All right. I think we're going to get started. I would like to welcome you to Prudential's 2016 Tokyo Investor Day. We thank you for your participation and the opportunity to share our Japan story. I'm Mark Finkelstein, Head of Investor Relations. If you look in your materials, you will find an agenda. We have seven presentations today. We will start with overview presentations by Charlie Lowrey, Head of International, and Mitsuo Kurashige, CEO of our Japan operations. This will be followed by presentations by the three presidents of the business units. Then we will conclude with a review of our investment operations in Japan and a financial overview of our international operations. There will be three Q&A sessions. The first two will be followed by a break.
At the conclusion of the formal program, we will host a lunch for those of you that don't have to run off to an airplane. We hope that you will have an opportunity to join us for that. We do have one curve ball. In the process of getting to Japan, Rob Falzon, our CFO, and Scott Sleyster, our Chief Investment Officer, encountered some transportation issues. To make a long story short, their plane was diverted to Alaska. As a consequence, they are not able to be here in person, but they will be presenting their materials by phone, and there's a lot of good content in their materials, and I'm sure you will find their presentations very useful. Did want to highlight this variance from normal practice. A couple of logistical items. Wi-Fi, if you want to get on Wi-Fi, there's an open network.
It's Roppongi Hills. You should be able to access that without trouble. You will also see a headset in front of you. Japanese is in channel one and English is in channel two. Also, if you can also mute your phones, if you have your phone on, that would be helpful to avoid any distractions. Before getting started, please review our forward-looking statements in non-GAAP measure and reconciliations of earnings measures. With that, I will hand it over to our Head of International Operations, Charlie Lowrey.
Good morning. We were thinking about all doing the presentation from afar because as we were testing the sound system this morning, Rob and Scott's voice boom in from the ceiling, and it gives them a certain gravitas that's actually quite wonderful. You'll experience that as we go through. I will provide some comments briefly and some introductory comments about our international business. Then turn the program and the forum over to my Japanese colleagues. We describe our international strategy as having four legs. The first is to make sure that we're executing our business well in each of the countries in which we're currently located. How we operate will have the greatest effect on our near-term performance. The second leg relates to the types of products that we offer, and there are two aspects to this.
Innovation to meet customer needs and product profitability to ensure that products meet our hurdle rates. You'll hear about both sides of this coin, namely innovation and product profitability from my colleagues. The third leg relates to the distribution expansion, of which Japan is probably our best example, but which is actually happening in all the different countries. Finally, there is M&A, either to expand in existing countries or to expand in select new countries, as we did in Chile earlier this year. As you can see on the following page, we have been able to grow this business consistently over time through a variety of interest rate markets as well as the stock market. Growth has flattened in the past two years as we've been burdened by unfavorable foreign exchange rates, less favorable alternative investments, and lower interest rates.
As you will hear, our underlying fundamentals of our businesses, especially in Japan, remain very strong. Let me talk briefly about our businesses outside of Japan. We take a very discerning view with regard to other markets, looking for growth markets that fit with our business model. We don't think the word strategic is a synonym for unprofitable. We will only enter into markets that we believe we will be able to achieve our hurdle rates over an acceptable period of time, such as our acquisition of AFP Habitat recently in Chile. Brazil would be another country to highlight, which while still relatively small to Japan, has been growing nicely and now has about 14% of all our Life Planners and about 11% of all Life Planner sales.
I mentioned product profitability as a real focus of ours, and you can see that the discipline we have with regard to hurdle rates results in high margins and high ROEs. Obviously, this environment has affected ROEs, but because of the product mix, the majority of which is recurring premium death protection , and the quick actions we take that you'll hear about, we continue to produce high and what we believe will be sustainable ROEs over time. Despite everything you may hear to the contrary, we believe Japan remains a very attractive market. In large part, this is because of our business model. 60% of our business is through captive distribution, and about two-thirds of our existing and new business is death protection. As a result, we derive the majority of our returns through mortality and expense margins, which are not dependent upon spread.
We've had a history of growth in Japan, as you will see on the next page and hear from my colleagues. We believe there are numerous avenues for future growth. The business model has provided stable cash flow that enables the business to return cash to its parent and has returned more than 60% of after-tax AOI for more than five years. We're positioned well for the future by virtue of the significant actions we have and will continue to take to respond to the economic environment, the high quality and type of products in our existing book of business and that we continue to sell, and the way in which we conservatively manage our portfolio, which Scott Sleyster will talk about later on today.
Many people say that Japan is shrinking and therefore ask the question: how can you continue to grow, and why do you continue to do business there? It's true that the population is decreasing, but if you look at our target market, which is the top two parts of the bar, this market will grow by 12 million people from 1980, when we started the business, to 2040, over a 60-year time period. It obviously peaked in the middle in 2010, but the point is there is still a very large market with significant needs going forward.
The part of the market that is growing most quickly, represented by the dark blue part of the bar at the top, has significant needs for income, tremendous intergenerational transfer of wealth, and healthcare, all of which require greater sophistication from the sales force, which is exactly our business model and what we have to offer. There are obviously challenges, including the macro environment leading to regulatory changes to discount rates and mortality tables and the like. These are issues that this management team has dealt with in the past and continues to ably navigate. On the other hand, we do believe there are reasons to be optimistic based upon our unique distribution model, the opportunities presented by an aging demographic, and our product expertise.
We hope that you come away from today with both the confidence and the optimism that we have in Kurashige-san and his team. Let me now turn the podium over to Kurashige-san. Kurashige-san has been with Prudential for 25 years and is only the third leader of our Japan businesses in over 30 years. Kurashige-san, over to you.
Good morning. I'll present an overview of Prudential's life insurance business in Japan. Prudential has established a strong presence in the Japanese market. To start, let me explain why we continue to believe the Japanese market remains highly attractive to Prudential. Next page, please. As a result of building and management our business based on a differentiated strategy, we have been able to produce higher returns than what you typically see in the Japanese market. We believe we can continue to grow our business driven by distribution expansion, a broad product portfolio, and ongoing customer needs for our product. Let me elaborate on these points. Prudential Japan, with its unique Life Planner model, is positioned to continue to increase the number of quality Life Planners as you have seen consistently over time.
At Gibraltar, with a life consultant count now stabilized following the integration of Star and Edison, we are positioned to start to show stable growth going forward. In Gibraltar's independent agency channel and Prudential Gibraltar Financial Life's bancassurance channel or third-party channels, as we say, we seek to selectively expand while remaining solid profitability. At the product level, we benefit from a broad collection of multi-currency product. In the second quarter, we had higher sales of foreign currency denominated product than JPY-denominated product. Further, in connection with the aging population in Japan, we see opportunities to use life insurance product to address post-retirement and estate planning needs and more broadly, satisfy the protection needs of our customers through our need-based sales process.
Key challenges are listed on the right-hand side of the table. To be specific, they include the impact of declining interest rates on investment returns, which has contributed to the need to revise product pricing to respond to the changing economic environment, which impact the attractiveness of our services or product to customers. The effect of revisions or expected revisions, the standard reserve discount rate, and expect changes to mortality tables, and the objective to continue to invest in system and infrastructure. In addition, there is a potential for increasing competition in third-party channels, such as the independent agency and bank channel. Next page, please. As you can see on page three, we have taken a number of actions on our product in 2016. This includes reducing the guarantee interest rate, reducing commissions, and suspending sales of single pay JPY-denominated product.
For product denominated in US dollar, on the other hand, we have expanded product. We have introduced new whole life product in Gibraltar and expect to introduce more later this year and in 2017 at both Gibraltar and Prudential, Japan. Next page, please. The chart shows the ROE of our Japanese business standalone since 2012. As you see, we have produced high returns historically and expect to continue to produce strong ROEs in the future, even if macro change persist. The next two slides show a profile of our overall block of business in Japan, as well as business we have sold more recently. Page five shows a breakdown by product category. This protection product made up nearly 6% of our annualized new business premium in 2015, while sales of retirement, saving, and A&H product were well-balanced for the remainder.
Our in-force policies have a similar composition with the majority of our in-force block of business focused on death protection. Page six shows the annualized new business composition by currency in 2011 and the first half of 2016. As you can see, we have experienced a shift from JPY-denominated product to US dollar-denominated product, with US dollar product representing a higher percentage of sales than JPY-denominated product through June 30th, 2016. Next slide, please. The chart shows the total value of the in-force base amount of our Japanese businesses on a constant currency basis over the past five years. We have generated a stable growth over this time period led by our Life Planner, life consultant, and third-party bancassurance and independent agency channel. Next slide, please. This slide shows the strong market position Prudential holds in the Japanese market.
Based on 2014 data, Prudential ranked in the top five in new business base amount, new business premiums, as well as total in-force base amount. Notably, Prudential was ranked two in new business base amount. Also, premium income and total assets were just outside the top five at rank six. Next slide, please. Now, let me explain how our businesses and distribution are organized to sell product to a broad cross-section of Japanese customers with different income and asset levels and varying life insurance need. We benefit from a multi-channel approach, including our captive agent channel with Life Planners and life consultants, as well as our third-party bancassurance and independent agency channels. In our Life Planner channels, our Life Planners also develop and expand their market through their own networking effort and referrals, including those that they get from their customers.
Their primary target is the high net worth market, as well as business insurance and professional market segment. The life consultant channels targets a wider mid-market clientele, and notably, it has a strong presence in affinity market, particularly with the teachers market. In our independent agency channel, we seek to grow through the active engagement of our marketing representatives, who teach sales skills and provide the training to agencies. In this channel, we have seen an increase in business insurance sales as well as individual insurance in the professional market. Finally, Prudential Gibraltar Financial and Life Insurance specialize in the bank channel. Through the bank, we are able to efficiently access high net worth customers and tap further into the risk protection need of customers. We have a differentiated strategy in the bank, as you will hear from more later this morning from Soeda-san. Next slide, please.
This slide shows the productivity of our Life Planners and their consultants as measured by the average policy sold per agent per month. As you can see, our proprietary distribution channels are very productive, and this is one of the key of our success. We believe the productivity of a captive agent will exceed industry average. Next slide, please. This slide shows the number of our Life Planners and life consultants that are member of Million Dollar Round Table, a special prestigious group that represents the top agent in the Japanese market as measured by sales level. This data is as of April 1st, 2016. Prudential Japan again achieved first place of MDRT membership and has now achieved this distinction for 19 consecutive years. Prudential Japan employs more than 40% of MDRT members than the next closest competitor, Sony Financial.
Gibraltar has also shown an increase in number of MDRT members, remaining third place in the ranking. Of significance, total number of MDRT members in Prudential Japan and Gibraltar account for about one third of total membership in Japan. Next, please. I'd like to touch on the advantage and challenges we see in our third-party channels, namely bank channel and independent agency channel. Through these channels, we are able to access new customers that our captive agent have not been able to access. This enable us to leverage Prudential's brand and financial strengths to the benefit of greater cross-section of Japanese customers. Further, by transferring the sales experience of Prudential to bank and independent agencies through training and the seconded Prudential Japan employees, we have been able to differentiate ourselves and build long-standing relationship with our third-party distribution partners.
There are, of course, some challenges in the bank and the independent agency channels. Notably, sales volume can be more volatile. This is particularly true for the bank channel, where the amount of sales can fluctuate more widely as a result of adjustment in premium rates and other changes. It can also be more affected by competitive factors such as the launching of new product. Obviously, we cannot control the factors in those channels to the same extent we are able with our captive agent channels, which contribute to this greater sales variety. We accept a level of fluctuation in our sales level as a result. However, our main focus is on product mix and making sure we are remaining appropriate level of profitability. As a consequence, we have seen us take numerous pricing and product action as the environment has evolved. Next slide, please.
In closing, I'd like to leave you with the following three points. We are adapting proactively to current market environment. We have adjusted product and pricing aggressively as interest rates have declined, and we have seen a shift in our sales mix to more foreign denominated product. We generate strong margins, and we believe that our strong margins are sustainable based on our differentiated business model and focus on sound risk management and asset liability management.
We continue to see growth opportunities through expanding distribution, leveraging product capabilities, and benefiting from our lifetime customer relationships. Thank you very much.
