Okay, we're going to get started here. Next up is Mark Grier, Vice Chairman of Prudential, and we also have the Head of IR, Mark Finkelstein, in the audience as well. As a long tenured and very well-respected executive in the life insurance space, we're pleased to have Mark join us here to share his thoughts on Prudential and more broadly on the industry. Mark?
Thanks, Tom. I like the well-respected part. I'm not so sure about the long tenured part. I've never been introduced that way before, so a new one. Well, thank you all. I'm going to talk about Prudential, and then we'll have plenty of time at the end for questions about Prudential or industry or any other issues I know in addition to what I'm going to talk about specifically on Prudential. I will not, in my prepared remarks, be addressing regulation and capital standards, so that's something to keep in the back of your mind, maybe for questions. I'm going to start with some legal gobbledygook and then talk generally about the company, and then I want to get into recent developments, issues, and questions that have come up since our first quarter earnings announcement.
The basic picture of Prudential is one of a differentiated ROE built on high-quality execution and what we think has been the right strategic selection with respect to business. We came out of the financial crisis stronger than most, and as a result of that, starting with the financial strength bullet, we were able to take advantage of opportunities to buy companies from AIG and an opportunity to buy a company from Hartford. We also were leading the market in product development and execution in pension risk transfer. All of those things building on the financial strength that we had coming out of the crisis and our opportunity to take advantage of it because we were strong at a time when not very many companies were. All of that energy and financial strength went into enhancing our core businesses. We have not been changing direction.
Our story has been very consistent around insurance, asset management, and retirement for a number of years now, balanced between international and domestic, and across a number of different well-diversified business models. We exploit our core strengths, and we pride ourselves on our ability to execute in large, complicated businesses, but to do it in a manner that's consistent with the financial strength objectives of the company and the business opportunities that we've identified strategically. As a result of that, as I said initially, we have a differentiated ROE driven by the attractive returns that we earn internationally and the attractive returns that we earn in selective domestic businesses.
We have a nice picture, a superior value proposition for clients because we are meeting needs in insurance, asset management, and retirement. Also an attractive value proposition for investors both in debt and in equity because we earn extraordinary returns. We also maintain very solid financial strength. The next slide goes through in words some of the things that I just said, characterizing the strengths of the company. Let me just highlight the bottom one, because talent and culture for a long time was kind of viewed as sociology and nice to hear people talk about.
I think over the past few years, we can say that we've demonstrated the connection between talent and culture and execution as it relates to successful acquisitions and as it relates to things like the large, complicated deals that we do in pension risk transfer, where we need to call on the collaborative efforts of people in a wide variety of areas within Prudential, and we need to call on very sophisticated high-level technical skills. The nice thing about talent and culture for us, I think, is not that we can talk about it like it's a good thing to have, but that we can talk about it in the context of the concrete connection to execution and to the business results that we produce. Speaking of business results, we have focused on return on equity as the key measure of strategic performance for us.
This reflects our view that within financial services, capital discipline and the deployment of capital are the real underlying themes behind building value over time and being successful. You see on this slide a very nice progression in return on assets from the days of financial strength, and then the deployment of that financial strength enhancing our ability to do more because we earn such a high return, and getting to the ROE neighborhood of 15%-16%. Nice picture of progress. Again, the jump in those bars reflects the things I talked about, acquisitions, pension risk transfer deals, and execution in the core businesses. This is going to be the only slide in which I talk very much specifically about individual businesses. You see on the right-hand side of this the way in which our equity is spread across the businesses that we're in.
You see on the left-hand side the earnings contributions from those businesses that we're in. Let me hit maybe a headline on each one. Our largest business in terms of both capital deployment and earnings is international insurance. This is one that if you have followed us since we went public, we've been very proud of, we've been investing in. It's grown very rapidly since 2001 and is now a real crown jewel in the Prudential portfolio of businesses. Earning a very attractive return on equity in the neighborhood of 20%. If you isolate out of that just Japan, which is a more mature business, the ROE is actually well north of 20%. Growing in single digits, but also growing with relatively low volatility.
