Good morning, everyone, and welcome. Thank you for attending the 2014 Financial Strength Symposium today. I'm Nandini Mongia. I'm the Senior Client Executive at Deutsche Bank, responsible for the Prudential relationship and for delivering our firm's global resources and capabilities to Prudential. The Deutsche Bank and Prudential relationship is a true partnership across a number of areas in which we do business together, and it is our honor to be here today as the sponsor of this event. Prudential is one of the world's largest financial services institutions. For more than 135 years, Prudential has helped its individual and institutional customers grow and protect their wealth. Prudential's financial strength is key to delivering on those long-term promises and is the focus of the agenda today. With that said, it's my pleasure to hand over to run through the agenda today. Thank you.
Thank you. On behalf of Prudential colleagues in the room and around the world, welcome. Welcome also to those of you taking this in on the webcast and also to those of you who will watch Financial Strength Symposium, the movie, over the next two weeks, because this will be archived at www.investor.prudential.com. To those of you in the room, you will find an agenda. I would characterize the agenda as packed. Unfortunately, I do not have time to read you the forward-looking statement, nor do I have time to take you through all the very interesting reconciliations of non-GAAP measures to GAAP. However, they are included in your binders for your edification, should you be so inclined. Last week, we had another one of these shows for the equity side, and I quipped that the length of the forward-looking statement presentation exceeded that of some of our executives.
That will not be the case today. The first up to present is Prudential's Chief Financial Officer, Rob Falzon.
Thank you, Eric. Good morning, everyone. First, let me extend my welcome. I think this is the fourth year that we're doing this. Someone will correct me if I got that wrong. By the attendance that we're getting, which is very robust, I presume that you're finding this of value. We find it of value. We find it to be a very nice complement to what we're doing with our traditional Investor Day. We did have to bump this a week. We're doing it a week later than we usually do, and that's because with the S&P conference last week, we were afraid that no one would show up to our conference by virtue of the competition. We altered it, and we thank you for coming today. The agenda today's got a number of topics.
I'm going to spend a little bit of time upfront, and I'll come back to my specific agenda. After me, we're going to have Steve Pelletier, Executive Vice President and head of our U.S. businesses, come up and do a presentation. He will be followed by David Hunt, who will present on our asset management business. We will pause for Q&A. David and Steve will take questions together. I think we do a break after that, but I'll leave that in Eric's hands. Following our U.S. businesses, we'll then do a presentation on our international businesses. John Hanrahan, who is the Chief Financial Officer for our international businesses and actually the Chief Operating Officer for those businesses as well, will be making that presentation. Charlie Lowrey made the presentation for Investor Day.
Charlie is, as the Executive Vice President in charge of traveling internationally for actually the next two or three weeks solid, so could not be here today. John, however, is well qualified to do this presentation. He's actually done it in the past. He is the former CEO and President of our Prudential of Japan business, so intimately familiar with those operations in that business and I think can both carry off the presentation and respond to any questions that you might have. Following John, Scott Sleyster, our Chief Investment Officer, will give you a presentation on the portfolio. Then we'll conclude with Ken Tanji, our Treasurer, doing a presentation on capital and liquidity. Today, I have four topics that I want to cover. The first is our value proposition to investors.
When I say investors, I want to pause for a moment and ensure that you understand what we mean by investors. When we say investors, we mean the full spectrum of investors. Our value proposition isn't targeted solely to shareholders, it's targeted to investors. It includes our fixed income investors, it includes our lending relationships, it includes our business partners for our institutional retirement business. As you see in the slides that I'll go through, our business model is such that we think that what is important to one constituent is actually important to all constituents that we have from an investment standpoint. The second topic will be how we deliver on that proposition. Third, I'll talk a little bit about the financial manifestations of our value proposition and some of the metrics that we think about.
Then I'll conclude with a little bit on regulation. I will not be taking Q&A at the end of my presentation, solely because if I do it then, I think you'll ask a bunch of questions that will probably be answered during the course of the morning. What I'll do is, after Ken has finished with his presentation at the end of the day, I'll rejoin Ken, and together we'll take questions and answers. We'll provide answers to your questions at the end of the forum this morning. This is a slide that should look familiar. It's our three-pillar slide. If you like consistency, I think you'll like most of my presentation because it's fairly consistent with things that we've told you about in the past.
We have Three pillars to our investor value proposition: generating a superior ROE, generating sustainable and growing earnings and distributable cash flow, and conservatively managing our balance sheet. Let me just pause and talk about each of those for a moment. When we talk about a superior ROE, we mean superior in the context on an absolute basis, we mean it relative to our peers, and we mean it relative to our cost of capital, and we try to manage the cost of capital down and the return on equity up, obviously. Our second pillar, growth, is an important pillar, but I want to put a caveat out there. We actually don't target a growth rate. We believe that for a financial institution to target a growth rate is essentially a predestination suicide.
You'll wind up going off the curb and over the cliff to the extent that you try to drive growth too hard. Instead, what we think about is having a mix and composition of businesses that generate a sustainable level of growth and a consistent level of growth, and where those earnings translate into free cash flow that we can then redeploy. With respect to the balance sheet, financial strength is core to our value proposition. It's important to our customers, it's important to our employees, and it's important to our investors in that broad sense that I've defined those investors. Our businesses generate a substantial amount of redeployable capital. We think about that in the context of a strong balance sheet.
The first use of that redeployable capital is to make sure that we're hitting our balance sheet targets, specifically that our leverage is in line with where we want it to be, and that our capital surplus is where we want it to be as well. Then we look at financing the organic growth that we have within our businesses. Then we look to what we call super or extra organic growth, things like our pension risk transfer. Then we'll look at M&A opportunities, and we'll also look at providing a return to our shareholders of capital, of the cash that's generated from the business, both in the form of a sustainable dividend and periodic stock buybacks.
The foundation to all of those pillars is talent and culture, I'm going to actually spend one slide returning to that because I think it's an important topic for us at Prudential. The investor alignment across these three pillars should be relatively obvious. If you think about the nature of our business, which is we're in the business of making long-term promises. Financial strength is an important component to the success of that business paradigm. Therefore, not only are debt investors and folks who think about us as a counterparty sensitive to that financial strength, but our equity investors need to be sensitive to that financial strength as well. Without financial strength, we can't execute on our business. That's ultimately what generates our earnings and our return on equity.
There's, we think, a strong alignment with regard to the full spectrum of investors with respect to our balance sheet strength. Similarly, when you look at ROE and you look at growth, we believe that a high ROE and a sustainable level of growth are indicators of a very healthy underlying business franchise. That's good for equity investors, but frankly, that's also good for our creditors and for our retirement partners and for our creditors in the form of fixed income investors and bank lenders and people that buy our commercial paper on an overnight basis. That end of the spectrum is just as important to the credit side as it is to the equity side.
The combination of all three of those, delivering across all three of those pillars ensures that we will have access to the full breadth of the capital markets on an ongoing basis. This is actually a slide you've seen many times before, but you will recognize it. It's a story we've told about how we deliver on our investor value proposition. We got tired of just putting bullet points up there, we got creative. We made the slide so complex that you'll actually have to study it, and pay attention to understand what we're trying to get at. Let me start with the bottom of this pyramid.
We believe that we have a unique combination of investment, actuarial, and risk management skills that used both independently and in combination with each other, allow us to create products and services that provide solutions to the retirement and protection needs of first, the world's largest market. Japan and the United States, two largest markets in the world for the sorts of things that we sell and the services that we provide, and then also in targeted growth markets. That brings you up to the center part of that pyramid. We take those products and those services, you combine that with our track record and with the strength of our brand, and that's what allows us to access competitive distribution. Whether that distribution will be specific to the market or to the segment of the market that we're looking to serve.
Our distribution models actually look very different business to business and geography to geography. Steve and John will talk further about that when they come up and give you their presentations. Take all the proceeding, you add scale, you add the mix of our businesses, what you result with is what we believe is sustainable outperformance. I'm going to return to the mix because I think that's an important component of that sustainability. Not on this slide, but an important perhaps footnote to this is that we're also active in acquisitions in M&A. I should say M&A because it's both acquisitions and divestitures. As our chairman likes to say, for us, M&A is a nice to have, not a need to have. Where we do undertake M&A, you're going to find that there's a predictable pattern to that.