Okay. We're going to start our Am I on? Yeah. We're going to start our first Q&A session with Charlie and Kurashige-san. Just to remind everybody of the ground rules, please wait for the mic to ask your question. This is webcast. Please, and I beg you, keep your questions short and speak slowly and one at a time with a follow-up. We are going to try to not repeat all the questions, so that would be very helpful in that process. You also may want to have your headset on as for our Japanese speakers, their responses will likely be in Japanese and translated. With that, we can start the Q&A. The first hand I saw up was Thomas Gallagher.
Thank you. Tom Gallagher, Evercore ISI. The yen-based products that you are either repricing or suspending, which I assume are most of the whole life or retirement-oriented yen policies, can you comment on what % of sales or in-force premium this represents? Is this a bigger challenge for Gibraltar or POJ?
Yen products, in terms of the sales suspension of yen products, as to single yen, single pay yen products, we already suspended some of the sales. The recurring pay whole life or other products, we don't intend to suspend the sales. In terms of the share, I don't have the number at my hand right now to be able to answer, but that's the current situation.
If I can just add a couple of quick things. I think over 80% of our products are recurring premium. That'll give you at least some ballpark of some of the amount that we may have eliminated, because it's not all of the rest. Most of the rest of the product is single premium fixed annuities, but we reprice those every 2 weeks. Of the amount, it's probably 2% or 3%. It's not a lot, but it was the stuff that was unprofitable and wasn't meeting our hurdle rate, so we eliminated it. That gives you sort of rough justice, I think, where we are.
That's the product that was suspended to only 2% or 3%?
Yes.
We'll try and confirm that over the app.
The product, can you provide a little color on the repricing of the other products? Are you repricing both recurring premium yen products and single pay?
2017 April, standard reserve rate is likely to be updated. Because of that, right now standard reserve rate is 1%, but it's going to be lowered to 0.25%. We have to take action against that, and we have to optimize our pricing for yen products. We plan to do so. Having said that, do we really need to change pricing for all yen products or not? We are still in progress of planning, so we haven't decided the detail yet. The reserve, we have to accumulate based on the new rate, which means we have to optimize our pricing, so we have to take necessary action.
We'll move to Ryan Krueger, who is
Thanks. Ryan Krueger with KBW. Charlie, you mentioned mortality table changes as a potential risk. Can you comment on when the changes are expected to be implemented and if you would be required to reduce your prices? Lastly, if there's other offsets that you could take to offset that risk?
Yes. Mortality table change is currently under discussion with an actuary association. It has still being discussed. When and how much, those details happen to not be decided. Just like reserving rate, the mortality table, if that is changed, we will appropriately price our product. We'd like to take certain actions accordingly.
As a follow-up, I guess when new mortality tables have come out in the past, does the FSA actually require companies to adjust their pricing to reflect the new mortality tables? Are there things you can do to maintain the same level of mortality margins on new business?
Basically, FSA's policy is that reserving rates and standard mortality table are established, and based on that, reserve has to be accumulated. That is the rules by FSA. Regarding pricing, that is up to discretion of each company. In many cases, regarding the changes, many companies, I think, are responding to the changes accordingly. In the past, historically, when reserving rates changed, we sometimes didn't change our pricing for one year or so. Basically, afterwards, we basically tried to accommodate the pricing to the changing of the reserving rates.
The other with mortality tables is that there are a lot of factors that go into it. It's not as simple as, say, the changing of the reserve rate. There can be offsets. The good news is we have time to think about it. We have time to see what the new mortality tables are, and we'll have time to react to it in a different way. The other thing, let me just go back to, Tom, your question a little bit more, and that is the kind of changes that are being made. I think what you'll see in the other presentations from our Japan colleagues is that they have not been shy about making changes and making changes quickly to react to certain changes that have taken place in discount rates and other things.
You'll see not only the elimination of products, but you will see reduction in commissions or crediting rates increasing in premiums. There are a lot of tools in the toolbox or levers that they can use in order to protect the profitability. I think this team, frankly, is a role model for all our organizations here, around the world, and in the U.S. for being extraordinarily anticipatory about the changes they make in order to protect the margins. You'll see that in some of the presentations, the kinds of actions that have been taken.
Erik Bass.
Thank you. Erik Bass with Autonomous Research. You mentioned as one of the potential challenges increased competition in third-party channels. I was just hoping you could expand a little bit more on what you're seeing or what you think you may see there. Thank you.
Right. Third-party channel competition. Product need to be very attractive, product competition, and also commission, whether high or low. Commission competition are two things drawing attention a lot. However, when it comes to competition of commission, including bancassurance, we are asked to disclose the commission concerning fiduciary duty. We have to maintain a commission at the appropriate level. Just because commission is high, distributors should not recommend the product to the customer, not considering the customer's needs. That's the discussion here in Japan. I think commission competition will be a little bit alleviated because of this. Our strategy is basically totally different from those competition. We focus on the producer at third-party distributor and make sure they sell death protection products, life insurance products, appropriately to the customer considering the customer's benefit.
We solicit the benefit to the customer and make sure our customer is satisfied with the products and purchase the products. That is the process we take. I know there's a fierce competition out there, but we are not going in there. That is our strategy.
The other thing I might add is that if you look at our distribution model we compete based on service. You all may roll your eyes and say, "How can you do that?" It actually is the fundamental basis of this distribution model. We're very different than others in that, say, we have 60% are captive agents, the Life Planners and life consultants, and you can see how many MDRT members we have. You can see the quality of the distribution of those people and the way in which they interact with their clients. They're lifetime clients. You'll hear this from Ichitani-san. You'll hear it from others. It's a very different distribution model than many other companies here. In terms of the third party, the other 40%, we also compete on service. You'll hear about the seconded LPs in the bank channel.
You'll hear about how we have reduced the number of independent agents that we do business with by half in order to do business with the companies that appreciate the level of service that we provide. That level of service is a real differentiator. As a differentiator and a source of competitive advantage, enables us to sell product, especially as Kurashige-san, recurring premium death protection in a way that others don't. That's a real point of differentiation for us.
Thank you. If I could just follow up specifically for competition on dollar-denominated products, if the domestic competitors pivot towards offering those products, have you seen an increase in competition?
Right. Domestic players. I'm not sure if I should represent them and say something, dollar products are newly launched. I heard the rumors. Some companies are planning to do that. I think you know more than I do, actually. That may be the case, to sell dollar products, in reality, in the market, customer is going to take Forex risks. You need to be able to explain that, disclose the fact, make sure customer understand that and buy it. We, in Prudential program, we have a suitability program over the phone call. We confirm the customer, make sure there's no misunderstanding, and customer agree to take the Forex risks. That procedure takes a lot of effort. It's not easy thing to do. We already have experience over a few years, we already accumulated know-hows.
To make sure customer to understand the risk, disclose the risk, otherwise, it's very inappropriate to sell the products with the risk. New companies who's going to enter the market have to take and go through this sales process. I don't really know which company will introduce what products to the market.
The other point I would make is there are dollar products and there are dollar products, right? You can have much more simple dollar savings products, then you can have more complex dollar debt protection products. We focus, and this is a recurring theme you'll hear, on debt protection. That is not easy to sell. You overlay on top of that multi-currency debt protection, that's a really difficult sale. Therefore, you need very sophisticated people who have real knowledge and can provide the level of service in order to sell those products. Again, we think that that's a sustainable source of competitive advantage for us.
Erik Burke in the green shirt. Yep.
Thank you. Erik Burke from RBC. I'm actually going to ask a different question from the one that I was going to ask because of something you just said. Thank you. I just find it, and I'm hoping you'll go beyond saying it's a cultural thing. I just find it really surprising that Japanese nationals, say wealthy Japanese nationals, would be willing to take a chance on the value of the death benefit that their family's going to receive upon the policyholder's death based on foreign exchange risk. That's just what I want to say, and maybe you could respond to that. Why would a person who presumably is buying the coverage to know that his or her family will be okay after that person's death take a chance on the foreign exchange risk?
Hi.
Right. First, our approach on need-based sales is that we try to find out how much customers need of this protection. We first think about it, and maybe JPY 30 million is necessary for one particular customer. How it can be covered. For example, it can be a whole life product. With this current pricing, yen whole life and the dollar whole life, if you compare them, yen whole life tend to be more expensive for customer. For customers, payment capability may not be strong enough so that customer may prefer a dollar product or maybe variable insurance may be chosen possibly. Why even taking a FX risk the customer would like to purchase dollar insurance is because dollar whole life guaranteed interest rate is higher, premium tends to be lower. The customer can purchase a lower pricing death protection.
Death protection might fluctuate. Likewise, premium might fluctuate. That range of fluctuation should be acceptable range for the customer. That is what we focus on. I don't know if I answered to your question sufficiently, but the FX risk perspective, Japanese people accept that relatively. That is what we think. Customers, even there is a FX risk, customer accept it because they understand it. That's how they purchase the product. We further confirm their understanding on suitability program.
My one follow-up question relates to.
One sec.
Oh, sure.
Just two other quick comments. What Kurashige-san is saying is you can buy more death protection for the same amount of premium. You look at the variability of that in the FX, and if the downside is still acceptable, then they have upside. That's the first point. The second is that Japan consumers don't take a lot of investment risk, right? Most of their investments are either in fixed income or cash. You won't see them a lot in equities or other things. If you have a bucket of risk, if you will, and they want to spend that bucket here, they're not spending it anywhere else. It's not like they have half their portfolio in equities, which could go up and down and other things. This to them would be the one area where they might take a risk.
If you look at all their assets, this would be an acceptable level of risk.
My second question relates to your intended focus on the estate planning market or your interest in the estate planning market perspectively. My question is, in the U.S., of course, the estate planning business is tied up closely with taxes, in particular the estate tax, right? The inheritance tax. Briefly, is it similar here? Do you expect increases in the estate tax? My question, in other words, is what is the connection here between life insurance and estate taxes, and what is the outlook for the estate tax?
Inheritance tax rate increased about two years ago. The inheritance tax measures are based for the lots of financial institutions products, new products release. In Japan, the concept is how to use life insurance product. Inheritance is when the person dies, which happens only one time in your life. But the asset to transfer every year while you are still alive, you can give the estate by gifting to your children, then you can reduce the inheritance tax. For example, if you have $200 million of estate, every year, if you want to give that estate to two children by JPY 3 million, then that could be converted to the recurring premium of life insurance.
Of course, he or she has to pay like 10% of the tax, but every year, like $6 million in decrease, and that would be $60 million, and eventually $120 million in 20 years. It becomes $80 million. That would be like 30% of the tax. That's how the inheritance tax and gifting tax structure is structured. That's why we can apply a recurring premium life insurance. That's how the needs can be satisfied. What to be left to which child, if you have a lot of children, you might have a real estate property. Maybe you can give the real estate property to your son, and this claim can be given to the second son, for example. Through life insurance product, you can directly give your financial asset to your child. Otherwise, your house, your land has to be split.
That is another way to use life insurance. There are a lot of consultations around use of life insurance. That's how we try to plan based on the customer needs. With the use of life insurance, that is very important. Of course, with life insurance, there is a tax advantage as well. Including that, there are a lot of different cases that we can apply life insurance for the measure of inheritance tax. That is what currently we are doing.
Jimmy?
Thank you. You've grown your Japanese business partly through acquisitions and usually during times of distress. Obviously, low interest rates are creating some challenges, but not extremely severe yet either. What's your view of the environment for the type 2 deals that you tend to do here, and what's your appetite for additional deals in Japan, given that the business is becoming a bigger and bigger portion of your overall earnings?
The current situation is that it is creating some stress in obviously the Japanese market with Japanese companies, but not undue stress at this point. We don't see any obvious acquisition opportunities. To speak about opportunities, I think we're in a really good position. That they are nice to do. They're not a have to do. If something came up, we would look at it. Our view is that we have an extraordinary business here, and the last thing we'd want to do is to challenge that business in any meaningful way. If something came up that was a potential bolt-on, would we look at it? Sure. The proof of concept would be extraordinarily high. We really like the business we have here. We think it's extraordinarily well run, and we'd be very cautious about doing something.