Become somewhat more volatile as markets have changed, the trade-off between return and volatility and an attractive growth rate here still remains very important and what we consider to be almost kind of flagship element of our value proposition to investors. Moving around the pie, I'll skip over Group. In Individual Life, I mentioned that we bought a business from Hartford. We bought their Individual Life business, and the integration of that deal went extremely well. That brought with it distribution capabilities that were new to us in particularly the important broker-dealer third-party channel. We also got product development skills that have been a good complement for our business. We've done very well there. The returns in Individual Life have been attractive. Sales have been somewhat volatile, particularly because of what's happened in the guaranteed universal life market.
Overall, nice trajectory, nice returns, and good solid business. Retirement, the main story in Retirement has been pension risk transfer, where our market share of jumbo pension risk transfer deals is just about 100%. We've talked about that a lot. We like the opportunity. We like the available returns. We like the risk profile. It plays to core competencies that we have in investments and actuarial, and also, by the way, back office. We don't focus on this a lot, but for example, the day we did the General Motors deal, which was about $25 billion of pension liabilities, we had to start mailing checks to 115,000 General Motors retirees. There's a whole package here that goes beyond what you see when we book it on the balance sheet and report the earnings.
Nice story in Retirement, good growth, but heavy focus on pension risk transfer, either funded deals or longevity swaps. Asset management has been performing very well for us, and they're performing in ways that reflect quality drivers. The quality drivers include investment performance, which has been extraordinary just about across the board in everything we do in Asset Management, but also consistent execution. The retention of our portfolio managers, the retention of our client relationship people, and the staying power that we've had in terms of a consistent story to the market, meaning the client market, over a number of years has paid off. We have 12 consecutive years of positive net flows in our institutional Asset Management business, and that's extraordinary. The annuity business is one that's complicated.
We're at the point now, though, where as we can talk about it on the earnings call and pick out some of the trends, meaning the relationship between earnings and growth in assets under management, account values, it's technically called. Now as we can look back over time and see how those relationships work, and then understand the overlay of the volatility that we tolerate, I think the value proposition is becoming more clear. We retain very attractive and productive account values in the annuity business. The fees that these assets throw off amount to three percentage points or more. The core story of packaging these living benefits to increase persistency, and as a result of that, earn these fees for longer periods of time, is working. As I said, now that we've got a number of years behind us, we can see those trends more clearly.
It bounces around a bit, the return on assets in the annuity business is right around one percentage point. We've been above that a little bit and below that a little bit, overall, that's a nice center of gravity. I'm going to come back to this one when I talk about capital, as I said, we tolerate some accounting volatility because the accounting doesn't quite match the economics, and we manage more to the economics. That nice story of growth in account values and growth in earnings is playing out. I want to turn now to financial strength, I'm going to talk a little bit about year-end results and some of the comments that we had made on the earnings call.
In a way, the next two slides represent the punchline because this is the picture of the elements of financial strength that I think at the end of the day, aren't based on assumptions or plans or interpretations. This is what's in front of us today. Starting with this slide, in terms of our statutory capital ratios, which is what drives the availability of capital ultimately within the company, we target a 400% RBC ratio in Prudential Insurance. That's our big U.S. life insurance company. At the end of last year, we were somewhere above 450 percentage points, we have not yet filed our statutory statement, I'm not going to give you a number. The qualitative comment here says, well above target, and I'll emphasize the word well in that statement. We are substantially above our 400% target as of the end of the year.
You'll see as part of, again, the sort of objective capital snapshot, very strong RBC ratio in our major U.S. insurance company. You see the Japanese solvency margin ratio shown below that. You see targets of 600%-700%, you see the most recent published numbers there, well above 800%. Again, in terms of the drivers of the way capital can work its way through the company up to the holding company Very strong pictures at year-end in the big U.S. insurance company and on a quarterly basis in the Japanese businesses. On this slide, the estimated on-balance sheet capital capacity of $2 billion is benchmarked against a financial leverage ratio of 25%. In other words, that number reflects the view of capital capacity after we have to pay down some debt. Our financial leverage ratio was higher than 25% at year-end.