That is, we're very disciplined around it and strategic, we leverage our core competencies when we undertake acquisitions in order to ensure that we can execute on those and ultimately deliver on the promise of those acquisitions. Let me return to talent and culture. We believe that this is the true source of long-term sustainable competitive advantage at Prudential. It is in our DNA. We have a culture of collaboration, teamwork, and diversity. I like to quote Mark when he was asked a question about this once, Mark Grier, he said, "If you think about the things that we do well, what we do really well are very complex things that require a high degree of either cross-business and/or cross-functional collaboration." Think about our pension risk transfer business as being really a very good example of that.
When it requires intellect, it's got complexity to it requires that you cut across disciplines and cut across businesses. That's where we tend to excel, that comes from that culture that we have of collaboration and teamwork within the organization. The other way in which this manifests itself is in our orderly succession. We've had a number of changes, actually throughout the organization. Some have been very visible to you, some have been less visible. Most recently, Ed Baird retired. Charlie Lowrey, who had been head of our U.S. businesses, stepped into that position. Steve Pelletier stepped in to Charlie's position, with a very long history on having run a number of our U.S. businesses. Filling in behind Steve Pelletier was Lori Fouché, who we'd brought into the organization from outside some time ago, there was a natural succession from that.
You also saw that our longtime controller, Peter Sayre, announced his retirement this year, Rob Axel, one of our deputy controllers, was elevated to take Peter's position. We have a very deep bench, the bench is a result of our focus on talent, that bench provides for very orderly transition within our management of our businesses and our functions. The other area I wanted to return to was the diversified mix of businesses that we have. We really focus on 3 things. We focus on life, retirement, and asset management. The mix of businesses we have, we like to say, is by design, not by default. It's a result of a number of things. It's a result of reinvesting in organic growth within the businesses that are strategic to us that we want to grow.
It's a result of having done extra organic and M&A activity within those businesses. You've seen us do a number of things over the course of the last couple of years, PRT, The Hartford acquisition earlier this year, Star & Edison in 2010. It's a result of also disposing of things that are either non-strategic or not profitable. That tends to get a little less air time, we've disposed over the period of the last couple of years of half a dozen smaller businesses that we thought either added volatility to our business that we didn't want, they could have been successful businesses but not strategic to us, or they were businesses that we found were not consistent with the ROE objectives that we had as an overall enterprise.
There's a line that goes around the outside of this pie, and that's meant to represent the types of risks that are inherent within those businesses. On the right-hand side of the pie, between 12 o'clock and six o'clock, you see businesses that are more oriented toward insurance type risks. On the left-hand side, between six and 12 going the other way, you find risks that are more market sensitive. We think about our businesses with a second lens. When we think about the management of the composition of our businesses, we don't think just about how large do we want the annuities business to be as a component of our overall enterprise. Rather, we also think about it in the context of how much equity risk do we want to have in the enterprise?
How much interest rate risk do we want to have in the enterprise? How much mortality, morbidity, longevity risk do we want to have in the enterprise? We manage not just by the composition of the businesses, but rather by the composition of the risks that underlie those businesses. In fact, within businesses, we manage the product profile of those businesses such that we attract the kind of risks that provide the right kind of diversification for us and provide us the returns that we think are superior to that we can get by pursuing more commodity types of risks. I think Steve and John could talk a little bit about that further in their presentations as well.
The result of this process is that we have a very focused deployment of people and financial resources across the places that are strategic and important to us and for which we get the best return. We generate attractive returns. We're able to generate a sustainable level of growth, and we're also able to produce stability. We like to remind people that when the crisis hit, a number of our businesses actually had record years. We're able to mute the volatility of any one individual business by looking at the mix of risks that we have and the mix of businesses and the economic drivers to those businesses. How does that value proposition manifest itself in our financial results? Here you see a multi-year presentation of our results. We think it actually reflects the success we've had in executing on the drivers to that value proposition.
It looks to sort of people not familiar with our business as if all of that manifestation was just in 2013, that belies a deeper underlying story. While it was in fact manifested largely in 2013, we believe that there are three important points to remember about this. The first is that this was not a once and done for us, that we think that what got us to our 13 to 14, and in fact, in that year, well in excess of our objective ROE, were a series of drivers that will facilitate a sustainable level of return on equity on a go-forward basis. We've targeted 13 to 14, not as a one-time objective, but rather as sustainable over a cycle. Secondly, this was the result of a multi-year effort.
Go back to the earlier parts of this graph in 2010, $4 billion acquisition of Star & Edison, which took multiple years in order to be able to realize the synergies associated with that acquisition that were fully realized for the most part by the end of last year. The pension risk transfer transactions we did at the end of 2012. Excuse me, 2011. End of 2011. Get that right. The Hartford acquisition we did at the beginning of 2013. The pruning of the portfolio that I described that we did during this entire period of time, divesting of businesses, taking the capital that got freed up from that divestiture and redeploying it in ways that were then accretive to our return on equity, and then financing the organic growth within our businesses that were important to us on a go-forward basis.
The third point to take away from this is that during this period of time that we generated a higher level of returns and higher earnings, we also strengthened the balance sheet. We did not resort to financial engineering as a way to get to the targeted return on equity. In fact, over this period of time, we reduced our leverage ratios by over 300 basis points, and we strengthened the composition of our balance sheet, where capital debt, if you look back at the earlier part of this period, would have consisted largely of senior debt with less than 10% of that represented in hybrids. Today, if you look at the capital debt that we have, almost half that capital debt is in the form of hybrids.
A stronger balance sheet that's as a result of different instruments that we're using, and a lower level of leverage. With that stronger balance sheet, still able to achieve the level of earnings and ROE that we had targeted. Our metrics for the future. These are some of the things that we're thinking about as how do we internally, when we look, we articulate to the marketplace ROE and earnings per share and growth, but there are a number of other things that we think about internally. I think as time goes forward, we'll probably talk about more externally as well. First is that diversified mix of business and market risk. Historically, we've talked about composition of businesses. Over time, I think we'll gravitate to talking more about not just the businesses, but the composition of the mix of the risks that underlie those businesses.
The source and balance of our growth. We want to look at getting growth from growth markets like emerging markets, from growth markets in some of the developed markets that we serve, things like retirement and pension risk transfer. We want to get growth from the organic growth that's available within our businesses, even if they are mature. We also will continue to target that 13%-14% return on equity as a sustainable number for us over a market cycle. We want to look at the cash flow that's generated from earnings. We look very closely at this. We've given metrics about this in the past, but as we look at our earnings on a go-forward basis, we would expect that as businesses mature, they generate an increasing level of cash coming out of that earnings stream.
That's important to us and something we spend a lot of time looking at, thinking about, and planning for. Finally, strong ratings. That goes back to the core of our value proposition being financial strength. Last topic, regulatory developments. I have a sense that this is where I'll wind up getting most questions at the end of the day. When we think about regulatory developments, it's often put in the context of SIFI, people thinking about the Fed, but I want to pause, and we've got three gear wheels on here because it isn't just about the Fed. There are at least two other, but two material other constructs that we need to think about. We talk about the NAIC, and probably we should have labeled this local regulators because we have, for instance, the FSA in Japan.
We have our existing regulatory fabric that has managed the businesses in which we operate for a long time now. It's the FSA in Japan, it's the NAIC in the U.S., and it's the other regulatory bodies in the other countries in which we're operating. Each of them have initiatives of their own that they're prosecuting. With the NAIC, the two headline items would be ORSA, which is a set of stress testing and sensitivity analytics that need to be done on a prospective basis, and the issue of captives that seems to dominate the dialogue in that association today. There is an international body known as the IAIS, the International Association of Insurance Supervisors, falling underneath the FSB, and I'm not going to remember what that stands for, so I won't try. The acronyms sometimes overwhelm me.
That's a very active body that is pursuing global consistency, a common framework that'll be applied to material sized insurers operating across the world. They're looking to have consistency both with regard to the way in which they're regulated and capital metrics that are used as a component of that regulation. You return to the Fed, and the Fed has an agenda associated with non-bank SIFIs. From an insurance standpoint, there are two of us today and one under consideration, and they're looking at some migration from a Basel framework that they've used with banks to figuring out how they're going to apply that in an insurance context on a go-forward basis.
Obviously, there's a full spectrum of consequences of that, starting with the types of reporting and governance expectations that they have, resolution and recovery planning, then a set of capital metrics that they'll be using, then stress testing against those capital metrics on a go-forward basis. You've got three gears. We show arrows that show that those gears would all actually work with each other in synchronization. In fact, they're not quite together yet, and we actually spend part of our time working between the agencies in the coordination between them.