Just since you're already here, but you're not discussing your Chilean business, obviously, there's been a lot of talk about pension reform in Chile and different proposals being thrown around. What's your view of if and what form pension reform in that country will take, and how does that affect Habitat?
A couple of comments. The first, let me comment on AFP Habitat itself. We really like the company. We like the management there. It is the second largest pension fund manager. It has the lowest fees of any company, which we think is a very good fact. It also has extraordinarily good investment performance. In terms of the kind of dynamics and metrics of the company itself, we feel very good about it and where it stacks up in relation to all the pension managers. The situation, as you say, I'll use a word euphemistically, is fluid at this point. We are monitoring it very carefully to see what the government response will be. I think the government inherently is very supportive of the existing structure, but there's obviously a populist movement to make some changes to it.
The thoughts that have been proffered by the government this time are kind of at this point or at the margin. It's something we are actively looking at, trying to help manage, et cetera, and we'll see what happens. Way too early to make any predictions at this point. We do think relative to the field, we're in a very good position in terms of having the lowest fees and some of the best performance, but more to come.
Thank you.
Okay, I think we're going to take our first break. We will break for 15 minutes. If you can be back then, that would be appreciated. Thank you. Section. Let me just go back to Thomas Gallagher's question, and the answer that Charlie Lowrey provided was correct. If you look at the single premium whole life JPY product in 2015, it represented about 3% of total sales. Okay, the next section is going to cover the three business units, and we will start with a presentation on Prudential of Japan by Ichitani-san.
Thank you and good morning. I am Shoichiro Ichitani, President and CEO of Prudential of Japan. I'd like to discuss our Life Planner model, which is the foundation for the overall business of Prudential International Businesses, the sustained track record of performance we have achieved at POJ, and our continuing growth opportunities. This graph shows the steady growth of our in-force business since POJ commenced sales in 1987 after its formation as a separate company following Prudential's initial entry to the Japanese life insurance market through a joint venture with Sony. Our core principle of providing life insurance solutions through needs-based selling by full-time professional Life Planners is a differentiated, superior approach in the Japanese market, and its appeal to customers, together with our execution, have supported steady growth of our in-force business over 28 years since we began business.
Our 20-year compound growth rate of 9% reflects our rapid growth from startup, driven by the success of our model. The sustained mid-single digit growth over the past 10 years, including through the financial crisis and the many challenges in the business environment, reflect the resilience of our model as we continue to adhere to the principles that drove our early success. This is our sales trend by product category. Our sales in 2012 reflected increased purchases of certain products due to tax law and pricing changes. While events such as these can have an impact on our sales pattern in the short term, our trend is largely driven over time by growth of our Life Planner force. Over the past five years, we achieved an 18% average annual compound growth rate in death protection products, including term life and whole life.
The contribution of these products to our overall sales has increased, while the share of retirement business has declined, reflecting our adaptation as declining interest rates made it more challenging to provide attractive value propositions for customers in products with greater cash accumulation features. We add the key drivers you see here as measures of the underlying success of our distribution model. Our Life Planner count has consistently increased at a moderate pace, reflecting our highly selective recruiting and superior agent retention. Productivity measured in terms of both annualized premiums per policy sold and number of policies sold per Life Planner per month has been sustained at levels that are well above what we would consider typical in the market, reflecting the quality of our agents. This graph shows the growth of our insurance revenues, including premiums, policy charges, and fees on a constant dollar basis.
Revenues have increased consistently along with the growth of our in-force business, reflecting both our sold sales results and superior persistency, driven by customer satisfaction achieved through our needs-based selling approach, and the ongoing service support of our Life Planners. This is an illustration of what we call the beneficial cycle of our Life Planner model, which drives the strong key indicators of success that I discussed. The high-quality service our customers receive from our Life Planners, which start with a comprehensive evaluation of life insurance needs, leading to an appropriate product solution, and support by a highly skilled professional advisor, produces a high level of customer satisfaction. This drives strong policy persistency and quality referrals to our Life Planners, reinforcing their high productivity and income levels.
This, in turn, drives a high level of agent retention, and agents who stay with our company for long careers can support the financial security needs of their customers over a lifetime. With our diverse portfolio of quality products, the outcome is our sustained track record of superior returns and steady growth. Our high level of customer satisfaction has been externally validated by superior rankings in surveys by J.D. Power. In these surveys, the customer satisfaction level was assessed by categories covering acquiring a policy claims handling and policy service, and Prudential of Japan has consistently ranked at or near the top in each of these categories. Here are some key drivers of our ongoing growth opportunities.
These include continued growth in our LifePlan account, the prospect of second sales to the customers we serve over a lifetime, retirement and estate planning needs of an increasing older population, and the experience and skills of our Life Planners in offering U.S. dollar products, emphasizing recalling premiums, for which demand has increased in the current Japanese interest rate environment. This is an illustration of the changing needs we serve over a customer's life cycle, and in the markets that are the main focuses of POJ. You can see, needs for financial products grow over time, and the types of products that fit these needs change. Our Life Planners draw on their training and experience to propose solutions tailored to the different needs of each client, and our comprehensive product portfolio can meet a broad spectrum of these needs.
This slide shows how we have benefited from the second sale opportunities that arises as a result of long tenured Life Planners maintaining relationships with their clients as trusted advisors over a lifetime. Nearly 800 of our Life Planners have more than 15 years of experience with us, and their client relationships average more than 10 years. These relationships bolster our future growth prospects as the experienced Life Planners serve the increasingly sophisticated needs of their clients, especially our core customers who are in their 30s-50s as they move toward retirement and begin to consider estate planning needs. This chart shows the sensitivity of growth of our in-force business at various levels of sales. With our high policy persistency, we would project that a continuation of our 2015 sales level over 5 years would produce an 18% total increase in in-force business by year end 2012.
Sorry, 2020. With that level of sales, more than offsetting expected runoff from lapse, surrender, and mortality. Assuming continuation of the strong persistency we have enjoyed for many years, we would project a flat in-force looking 5 years forward in a stress scenario With annual sales over the period 36% below the level of 2015. We are well-positioned to meet the challenges of the current environment and are actively managing our product portfolio to maintain appropriate return expectations with low and negative JPY interest rate. I discussed, the core focus of our business model is on recurring premium death protection products, with returns mainly driven by solid mortality and expense margin. We've increased our emphasis on U.S. dollar products while taking actions on JPY products, where returns would be compromised by the declines interest rate.
In addition, our strong asset liability management reduces our exposure to reinvesting at lower yields. Scott Sleyster will cover this in detail later today. In summary, our proven Life Planner model has driven an industry-leading level of customer satisfaction, superior sales productivity, benefiting from referrals by satisfied customers, and strong agent retention as our Life Planners are rewarded for their high-quality performance. We will continue to pursue steady growth of our Life Planner force over time through the selective recruiting that is a key element of our model. We are actively managing through the current market environment as we have through a variety of financial market developments over our history, with effective product and asset liability management strategies mitigating our exposure to low interest rates. We remain confident in our prospects for continued superior returns and steady growth. Thank you very much.
Okay. Our next speaker will be Yamauchi-san to talk about our Gibraltar Life business, which includes our life consultant and independent agency channels.
Good morning, and thank you for participating in our Investor Day 2016. I'm Kazuhiro Yamauchi, President and CEO of Gibraltar Life. I joined Gibraltar Life in 2007 and became its president in April of this year. During my nine years with the company, I have seen it meet many challenges and achieve substantial growth. Today, I would like to share some key aspects of our business model and strategies that we believe position us for continued growth and solid returns. Today's Gibraltar Life is a product of a series of successful business acquisitions and integrations, with the common theme of consolidating under Prudential's proven business principles to build a stable foundation for solid returns and growth prospects.
Following the integration of the Star and Edison businesses after our acquisition in 2011, we have stabilized the agent count and achieved a more cost-effective captivity distribution system, and the life consultant force is now positioned for organic growth. We benefit from a long-standing distribution relationship with the Japan Teachers Union, which is called Nikkyoko. We have complemented our life consultant distribution with an independent agency channel commencing in 2009. Focusing on protection products consists with our business model. We have achieved solid returns results through challenging financial market conditions. Our focus on death protection products, strength in US dollar and other non-yen products, and strong asset liability management help mitigate our exposure to low and negative interest rates in Japan. In addition, we are actively managing our product portfolio to maintain appropriate expected returns.
This is a view of the acquired companies that were integrated to comprise today's Gibraltar Life, which began with Prudential's acquisition of Kyoei Life in 2001, following its bankruptcy. The restructuring of Kyoei left us with a large block of in-force business with very attractive returns. We built upon this business by leveraging many of the principles of our successful Life Planner business at Prudential of Japan. With this solid foundation, we acquired and integrated Star and Edison and another company called Yamato Life Insurance, leading to a structure with broad coverage of the Japanese market through our life consultant captive agents, independent agents and the bank channel through our PGFL subsidiary. Soeda-san, who heads PGFL, will discuss the bank channel. The life consultant and independent agency channels each follow our basic strategy focused on death protection products with face-to-face selling based on customer needs.
In both channels, choosing the right people is a key to success. For life consultant, we focus on selection and training of quality agents. For agency channel, it is vital to form relationships with quality partners and cultivate marketing and sales representatives to work effectively with the producers. These channels complement each other by focusing on different customer segments. The life consultant focus on middle-class clients and teachers across the nation, giving us a broad geographic reach across Japan's prefectures, whilst agency channel mainly focus on upper middle-class customers in urban market, as well as the business and professional market. This slide shows the relative contribution of the life consultant and agency channel to Gibraltar Life sales and policies in force, excluding the bank channel. The agency channel contributed 27% of 2015 sales, a meaningful complement to the sales of our life consultants.
The life consultant channel accounts for 94% of policies in force, reflecting the vast majority of business that came to us through acquisitions as well as the channel's sales contribution. I will discuss each of the channels in the subsequent slides. Starting with the life consultant channel. You can see a large increase in the count for 2011 when we acquired Star and Edison, followed by a decline, which we expected as we integrated the businesses adapting Prudential's productivity and quality standards, value of compensation, and emphasis on death protection products. After the integration, you can see the stabilization and modest increase in the count in 2015. We have returned productivity to pre-acquisition levels. This was the same pattern we experienced in the early 2000s when we transitioned the former Kyoei agents to Prudential's model.
We will pursue further growth at a measured pace as we appoint additional experienced life consultants to field management positions to support our selective recruiting with an emphasis on quality. This slide shows the broad geographical coverage of the life consultant channel, providing access to our major customer segments across the nations, including teachers, members of Self-Defense Force, and general customers in both urban and less densely populated areas. We cover all of Japan's prefectures with 83 branches and nearly 740 sales offices, enabling us not only to enjoy broad sales reach, but also to provide high-quality service for our policyholders. The teachers market accounted for 27 of our life consultant sales in 2015. We offer exclusive products for this highly attractive market, appealing to new teachers entering their careers, experienced teachers with changing insurance needs, and retiring teachers with products appropriate for each career phase.
Let me provide some additional detail on the Teachers Association market. Our relationship with the Teachers Association in Japan dates back to 1952 when it was established by the former Kyoei Life. We gained direct access to public school teachers and support employees through this organization under a relationship of trust built over more than 60 years. This is a large-scale market providing access to about 35,000 schools with roughly 950,000 teachers, which we serve through approximately 5,000 Life Planners. This market is important to us not just for its size, but also for the perennial sales opportunities that arise from new teachers entering their career each year and annual mandatory teacher retirement. Moving to our independent agency channel. Independent agency distribution is highly competitive, with many companies seeking sales through agencies based on products and commissions. Gibraltar Life, however, has approached this channel with a clearly differentiated strategy.
This strategy includes pursuing quality long-term relationships rather than just augmenting policy sales, avoiding price competition as a key to winning sales, and building strong partnerships with agencies who resonate with Prudential's approach. Agency distribution is based on partnership, and we cultivate high-quality business-to-business relationships rather than attracting and retaining agencies through commissions levels. We provide solid support through highly skilled trained marketing representatives. As you can see in the chart, we have grown the number of these representatives and now support a monthly average of about 1,500 active producers. We see the agency channel as a growth opportunity, and we expect to continue to increase our complement of marketing and sales representatives while cultivating additional agency partners. This slide presents sales trends for our Life Planner and independent agency channel.