We've taken what it takes to achieve 25% financial leverage out of that and stated capital capacity of $2 billion. I think more importantly, the second element of the punch line, the first one being statutory capital ratios, the second one, cash at the holding company is around $4 billion. Our operating target for that right now is about $1.3 billion. Very substantial margins between the cash that we have available in the holding company and the cash that we've targeted as our cash requirement. Again, to recap the punch line, the statutory capital ratios and cash at the holding company are both extraordinarily strong. I want to talk about the on-balance sheet capital capacity number of $2 billion that we talked about on the earnings call.
This is a challenging conversation because there are so many moving parts in the capital story, there's a certain amount of risk in trying to pick out individual line items and talk about what's happening. There's also a certain amount of risk in thinking about the line of sight between anything that's happening that you can observe and the way some of the things move in insurance reserves or the investment portfolio. That's a long way of saying there's a context here that you need to keep in mind. It's not simple linear connections. It's not one thing driving another thing. There's a lot happening in the balance sheet of Prudential or any other very large life insurance company. Part of that context, by the way, includes a theme that we've emphasized before, which is that risk within Prudential is managed very broadly.
Where you might see a line item moving, there's a context for that that reflects, for example, the consideration of stress scenarios and capital plans and what we call our capital protection framework, which is the way in which we scale various elements of either actual or available capital in the context of stress scenarios and the objectives that we would set in different stress scenarios. Picking out line items in that context when you're missing the whole broader point of what it's all about, again, can be misleading. There's volatility that we've chosen to tolerate because there are other things happening, I'm going to come to particularly a piece of that in a minute.
Second broad context point to make here is that I don't think I have to tell you that the way we account for it in GAAP, our variable annuity liability, the embedded derivative valuation process, is both volatile and also amplified relative to the real economics. I said when I was talking about annuities, that we tolerate volatility in some of this accounting because we're focused on the economics. We also tolerate some of this volatility in accounting because we use that annuity business to offset other exposures in stress scenarios. You've heard us talk about the corporate underhedge, where we have an exposure in annuities to falling rates. That's actually part of a broader story within the company that protects us from rising rates. Again, there's that element of context, I want to emphasize here that we have chosen to tolerate some of this volatility.
We anticipate absorbing the consequences, and we do. It doesn't affect our capital plans, or at least it hasn't yet. There's normal noise in here that's part of the way this is expected to work. As I said, it's absorbed and managed. Again, when you think about it differently, there is a bigger context where we're protected from the stress shock of a rising rate scenario because of what we've done in representing an exposure to falling rates. The final context point I want to make is that AAT testing gets a lot of attention sometimes. As rates initially fell a few years ago, there was a lot of discussion around AAT. That's asset adequacy testing.
It's a statutory process that we go through. It's getting some attention again because rates spike downward, and they have actually a couple of times during the fourth quarter and then more recently spiked downward. The point I want to make about AAT testing is that it's a very large, elaborate, complicated process. It isn't a matter of looking at what you think liability flows are going to be, meaning taking a mortality table and projecting death claims and then discounting those claims. Now in that simple story, it looks like a bond, and rates go down, the value goes up, the liability goes up. The AAT testing process plays out both sides of the balance sheet. You project asset cash flows, and you project liability cash flows, there's a whole bunch of stuff in there. There are layers and layers and layers of complexity.
It's a long, time-consuming, challenging process. It's not something we can run every day and market to market. It's a huge, elaborate extrapolation of all the cash flows that come from the insurance liabilities we have and then the assets that are associated with those liabilities. The test, in quotes, is to make sure that you have enough in assets to meet those liability cash flows. Let me give you an extreme example to help understand what I'm saying. Suppose all of our commercial mortgages prepaid. Now we get prepayment charges. We get money in the door today. Now the whole portfolio is different. We go reinvest, and we have lower interest rates. Liabilities don't change, but AAT reserves are going to change dramatically because AAT reserves include both sides of the books.
That's part of the point of what's involved in understanding this, is not just thinking about it like a stream of cash flows discounted like a bond. There's this whole picture. We said on the call, be very careful about extrapolating one quarter's AAT results relative to interest rates into a broader theme about interest rate exposures. The point I'm making in this discussion about AAT is that's why be careful about extrapolating. There are a lot of moving parts in the guts of this AAT thing that create the AAT reserve results that may or may not be directly related to whatever move in interest rates you're currently processing or analyzing.