As this enhanced supervision has come across the industry, the regulators themselves are still trying to figure out how they interact with each other, we spend time on that from the standpoint of, from our view, trying to ensure that there is a consistency in how they do that, if not ultimately a convergence in how they go about doing that. We have had a constructive engagement across all three fronts. We have chosen as a firm to pursue that agenda rather than have a confrontational agenda with our regulators. We think that the idea of group supervision of the insurance industry is something that is coming. It is inevitable. It is appropriate.
We believe as well, therefore, our time is best spent in figuring out how that can be appropriately developed in a way that is consistent with insurance industries, insurance companies, and sensitive to the types of risks that insurers have. There have been some very positive developments on that front, specifically with the Fed in the last week or so. You had the announcement of Tom Sullivan as an insurance advisor to the Fed, having a very meaningful role. In addition to that for those that are familiar with the Collins Amendment, which has been the primary impediment to the Fed being able to implement an insurance-centric framework for insurers as opposed to the application of a bank-centric framework.
The Senate voted unanimously or did by unanimous consent to adopt an amendment which would allow the Fed to tailor regulation to insurers as opposed to following a very bank-centric methodology. That still has to go through the House, there is a lot of heavy lifting to be done there. We think the signal coming out of the lawmakers is an important signal to the Fed in terms of what the intent was when they were assigned responsibility for regulating the insurance industry. As I said before, as we work with these three specifically work with the Fed, we are striving for consistency, if not convergence. We think about that, there are probably three critical fundamental concepts that we have articulated on both the international front and on the domestic front that drive that consistency and ultimately perhaps even convergence.
The first of those would be the identification of risks on the balance sheet that actually have a line of sight to an insurer's capital or equity. What do I mean by that? Let me give you some examples. Think about separate accounts, putting guarantees of separate accounts aside for the time being. The separate account is owned by the customer. The financial performance associated with that separate account inures to the benefit of our customers. That performance does not have a line of sight to our capital. To the extent that we have guarantees on separate accounts, those guarantees do have lines of sight to capital. They need to be bifurcated and treated separately, as opposed to a more simplistic view of looking at assets on balance sheet and trying to map the risk associated with those assets directly over to capital.
Another good example of that would be participating policies. In our case, the largest and most meaningful of those would be our closed block. Again, that's a ring-fence set of economics where the benefits of economic performance pass through to the policyholders and not through to our equity. We neither benefit from nor are at risk from the performance ultimately of those closed blocks. We have other types of participating policies where it's somewhere in the spectrum of full participation and full risk bearing from our standpoint. That needs to be accommodated and factored in. Those are things that need to be sort of taken off the table as you think about the capital that needs to be held for an insurer.
On the other side, there need to be things that have to be put on the table that the Fed in particular is not used to looking at. Insurance liabilities, these are stochastic liabilities. They're not like banks that have deterministic liabilities. There's a CD, it's due on a date certain. You know what that $ amount is. We have things like mortality. There's an estimate of when people are going to die and the liability we'll have at that point in time. The stochastic nature of that means that it is variable and that you'll have to hold some level of capital to reflect the variability in that estimate. Similarly, ALM, asset liability match, is an enormous issue for the insurance industry. It is one of the couple of key risks that we face and manage on a day-to-day basis.
The framework that exists within the Fed doesn't anticipate ALM because they're dealing in a construct where everything is liquid and is marked on an overnight basis and needs to be liquid on an overnight basis as well. That's an area where we're spending some time in education and making sure that it gets appropriately reflected within capital constructs. Risk on our balance sheet and which of those risks actually have a line of sight to capital and recognizing that those risks don't all sit on the left-hand side of the balance sheet, namely the asset side, but a number of those risks also sit on the right-hand side, the liability side, and there are risks that come about as a result of the matching of both the asset and the liability side of that. The second critical fundamental concept is the timing of risk emergence.
For regulators that are used to bank-centric frameworks, they think of risk emerging on an overnight basis. They think about the First Republic Bank closing on a Friday, it needing to be resolved over the weekend, a new banner being put up labeled the Second Republic Bank and opening back up on Monday morning. That's not how risk emerges with an insurance company, obviously, as you all well know, but this has been an education process. We have insurance risks. If we get mortality wrong, it will cost us capital, but it will cost us capital over a 30, 40, 50, 60-year horizon, not when we close the shop up on Friday and open back up on Monday. Important and closely related to this is the idea of how we think about credit risk as an insurer.
When we hold fixed income instruments in our portfolio, we're concerned about the risk of default. We're taking that asset and we're matching it up with a liability. At the end of the day, if the mark-to-market on that asset changes on a day-to-day basis, that's not particularly important to us because it's matched up with a liability that at least theoretically, on a mark-to-market basis, is changing in the same amplitudes. What's important to us is the actual risk of default. When we think about credit risk, we think about not daily mark-to-market, but we think about default probability and reserving against the probability of default. Banks largely need to think about taking those fixed income instruments that they hold or their investments that they hold and being able to meet a run on the bank, an overnight demand, which means that the daily mark-to-market is important.
We don't have the run on the insurance company, and that daily mark-to-market is not particularly important. Again, we think about credit risk very differently than the way the Fed has typically thought about it, which has been a combination of default risk and mark-to-market risk. Third and final fundamental concept is where risk absorption capacity and capital resides with an insurance company balance sheet. Insurers are unique in that we have these things that are called reserves. The reserves have a component to it which is beyond the best estimate of what we think the liability will ultimately be. We hold capital, we hold reserves for what we think is the best estimate of the liability, and then we hold reserves on top of that.
The amount that we hold on top of that is a historical legacy of accounting, where because GAAP, as they looked at insurance contracts, recognized that it will take a very long period of time before you actually know the true profitability of that contract, had put in a process where profits or losses on contracts could not be realized day one. Rather, they would need to be capitalized, deferred, and then amortized in over the life of the product. As a result of that, we have no day one profits. We have nothing like what, again, a bank would have on the mark on a derivative where it gets marked up and that profit is booked day one and the trading house thinks they've done a very good job. For us, the profit will be hung up in reserves.
It will be not booked down in equity, and then it will be gradually moved into equity over time. What's unique about that is those reserves are backed by real financial assets. There is risk absorption capacity within the reserves beyond that which we have in our capital. In fact, the very design of insurance accounting is such that you set up the reserves to protect capital. You burn through the reserves before you ever touch capital. This has been an important educational process, both on the international front and on the domestic front, to understand that as they look at capital adequacy for insurers, they're really talking about risk absorption capacity. Risk absorption capacity starts with super tier 1, the margins that we have in reserves, and then goes to capital.
We look at our total capital, quote unquote, availability as defined as the margin in reserve, which is the amount above the best estimate liability, as well as the actual equity capital we have. The good news for us is that the FASB and the IASB at one point were looking to converge on accounting constructs around insurance contracts. They've since gone their own way, and in fact, FASB has decided that they're probably not going to be tinkering too much with insurance contracts. There was a lot of analytics that were done in the process of that review. In that, both the International Accounting Board and the Domestic Accounting Board identified that within insurance liabilities, these margins exist. The international front, they broke the margins into profits and pads. On the U.S. front, they just looked at the totality of the margins.
What we're able to point to is the validation that accounting recognizes these margins exist. Within the U.S., through loss recognition testing, we're actually able to quantify the best estimate liability and therefore the margin that exists. That's an important process we're going through and will be critical to the foundational elements of designing a capital framework appropriate to the insurance industry. With that, I'm going to stop and I'm going to ask Steve and David to join me up here or to join Eric up here. Again, I will take questions at the end of the morning. Thank you.
Thank you, Rob. Good morning, everyone, and thank you for the opportunity to review Prudential's U.S. business with you. I'm first going to make some overall comments about the businesses as an overall portfolio, then I'll make some brief comments about each individual business in turn. As Eric mentioned and Rob mentioned, my comments about the asset management business will be particularly brief. David will follow me. He knows a lot more about that business than I do. Following David's remarks, he and I will both take your questions. Let's get underway. The key points I want to convey to you this morning are as follows, it's no surprise at all and no accident that they're very consistent with some of the points that Rob was making. Prudential's U.S. business portfolio has been designed to represent an attractive mix of businesses and risks.