For the Life Planner, you can see the jump in sales when we acquired Star and Edison in 2011, and the decline as we integrated the businesses, including implementation of Prudential's distribution model. As we expected, attrition of mainly lower producers had a negative impact on sales. With the count now stabilized and productivity returns to pre-acquisition level, we are back on the path to sales growth for the channel. Sales for the agency channel first became significant with the relationship that came to us in 2011 through the Star and Edison acquisition, and both in that year and 2012 reflected elevated demand for certain products by business customers in advance of tax law change. After those years, you can see modest growth reflecting our development of the channel. As you see here, each of the channels emphasize death protection products.
The fixed annuities are mainly U.S. dollar products with market value adjustments in event of premature surrender. This chart shows the sensitivity of our in-force business at various level of sales. Since Gibraltar Life was built on a foundation of large acquired blocks of business, there is substantial expected annual business run-off. If sales were to continue to over five years at the same level as 2015 and always held constant, we would project that this would more than offset expected attrition and produce a 4% total increase in our business in-force. With a similar assumption of unchanged lapse rates and other factors, we would project a flat in-force looking five years forward in a stress scenario with annual sales 7% below the 2015 level. Here is some key productivity data.
For life consultant, we have stabilized the count. As I mentioned, productivity in terms of the both annualized premium per sale and policies sold per agent per month has increased since our successful completion of the integration of Star and Edison. For the agency channel, an initial decrease in agency count as we focus on relationships with partners who we identified as a best fit for our strategy as part of the business integration, followed by modest growth. To summarize, Gibraltar Life has built a solid earning base through successful acquisition and business integrations. We have applied key principles of Prudential's business model to grow a strong sales and marketing organization, emphasizing death protection products. Our life consultant and agency channels provide broad national coverage of the Japanese life insurance market to meet protection needs.
With our diversified product portfolio, emphasis on products driven by mortality margins, and solid asset liability management, we are well-positioned to generate strong earnings, even under the challenging current environment. In the 15 years since Gibraltar started operation as a Prudential company, and almost five years since the merger that formed our current structure, we have built a strong foundation to generate stable earnings and growth. I will continue to make every effort to make the foundation stronger and bigger. Thank you for listening
The next presentation will be on the bank channel. Soeda-san will give his presentation in Japanese, so if you could please put your headset on if it's not on already.
Thank you, and good morning. I am Takeshi Soeda, President and CEO of Prudential Gibraltar Financial Life or PGFL. I will discuss Prudential's highly differentiated strategy in a bancassurance market in Japan. During the 12 years since we entered bancassurance, we have consistently grown a stable business on a solid foundation focused on death protection products through a changing business environment, including the financial crisis and declining interest rates. Next slide, please. The bancassurance market in Japan, similar to Europe and other parts of the world, is mainly focused on saving-type products. In contrast, we conduct a business model that is differentiated from other companies in this market by pursuing high-quality business with emphasis on these protection products that provide solid mortality delivery margins. What differentiates our business? There are four main points. First is our core business strategy, emphasizing death protection products and recording premium policies in particular.
This foundation of our business model supports achievement of stable results that are resilient to changes in the financial environment. Second, we provide high-quality sales support through former Life Planners who are seconded to certain of our partner banks and through highly skilled wholesalers. This support is key to our focus on death protection products, which are more difficult to sell than saving-type products. The third point is that our insurance product portfolio features non-JPY products, mainly U.S. dollar denominated, which are highly attractive to bank customers with substantial deposit funds. The fourth point is our active product management. We seek to maintain appropriate expected returns by responding to changes in the financial environment by adapting our product portfolio, including ongoing review of pricing and commissions, and suspensions of sales where necessary. Next, please. Here is a view of the customer pool that can be accessed through bancassurance in Japan.
With our aging society, those who are age 50 or over comprise 46% of the population, and this senior population owns 85% of total household financial assets. This is very distinctive to Japan. This senior population represents the main customers of our partner banks for their financial deposit products. Our sales channel can effectively approach these customers through the banks. Currently, a large volume of variable annuities and similar products sold several years ago are reaching maturity, and at the same time, the banks hold trillions of dollars of term deposit together creating a substantial opportunity for sales of insurance products. Direct access to this opportunity is one of the strengths of our banks channel. Next, please. This slide shows the number of our partner financial institutions.
We have established partnerships with all of the mega banks in Japan, several leading trust banks, many regional banks, and the largest securities company. With 75 distribution partners, we have a leading foundation in bancassurance. The branch network of these financial institutions covers a wide area across Japan, giving us broad national access to a highly attractive customer pool. Next, please. We offer a comprehensive product lineup through our 75 partner financial institutions, mainly consisting of protection products such as whole life insurance. With a broader product portfolio than other companies engaged in bancassurance in Japan. Next, please. This slide shows the relative contributions to our sales by product type for the year 2015 and the first half of 2016. In 2015, non-JPY products contributed 69% of our sales. The percentage contribution of these products, which are mainly U.S. dollar denominated, grew to 78% for the first half of 2016.
With emerging negative interest rates on Japanese government bonds, we suspended sales of single premium JPY-denominated products, leading to a decline in the overall contribution of JPY-based products to our sales. However, at the same time, we grew our sales of non-JPY products, primarily U.S. dollar denominated business, and achieved a 12% increase in sales for the first half of 2016 on a constant currency basis. Reform of the inheritance tax system, effective in January 2015, enhanced our bancassurance opportunity. Life insurance can serve as an effective solution for inheritance planning and lifetime gifting. The confidence customers place in banks for consultation in these areas enhances the value of the banks to us as distribution partners. That's something I'd like to cover now.
Since regulatory changes made sales of all insurance products through banks possible commencing in 2007, we have actively developed sales of protection life insurance products by leveraging credentials, product, and marketing expertise. With our focused development of a skilled sales resource over the past eight years, we now have about 130 wholesalers providing sales support to banks. We also have 240 of what we call insurance consultants, or so-called IC, who are former Life Planners that we have seconded to banks to directly sell life insurance products at bank branches, and also to train bank employees so that they are able to sell our products on their own. We have enhanced this program through rotation between IC and wholesalers, and we now have many skilled professionals in the banks who can both train and sell. This is a strong competitive advantage for us. Please go to the next slide.
Let me expand on the insurance consultant IC secondment model. Under this model, former Life Planners apply their experience and expertise in selling life insurance products directly within the banks, resulting in two major benefits for our bank distribution partners. First, the banks can realize significant life insurance sales at early stage of the relationship with us as the insurance consultants sell directly to the customers. Second, the banks can leverage skills of these professionals through their training of employees at the branches to sell protection products on their own. The growth in the numbers of insurance consultants shown in the chart reflects the support for this approach in leading banks, reinforced by its success. Next slide, please. This slide shows our sales trend. Over the past five years, we achieved a 14% average annual compound growth rate in sales of the debt protection products we emphasize.
Sales of other products are more opportunistic and therefore vary over the time. Next slide, please. Even in the challenging current environment, we can achieve stable result and appropriate expected returns through active product management. For example, in response to declining and negative yen interest rates, we suspended sales of yen-denominated single premium products early this year, as I mentioned earlier. In addition, in June 2016, we reduced the discount rate for advanced payments on yen-denominated recurring premium products and suspended acceptance of full year advanced premiums on our yen-based increasing whole life products. We'll continue to actively manage our product portfolio considering interest rate trends and to emphasize sales of U.S. dollar denominated products. Next one is my last slide. In closing, let me summarize the strength of the bank channel.
First, in Japan, the majority of household financial assets rest with the senior population, which we can effectively address through our partner banks. Second, we've leveraged Prudential's sales expertise for protection products to develop a solid competitive advantage for the bank channel over the past eight years. Third, we focus on sales of recurring premium protection products with earnings driven by solid mortality margin, emphasizing U.S. dollar products as a core element of our strategy. Fourth, the growth of intergenerational wealth transfer in Japan, coupled with the reform of inheritance tax system, has enhanced our opportunity in the bank channel. Finally, our ongoing active product management supports our achievement of stable results and maintenance of appropriate expected returns through the challenges of a changing financial environment, including today's low interest rate.
By building on the strength on our differentiated strategy in the bank channel, we have solid prospects for continued growth of high-quality business focused on death protection products. Thank you for your attention.
Thank you, sir. Okay. We're going to start our second Q&A session. Before we open the mics to the audience, I did receive a question at the break, related to the prior session. Let's tackle that one first. The question related to specifically, what are margins on JPY and non-JPY products, and how do they compare? We don't give product-by-product margins, of course, but I thought maybe Kurashige-san and potentially Charlie will want to have some comments on this before we get started with the second Q&A.
JPY and non-JPY product margin. JPY products include whole life or term insurance varies. As a growth wise, it's difficult to express about margin. Investment spread. About investment spread, it would be better or higher with non-JPY. JPY, we can get mortality margin with JPY. Overall, margin perspective, we are comfortable with our current margin level.
If I may add a couple of comments to what Kurashige-san said. I think it would sort of stretch the realm of credibility to say that our margins on our JPY products haven't gone down. They have a little bit. I think there are a fair number of mitigants in place. One is the speed and severity of the kind of changes that our Japanese colleagues have made to many of the products. The second is obviously the kind of products we sell, right? Again, over 80% of what we sell is recurring premium, and death protection. There is, just by nature of the kind of product we sell, there's a certain mitigation to the effect of interest rates, because as Kurashige-san said, we're not as dependent upon spread.
Having said that, the returns have gone down somewhat, but, I think the mitigation of some of these other actions are very powerful and have really limited the damage that could be done.
Great. Okay. Yaron in the middle.
Thank you. Yaron Kinar with Deutsche Bank. My question pertains to the Life Planner business. As I understand it, there's aging in the Japanese population, there's an increased demand for more sophisticated products as one ages. Why aren't we seeing an improvement in productivity as that trend continues?
Aging society, and you're talking about our productivity against that sort of aging society, productivity is not going up. Is that your question? Basically, POJ is focused on death protection products, so-called need-based sales of death protection products. Recent growth, we hire a lot of young Life Planners, especially those in 20s and 30s. There are lots of unserved demand of death protection. We are mainly focused on those young family to meet their death protection needs, and we're still doing that. Gradually, those Life Planners also accumulate their experience, then they will shift to more aged customers. In the future, we have lots of room to grow in those senior segment of the market. POJ, since the commencement of business, it's about 30 years or so. Captive agent recruiting, we hire around 30 years old people.
We started 30 years ago, around 30-year-old people, and now they are hitting 60 years old after 30 years. People in their 30s served their own generation customers at the beginning. They called their so-called X market, Y market, which is their acquaintance market or family markets. They are about same age with the Life Planner. Their customer also grew together with Life Planners, and they're hitting around 60 years old, which is a little bit different from Japanese demographic as a society as a whole. We'll see more senior customers going forward. Right now, we don't have that many senior customers. That's because our demographic of Life Planner is different from the Japan's demographic.
If I can add one other comment, and that is, six policies per month is an extraordinary number. If you look at the average policies, I think, for all of Japan agents, it's about 1.8 to 2. You have 1.8 to 2, you have Gibraltar at 3 to 4, you have POJ at 6 plus. They redline at some point. You can't do more than that. The fact that there is a tremendous opportunity, they're producing at 6 plus policies per month. They're kind of maxing out there. You might be able to do a few more in a certain month, but in general, that's extraordinarily productive. That's why I think Ichitani-san is focused on adding to the Life Planner count because there is more opportunity there. Just human beings can only do so much. They have to actually sleep.
It's pretty impressive that they're able to continue at that level of productivity for that long, which is why you see how many MDRT members there are.
My follow-up would be, assuming that the 6 product sales per month continue, should one over time expect the premium level for that average sale grow? The youth customer is addressed by young Life Planner versus older Life Planner with older customer relationship, and the product nature also changes. One Life Planner amount of the premium they sell becomes bigger according to the different customer they sell. We don't really plan by the company, but customer environment changes, and age changes, then volume of premium is likely to increase. We can imagine that.