Let me go to the chart here, which shows the guidance discussion of available capital on the left, the financial outlook preview, and then the capital position that we talked about on the earnings call when we actually announced first quarter earnings. You see the $3.5 billion down to $2.0 billion. You also see, by the way, that the size of the total bar, the dark blue plus the hashed part, didn't change. It's not that capital went down or went up relative to what we thought. By the way, it did, because a whole lot of other stuff happened. It's not that capital disappeared. Capital went from the dark blue bar, which we considered capacity, to the hash marked part, which we identified as earmarked to repay debt.
Also on the call, I made the point that we haven't repaid debt yet. We could have characterized this as $4 billion, but we think we're going to use $2 billion to pay back debt. We said $2 billion net of earmarking $2 billion to pay back debt. One of the things that happens when I talked about absorbing volatility is that we do allow that leverage ratio to fluctuate in response to some of these movements in the market. We don't go out and plug these leverage holes the day they happen. It's part of a broader capital deployment strategy and also risk management strategy. As I said, we could have said four, but we think we're going to use two. Instead we said two, but we're earmarking two to repay debt.
We're highlighting the rate difference here on the bottom in the yellow boxes. The interest rate assumption that was underlying that statement when we had the guidance call called for a 10-year of 2.6% at year-end. It actually came out at 2.2%. The leverage ratio, 25 and 25 in both scenarios. Yes, rates were lower at year-end than we had contemplated. We used a forward curve when we did our forecast, which is the basis for guidance and also was the basis for the statements about capital. That forward curve forecast didn't come true. There was a difference. You can think about that difference in rates as being an important influence. Again, I want to caution you, based on the context that I brought up upfront, extrapolating this and assuming that that's our exposure to rates. It's not.
This is also an unmanaged outcome in the context that we're tolerating these moves. We anticipate volatility, especially in the reserve for VAs. That volatility happens, and we have the capacity to absorb it, and we tolerate it. We could choose to do things differently. We could change the optics of this rate exposure and deal with that spike in rate stress scenario differently. We think it would cost us more, but we could do things differently. You need to think about this as an unmanaged outcome, but only in the context that it's volatility that we've decided to tolerate and absorb, and we're doing fine at tolerating and absorbing it.
The theme of this slide, and I won't go through every line item, is that we have not been derailed in our capital plans by the drop in rates or the other influences on AAT reserves or capital at the end of the year. We fully anticipate implementing our capital plans for this year. We have plenty of capacity to do the things that we have signaled to the market we plan to do. We have an obligation to fund an acquisition coming up. We have a shareholder distribution strategy, and we're going to continue to look for more opportunities to deploy capital in ways that are consistent with our strategy and our financial objectives.
As I said, the headline is we are not at all derailed or stressed by the events that resulted in, and again, events, not just rates, the whole series of events that resulted in this balance sheet at year-end. We will continue ongoing capital management, as the yellow arrow indicates, according to the plans that we've talked about. I've made a lot of points about the highlights of capital strength. Let me just make maybe one comment on each bullet here. The Capital Protection Framework is a very broad approach to stress scenarios, and we manage a lot of different things within the company to contribute to achieving our objectives in the various stress scenarios. When I say objectives, by the way, our objective in the absolute worst-case tail scenario is not the same as our objective in a normal cycle.
There are gradations of situations that we're willing to target based on the magnitude of stress. It's a comprehensive Capital Protection Framework that uses a lot of different things like the underhedge and the annuity product to provide protection against stress outcomes. We have a very conservative balance sheet. One thing that we need to focus on maybe more in the industry is talking about reserving practices and strength. We have tens and tens of billions of dollars in our insurance reserves in excess of our base case liabilities, in excess of what you would expect that we would have to pay out.
There are sources of embedded strength in there that represent serious loss absorption capacity in different outcomes that can allow for deviations in liability experience and deviations in asset experience, and can all be covered by the strength that we have in our reserves without even calling on the capital of the company. We generate a lot of capital in our businesses. On our guidance call, we talked about our expectation that about 60% of operating earnings will be available over time as capital. That ROE, that 15% plus ROE and the longer-term target of 13 to 14, represents capital generation capacity. Debtholders like it because it's a real serious source of financial strength. Shareholders like it because it's a real source of available capital for distribution or for deployment that would allow us to distribute more capital in the future.