By virtue of that business mix and the capabilities, solutions, and reach that it generates, I believe we're among the very best positioned in the industry to capitalize on the significant growth opportunities that we see in the U.S. marketplace. Our pursuit of these market opportunities is always governed by the twin disciplines of achieving appropriate returns and maintaining a balanced risk profile. We view sales as an outcome of the application of these disciplines. This discipline is consistently reflected in our strong financial performance, in particular, in the quality of our earnings. Let's go into greater depth on each of these points. Prudential's U.S. business portfolio is complementary and diversified in terms of both businesses and risks. We have varying degrees of exposure to capital market risk, equity markets, interest rates.
For example, businesses with very little sensitivity to equity market risk, such as our domestic life insurance businesses, individual and group, help balance businesses with greater equity sensitivity, such as our annuities business and to a lesser extent, our asset management business. We also have varying and highly complementary degrees of exposure to mortality risk and longevity risk. Again, our domestic life insurance businesses act as something of a natural hedge to the longevity risk that we have purposefully assumed in our annuities business and our pension risk transfer business. We like this mix very much, and we continue to actively manage it. We selectively add to scale and capabilities, such as we did with The Hartford Life acquisition and the outsized organic growth represented by pension risk transfer. We're willing to exit non-strategic or underperforming businesses.
This is a discipline that Prudential has shown over a number of years, including most recently with our disposition of the wealth management business. We carefully govern our activities within businesses, again, to achieve appropriate returns and maintain that balanced risk profile. We see this most clearly today in our individual life insurance business and our annuities business in ways that I'll get into in a minute. At Prudential, we firmly believe that long-term demographic trends are the primary force shaping the U.S. financial services landscape. There's nothing particularly new about that insight. You've heard it before from ourselves and others. Two key points. First of all, just because this observation has been around for a while does not at all mean that it's passé. In fact, we're still in the very earliest stages of the impact that these trends will have in the marketplace.
The oldest baby boomers have just been starting to retire in the past couple of years. The age wave that is spoken of so much is still going to be breaking on the shores 15 years from now. Second, at Prudential, we have made these trends the basis of our business strategy and our business choices for well over 10 years now. Corporate plan sponsors in large defined benefit markets have been showing a keen and growing interest in de-risking. This movement towards de-risking has several drivers, including a keen focus on longevity risk. Prudential is recognized as a leader in pension risk transfer, with solutions ranging from funded buyouts to pure longevity reinsurance to liability-driven investing. Individuals now shoulder greater responsibility for retirement security, and that's driven a shift over decades now from pension plans having primarily a defined benefit framework to a defined contribution framework.
In recent years, these shifts in the U.S. retirement system have driven a need for defined contribution plans to drive more defined benefit-like outcomes. That's been sought by both participants and by plan sponsors. Prudential is a leader in features and products that respond to this need, such as products as in stable value and in-plan income solutions, and plan design features like automatic enrollment, automatic contribution escalation, and default investment options. Target date funds are capturing a large and growing share of contributions to 401 plans. In 2013, our retirement business and our asset management business collaborated to launch the Day One target date funds, a suite of funds for use in retirement plans on our own platform and that of others. There we go. Individuals are not only bearing more responsibility for retirement security, they're also bearing more responsibility for growing out-of-pocket healthcare costs.
Both at the work site and in the retail marketplace, we offer solutions to help individuals manage those growing out-of-pocket costs. Amplifying a point that Rob made earlier, the solutions that we present to the marketplace stem from our superior and highly relevant set of capabilities. We leverage those capabilities both within businesses and increasingly over the past several years across businesses to meet client needs. These capabilities include strength in product innovation and solution development, investment management expertise, and strong investment performance, actuarial expertise that helps us make and keep long-dated promises. Risk management expertise, especially expertise in asset liability management, and strong capabilities in operations and client service. These skills are embedded in businesses that are performing at a high level, operating at scale, and continuously validated by flows from institutional and individual clients.
Our ability to reach institutional and individual clients greatly contributes to our ability to participate in growth opportunities. We have over 25,000 institutional client relationships. We do business with over half the Fortune 500. We are also very proud to serve over 30 million individual customers, including over 9 million retirees and near retirees. We are a distribution powerhouse. Over 125,000 financial professionals, including those in our own agency distribution channel, use Prudential solutions to meet their client needs. As you can see in the bottom half of this chart, our mix of distribution in our retail businesses, mixed between our own proprietary distribution and third-party distribution, has shifted dramatically over the past 10 years towards third-party. Our retail and institutional businesses, annuities and retirement in particular, are sources of opportunities for our asset management business, which is able to compete successfully for mandates on those platforms.
Turning to our financial performance, 2013 represented the all-time high in the earnings of our U.S. businesses. That is certainly a striking milestone, but I think the even more telling part of the story is an enhancement of the quality of our earnings, and that is certainly the part of the story that bodes well for the sustainability of our performance. 2013 was obviously a very strong year for equity market performance, and our business mix put us in a position to benefit from that overall market lift. While these yellow boxes in the middle here aren't drawn to any sort of a scale, they do illustrate a point. The point is that even in a year of a very strong bull market like 2013, the majority of our earnings growth came from how we run the business.
Net flows, improved margins due to pricing discipline and effective cost management, and the outsized organic growth represented by pension risk transfer. This is not just a 2013 phenomenon. These same business-led factors have been driving our earnings growth and our improved quality of earnings since 2009. Let us spend a few minutes on each of our U.S. businesses. The goal of our annuities business is to help clients achieve secure retirement income. We do not mean to be too clever about the wording, but that word secure is specifically chosen. It is meant to include guaranteed income, but by no means be limited to it. Within the past year, in fact, annuities has implemented a product diversification strategy that improves our risk profile while meeting a wider range of client needs.
I'm not going to update the cash flow analysis that Bob O'Donnell presented to this group last year, not because I have any reluctance to show you that data. In fact, the long-term cash flow expectations for our overall book of business are even more robust than what Bob showed last year, both in the base case and under a range of stress scenarios. Annuities product diversification strategy and product designs dramatically enhance our ability to respond to changing market conditions. In 2013, we began our diversification effort with the introduction of our Prudential Defined Income product, or PDI. Since then, we've added to that suite of products by introducing a single premium immediate annuity and an investment-only variable annuity product, as well as updating our existing HDI product offering. A key point I want to make regarding our two leading selling products, which are PDI and HDI.
We are very distinct in the marketplace now because both of those products give us the ability to reset on a monthly basis key features of product design for new business, features such as roll-up rates and payout rates. We don't have to go through a refiling process in order to do it. This makes us nimble in the marketplace, distinctly for us, it means that the fire sale phenomenon that has been so much a part of the variable annuity industry story over the past several years has been significantly reduced. We're offering retirement solutions that are relevant in the marketplace, achieve targeted returns, and help us improve our risk profile. This chart is illustrative, again, don't try to measure where these balloons stand in relationship to each other.
It's meant to illustrate a point, that from products with relatively higher risk profiles, we expect higher returns. The range of returns illustrated in the vertical axis on this slide range from the very low double digits to the very high teens. The economic exposure created by our living benefit guarantee is materially lower than the notional exposure, it's been reduced in the past year due to market appreciation. This slide shows two charts displaying similar data for both 2012 and 2013. In each chart, the traditional measure of in-the-money-ness is shown in red, that being the difference between account values shown in green the protected withdrawal value shown in the lighter blue. Two points about protected withdrawal value. First, let's remember it's a notional amount. It cannot be accessed as a lump sum by the policyholder.
Second, the account value is the first source of payment for all claims under the guarantee. Prudential is responsible for paying those claims only when the account value has been fully exhausted. Our true economic exposure is best measured by the cost to defease that exposure, the cost to purchase an immediate annuity that replicates the cash flow paid under the guarantee but not funded by client account values. In each of these charts, that's shown in the navy blue bar. Last year, that cost was $2 billion. This year, rising markets have lowered that cost to $1 billion, that cost is hedged and supported by assets on our balance sheet. Let's take a look at the multi-year trajectory of our annuities business and the consistent application of a disciplined approach to achieving appropriate returns.
In the early stages of the market crisis, we saw a critical need going largely unmet in the marketplace. We sought to fulfill that need. We had an edge in doing so in a responsible fashion due to our, at that time, recently introduced product design that contains the unique risk mitigating feature of automatic rebalancing that we've discussed before. We saw our sales increase due to demand for that solution, even as from the very earliest days of the market crisis, we continuously raised prices on that solution and reduced the benefit levels associated with it. Our risk in doing this was further mitigated by the reversion to the mean that was so clearly underway in equity markets at that time.