Okay, two rows behind Yaron .
Humphrey Lee from Dowling & Partners. I think from the POJ comments earlier, you talked about second sales. I guess, maybe can you give us some statistics in terms of customer penetration, maybe number of policies per customer, and how does that compare to the industry?
The second sales volume-wise, as Kurashige explained earlier, the young LPs are getting older little by little. They have started to address that in particular. One protection per household, but after that, there are children. When the children gets older, maybe you can sell additional products to the household. That story is ongoing. I don't have a specific number, but compared to other companies, the expansion of account should be realized by our need-based sales. We are observing that trend currently.
Shifting gear a little bit. I think two years ago, you guys talked about the change in inheritance tax and how that create potential opportunities for more life-related sales. Looking at kind of the past two years in terms of death protection sales, do you have a mix in terms of pure death protection driven sales versus inheritance tax or tax planning type sales in your sales mix?
Right. People in 20s or 30s need death protection for their life. They purchase death protection in that segment of customers. After that, 10 years later, 20 years later, the customers become 40s or 50s in age. As a second opportunity, in past two years in particular, Life Planners started to talk about inheritance needs. Additional sales in terms of that, customers in 40s or 50s are buying more the insurance for the inheritance needs. Initial pure death protection sales compared to the pure death protection volume, it is not that significant yet. We are trying to enhance that direction.
Soeda-san, do you want to address that as well?
Right. Life insurance, in case of death protection, there is the protection of death or also the retirement saving or nursing care needs or estate planning. There are many way to use. There's a multiple purpose you can serve with the policy. It's really hard to draw a line, this product goes with this purpose. Just before break of the first session, we talked a little bit about estate planning, and we can do the gift. You shrink. You do the gift so that you can shrink the inheritance assets itself. That sort of solution seems to be active in our product. If you look at the policy, customers using our policy to do that sort of solution.
Thomas Gallagher.
Thanks. Tom Gallagher. Question on page 12 in the POJ slide. You show the in-force sensitivity to sales being down zero to 50%. I get the punchline here is to highlight the benefits of high persistency. Is the other point that we should be taking away from this that you expect the sales environment to be challenged? Can you comment at all about what we should be reading into this slide?
I will just start off and say you shouldn't read anything into this, to address your question specifically. It is purely a sensitivity that shows some numbers. If you wanted some additional numbers, if you increase sales 10%, the in-force increase would be roughly 23% at that same timeframe. If you increase sales 20%, it would be 28%. You shouldn't read anything into it, but I'll let others comment.
Listen.
Right. POJ, over many years, we have grow our in-force. I know you mentioned it's a very challenging environment. Even in a challenging environment, just like how I used to be, we're still generating the same numbers, and we can grow the in-force. If we continue to sell the same level, then we can increase our in-force. This data just explain that.
I think your initial impression was right. The point of the slide was to emphasize the power of persistency. Our high level of persistency enables the in-force to grow even without sales. It's purely a sensitivity.
I think that's Mike Levy that time.
It is. Just quickly, maybe you touched on this a little bit. It seems like all the domestic companies are focusing on the same non-yen-denominated products that you guys have been doing for quite some time. Does that represent increased competition if the larger legacy mutual or non-mutual life insurers in Japan are sort of getting into what historically has been your turf?
Toshiko.
As I said earlier, the non-yen product, we don't know whether there will be strong non-yen products. We don't know yet. Regarding the hard work to sell products would be a difficulty. It requires good education to Life Planner to be able to sell non-yen products. The sales skills, education-wise, we are much more advantageous. We are confident because some Japanese companies also sold a single premium non-yen product before in the past, but single premium and recurring premium product to satisfy protection needs. That perspective, we have already advantages. That is not something that other companies can easily copy.
Right there in the middle.
Michael Kovac, Goldman Sachs. Can you discuss, just sort of across the board, some of the shifts that you're potentially making to commission structures across the different products and distribution channels to facilitate some of your sales goals?
Should we just go down the line?
Okay. You.
I'm not quite sure which pages or which presentation you're referring to. We are planning to change pricing. Once we change pricing, then we have to change our commission, and it happened in before, too. When we change commission, then that's going to affect the compensation of our agent. We have to be very prudent. On the other hand, bancassurance. Commission disclosure is required from October in the major banks. If the insurance product is sold from major banks, then that's going to be disclosed from October. I heard that the way of paying commission will be changed. In October, you will get information from the market, I think, how commission is paid by different insurers.
Erik.
Thanks very much, Mark. All over the world, life insurers and asset managers and others who manage the public's money are talking about income solutions. Lots of people besides Prudential. I guess my question is: how does that work in the sense that interest rates are extremely low everywhere? To be sure, they're lower here than in North America, but there's no magic here. Everyone's looking at the same fixed income market. How do you give income to people when interest rates are essentially extremely low everywhere?
Just what we do here with perhaps retirement income?
How to manage. I think how we manage, I think that is your question. Basically, regarding asset, we match the asset to liability duration, which is ALM strategy. We have a parent company, we learn investment knowhow from the parent company. I wonder if I'm answering to the question.
As you said, there's no magic bullet, right? You can't promise that which you can't deliver. Scott will go into, I think, more detail about our, as Kurashige-san said, our ALM strategy and what we do with alternative investments in order to boost yield in Japan. I think we have a distinct competitive advantage with our investment management division and some of the products that they invest in, like mortgages and private placements and whatnot, which can augment the interest rate that one would otherwise get from just investing in either corporate bonds or governments. That's at the margin. We have looked at the crediting rates. We have lowered crediting rates. There is no magic bullet, and I think we have, again, we have the capabilities to augment what people could otherwise get in the market, but that's all.
It's a tough environment, and there is no magic bullet.
It could be a little bit different from what you asked, but as long as you sell death protection and death protection products, it's not mainly focused on interest gain. It's more on selling protection, and we can enjoy mortality gain and expense gain. We can enjoy those gains. That's the primary focus. It's not just focused on investment area. It's quite different profit structure, and Prudential group is enjoying very solid mortality and expense margin. We have a very thick portion of profits coming from them. Our fundamental profit are insured from selling death protection. I'm not directly answering your question, maybe, but that's how we are.
Okay. We will take a 15-minute break.
What you really need is a little different. I actually love that. Oh, yeah. All right. You know what we're going to do? We're going to do something. We're going to reorganize a little bit.
Yeah. Just what can I do to help?
Let me just move this way a little bit. This over here.
All right. Clearing the decks.
It's funny. There are no quarters on these.
Yeah.
All right. If we can start to find our seats, please.
There you go. They actually listened to you.
Every now and then. All right. We are in the final set of presentations. We are going to start with a presentation on investments and asset liability management in Japan. The presenter is Scott Sleyster, our Chief Investment Officer. Scott, you may begin.
Thanks, Mark. I'm sorry I could not be with you in person today. Why don't I start on my second slide, labeled Meeting Investment Challenges in Japanese Macro Environment? Let me start with what our experience has been in investing assets to support insurance liabilities in Japan over the past 30 years. In both Charlie's presentation and again in Rob's, which will be following mine, we have a chart which shows long-term Japan interest rates for the 10-year JGB. If you look at Rob's carefully, you'll see that the first time it dipped under 1% was all the way back in 1998. I point that out to simply say that we've been dealing with low rates in Japan for most of our operating history.
Thus, low rates have informed our product mix, and therefore, we've largely developed products that primarily generate their returns from actuarial and administrative margins and require little to no investment margin to achieve the attractive returns that you saw in Charlie, Kurashige-san, and the other business executives' presentations. That being said, I don't want to imply that negative rates out to 10 years are not a headwind. They are. Rob will be providing some sensitivity analysis based on sustained low rates in his presentation. However, the effects of low rates have been significantly moderated by our strong asset liability management discipline, which has strongly influenced both our product offerings as well as our portfolio construction.
Lastly, I would note that there are limited opportunities to invest in attractively priced, long-dated yen-denominated credit instruments. This has resulted in leaving us with a very high-quality portfolio and potentially some flexibility to take credit risk if the market offers it down the road. Also, to the extent that sales continue to shift to US dollar products, our opportunities to take advantage of credit market opportunities in the U.S. market and the European credit market will only increase. We are very well positioned to do that through the strong credit management capabilities that exist within PGIM, Prudential's asset management business. In the pages that follow, I plan to focus on a number of capabilities that position us well to manage through the low rate environment and should allow us to continue to manufacture attractive and profitable insurance products for our Japanese customers.
Those include a very strong ALM discipline, a modest amount of reinvestment risk from our existing block of business, a very high-quality portfolio with the flexibility to take advantage of future market opportunities, a product mix shift that favors the strengths of our internal asset management businesses. With that, why don't I switch over to the next slide, please? Prudential has a globally consistent asset liability management approach, and it is very much what I would call a strong form liability driven discipline. The chief investment officer, the ALM organization in Prudential, is separate and distinct from our investment department. Prudential's former investment department, if you will, is PGIM, and it's an asset management business. The work that my department does in asset liability management views PGIM as a customer.
Therefore, my staff spends the majority of their time with the product businesses, with the actuaries, with the product development people and the finance people, to make sure that the assumptions that they're using on new products that are being developed can be achieved in the market, and so that we really understand the liability characteristics of the existing block so that we manage it very well. In that process, we basically look at legal entities. Within legal entities, we look at the currency buckets of the products, and then within the currency buckets, we look at the individual product characteristics, and we call those investment segments. What our portfolio managers do is look at the characteristics of those individual segments under a series of market paths, if you will, and we come up with what we replicate to be the expected liability characteristics over time.
The job of the portfolio manager then isn't to manage a total return portfolio, but it's to hedge that liability with specific instruments that will manage the risk out of that, and in fact, will protect the margin that we priced into the product. We have a well-matched portfolio then against those portfolios so that we'll take each of those replicated portfolios, we'll look at the key rate durations, and then we'll buy assets that line up against those key rate durations. We do that, in essence, out the entire investable curve, which is, of course, 30 years in the U.S., and at times, goes out to 40 years in Japan.
As it relates to our asset liability management positioning in Japan, particularly for the POJ type, the protection and long-dated products, we have very long duration liabilities, and therefore, we hold very long duration assets against them. We have tight key rate duration targets and tolerances that keep our portfolios in line with those liabilities. We manage our interest rate positions by currency. While we don't always go out to 40 years because we find the market isn't as liquid, we're very tightly matched out to 30 years and, in fact, have a fair amount of 40-year positions in Japan. Can we go to the next page, please? On this slide, I would like to direct your attention to the right side or the reserves of $138 billion. 70% of the existing block of reserves, the $96 billion, relates to Japanese yen related products.
The balance, $32 billion in U.S. and $10 billion in other, complete the total. The other $10 billion is essentially all Australian dollar reserves. As Charlie noted earlier in the presentations today, less than 50% of our sales were in yen year to date, this portfolio mix or this reserve mix that's 70% today will be increasingly dollar and Australian dollar based with the passage of time. Shifting over to the other pie chart on the left, you'll see that we have about $167 billion of invested assets against those reserves. First of all, you'll notice that the pie is largely proportional, showing that we are buying assets to hedge those reserves in local currencies.
You will see that we hold some additional US dollar assets of $50 billion versus the 32 in reserves, and that's because of an intent on Prudential to want to have some of its excess surplus in US dollars because we're a US dollar denominated company, and Rob Falzon will talk to that in his presentation a bit. Essentially, $14 billion represented by the bright part of the pie chart, whereas the $36 billion is against the reserves. Let's go to the next slide, please. On this slide, we're actually taking a drill down looking at the assets or the investments supporting the yen liability portfolio. Why don't I start with the top line, which is Prudential of Japan and our LP model. There you see we have $33.2 billion in assets.
If you go over to the middle column there, you'll see that we only have $500 million running off against that in any given year. Not only that, if you look at the line below that where we have $28.1 billion in assets, you see we literally are only going to have about $100 million of runoff against that portfolio per year over the next three years. That's a runoff rate for POJ that's about 1.5%, and that really is the benefit of our ALM discipline. We have long-duration products, therefore we've constructed a very long-duration portfolio. The fact that we're getting a 2.5% yield on that block of business in the Japanese market lets you know that we bought those assets along the way when we were selling products and yields were higher, and that's a very long-duration portfolio.
