that goal because we knew we were benefiting from tailwinds. We didn't want to chase returns. We wanted to preserve our ability to invest in our business in ways that didn't always have an immediate positive effect on ROE. We continue to think exactly the same way. If we find the interest rate environment is a sustainably more favorable one, our business mix is going to drive stronger outcomes.
In the meantime, actually our biggest focus around this also is relative performance. We think our business mix should drive superior performance in relationship to our peers. That's been historically reflected, we would expect that would continue on from today.
That's helpful, John. My just second question, just to follow up, I think, on Erik Bass' line of questioning in terms of the below the line noise. Was there any impact from those items on your statutory performance in the quarter, or was it all GAAP?
The mark-to-market on derivatives will affect both GAAP and statutory. For us, that derivative impact was relatively modest. I'm talking about the portfolio management derivatives. The noise that got created as a result of the annuities business, the noneconomic component of the liability, and the NPR that offsets that noneconomic component are outside of our statutory construct. Our statutory construct isn't identical to but largely mirrors the economic construct that we've put together from a GAAP standpoint. That portion of the noise, which dominated the delta between reported operating earnings and GAAP, is entirely noneconomic in both a GAAP and a statutory context.
Got it. How big was that mark number that you just referenced that will affect stat?
The derivatives piece, I don't know that we've disclosed that, but it was not a particularly material number. Our net derivatives are relatively modest from a duration standpoint. The notional amount we have outstanding there has been substantially decreased over the course of the last several years. It's like half what it used to be a handful of years ago. We've been encouraging our portfolios as they do their ALM, to increasingly utilize cash instruments over derivative instruments, it was not a particularly material impact.
Okay, thank you.
Thank you. Our next question comes from the line of Ryan Krueger with KBW. Your line is open.
Hi. Thanks. Good morning. I had a question for Charlie. Can you talk about the potential impact to Japan sales ahead of and following the April discount rate reduction?
As you know, in July of last year, the standard valuation interest rate for the yen single premium whole life products decreased to 25 basis points. We think potentially in April of this year, the discount rate for reserves for recurring premium product will decrease from 1% down to 25 basis points. Our view is that we have adapted in the past in terms of pricing and products, and we'll continue to do so in the future. We don't anticipate a meaningful impact on our capital levels or solvency margins. For example, we've already discontinued all our Japanese yen single premium whole life offerings through all our channels. We did that last year. Don't forget that this new change in discount rates will only apply to new business. We should be able to manage the efforts of the new rules.
It may involve some repricing of products as we go forward, we'll take that as it comes.
Okay. Somewhat related, are you seeing any domestic competitors start to offer more U.S. dollar-denominated products, or is it more isolated to the international competitors that operate in Japan?
We've seen some, or we've heard a fair amount of talk about it, and we're beginning to see a little of it. Where we've seen it has been primarily in the bank channel. We think there'll be more competition in the future, but let's review the bank channel for a minute because I think it's quite interesting. For us, the bank channel is less than a quarter of what we sell. Obviously, most of what we sell is through our tied agency systems with Life Planners and life plan consultants. Most of what we sell is death protection. Two-thirds of what we sell is death protection. Where we're seeing the competition come in is not so much on the recurring premium product, especially recurring premium U.S. dollar product. We really haven't seen any competition from anyone there yet.
We've seen a little bit on the single premium U.S. dollar product, and we've seen some on the recurring premium yen-denominated dollar product. We don't sell any more single premium yen-denominated product. We've seen some come in, and we'll probably see a little bit more, but we also think we have a competitive advantage when it comes to selling death protection either through the bank channel or through our tied agency system.
Great. Thanks a lot.
Thank you. Our next question comes from the line of Thomas Gallagher with Evercore. Your line is open.
Hi. First, just a follow-up question to Rob. I think you mentioned new money yield related to the Japan portfolio is running at around 2.5%. Can you split that up between how much of your cash flows are being invested to back the U.S. dollar portfolio versus how much is backing the yen portfolio? That just seems like a high number relative to at least yen cash flows.
It's a good question, Tom. I don't have those numbers off the top of my head, so it's something we'd have to follow up with you on. I think we do provide that. I just don't have it immediately at my fingertips.
Let me throw out a couple of numbers. If you look at our whole portfolio, about 45% is JGBs, and then there's about another 25% that's probably Japanese corporates, and then you have U.S. product as well. When you look at our overall portfolio, it's really high quality. You have 45% that's JGBs, you have 85% that's fixed income, you have 97% of that is investment grade, and of the other 15%, it's really investment grade surrogates, right? That's where you get some other U.S. dollar product. You get private placements, you get mortgages, you get other things. In general, one, it's a very high-quality, stable portfolio, and two, you have a fair proportion of U.S. dollar product in there, and that's what raises the yield.