Taking this approach enabled us to increase the percentage to which auto rebalancing covers our entire book of business from under 30% in 2008 to over 70% at the end of last year. More recently, we've seen our VA sales moderate as we focused on putting in place these elements of our product diversification strategy that I just covered a few minutes ago. I know that some firms like to give indications on a continuing basis as to the direction and projected level of their VA sales. For us, the relevant metric of our success will be the composition of sales as we seek to employ a range of product solutions to diversify our risk and help clients achieve secure retirement income. This multi-year trajectory in the annuities business has certainly been a rewarding one.
Rising markets and the operating leverage inherent in the business have driven an impressive expansion of the return on assets in the business, more than doubling between 2009 and 2013. Let's turn next to our retirement business. Within retirement, we have 2 segments, the institutional investment products or IIP segment and the full service segment. IIP includes our pension risk transfer and our stable value businesses. We are the clear market leader in pension risk transfer. The pipeline for transactions remains strong, although of course the nature of the business is such that the actual emergence of transactions will be somewhat lumpy. We participate in the full range of the market, whether you segment the market according to size or according to type of business. That is to say funded business where we're taking on the assets versus pure longevity reinsurance.
Having said that, we fully recognize that it's the larger case segment of the market that plays to our distinctive capabilities and our ability to provide customized solutions to our clients. Stable value is another clear example of our being able to step into a market vacuum during the financial crisis and to do so on a highly responsible basis. The capacity we provided to the market was critically needed at the time, so we were able to provide it on very attractive terms. That in turn means that the $70 billion in investment only stable value assets that we've added during the past five years has a very attractive risk profile. We're now seeing an increase in competition in this market, which is no surprise at all.
While we continue to pursue opportunities, we don't expect our growth to continue at the same pace that it has in recent years. In our full service business, we continue to take a disciplined and selective approach to what we still see as a highly competitive market. Having said that, our investments in the business are paying off in terms of an improved pipeline and improved cost efficiency. Persistency in the stable value business remains very strong. Here we see the forces at work in the pension risk transfer market. Improved funded status of pension plans, heightened awareness of pension plan risk, including a deeper, much deeper understanding of longevity risk, and greater comprehension of risk transfer solutions. Today, these drivers very much exist in the U.K. and the U.S., and they're emerging in Canada.
In a recent study by Mercer and CFO Research, over three quarters, 77% to be exact, of corporate plan sponsors said they plan to undertake some form of dynamic de-risking or liability driven investment over the next two years. Almost half, 48%, said they intend to employ a form of pension risk transfer over the next two years, and these findings are largely consistent with our own proprietary research. We continue to feel very, very positive about prospects for development of the overall pension risk transfer market and our role in it. The pending adoption of new mortality tables certainly is serving to increase the focus on longevity risk, and this bodes well for the propensity of counterparties and clients to transact. These things do take time to work their way through the system, particularly in the large case market.
Again, we continue to expect the emergence of transactions to be episodic. As compared with 2012, during 2013, full service sales increased somewhat, while investment-only stable value sales decreased somewhat. Our very strong position in the investment-only stable value market naturally means that some counterparties are approaching concentration limits on our name. In the full service business, our focus on profitability and pricing discipline has not lessened at all. Net flows overall remained positive in 2013, although of course reduced from the elevated levels we saw in 2012, when we booked the GM and Verizon pension risk transfer transactions. Account values in both full service and IIP have increased. Let's turn to our individual life business, one that is a strong and steady contributor to earnings and that helps, as I mentioned earlier, balance some of the market sensitivity of other businesses in our portfolio.
Within individual life, we're shifting our product emphasis in order to maintain an attractive risk profile. More on that in a moment. The Hartford integration is on track and is fully achieving all the targets that we set at the beginning of the transaction, financial targets, distribution targets, product related targets. At the beginning of the transaction, we posited $120 million in expected integration costs. We're about halfway through that spend, and we posited a $90 million eventual annual run rate of cost savings from the integration. We're about two-thirds of the way along that path. We expect to substantially complete both the integration cost and the cost savings paths towards the latter part of this year. Our unified Prudential branded product portfolio reflects enhanced innovation and greatly facilitates our ability to shift product focus, as I'll touch on in a minute.
On the distribution front, The Hartford acquisition has significantly increased our footprint in the bank and wirehouse channels. On the left here, we see growth in sales in 2013 due to organic growth in the business and to The Hartford Life acquisition. On the right, we see the composition of the in-force book by product. Going from the bottom up on each of these columns, you see term insurance, guaranteed universal life, other universal life, and variable life. The second bar for 2013, all the way to the right, shows how much of the growth in the in-force book in that year is attributable to The Hartford acquisition. The acquired block of business from The Hartford does contain a meaningful portion of guaranteed universal life.
As you can see in the second bar from the right, that product still represents a relatively small portion of the total in-force book of business, and our sales diversification is intended to mitigate any concentration in guaranteed universal life. Our goal is to have a diversified mix of products that delivers profitable and predictable sales growth across all products. Our intent is to have a sales mix that's roughly a third, a third, a third among guaranteed universal life, other universal and variable life, and term life. Here you see our progress against that goal. During the first half of 2013, guaranteed universal life represented almost 60% of our sales. In the most recent quarter, that same figure was down to under 40%.
This decline in guaranteed universal life sales since early 2013 is an outcome of actions we've taken to maintain that attractive risk profile, including a series of price increases over this entire time period. In our group insurance business, reduced sales definitely reflect our focus on restoring appropriate returns in this business. We're investing in underwriting and technology, and we're also investing in the continued expansion of our voluntary suite of products, which really responds to the fundamental shift towards voluntary products that we see in the marketplace and that is already evident in our results. Group life is the dominant source of profitability for group insurance, and over a period of several years, our benefit ratios in group life have remained within targeted ranges. We're benefiting, again, from strong demand for our voluntary product, which represented over three quarters of group life sales in 2013.
In group disability, our progress is evident but not always linear. Over the past two years, 60% of the book has been repriced or lapsed. At the same time, we've made significant investments in our claims management capability, increasing the number of claims managers, bringing down the caseload per claims manager, and improving the pace and quality of claims resolution. These efforts helped group insurance improve its results from 2012 to 2013. The recent reversal in the business' results in the first quarter of this year was purely due to claims severity, a handful of large claims in disability. Despite that, all the metrics we track tell us that our actions are the right ones, that those actions continue to place the business on a path of recovery, a path that will admittedly have its ups and downs.
Here we can clearly see that sales are an outcome of our focus on pricing discipline and scrutiny of underwriting risk. While overall sales have declined, the percentage of total sales related to the more profitable voluntary product has been increasing. Over this past two years, even with the decline in sales, our net enforced premiums have grown over the same time period, with new sales concentrated and voluntary, and price increases more than offsetting the impact on premium from the lapsation of unprofitable cases. David will speak about our asset management business in much greater detail, so I'll just make a few overall comments. We are a top 10 global asset manager with a distinctive multi-manager model, and we serve many of the world's most demanding and sophisticated institutional clients. We enjoy robust underlying fundamentals, including strong and consistent financial performance.
We've greatly enhanced the quality of earnings and asset management. This is very much a case in point of the overall trend in our business that I was speaking of earlier. Earnings growth in this business in recent periods has been driven almost purely by growth in asset management fees. Our asset management business is a bona fide third-party asset manager in its own right and greatly contributes to the overall enterprise results. It delivers improved margins to the general account, and the investment capabilities embedded in the business underpin many of the solutions that we bring to bear across our entire business portfolio, including most specifically pension risk transfer, but with many other examples as well. We continue to invest in this business to drive further profitable growth. Let me wrap up with the same thoughts I started with.
We like our business mix very much, as well we should. It's been purposefully designed to look the way that it does today. We're among the best positioned in the industry to capture money in motion by virtue of our superior set of capabilities, the solutions those capabilities generate, and our distribution strength. Our focus is always on pursuing market opportunities, achieving appropriate returns, and maintaining a balanced risk profile. Following through on that focus keeps our financial performance strong and sustainable. Thanks for your interest. David, over to you.