It greatly mitigates the runoff and the reinvestment risk against the existing block of business. If you look at Gibraltar Life below that, I think you'll find that it's similar. That is a much larger block of business at almost $64 billion. In a similar manner, it has about a 2.4% weighted average book yield, and the runoff is a little greater because some of those products are, in fact, shorter in Gibraltar, and the runoff rate there is about 3%. Next slide, please. I thought I would do the same thing for the US dollar liability portfolio of just over $32 billion. I think the first thing I'd like to do is direct you over to the weighted average yield column on the right. You would note that in POJ, that portfolio is yielding 5.3%, and in Gibraltar Life, it's yielding 4.2%.
What that really highlights is the fact that by investing in US dollar and Australian dollar products, we can take advantage of our investment capabilities in PGIM. We can put in higher-yielding assets simply from being in higher-yielding markets. We can also benefit from PGIM's capabilities in commercial mortgages and private corporate loans, where we pick up additional spread. That then allows us to offer much more attractive yields within those products, which I think kind of goes back to one of the comments earlier about the value of the insurance being greater in these dollar products. The runoff, of course, is a little bit faster in the US dollar portfolio since many of these products are a little bit shorter.
Because of our strong ALM discipline and the duration that we have, it's only 4.4% for the POJ products and 6.1% for the Gibraltar Life products. Next slide, please. I wanted to speak to how we invest the $50 billion of U.S. dollar assets in some additional detail. Let me talk about the light blue segments, if you will, that relate to the $32.5 billion that are directly supporting U.S. dollar liabilities. The first point I would like to make is that about $10.4 billion of that total or a third of that total relates to single premium products in which we're not going to have additional deposits, that takes away reinvestment-type issues. For the other $22 billion, we do have some recurring premium risk.
That takes me to the gray and the very dark blue segments of the pie, which is the additional assets that total $17.2 billion. $12.7 billion of that relates to our JPY equity hedge program that I spoke to earlier. That does leave $4.5 billion in which we're buying U.S. dollar assets that we have hedged into JPY through the forward markets. That's not a particularly large program for us. We are still getting attractive returns on those assets, but that's getting to be a crowded trade. We're seeing a lot of flows, quite frankly, in our asset management business from JPY into U.S. dollar assets with hedges. Just given that we think it's such a crowded trade, we don't really have any intent to increase that by any significance in the near term. Next slide, please.
What I was speaking to before was really the stability and the long-duration nature of the existing block. We are continuing to sell new business. On this slide, I highlight that our annual net insurance cash flows are expected to be, or actually were $9.6 billion in 2015. You'll notice that 45% of those flows were U.S. dollar and AUD, you're starting to see that sales effect. We are underwriting some additional JPY business. As you heard from the business executives, we work closely with them to make sure that the investment assumptions, combined with the actuarial and administrative expense assumptions, allow us to manufacture attractively priced products. Next slide, please.
On this slide, I've simply listed PGIM, our internal asset manager. I wanted to talk about some of their capabilities because I really do believe having an organization like PGIM is a competitive advantage to Prudential, particularly in terms of the kinds of returns that we can deliver on U.S. dollar products in Japan. I think that's something that exists for us and not necessarily for many other competitors. First and foremost, our asset management business grew out of the investing that we do for the insurance company. It's very strong in fixed income. The largest component is public fixed income, we have a very strong team in the public fixed income market.
Most of the third-party money they manage is total return, whereas our insurance portfolio is buy and hold. We really do benefit from the quality of the research and the strengths of the team that exists there. However, I think our biggest competitive advantage relates to the Prudential Capital Group and the Prudential Mortgage Capital Company, which are listed on the right side of the page. For Prudential Capital, over 50% of their origination, in some years over two-thirds, is direct. They have regional offices across the U.S., several in Europe, and one in Australia, where they directly work with borrowers. In the case of Prudential Mortgage Capital Company, they have even more offices in the U.S. than Pru Cap. They have one, maybe two offices in Europe now, and they do actually have a Tokyo office for originating mortgages.
The benefit of this is that these help diversify us away from public credits. All of these loans have covenants, which is not common in public instruments or 144As. We do also collect an illiquidity premium. We have superior recoveries when these credits do fall behind and, in fact, have features that allow us to bump interest rates. We think those are very attractive asset classes, and to the extent the Japanese businesses are doing more U.S. dollar business, they will get their proportionate share of those assets. Next slide, please. I just wanted to point out the quality of the Japan portfolios. 97% of this portfolio is in fixed income, and 95% of the portfolio is in investment-grade assets. That's a really high-quality portfolio by U.S., European, or Japanese standards. As a matter of fact, 69% of the credit portfolio is rated A and above.
When we think about our portfolio, we actually refer to risk assets, including high-yield bonds. In this case, that's only 5% of the portfolio, and when you back out the below investment-grade bonds, that simply highlights that our non-coupon investments are only 2% of this portfolio, and that's mostly in Japanese equities and J-REITs. If you look at the pie charts below, the pie chart on the left highlights that fully 48% of the portfolio is in JGBs today. If you carve out the 5% high yield, you're left with the 47%, which is in mortgages, privates, and public fixed income. We break that out or break that down on the pie chart on the right, and you'll see that fully 29% of that is in double A and above securities.
Another 40% is in single A, and that leaves us with less than a third of the credit portfolio in triple B instruments. That's a very high-quality portfolio. Next slide, please. I get a lot of questions these days about in these low-rate environments, are you guys reaching for yield? Are you stuffing the portfolio with a lot more risky assets? It's a natural concern for investors and rating agencies, and it's certainly a natural concern for regulators. I thought this slide would be helpful to respond to that. First of all, year-to-date, you can see that 23% of the portfolio went into JGBs and another 9% went into U.S. Treasuries in the dollar portfolio. Again, almost a third of the portfolio is going into government securities. Another 37% went into investment-grade public fixed income.
The trend you see here that I think is important is that the 10 and 13, the 23% of the portfolio went into private placement mortgages and private corporate investments. That is to back the U.S. dollar block of business. We're not rolling that in or hedging that on a forward basis. That's pure U.S. dollar assets against U.S. dollar liabilities. Then lastly, I would highlight that our below investment-grade purchases, the portfolio is at 3%. Our purchases year-to-date are at 4%, so certainly no dramatic increase. I would tell you that actually the reason you're closer to four today is that as we get more U.S. dollar assets, we can actually put in some privately underwritten below investment-grade bonds.
I think this page really just highlights that with the U.S. dollar product shift, we're really able to take greater advantage of the PGIM capabilities. My last slide that I'll speak to relates to really just a snapshot of the credit profile of the U.S. businesses, excluding Japan, of the total company, excluding Japan and excluding our closed block. You can see that for that business, which is largely the U.S. businesses, 88% of the portfolio is invested in credit instruments. We're doing this inside of a double A rated U.S. business, and it's a really high-quality portfolio. Yet, when you look over on the right side of the page, you can see that we only have 50% of the portfolio is in JGBs, leaving half the portfolio in credit.
I'm not positing that you should expect to see any significant change in this portfolio in the short run. It simply points out that as we sell more U.S. dollar business, we really got the ability to take advantage of those PGIM capabilities and put some more credit risky assets in the portfolio. We've got a lot of room to go if we want to do that over time. Why don't I stop there and turn things over to Rob?
Thank you, Scott. Let's take this down to the home stretch. Then actually, if we could just advance to the slide that's got the Venn diagram on it, we'll start there. From a finance perspective, we think about operating metrics for our Japan business in much the same way as we think about the metrics for the overall enterprise. We think about that in the context of it being a balancing act. We seek to have strong fundamental performance and execution that generate growth and an ROE in excess of our cost of capital for the businesses that we operate here. That performance should manifest in high quality, predictable reported results consistent with the relatively low risk of the businesses. We want earnings to translate into free cash flow that can be redeployed either into inorganic growth opportunities or distributions back to the U.S. holding company.
All the above needs to be underpinned by financial strength and stability. Any component of this can be enhanced at the expense of having some other component of it sub-optimized. For instance, free cash flow could be increased by reducing our organic growth and not taking advantage of the attractive ROE that we earn by reinvesting in our existing businesses. Alternatively, earnings growth could be accelerated by pursuing a lower quality, higher risk business mix or by compromising our financial strength. We seek to balance growth in ROE, risk, and cash generation in a way that optimizes the value of our Japan operations to us and, in turn, to our shareholders. Let's start by taking a high look at our results over the last decade and flipping over to the next slide.
This is very similar to a slide that you saw in Charlie Lowrey's presentation and Scott alluded to, but with some added detail. The bars show the growth in our earnings over time. Through a combination of organic and inorganic sources, earnings have grown at almost 12% per annum since 2007. The acceleration since 2010 was driven in part by the Star and Edison acquisitions and the subsequent synergies that were realized from those acquisitions. The lighter blue sections of each bar show the proportion of earnings that has been redeployed. Since 2007, almost $10.5 billion or 67% of our earnings have been redeployed. $800 million of this was used to fund a portion of the Star and Edison acquisitions in 2011, and the remaining $9.5 billion was returned to the U.S. holding company. The yellow line at the top shows the ROE that we've earned over this period.
It has and continues to be well in excess of our cost of capital and hurdle rates for this business, particularly in light of the relative risk and stable earnings profile. You will notice a dip that occurred in 2011, which coincides with the acquisition of the Star and Edison businesses. These businesses were acquired at very attractive returns, albeit below the ROEs that we were generating from our organic business. As we integrated Star and Edison, we incurred about $400 million in costs, but realized run rate synergies of about a quarter of a billion dollars, which were fully reflected by 2013. This drove the subsequent recovery in our ROE that you see in the graphic.
While recently there's been a flattening of our earnings growth and a modest decline in ROE due in part to currency exchange rates and returns on non-coupon investments, we continue to achieve highly attractive absolute and risk-adjusted returns. At the bottom of the chart, you can see the average interest and FX rates for each year as well as the return on the Nikkei. I will talk about our FX hedging strategy later in the presentation. Turning to the next slide. That earnings and return picture, the sustained growth, the high ROE, and the low volatility is largely attributable to our business design as you've already heard this morning. Our unique distribution model and our needs-based selling orientation emphasize protection versus savings-oriented products and produce a high level of policy persistency and repeat customer sales.
This is a significantly better and more predictable business mix and model than that of our competitors. In addition, unlike many of our peers, our legacy book in Japan is not burdened with policies underwritten at high levels of assumed investment returns. As a result, we have an attractive earnings and return picture driven primarily from mortality and expense margins. This slide is an illustrative depiction of the relative contribution of M&E margins and investment margins by product. The largest concentration of our book and sales is in the more protection-oriented products, as you've heard this morning. Earnings are largely derived from these protection products, including term, A&H or accident health, and whole life. As I mentioned, our business model also benefits from relatively high persistency in repeat customer sales. The virtuous cycle described by Ichitani-san this morning helps to produce the attractive economics that we're able to generate.
Turning to the next slide. Moving in our operating metrics in that Venn diagram I showed up front from growth and ROE to volatility and risk, I'd like to first address the impact of sustained low interest rates then to turn to the impact of currency movements. We've operated in a low interest rate environment in Japan for about two decades, albeit not a negative one until very recently. As I mentioned before, our business mix is concentrated in protection-oriented products with profits mainly generated by M&E margins, therefore, we're less reliant on spread income. We have a number of other key mitigants to a sustained low interest rate environment. Our yen portfolio rollover, as Scott pointed out, only averages roughly 1%-2% per year, this includes investment maturities needed to meet expected claims.
As you heard from Scott, we have a strong ALM discipline, we have access to investment-grade securities that produce attractive risk-adjusted returns. We have a long history of sales of US dollar and AUD-denominated products dating actually back to 1999, have pivoted further to US dollar sales in the current environment. We have and will continue to reprice our products to mitigate the impact of low rates. For certain of our more interest rate sensitive products, like fixed annuities, we've built in features to enhance our flexibility, like biweekly repricing for new sales and ongoing MVA adjustments or market value adjustment features. Turning to the next slide. In order to provide more transparency on the potential impact of sustained low interest rates on our earnings, we've pulled this slide together. It shows the hypothetical impact to the earnings generated from our existing block of business.