While Charlie bought me some time, I was able to look up some numbers for you. If you look at the total international portfolio, I call it around $175 billion, about $100 billion of that would be in JPY products, and about $75 billion of that would be in other currencies, primarily in U.S. and AUD.
At the margin, more U.S. dollar business is coming in.
Yes, that's a good point.
You heard the numbers I quoted on the mix of sales, and U.S. dollar sales are now the majority.
We've got like, I think the non-yen denominated sales in the last quarter were over 60% of our sales. When you think about the incremental dollar flow, it's going to be more heavily influenced by sales because we've got a fairly modest turnover in the existing portfolio given the very long duration of those liabilities.
Okay. How much of the yen cash flows that are coming in, are you pivoting more into US dollar investments? I don't need precise numbers, but have you been investing 20%, 50% of yen cash flows into US dollar or non-yen type investments or is it something much smaller than that?
We have a relatively small portfolio, Tom, that's invested in where we've taken yen liabilities invested in dollars and then swap back to yen, which I think is the strategy that you're talking about. The aggregate of that portfolio is about $5.5 billion. When we first started that, it was a very attractive trade. We were earning 2%, 2.25% in premium over what we could earn if we invested in Japan. Today, that's more like 1.5%, we continue to selectively pursue it. I think our CIO has referred to it as getting to be a little bit of a crowded trade. We have some of that, but relatively modest.
Okay. Just final question, Rob, in response to, I think it was Erik Bass' question, you were talking about an effort to eliminate the below the line noise and strategies. Can you just expand a bit on that? Would it be significant altering of economics or are we talking about accounting legal entity type restructuring where you think you can actually optimize the accounting better without changing the underlying economics much?
Yeah. Tom, we seek to do this without compromising on economics. I think what we did with FX remeasurement is a perfect example of that. What we did is we created a divisional structure within Japan in order to create three functional currencies, which then allowed us to eliminate the FX remeasurement issue that was occurring as a result of having a single yen-denominated functional currency there. When we look at eliminating that noise, what we're trying to do is look at uneconomic noise and figure out noneconomic ways of reducing that noise such that we don't impair the underlying fundamentals and economics of our business. We think there are levers that allow us to do that.
Okay, thanks.
Thank you. Our next question comes from the line of Seth Weiss with Bank of America. Your line is open.
Hi, thank you. A question on the retirement and the asset management businesses. If you strip out what you consider trend adjustments, retirement's quarterly run rate appears right around $260 million. This is a significant step up in where you've been. You commented on some of the fund flow dynamics earlier in the call. Just curious if you could speak to what you think is a sustainable level of run rate quarterly earnings.
Seth, it is Stephen. I will address your question and talk about how we view trends in core earnings in both of those businesses. First of all, in both businesses, particularly in retirement, earnings benefited from some items that are not necessarily trendable, as Mark addressed in his review of business results. However, we have seen core progress. In the retirement business, I would say that that core progress very much reflects higher account values in both PRT and full service, arising from a variety of factors, our sales, our flows, persistency of our business, and in some cases, market appreciation. We have seen it reflecting effective expense management over the course of the year. We have seen it reflect the benefit of portfolio rotation as we onboard PRT transactions.
What I mean by that is, for example, as we onboard these transactions, we are taking in large amounts of public fixed income assets, and we are able to rotate some of those to private fixed income, picking up some yield while still matching the liability very well and not increasing any risk. In the asset management business, I would say our core growth in earnings reflects two very basic trends. One, obviously the strength of our flows, and two, our ability to sustain our fee level on an average basis across the entire platform.
Now that is fairly distinctive, and it is encouraging to us in the sense that even while we are in a period where there is secular pressure on asset management fees, the strength and the diversity of our multi-manager structure and our ability to draw flows in some higher yielding parts of the business, higher fee basis parts of the business has, on an average basis, enabled us to hold our average fee levels pretty steady. I would say we are encouraged by the trends in core earnings in both of these businesses. At the same time, though, I would say that that progress is reflected in the guidance that we issued in December.
Great. On asset management, you specifically commented on fee rate modifications for certain real estate funds.
Yeah.
Does that have a notable improvement in the run rate?
It has a double digits of dollars over the course of the full year.
Great. Thank you.
Thank you. Our next question comes from the line of Nigel Dally with Morgan Stanley. Your line is open.
Great. Thanks, and good morning. I had a question on annuities. The flows deteriorated a fair amount, and you highlighted the reasons why. If that continues, I'm guessing the capital strain will be lighter. Would that be meaningful enough to add to the available capital? Any color on implications to capital would be helpful.
Nigel, it's Rob. I'll take a stab at that. You know what? Let me step back a little further because I think what this really relates to is the success we've had with our restructuring of the annuities business, and maybe it's worth just going through that real quickly, and then it leads to the results that I'll describe to you that'll answer your question directly. Remember we did four things when we undertook this restructuring of our annuities business. First, we took all of the operations that we had, and we consolidated them into a more limited number of legal entities, primarily one being PALAC. Two, we eliminated the corporate underhedge.