Can I borrow your clicker? Thank you very much. Good morning to you. Ladies and gentlemen, we really appreciate the time you're taking today with us. We know the demands for all of you on your time are significant, and the fact that you've taken a full morning to become even more familiar with our businesses means a great deal to us. We want to make this as useful as possible. I'm going to spend the next 30 minutes on an overview of the asset management business, we will open it for questions. Steve and I would be happy to address anything that we haven't covered here on the U.S. businesses overall. As you listen through this, please do make a note, and feel free to raise your hand during the Q&A period. We want this to be incredibly useful for you.
Let me turn to asset management. Prudential has been investing in a broad range of stocks, bonds, and real estate for over 100 years. It's part of the heritage of any large insurance company. The investment business, as it is structured today, really dates its history to about 15 years ago. It was run at that time by John Strangfeld, our current CEO, and he is the person who had the vision to say that we needed to have a vibrant, leading third-party business in order to attract the kind of talent we needed in order to drive investment returns, both for the general account and also for our third-party clients. Today's presentation is really the story of that 15 years, of the evolution of that, of the investments that we made in it, and now the health and strength that you see from it.
I want to do that really in four pieces. I want to talk about the business as it is today so you have a snapshot of the capabilities that we have. We want to talk about the financial returns and the robust underlying fundamentals of the business. I do want to spend a moment on how the asset management business works with other parts of Prudential. Steve mentioned the important role it plays with other of our affiliate businesses, and I want to give some examples of that. Finally, I want to talk a little bit about where we're investing. This is a very important business for us. We believe that many of the trends in the industry are actually to our advantage, and I'll explain why we believe in the further growth of the business over the next couple of years.
Let's start just with some of the basics of the business today. Over that 15 years, we've gone from what was effectively a captive insurance division to one of the leading global asset managers in the world. We now enjoy a broad client base, which includes many of the world's most sophisticated clients, and I'm going to show you a little bit more about those in a moment. We have a very wide range of investment capabilities that span not just stocks and bonds, but really into real estate and alternatives. We also have a truly global business model. We have 30 offices on five continents around the world, and 21% of our third-party assets are from non-U.S. clients.
As you listen to the presentation here, part of it will be domestic U.S., but a large part of both where we are and where we're going has a global nature to it. I do want to highlight our multi-manager model. We really believe in the setup that we have. It is different from many other asset managers, and I want to describe a bit about why we believe this to be a good model for us. There are many measures of kind of leading asset managers. Here's one. This is the P&I market data on just total assets. According to P&I, we are the 10th largest asset manager in the world.
If you were to cut it another way and strip out many of the assets that are managed passively by a lot of the businesses here and just focus on the institutional market, you would find that for tax-exempt institutions in the U.S. for actively managed money, we are the fifth largest in the world. I want to underscore the degree to which this 15-year journey has succeeded from moving from a general account-focused asset manager to third party. The way that I would like to illustrate that is by just taking you through our fees. The general account, at this point, makes up 22% of our fee base within PIM. Third party institutional is up into the mid-40s. We have about 25% is third party retail, and the other is a mix of other affiliate businesses.
It's very well-balanced and diversified across a range of client segments around the world. If I just look at the institutional base for a moment, we have about 1,100 third-party clients. A lot of these are very large. They are the world's most sophisticated investors. We have over 60 that have more than $1 billion with us, and in fact, the average of those larger is more like $2.5 billion-$3 billion with us. A lot of those are in the U.S., but increasingly, they're around the world as well. These are also the real blue-chip names from the investing world. They are the largest Fortune 500 companies. They're also virtually all of the largest, both corporate and public pension plans are our clients. Increasingly, that's true around the world.
We now count 116 out of the largest 300 global pension plans as our core clients. On the institutional side, we truly do have a blue-chip client base. Our product offerings are very diverse. We have a very large fixed income business, which is made up both of public securities, but also a very large and market-leading private fixed income business. We have a very diversified equities business, which is both a fundamental equity business as well as a quantitative business. In addition, we have our asset allocation businesses that are mixed into that as well. In real estate, which is something that we've been in for more than 100 years, we have one of the leading equity real estate operations, and we're one of the largest commercial mortgage lenders in the United States.
We also have a very robust set of alternative strategies where we use alternative techniques to manage both the public equities, private equities, and on into a whole series of more sophisticated volatility managed strategies, which I'm going to talk about more in a moment. My main point here is that it's a very broad mix of asset classes and far broader than you would find in a kind of a more traditional asset manager of the last 10 years. Here's just the mix. Again, I do this based on fees rather than AUM because I think it gives you a better sense of the real economics, and the importance of these different segments. We have about almost 40% is public fixed income. We have almost a third, which is public equity, and real estate is about 17% of this.
It is, again, a very balanced mix, right across the entire spectrum of asset classes. I mentioned before the global footprint. Here are the offices within PIM. There's 30 offices on five continents. We have quite significant penetration in the most sophisticated financial centers around the world. The two biggest areas for us outside the U.S. are London and Tokyo. As you can see, we have important presence on the continent in Europe, in other parts of Southeast Asia, and in the Middle East. We do see this as an important area of differentiation and one that I will talk about more when I talk about our investing trends. We also believe that this is not just beginning to build out our product capabilities, but it's also about client servicing.
You'll see here I've highlighted the $26 billion in assets that we currently manage for sovereign wealth funds, that's certainly been one of the faster-growing market segments for us overall. I mentioned before our distinct multi-manager capability, this we do really believe serves our purposes very well. I think its origin goes back again to the setup that John had 15 years ago in thinking about the purpose for our asset manager. Remember, the purpose of setting this up, the third-party business, was to drive outstanding investment performance. I highlight that because it was not to become larger in and of itself. It was not to generate attractive other financial businesses. It was around investment performance. Our belief is that size can certainly be the enemy of performance in investing.
Our belief is that great investors want to work in small groups where they feel that they have autonomy and where they feel as if they're part of a partnership. These are the eight businesses that report up to me. They focus largely on an individual asset class, they make their own investment decisions, they also largely make their own business decisions. Now, the critical control functions like finance, risk management, compliance, legal, all report up separately into Prudential. Those we do keep a tight rein on. The business decisions and the investment decisions are made by small groups of people in these businesses. That's really important to us because we do believe that the accountability that each one of these folks feels is critical to our success in driving strong investment returns.
Great investors do not want to be part of large corporations, they don't want to feel that they're a resource. They want to feel that they're working in a partnership where they have real control over their business direction, investment direction, compensation and people processes. That's the autonomy that we provide for each one of these businesses. It's a somewhat unique model. There are other multi-managers that are out there. We believe anyway that by having, in our case, there's no group here that's larger than 600 people, having the real focus gives us a distinct advantage. When I meet with industry groups, I tend to try to put these advantage into three little taglines, but they do go much deeper than that. One of the pure powers of this model is the power of focus.
I really like the fact that at Jennison, people are not worrying about how things are going in the real estate business. I like the fact that the folks who are really focused in Taiwan are not worrying here about how we're doing with our private placement business in the U.S. We have people who care deeply about an asset class. That's all they do, and they focus on that every day of the week. We also really like the clarity of accountability. In this model, it's not as if somebody else told anybody to do it or there's some kind of matrix reporting or anything else. There is a CEO in each one of these cases who's responsible for the fundamentals of that business, the investment performance and the business performance.
The clarity of accountability is really clear here, that goes right down through the organizations to the individual portfolio managers. An important part of that accountability is that they have line of sight into their compensation. When we talk to our clients, one of the things they love about this model is that within each of these groups, their bonus pools fill based on how they do, not based on how Prudential overall does or even how PIM does here. They have line of sight into their own performance, and that's the way clients want to have their investment professionals compensated. Last, we do believe we have real strength in the diversification of this. We've run a lot of different scenarios and different economic conditions of how these businesses will perform.
In different scenarios, you can see that in some where we have a higher inflation rate, we have the equities business and the real estate business to perform well. In periods like we've been through over the last couple of years, we have the fixed income business and our private businesses doing really well. In almost any economic cycle that you can dream out, we have some businesses that are going to do quite well and other businesses that will probably stand still and other businesses that will have a little bit of a harder time. The broad strength of the diversification we have is a real natural hedge within asset management. We're very happy with that multi-manager model that we think we've perfected over the last 15 years.
Let me talk a little bit about the fundamentals and talk about some of the returns that have been generated in this. Almost any business has its own virtuous cycle. I want to take you through our virtuous cycle. I will also, in full disclosure, almost all businesses have the reverse of this, which if it doesn't go well, can actually quite quickly unwind, and I think in asset management, that's particularly true. Over the last five years, this really has been our virtuous cycle. The place we start with our virtuous cycle is investment performance. I mentioned to all of you that that was the reason that PIM was originally set up, and indeed, that remains what we view as our primary objective today.