Specifically, we started with our entire in-place block of business, all currencies, liabilities, and assets backing the liabilities as of year-end 2015. We froze the block, essentially putting it into a runoff mode, reflecting all cash flows, so portfolio rollover, recurring premiums, claims, settlements, and any related costs. We assumed that the interest rate environment existing as of June 30th of this year remained unchanged over the forecast period, that we followed our existing long-term plan of investments. As you can see, over a three-year period of time through 2019, the cumulative impact to earnings from investing at rates lower than the current portfolio yield is relatively modest, about $200 million pre-tax by 2019. This compares to $3.2 billion of pre-tax AOI from our international business in 2015, to $6.2 billion of consolidated pre-tax AOI at the enterprise or PFI level.
While the effect compounds each year, the marginal impact actually declines each year, primarily due to the runoff of the block. This analysis reflects the earlier points I made about the relative contribution of our M&E margins as compared to spread income. Moving to the next slide. Further concerns about the effects of sustained low interest rates have been raised in connection with the recent and anticipated changes in the statutory reserve rates. As you're undoubtedly aware, the standard reserve rates prescribed by the FSA changed from 75 basis points to 25 basis points for yen-denominated single-pay whole life sales back in July of this year. The standard rates for yen-denominated recurring premium whole life sales is expected to decline by about 75 basis points. That would be from 100 basis points down to 25 basis points effective April of 2017.
These changes are only applicable to new business for yen-denominated products commencing as of the effective dates. When we look at pricing for new business, we evaluate returns using multiple lenses for both capital and under a range of interest rate scenarios. Our capital lenses include statutory and economic frameworks, and our interest rate scenarios include what I call a gap view, that assumes that rates rise to our long-term reversion rate over the course of a decade, and the benchmark is 1.9% for the 10-year JGB over that decade. Secondly, a market neutral view, which assumes that rates just follow the forward curve that's in place. Finally, the other bookend of it, which is a sustained low interest rate environment, which assumes that rates remain at the current prevailing levels for forever.
When products don't produce returns on capital consistent with our hurdle rates appropriate to each of these scenarios, we either reprice or redesign the products, we suspend or limit sales, and/or we place a greater emphasis on other products, including, for example, what we've done with our U.S. dollar-based products. Turning to the next slide. Let me go now to the risks associated with sustained low interest rates to those associated with currency movements. We have a robust hedging program for our U.S. dollar/yen currency risk. Our objectives are to dampen annual reported earnings volatility due to changes in those exchange rates, to protect the enterprise earnings and ROE. To protect long-term value of our investment in the Japan business and to mitigate the potential exchange rate impact on our solvency margin ratio. Turning to the next slide.
Before I jump further into the hedging program, I first thought it would be helpful to provide context by looking at the degree of our earnings sensitivity to currency movements. Recall that a significant portion of our products sold in Japan are U.S. dollar denominated, providing dollar returns, dollar revenues, and gross profits. However, all of our expenses are yen denominated. As a result, only about 34% of pre-tax earnings are actually yen based. Our earnings are significantly less exposed to the appreciation or depreciation of the yen than you might otherwise have assumed. The graphic on this slide shows the impact to earnings of changes in our hedged FX rates. The center column represents actual results for the first six months of this year.
Our hedged rate, or what we call our plan rate, that we share with you, is a result of hedges that we put into place over the course of the last three years and was at JPY 106 to the USD. Earnings were $1,582,000,000. Looking to the extreme left, if our hedged rate reflected a significant strengthening of the yen to JPY 80 to the USD or a 25% appreciation, the pro forma impact would increase AOI by about $172 million or $1,754,000,000. That's 11% from our actual results. Conversely, looking to the extreme right, if our hedged rate reflected a significant weakening of the yen to JPY 140 to the USD or a 32% depreciation, the pro forma impact would reduce AOI by $129 million to $1,453,000,000, or only 8% from our actual results.
Having given you this view of our earnings sensitivity to changes in the value of the yen, now I'll walk you through our hedging strategy and show how we achieve the objectives that I had just laid out on the previous slide. Turning to the next slide. There are two principal components to our hedging strategy, income hedges, shown in the dark blue on the left, and equity hedges, shown in the light blue and the orange, also on the left. The total size of our hedge program is about $15.4 billion. Our income hedges are executed through forward swaps and protect the near-term earnings and cash flow. As I will show in the next slide, these hedges smooth the impacts of the change in the yen by layering in swaps over a rolling 36-month period.
We are always 100% hedged for the upcoming year, which allows us to forecast earnings, which is the basis of our guidance, and explain variances to that forecast that are independent of fluctuations in the exchange rate. For 2016, our hedged or plan rate resulting from that program of three-year rolling swaps is JPY 106 to the USD, as I had mentioned in the previous slide. Our equity hedge is primarily executed through the acquisition of U.S. dollar assets. We also have a modest amount of dual currency bonds. Matching U.S. dollar assets against our yen liabilities effectively protects the dollar value of our investment in our Japan business. By way of example, if the yen depreciates unhedged, the dollar value of our equity in Japan would also decline.
However, because we own U.S. dollar assets, the value of the yen liabilities declines, but the value of the assets does not. This creates a gain. We use an internal swap as a mechanism to move this gain out of Japan up to the parent company. We calibrate the size of the U.S. dollar portfolio to protect the economic value of our investment in Japan and to preserve the enterprise ROE. I'll walk through this in a little bit more detail in just a few slides. Turning to the next slide. Taking a closer look at the earnings hedge component of our hedge strategy. As I mentioned before, we hedge earnings by layering in swaps over a 36-month rolling period.
At any point in time, we've hedged 100% of the next four quarters, so year one, about 85% of quarters five through eight, so year two, and about 40% of quarters nine through 12, year three. This has the effect of smoothing the impact of changes in value of the yen on our reported earnings. The dark blue line on this chart shows the actual spot value of the yen versus the dollar over time. The green line is a trailing three-year rolling average spot rate, which would approximate our actual hedging strategy. The red line shows our plan rates for each fiscal year, which is the average of our actual hedges over the course of that year. As you can see, it roughly follows that three-year smooth rolling average spot rate.
While the earnings hedge does protect against near-term volatility in the value of the yen, it does not protect the value of those earnings over the longer term. For that, we have our equity hedge. Turn to the next slide. As I described before, we use US dollar investments in Japan to support the value of our yen-based business. We establish an internal hedge, which facilitates cash flows from and to Japan and protects the local solvency margin by creating yen-denominated assets on our Japanese books. Look at the chart on the bottom part of this slide. When the yen weakens, which is the top row of that chart, the value of US dollar assets rises. The internal hedge transfers this increase in value from Japan to the parent over time through staggered cash settlements.
This cash mitigates the decline in the value in our Japan business as a result of the expected lower dollar value of future dividends coming from Japan. Our solvency margin ratio is unaffected as our liabilities are yen-denominated and therefore unchanged in yen terms, and the value of the US dollar assets net of the internal hedge is also unchanged in yen terms. Conversely, now look at what happens when the yen strengthens, which would be the bottom row. The value of the US dollar assets fall in this scenario. The internal hedge offsets this decline in value by transferring cash from the parent to Japan through staggered settlements over time. These cash payments from the parent are offset by the higher dollar value of future dividends from Japan over time as well.
Our solvency margin ratio, again, is unaffected as the net value of the US dollar assets plus the mark-to-market on the internal hedge is unchanged in yen terms. Turning to the next slide. Our equity hedge target is about $13.6 billion, and that's on top of the $1.8 billion notional value of our income hedges. We sized the equity hedge such that the cash settlements when redeployed, are sufficient on an after-tax basis to fully offset the impact to our enterprise ROE from a change in the value of the yen. The fair value of the equity hedge at June 30th of this year was a negative $500 million based on an exchange rate of 103 yen to the dollar as of that date.
A 10% appreciation in the yen, which would have taken it to JPY 92 to the dollar, would further reduce that value to about a negative $2 billion. A 10% depreciation in the yen to JPY 113 to the dollar would increase the value of the equity hedge to a positive $0.9 billion. The break even on the hedge as of June 30th was about JPY 107 to the dollar. The projected settlements under the equity hedge using the JPY 103 to the U.S. dollar as of June 30th are actually shown at the bottom of the slide here. These settlements are staggered over time and actually go out beyond 2020. How should you interpret this?
What this means is that since inception, and incidentally, we began implementing this hedge back when the yen was in the 70s against the dollar, the cumulative net settlements under the hedge, plus the projected future net settlements, when redeployed, either in share repurchases or back into our businesses are and have been sufficient to offset the dilution to our enterprise ROE that otherwise would occur as a result of the depreciation of the yen over that time. Turning to the next slide. I now want to turn to the third component of that operating metrics Venn that I showed you in the opening page, and that is cash generation and deployment. Up front, I showed you the annual history of earnings and capital redeployment from our international businesses. This slide shows a cumulative picture of that history from 2009 through the end of 2015.
Over this period, we've generated $13.4 billion in AOI net of tax effecting, and redeployed about two-thirds of this or about $8.6 billion using a variety of mechanisms as shown in the pie chart on the right and as I'll describe on the next slide, if we could turn to that. We have several mechanisms for redeploying our international earnings. These include dividends, affiliate debt repayment, of which we have about $1 billion outstanding, structured notes, for which we have in excess of $2 billion of capacity as of June 30th, and acquisition funding, including, for example, the funding of Star and Edison that we did in 2011, and other mechanisms such as internal reinsurance and intercompany hedges. We expect that these mechanisms will allow us to continue to achieve strong redeployment of earnings. Turning to the next slide.
Even with this level of earnings redeployment, we've maintained solvency margin ratios consistent with our target, including under moderately adverse stress scenarios, including the scenario shown here where equities decline 55%, real estate values decline 35%, the yen depreciates by 20% against the U.S. and AUD dollar, and interest rates spike by 100 basis points. In such a scenario, we would still maintain solvency margin ratios in Prudential of Japan and Gibraltar Life that are consistent with our 700% target and our desire to operate at AA criteria for financial strength. Turning to the final slide. What I hope that you've taken away from this presentation is that we're balancing what we believe to be the key drivers to optimizing both our international business and enterprise values, growth in ROE, low volatility and risk, and cash generation and redeployment.
Specifically, our product focus enabled by our unique distribution model and our needs-based selling orientation drives prospects for continued attractive returns and growth. We have a very manageable exposure to macroeconomic risks, including interest rates and foreign currency markets, and we have a robust financial position that we've maintained due to our strong capital generation net of the significant proportion of earnings that we've been able to redeploy. Thank you for listening. I think I'm going to turn it, Mark, over to you, and Scott and I are ready to answer questions.
Thank you, Rob, and thank you, Scott. We'll now open it up for our third and final Q&A. A whole bunch of hands just went up. Nigel?
Thanks. Nigel Dally , Morgan Stanley. You provided details on the solvency margin ratio. Several of your peers are also talking about economic solvency ratios. We'd be interested as to how you would now come out under that alternative approach. Nigel, it's Rob. We do not calculate a solvency regime-based capital ratio. There's lots of issues with that particular calculation, varying from internal models to some concepts that don't particularly work well for insurers. Having said that, our risk-adjusted capital framework includes an economic lens, which in many ways is similar to the types of economic solvency ratios that are calculated by others.
Some key differences that I just want to point out is, 1, we look at total available resources, so the ATAR concept as opposed to looking solely at a capital construct, which particularly in Japan is important because of the very significant margins in reserves that we have on our balance sheet there. 2nd, we discount our assets and our liabilities using similar yield curves to avoid noneconomic volatility. Depending on the type of calculation you do under a Solvency II type regime, by way of example, you might not do it that way, and you get some odd results that overstate ratios in certain environments and significantly understate them in others. This is an internal management tool, and we've not made it public, so I can't share with you the actual ratios coming from that. Let me share a couple of other observations that might be helpful.