Three, we migrated toward a statutory construct that we think is more reflective of the long-term nature of the risks, and consistent with the NAIC is going, consistent with our methodology for managing to a CTE 97 through the cycle that we've historically had in place, and consistent with our desire to have a double A ratings. The fourth thing that we did, is we used a combination of derivatives and financial assets to defease the liability, whereas before we were using primarily, if not exclusively, derivatives.
The immediate results of that were that we've reduced our capital sensitivity to interest rate risk, which has resulted in a stable and higher level of free cash flow, getting to the question you're asking, that enables us to have more confidence around our ability to pay dividends, and hence what you saw in the fourth quarter was a billion-dollar dividend coming out of our annuities business. We think that going forward, that is a high cash flow business. When we've reduced the volatility around the business, we have more comfort then in distributing that cash flow out to the parent company and ultimately making it part of our redeployable capital.
That was on top, incidentally, of just to remind you, releasing about $1 billion as a result of the combination, half a billion dollars of which we distributed out to shareholders as a special authorization last year. We used the other half billion dollars to reduce our debt and our leverage. Incidentally, it's also led to lower costs. We have lower risk, lower costs, that's improved AOI coming out of the business as well. That volatility reduction and capital release and increased earnings all facilitated by the efficiencies coming out of the restructuring, we think enables us to take advantage of what we believe are the very attractive economics in that business, which is high return, high cash flow. The introduction of stability then allows us to translate that into cash flows to the parent company, and as I said, ultimately to shareholders as well.
Nigel, this is Steve. I'd kind of amplify Rob's remarks and speak to your comment about, kind of implied in your question about how we see future sales. First of all, I'd address it on a product basis. First of all, as I mentioned, our current products, we have the ability to be very nimble in how we keep those competitive. In terms of our forward-looking product plans, these really stem from our business strategy and not from any particular outcome one way or the other on the DOL rule. Our product plans in 2017 and 2018 are simply a continuation of that strategy that's already been successful in 2015 and 2016. We look to offer a broader range of solutions to client needs.
For example, in the first half of this year, we'll enhance our death benefit in a way that will make us more competitive in legacy planning. We're exploring new fixed indexed annuity solutions. We're looking to develop and introduce a highly innovative and simplified income solution into the group benefits market that will enable us to address a broader market segment. Again, all of these are grounded in our business strategy and aren't sensitive to outcomes one way or the other on the DOL Fiduciary Rule.
Very helpful. Thank you.
Cynthia, I think we have time for one more question.
Certainly, that will be from the line of Yaron Kinar with Deutsche Bank. Your line is open.
Good morning, everybody. I had a question around the U.S. dollar-denominated product sales in Japan. How much room do you have to continue to grow that or is kind of this roughly 60% of overall products sold where you want to be?
No, I'll answer that in a couple of ways. The first is, I don't think we have a set goal as to where we want to be. Just as Steve articulated in the U.S., we try to provide solutions to our clients, whatever they may be. That may be in yen product, it may be in dollar product. Also, as Steve said in the very beginning, you look at a balance. You look at a balance between product mix, pricing, and what the consumer wants. We don't have a goal, per se, and the answer is different for the different companies we have there. In the LifePlanner, as an example, U.S. dollar sales increased from 38% this quarter from 27% a year ago. There's a lot of room to move there. In Gibraltar, we're a little bit higher.
Overall, Gibraltar, the U.S. dollar sales were 67% versus 50% a year ago. In Life Consultants, they were 55%, so there's certainly room there. The bank channel, we are higher. We sell mostly U.S. dollar product because we have eliminated the single premium yen-denominated product. There isn't as much product on the yen side to sell, and that had to do with the profitability and frankly, the efficacy of that product. U.S. dollar product there was in the eighties, so not quite as much room to grow there, although a little bit. In the IA channel, we're at about 50%, which is up from about 30% a year ago. By giving you these numbers, you see a couple of things.
One is our ability to pivot products, and two is the creation of new products because one of the reasons why we were able to sell more dollar-denominated product is because we created some new products, especially on retirement income and some whole life products. I think you'll see we have the ability to do more as we go forward throughout a product creation or just through the absolute percentages.
Okay. That's helpful. Do you know what percentage, or do you have handy what percentage of your U.S. dollar-denominated products are single premium?
Of single premium? I don't offhand. I will tell you that overall in Japan, 86% of our product is recurring premium. Of the other 14%, 11% is the fixed annuities business, and the fixed annuities business is almost all U.S. dollar. I would say I'll give you those two percentages. We can get back to you with the actual percentage, but I'll leave it at that.
Okay. Thank you very much.
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