When John or Steve calls me up and says, "How is it going?" what they mean is, how is your investment performance? Of course, they care a lot because an awful lot of the general account and other money is invested with me. The real question is not how are your margins, how much has your AUM grown, it's how is your investment performance? We start with that. That's the priority that we have. We believe if we do well with that, we will have very good client flows because we will have earned that. We will have earned the alpha, and people will place more money with us. As they do that will drive our earnings, and we will invest a portion of those earnings back into our talent and capabilities in investment performance.
That's the virtuous cycle that we've had going over the last five years. Indeed, it has been self-reinforcing in a very positive way. Here's our investment performance over the three years, net of fees. This is truly the alpha that our investors would have. In fixed income, 82% of our strategies actually performed above their benchmark, 84% in equities. I've given you just a brief sampling of some of the larger and more important strategies that we offer. Core Plus is one of our more popular bond funds. Emerging markets debt, which has been a very important product for us. In the equity space, small-cap and large-cap growth, two important areas. You can see real outperformance over their benchmark net of fees. We spend a lot of time on this and on attribution analysis.
We believe we have world-class capabilities in figuring out whether we're lucky or good. For those of you in the audience who are in asset management, you know that for periods of time, lots of people can look very smart in asset management. It's only by really tearing apart how performance was generated and how decisions were made, whether it was by stock, by sector, can you really figure out whether you've got a great investor. We think we're very good at this, and we spend a lot of time discerning about whether or not we're good or whether we're lucky. One of the core beliefs we have is that great investment performance that is sustainable must be done by a sustainable team. We have a very deep and experienced set of portfolio managers. Their average tenure is 16 years with Prudential.
We have very little turnover. Our regretted turnover last year was below 1% within investment management. We do believe that once investors come to this model, they enjoy it and they stay. That is absolutely fundamental to the consistency of the returns that I showed you. I talked a little bit about the rigorous approach that we take to attribution analysis. The same is true to our overall research capabilities. We are, for the most part, bottom-up security selectors, both in public markets and in fixed income, and we believe we have real proprietary advantages when it comes to our research capabilities. We believe in a team-based approach. We don't have individual portfolio managers who are stars. We have groups of people who come together to put together the recommendations that we have. All of our approaches are institutionally based.
We have very well-defined and written mandates for them. We believe we bring a real world-class investment framework and risk management framework to each of our client mandates. This is done to the highest standards of what many of those elite clients that I showed you earlier expect of us. We believe that that team-based approach is far superior to many of the kind of more guru-like views of portfolio managers that are out in the industry today. Let's move around then that virtuous cycle. I talked about the investment returns that we start with. What has that led to? Those investment returns have led to very substantial flows over the last five years. In fact, last quarter, we announced the 26th consecutive quarter of positive institutional net flows.
We believe that in looking out at large asset managers, that no one else has that kind of record of consistency. That is truly unique in the industry. We think it's a great tribute to the trust that clients have put in us through the investment returns and the process that I described earlier. We've had right through what's obviously been a difficult economic climate, very strong investment flows. What that's resulted in has been very strong AUM growth. This is our retail business. You can see that I've spent a lot of time talking about the institutional business. In retail, we've seen a 17% growth in our AUM, which has been one of the faster in the industry. Our mutual fund family has had a terrific run over the last couple of years, and it's something that we've been investing in quite significantly as well.
Total AUM has grown at 14% annually. I highlight that because we do think that that's an important marker of our relevance in the industry, not because we target it. Steve talked earlier about our overall philosophy. We do not have an AUM target, nor do we have a financial target. We have investment performance targets. We believe by doing that, other things will take care of itself. This is strong, but it's an outcome of doing the other things well. Importantly, as we've been growing AUM and through those new client flows, our asset management fees have also grown very much in line with those flows. Again, it's a 14% growth rate over this period, again, which has been a difficult and tumultuous time.
We also view that as one of the fastest-growing, if you look out at the industry landscape, one of the fastest-growing of any leading asset manager. If you look at our adjusted operating income, AOI, over this period and just focus on the dark blue for a moment, what you'll see is that since 2009, our core earnings from asset management have more than doubled, from $279 to $595. Those are the core earnings coming from the fees that I described earlier. The light blue are something that we've historically called it pick 'em, and stick 'em, and now are famously called ORR. Those are other related revenues which largely come from transaction fees, incentive fees, some of the returns that we have on strategic investments that we make behind our business.
When we seed a fund or we co-invest with a client, we have returns that are in those. You can see that has historically been somewhat volatile. One of the things that we've been working hard on is to reduce the amplitude of that volatility. You can see starting in 2011, which was probably its largest, that as a proportion of the whole, it's been coming down quite a bit. That's very much by design. There have been two main drivers of the volatility of that. One has been the large balance sheet that sat behind some of the businesses, and that's come down a great deal. I'll show you the numbers in a minute.
The other one is that we made last year an accounting change whereby we're only going to recognize incentive fees as they're paid to us rather than on an accrued basis, which we also think will dampen the amplitude of the volatility here. One of the important things to note about the asset management business is that it's an important source of cash flow for the organization overall. Our business very much essentially gets paid on a quarterly basis on AUM. That money comes in in cash, and we largely dividend that cash back up to the parent. Overall, the capital out of the asset management business has 80%-90% been put back up to the parent. If you're following the money in asset management, this has been an important part of just quarterly cash flow that comes up through the parents.
I mentioned the balance sheet a moment ago. Here was the balance sheet in 2008. You can see $3.4 billion. The interim loan portfolio, which was a set of loans that were essentially in a warehouse to build the CMBS business, which we've subsequently moved away from. The other is the strategic investments, which are importantly the money that we put into seed capital and co-investments with our clients. We've brought that down dramatically. At the end of the first quarter of this year, you can see that we're down at $933. We do think probably around $1 billion of this is the right overall level. We like the current situation. Obviously, what that's done has been to quite dramatically drive up the ROE of the businesses during this time.
We find ourselves now in a period where we have kind of a high 20% ROE for the asset management business overall. Here are the key financial metrics for the year-end 2013. Our asset management fees were $1.9 billion. Our pre-tax AOI was $723 million. Operating margins were 27%, and the AUM, which I showed earlier, at $870 billion. That's our virtuous circle. Investment performance leading to flows, leading to earnings. Let me turn from that and talk a little bit about the positioning of asset management more broadly within Prudential Financial. There's a couple of elements to this. One is just to highlight, and I think Scott's going to talk more about this in a little bit, the importance of our private businesses in generating higher margins for the general account.
We do believe that because we have a really unique origination capability within private placements and within commercial mortgages, that we're able to, and historically it's been quite a significant spread that we've gotten about over what you would get in publics, and that has provided a significant step-up to the margins within our general account. Obviously those aren't figures that accrue to the asset management business, but will be seen in the other businesses overall. That's a very important part of the overall construct of asset management and an important part of understanding the overall enterprise value of asset management to PFI.
I do want to highlight a couple of points that Steve made on innovation, because I think that as we move forward and these demographic trends play out, the combination of life insurance and insurance capabilities, risk management, and asset management will only come together more and more. As we do new product innovation, Steve talked about some of the new products and annuities. Many of those have been the result of very active collaboration between asset management and annuities. In retirement, the same thing has been true. Pension risk transfer has been a great collaboration in terms of how do you get that investment portfolio just right between the retirement business and asset management.
Stable value has been another terrific example of where the decision to really invest in that during the difficult economic climate and the subsequent success of that business has been very much a joint effort with asset management and retirement. Core capabilities of investing are widely infused in other of the affiliates, and we use those together very importantly for new product development. Let me talk a little bit about the future. You've heard the story of the last, well, really kind of 15 years and a highlight on the last five. Where are we headed going forward? The first thing I want to say is that we have, just over the last couple of years, invested very significantly in asset management. Just in the last two years, we have over 50 new investment products and strategies that we have launched.
We've had over $400 million in seed capital committed by the end of 2013, and we've had 40 new kind of fairly senior jobs that we've created. That's about a 10% increase over the last couple of years of headcount designed to really lead the business overall. We have been investing over the last couple of years, and indeed, we invested in a similar way right through the heart of the economic crisis, which I think also explains some of the really great talent that we were able to attract during that period. We have been investing, and the question is, why do we have confidence that those investments will pay off? It's because we see the landscape changing, and we see the landscape changing in ways that we think are attractive for us. I want to highlight three of them. The first one is globalization.