That ability that we have in our businesses to generate and make available, at the holding company, substantial amounts of capital is an important plus for us. This is, by the way, in a way, sort of the flip side of the negative part of having mature books. The growth rate of the mature books is challenged because of runoff, but they do generate more capital, and you see that happening to us in particularly Japan and U.S. Life. That's happening to us, and it's favorable from a financial flexibility perspective and a capital strength perspective. Finally, effective capital deployment. I've talked about acquisitions where we have an extraordinary record. We take a balanced approach to distribution to our shareholders between dividends, and we increased our dividend by a healthy amount in the fourth quarter, to dividends and to share repurchases.
We continue to believe that in addition to the operating story and the attractive ROE, we are a very attractive capital story as an investment. I want to talk about the Japan capital hedge. This is a source of less visible strength for the company, but it's very substantial. We have, as part of our broader capital protection framework, a structural short JPY position on our balance sheet. By structural short JPY, I mean we have US dollar assets and JPY liabilities, either equity or debt. The intent of that is to protect the value of our Japanese franchise in US dollars as the JPY changes. The JPY depreciates a lot, that hedge increases a lot in value. Right now, and when I say right now, put me back on December 31st of last year. Right now, the fair value of that hedge is $2.4 billion.
In addition to having that structural short JPY position, there is a mechanism, a structured transaction, that will turn that gain into cash at the holding company. Over the course of this year, from that $2.4 billion, we'll realize $700 million of additional cash at the holding company. This is nowhere in the capital numbers that I've talked about. It's not in our capital accounts yet. It's in unrealized gain. You ought to be thinking about the fact that if you really added all this stuff together, the amount of capital that we have, the earnings that we will use to generate capital this year, and then the embedded gain in the Japanese capital hedge, you're all of a sudden in the range of very, very large numbers.
This is also separate from the earnings translation hedges that protect AOI when we translate JPY earnings into dollars. This is, as I said, structural capital driven, it's big and it's real, as I said, we'll generate $700 million of new cash to the parent this year and over the life of this, which is a couple of years, that whole $2.4 billion, assuming the JPY stays in the neighborhood in which it's in right now, that whole $2.4 billion becomes available. This is another, like those margins and reserves I talked about, this is another meaningful source of strength and flexibility. This is also actually a source of cash. This is real money that will come in part of that bigger capital picture. Some things go one way, some things go the other way.
This one is substantial and favorable. This just shows the fair value of the hedge is $2.4 billion, and the anticipated settlements this year are $700 million. This is a summary, but I think I've probably summarized enough as I've gone along. I won't go through the particular bullets on this page. I think time to stop. We've got about 10 minutes for questions and discussions.
Thank you. I'll start it off, and then if anyone has a question, please raise your hand. Just getting into the capital discussion a little bit, can you explain why it seems like the big change here, the AAT reserves, I would agree with you, is something that happens at year-end. Sometimes it's bigger, sometimes it's smaller. That seems pretty straightforward to me. The part that was probably more surprising was the increase in leverage. Can you explain what happened there exactly? Why did the calculational leverage go up as much as it did?
When I say that we tolerate the accounting volatility and some of the fluctuations, one of the shock absorbers that we use on the balance sheet to address some of these, what in the bigger scheme of things are probably transitory fluctuations in either interest rates or equity markets or whatever, is the recharacterization of debt from operating debt to financial debt. The bigger picture for us is that total debt is coming down, and we are reducing macro leverage. When we have to fund a longer-term use within one of our subsidiaries, and the annuity hedge is in our Arizona captive called Pruco Re , when we have to fund capital there, that's not a working capital need or a use of operating leverage. We consider that to be capital debt.
It reflects our sensitivity to making sure that the capital structure where we're funding a subsidiary on their balance sheet as capital, that that's characterized as capital as it works its way up and is matched against a target that we have for capital leverage, which is 25%. That's called financial leverage. It's a recharacterization. Total debt didn't actually change, instead of thinking of it as working capital because it was used to finance that balance sheet event, the increase in liability, we recharacterize it as capital debt, and we will either manage it down or not, or it'll go down by itself. This is something, by the way, that's not new.