What you haven't seen from us that you've seen from others is a significant run-up in a published SMR ratio. In some instances, that significant run-up then doesn't seem to connect very well with the economic solvency ratios that are then published. In our particular case, you haven't seen that run-up because of, in part, the very disciplined ALM model that Scott described, and I'll come back to that. The fact that we have a very low equity exposure, less than 3%. We have a very low exposure to AFS securities, which are mark-to-market. It's less than 20% of our portfolio. We use the hold-to-maturity and hold-for-reserve designations, which requires that you operate with a relatively tight duration quarter, which gets back to that disciplined ALM.
Because we have much less in the way of mark-to-market assets, we haven't seen the run-up in valuations and therefore in SMR due to a decline in rates and a rise in global equities that are sort of inflating the value of assets. If you're only marking the assets but not marking the liabilities, which is that construct in Japan solvency, if you're using AFS, you wind up with results which could overstate the true strength. Also, as you've seen in the presentations, about 30% of our liabilities are non-yen. We're not subject to the negative interest rate environment that the yen assets of others are otherwise subject to. The combination of low equities, disciplined ALM, a high use of held for reserve and held to maturity and non-yen business means that we have less volatility in our solvency margin ratio.
It's probably a lot more representative of our economic strength than may be the case in other instances that you're seeing. I hope that that's helpful in responsive to the question, Nigel.
Great. Thank you.
Erik Bass.
Thank you. Erik Bass with Autonomous. Scott, you commented a lot about the tight ALM match. I was hoping you could provide a little bit more, I guess, clarity on specifically the durations of the assets and liabilities for both the Japanese portfolio and the U.S. dollar portfolio.
I think I can provide a little but I'm not sure how helpful that would be in the sense that across Prudential, for example, as I described, we look at legal entities, then we look at currency buckets, and then we look at products with similar characteristics. Across the organization, we have over 150 segments where we apply ALM discipline. As you can imagine when you start looking at the durations, we've got 150 durations on different sets of segments. I'm not sure how helpful aggregating them. As it relates to Japan, I'd make a couple of observations. The durations on the JPY liabilities are pretty long. It's not uncommon to see some of those protection products that you heard discussed to have actual durations of 15-20 years or so. That's just as true in POJ as it is in Gibraltar.
On the other hand, the U.S. dollar liabilities tend to be shorter, and Australian even shorter than that. You might see durations, call it in the 5-7 year range for AUD products and in the 8-10 year duration for the U.S. dollar products. Maybe the last thing I'll say because I think you were asking a little bit more about the technique as well. Without getting too in the weeds, we actually create individual replicating portfolios for each of those liabilities. I think for over 140 of those, we're able to do that with a lot of precision without a custom model. Then we chop that into 0-2, 3-5, 7-10, 10-20, and beyond 20. Those end up being our buckets. Then we match against those buckets with corridors around each.
That's what gives you the tight ALM matching that Rob was referring to.
Thank you. I guess within the yen-denominated portfolio though what is the duration mismatch? Can you quantify how wide that would be?
I guess, let me put it this way, because remember, for example, Rob was telling you that we hold U.S. dollar assets as part of our surplus, and obviously I don't want to take 30-year interest rate risk on my U.S. dollar assets. I want to pick up the belly of the curve, and I want to pick up private placement premiums on mortgages and private corporates. I guess, I think within 30 years, we're north of 90% tightly matched for 30 years in Japan. We do have a fair amount of cash flows that run beyond 30 and 40 years. I guess our philosophy on those is, first of all, each calendar quarter, think about it, each year 31 rolls into 30, and then it's very tightly matched.
All of the liabilities are tested in the actuarial testing every year with current rates. If rates have come down, those long-tail assets may require us to strengthen reserves a little bit so the balance sheet is getting stronger. Nonetheless, we tend to think of those tail liabilities as sort of benefiting more from the surplus that we have. To the extent that we take some high yield risk, some real estate, or some alternative assets, we think of the total returns on those really sort of being earned against the tail liabilities. I think you can see, you can take a fair amount of comfort from that.
Erik, it's Rob. The only thing I'd add to what Scott said was, I think it was a very full answer, is simply that the question seems straightforward. The answer isn't always as straightforward because depending on the character of the liability, some have very predictable cash outflows, and others are more stochastic and have convexity associated with them. So where there's high predictability around the cash flows, you're going to find that we're within the investable universe, 100% matched. Then where there's convexity in those cash flows, you're going to find that we're not entirely 100% matched because we're doing a series of scenarios and ensuring that we've got the right exposure under a variety of potential interest rate scenarios, not a single best estimate.
Yeah. In just sort of completing Rob's comment there, in the case of Japan, where we have these long-duration liabilities, to the extent we had a rate spike, not a further decline, it would have to be pretty significant, we could have some surrenders, therefore, we're going to run a little bit short.
Jimmy Bhullar.
Hi, I had a couple of questions. First, can you discuss what your discount rate assumptions are for yen-denominated liabilities and for the US dollar liabilities, both near-term discount rate that you're using and the ultimate forward rate? Then I have another one.
Jimmy, we're going to talk about this from a U.S. GAAP standpoint, I think is the question you're asking. The convention we use in Japan is the same as the convention that we use globally, and obviously in the U.S. We use the forward curve for the first two years, and then after that, we do a linear extrapolation to our long-term reversion rate. In Japan, that long-term reversion rate, we moved in the second quarter from 2% down to 1.9%.
Just on slide seven, I think, of Scott's presentation, there was the $4.5 billion of the portfolio that's invested in dollars hedged back to the JPY. Can you detail the nature of those, I guess they're forwards, but what type of hedges are you buying and the duration of those hedges versus the duration of the underlying investments?
Yeah. I think maybe the best thing to do is to say, what have we been experiencing year to date. First of all, we have hedges. As you can imagine, there's a portfolio of hedges, some as short as three months and others running out all the way up to two years. But our average is, call it five months. Year to date, the assets that we've been purchasing had a gross yield of 3.3%. The hedging cost has been, call it 1.1%. We've been netting 220 on that portfolio. I would contrast that with on our JPY-denominated purchases year to date, we were earning 58 basis points. We would still say we're picking up 165 basis points on that trade. Some of that is securities that we've underwritten, so we're really quite comfortable with when you think of the credit profile.
Nonetheless, I would say that is starting to feel like a very crowded trade.
Thank you.
Yaron.
Thank you. Yaron Kinar with Deutsche Bank. Question for Rob. If I go back to your presentation and look at, I think it's slide 14, the redeployment of excess capital of about 65% of earnings since 2009. Could you normalize that for the Japan equity hedge? Like what that ratio would be without the hedge?
Actually, Yaron, no, I don't have that number handy. I would say that the hedge has been one of multiple mechanisms that we've used in order to bring capital back. It is one that we will continue to use on a prospective basis. If you think about it kind of normalizes itself out depending on whether there's an appreciation or depreciation of the yen. I don't have at my fingertips a number that I could give you.
Okay. Would it be fair to assume that in a strengthening yen environment, at least for the next, let's say, two, three years, we'd see that ratio come in a little bit?
I think, let me answer the question more broadly, which is how we're feeling about the sustainability of the distribution rate for distribution of our earnings from Japan. What I said, Yaron, is that we've articulated a 60% level. Important to understand, when we establish that 60% level, as we do across our businesses, it's really a balance. It's not so much how much we can get out of the business, it's how much we should take out of the business. It's a balance between reinvesting for internal growth and distributing back to the parent. We continue to earn very attractive returns in Japan from our business and well in excess of our cost of capital. We're continuing to grow there, and we want to finance that growth.
We believe that 60% sort of strikes the right balance between reinvesting for growth at attractive ROEs as we're able to redeploy there and then bringing capital back. In any given period, you're going to find that we could be more or less than that 60%, but over time, it's expected to average to that number. There are challenges in the current environment with that around interest rate levels, around changes in the stat rate, which I'm sure I'll get some questions on that as well. We believe that our earnings will continue to be sustained and that our ability to take those earnings and take that same ratio of cash flow back to the parent company is sustainable over a long term as well. We have multiple mechanisms for doing that.
The affiliated debt that's outstanding that I mentioned, the structured notes that I mentioned, the internal hedges that we just asked about, and our internal reinsurance, which to date we've only used for our U.S. dollar business in order to enhance or maximize our ALM capabilities. While on the margin, there could be some impact on that in any given year as a result of the settlements that are occurring on the hedge running one way or the other. We think over time that noise sort of works itself out and that we'll be able to sustain that targeted 60% ratio.
Thank you. That's helpful. Maybe one quick clarification question on slide six. When you talk about the current interest rate environment, is that both in the U.S. and Japan or just Japan?
This represents the total portfolio, so that would be both U.S. and Japan. The total existing portfolio, including our U.S. dollar assets and our yen assets.
Thank you.
Thomas Gallagher.
Thomas Gallagher, Evercore ISI. Is this on? Yeah.
Yeah.
Robert, just follow-up question on the economic solvency ratio. You are calculating that and reporting that to the FSA. Is that correct? From everything we've heard, it's in field testing stages, and that is information that's being shared with the FSA. I just wanted to confirm that it is something that you calculate. Yes, Thomas, to be very clear, that's very different than a Solvency II ratio. That is the IAIS economic construct that they're developing, which has been in development, and the first field test on that was that construct looked very different than the second field test on it, and they're making some progress migrating, frankly, toward some of the things that I highlighted as being the key differences between how we calculate that economic lens and how it's calculated on a pure Solvency II basis. Yeah, we calculated that during the first field test.
We've calculated that in the second field test. The Japan FSA is going to be running a field test, a further specific field test on the Japanese companies. We will participate in that, and we're doing all those calculations, and we're participating in sort of the formulation and the evolving formulation of that international capital standard. Yes, we are doing that, but it is very different than a pure Solvency II calculation.
Understood, but I guess my question is, based on what you've seen, I don't know how much you can share, do you feel like you're in a good position? As you think about where that's likely to evolve to, how do you stack up?
We're not privy to everyone's results on that sort of stuff. What I would say, Thomas, is two things. One, we're working very closely with the Federal Reserve and with the rest of Team USA, so Department of the Treasury and the NAIC, working in conjunction with then the international players to further evolve this international capital standard. We believe that it's made progress and that there are indications we can continue to make progress in having it be more reflective of an insurer's actual capital strength. On that basis, we think we will show well on that because we have a very strong capital position. The results that we've seen to date, we think understate our capital strength, but by no means in a way that leave us overly concerned. We just don't think it's quite right, and it's not meant to be quite right.
There's a range of different outcomes based on they've got a variety of different calculations that they're using in order to sort of calibrate sensitivities and ultimately migrate toward a construct that will make more sense. I would say, Tom, there's nothing that we see out there that would cause us to be concerned that we would show more poorly than our peers under that ratio. That isn't to say that we think that that ratio is where it needs to be at this point in time. We think it actually needs a fair amount of additional work.
I guess my last question is when you showed that information about the capital redeployment, I guess only 14% of the capital redeployment has been dividends, so earnings-based, and the rest has been various other mechanisms, including internal leverage. When you think about the new framework, does that source of capital repatriation end up being a negative against you? When you think about the internal leverage that you've used to deploy capital over the years, is that under that new framework somehow a negative, or is that not a big consideration?
It's not a large consideration, Tom. It's a consolidated framework, and in consolidation, the intercompany stuff goes away.
Okay, thanks.
Connie?
Thank you. Connie Dibova, The Boston Company. Just following up on Tom and Yaron's question. When you think about upstreaming capital to the parent, how much of a factor should we consider for either the ESR or the SMR?
We want to maintain robust solvency margin ratios, whether they be the Japan FSA solvency margin ratio or our own internal calculations of economic capital. We believe we are at very strong ratios in both those metrics. When we look at the capital we're generating on an annual basis, the idea that we would be distributing 60% of those earnings up in any given year is not constrained by either of those views. They are relevant and they're at strong levels, and those strong levels will be sustained through the reinvestment of the 40% to support the growth that we're experiencing in our businesses.
Any further questions? Okay. Well, thank you for your participation today. We do have lunch. This floor cafe. We are here. For those that are running off to flights, have safe flights, and thank you again for your participation.