If you've followed Prudential, we've had a lot of discipline for a number of years about making sure that when we're funding capital in a subsidiary from the parent, that we properly characterize that, whether it's debt or equity, as capital, and we think about it as part of our capital structure. That's in a way more of a risk management issue because we don't want to wind up with a lot of operating debt funding long-term uses within our subsidiaries. You can think of it as sort of a way of maintaining discipline around matching the maturity of the use or the nature of the use with the source of the capital. That recharacterization is not new for us. We've talked about it.
It's happened in previous quarters, and as I said, it's one of the ways that we absorb some of these fluctuations in the balance sheet.
I'll just ask one follow-up, and then we'll go to you. The main question I've been getting is, okay, so that would then going forward, what happens from a capital volatility standpoint if the 10-year goes to 15, if equity markets correct to 15%? Can you say whether or not you'd still have excess capital?
That's probably more of a forward-looking statement than I want to make, but I would say that we're very comfortable with our capacity to absorb those kind of fluctuations. You saw, for example, $2.4 billion of gains on the JPY hedge, and you see excess capital on the balance sheet. You see the ability to generate a lot of capital. From the various sources that are out there for us, we have substantial capacity.
Question?
Well, actually, I came from banking, and I always thought debt was debt. The original construction of the characterization of debt as operating debt versus capital debt is a result of the work with the rating agencies. That characterization has been part of our rating agency framework since I got to Prudential in 1995. There was a lot of attention as a result of that to which characterization of debt would be applied by the rating agencies when we borrowed money. Would it be considered operating debt, or would it be considered capital debt? Now, as I said, I came from banking, and I didn't think the differences mattered very much. Debt was debt.
What I realized is the point I just made, which is it's a discipline around the structure and maturity of debt that's used for balance sheet capital purposes as opposed to working capital purposes. I've come to understand more about why it's viewed that way, and I understand your point. Actually, it's standard practice with respect to the way we've talked about this and the rating agencies have talked about this with us for many, many years. It really turns out to be more of a risk management discipline in matching maturities, but this goes back a long way with the rating agencies. First of all, a lot happens on a consolidated basis, and there are movements all the time across legal entities. Let me just qualify this a little bit by saying that there's a lot moving around all the time within Prudential.
Pruco Re is funded with a solid equity base. It's not a sham captive insurance company. It's got real assets, real equity, but we did inject capital to match the need in Pruco Re this time. It would have originated as operating debt. Without changing total debt. As I just said, when I got to Prudential, that concept didn't seem right to me, but I understand it now. As we look at that capital structure and that 25% capital debt target, that's allowing for some double leverage, as you say. As you look at the balance sheet, it fully reflects both where rates are now and the forward assumptions that are either made by the regulators as we do the AAT testing or embedded in the assumptions that we use to support our GAAP balance sheet.
In terms of the structure of the balance sheet, there's nothing left to take if rates don't change. We'll continue to have declines in earnings on our portfolios, but even that is running its course. The new money rate is converging on the maturity rate because rates have been low for a while. The sensitivity of earnings is diminishing. The answer is we can sustain this forever. Remember, we make a lot of mortality profits, we make a lot of fee-based profits, and we're much less sensitive in terms of the structure of our business model to the level of interest rates. The answer is we can sustain it forever. There's not an end to Prudential coming if rates stay low. We actually will continue to do well, and we have a lot of capacity. No.
I'll ask one last quick one in the last 30 seconds. Y ou had mentioned up until now you've tolerated accounting volatility. Is there a plan to potentially change that?
We're always analyzing options around the way in which we hedge and manage and account for. One point that Rob Falzon made on the call is that the GAAP reserve, which is our statutory reserve because of the way we manage Pruco Re, is more than twice as big as the required statutory reserve for that product. One thing to think about is how we want to view the GAAP accounting and the volatility that goes with it versus the pure statutory world in which capital lives. The answer is we're always looking at different approaches to both hedging within the product world and within the capital protection plan. Things will be considered.
Got it. Well, we're out of time. Thanks a lot, Mark. I appreciate it. We have a break.