When I'm out talking to the CIOs of large pension plans, they have a very common theme, and they say, "We would like to have fewer strategic partners and fewer managers." We have too many managers in their current group, we need to have strategic partners who have broader capabilities. They are looking to do more with less people, and we believe that that's a trend that really plays to our strength. Because of the breadth of capabilities that we have, and because we are one of, again, pretty much of a handful of firms that have the global capabilities, increasingly, the large clients are going to be looking to put more and more of their funds with the largest leading asset managers in the industry.
This is a trend that we think will not just benefit us, it will benefit a number of other large players. It will importantly begin to drive more of the large winners, which will separate out from a lot of the other players in asset management. The second one is that we really do believe there'll be a broadening of what are deemed appropriate and suitable investment categories. We think that there's been a long-term focus on the public markets, largely in long only or sometimes long-short capabilities. With new techniques, there are a wide range of ways to invest now that there weren't five years ago. I've laid out just a couple of them here. We do think retirement income, for example, which might be combinations of some guaranteed and some others, is an important theme going forward in the marketplace.
We think real assets, we think infrastructure are very important going forward. We think people will more and more want products that have some upside but some downside protection. Volatility-managed products will be much more important rather than people just moving back into the equity markets. As investment landscape broadens, people who have the range of capabilities that we do and the innovation that we've been able to achieve, I think are going to be quite advantaged. The last is that we've really noticed that the downturn has changed the way people want to invest. Pretty much all of us of a certain age grew up with the efficient frontier. We all believed in a stable kind of correlation matrix between asset classes. Lo and behold, we found that in distressed circumstances, correlations go to one.
That really does fundamentally call into question the whole kind of Markowitz theory of how this works. Many of our clients, with our help, are rethinking how they do portfolio construction. Should they move to more of a risk parity or risk budgeting perspective? Should they actually move to more of an outcome-oriented way of managing money? We are seeing clients actively move in those directions. We think that the movement towards solutions might be pension risk transfer or LDI. On the retail side, it might be target date funds or in-plan income. We think that those kinds of solutions, which say that investing doesn't depend on whether or not you perform better than the S&P, it depends on did your child get to go to college? Did you have enough money for that?
Did you have enough money for retirement? Those are the key parts of investing and will move away from the relative benchmark world. We believe we're well-positioned to play in that sphere. These are the 3 major trends that we see, this globalization and the desire of large institutions to concentrate their assets with fewer but broader players, the broadening of investment categories, and the shift to more of a solutions orientation to play right to our strengths. Those are the 3 major reasons that we feel that the growth that we've enjoyed can continue going into the future. In terms of where we're placing our bets, we have kind of 5 major themes. The first one is this continued build-out of a more diversified and resilient set of products around particularly the volatility managed area.
We will continue to invest disproportionately in building out our global platform, both in Europe and in Asia. We will be investing significantly in solutions capabilities and whether that's on the retail side or the institutional side, we do believe that clients more and more want answers to specific problems rather than relative outperformance. We also will continue to look at both individuals and lift outs. We also would consider some bolt-on acquisitions if that made sense. Probably of a relatively small nature, but would fit into our multi-manager capability. We'll continue to invest in working with our other affiliate partners within Prudential.
We believe that this combination of a real understanding of liabilities and insurance, risk management and asset management will continue to be combined in new and interesting ways. They may go under the rubric of annuities or retirement products, but fundamentally, they'll be ways of continuing to deliver solutions to both institutional individuals in very new ways. Asset management will be partnering directly with affiliates to do that. In conclusion, the business obviously has had that virtuous cycle going very well. We have reasons to believe that the next couple of years as well pick up on some of these longer-term trends. We do think that the multi-manager model that I described earlier serves us well. We do believe the robust fundamentals, provided that we continue to focus on investment performance as our core, will drive that cycle.
We will continue to work with our affiliates in providing advantage overall for the enterprise. Asset management will continue to invest in its people and in capital to drive further growth. With that, I'll pause. Steve and I'd be very happy to take questions in particular on any of the U.S. businesses.
Before we get started on the Q&A, a couple rules of the road. Please wait for me to call on you. Please wait for the mic. Please state your name and your firm. Please try to keep your questions brief. Please bear with me because this is a difficult room. Last week, there were people in the back with their hands up, and I couldn't even see that they had their hands up. If I don't call on you, please don't take it personally. I'm just blind. Okay. Who's first? Joel, I knew I could count on you. Please keep your hand up.
Good morning. Joel Gross from ICMA Retirement Corporation. Good morning, Eric and panel. One question I have is on annuities. Are there any considerations, or where does fixed and fixed index annuities come into the portfolio of the annuity business?
The primary emphasis of the business has been in building out the product suite in the ways illustrated. We certainly have a fixed business. It has not historically been a significant part of our business. We don't expect immediate changes in that type of construct. I will point out that things like PDI are meant to achieve similar types of goals, but in distinctive and innovative ways. That product is really for the individual who has a strong appetite for guaranteed income but doesn't have any particular appetite for equity market participation. We're definitely looking to cover that base, but to do so in more innovative ways that really play to our strengths.
Okay. Thank you. One other question. In regards to the pension risk transfer business, you mentioned that these kinds of deals are hard to predict and when they come along, they're usually pretty sizable. How long of a lead time does it take to book and close one of these deals? What's the life cycle of that?
It really depends. To have cycles, if you're talking about initial client consultation all the way through to eventual booking, to have this cycle be multi-year would not be at all out of keeping. Some are shorter than that. All of them are the result of a highly consultative process.
Okay. Thank you. If one of those happens to be booked during this year, would that preclude or constrain the growth of other types of businesses, like stable value products or acquisitions?
We think we have the financial capacity and the financial strength to continue growth along a multiple of lines as Rob addressed in his comments and as I've addressed in mine, and as John will address in the international context. We don't see that progress along one front would necessarily and significantly constrain continued progress on other fronts.
Okay. Thank you.
Thank you.
As I said, I'm blind, so I don't see any hands. It may be that there are hands up that I don't see. Yes, the gentleman in the front, third row center. Would have been quicker the other way, Jessica, but that's okay.
Good morning. Jukka Lipponen, independent insurance analyst. I have a question to David. I believe Cerulli just came out with a report saying that as the baby boomers now retire and start to withdraw their retirement assets, that that's going to be a real challenge for asset managers, at least in that part of the business, many managers will be in outflows going forward.
It's been a trend for quite a long period of time that there are two big shifts that have been going on. One has been the move from DB to DC, the other one has been the demographic that means that as people do retire, that they've been looking to move their funds out. Our experience, anyway, has not been that this has been in any way a diminution of opportunity. In fact, in many ways, we've seen this as a significant plus. If I take the institutional market for an example, while the total AUM has certainly slowed in DB markets, the opportunity for the kinds of products that we offer, which are more of the de-risking LDI approaches, has actually grown quite a lot.
While as we look out even over 10 years, while we can see that some of the AUM growth will slow as people begin to retire, they're actually moving that into the kinds of products that we actually offer, whether or not that's income-based products or target date funds or others that actually play to our strength. While it's true at the overall market, given our mix, we actually see that demographic trend as a plus.
Thank you.
We're apolitical at Prudential, nonpartisan, I should say. I don't mean to discriminate against the right side of the floor. Are there any questions over here? Seeing no hands, let's break.
There's one.
Oh, I beg your pardon. Where? Back on the left.
Thank you. Jay DiNizio with Hughes & Associates. Rob had a slide early on, it was the pie chart with the insurance risk on the right and the market risk businesses on the left. Just wondering if there's sort of a high level strategic target that you manage the businesses with respect to regarding the balancing of those different risks.
The way we look at that goes well beyond the level that Rob showed. Rob showed an illustrative level to kind of summarize our overall construct of business mix. When we look at how that impacts our trajectory and our strategies going forward in businesses, we look at multiple levels underneath that and look at the types of risks that those businesses are underwriting. An example would be in the annuities business. That's certainly one of our larger businesses. Our view as to growth prospects there is very much one that's driven entirely by the mix that that growth might look like. If the mix is diversified and is one that continues to serve to diversify the risk profile of the annuities business and of Prudential's overall business, then that would be something we would view as success.
Like I say, we look a couple of levels underneath the business unit type of construct and look at the types of risks being underwritten in each business and across the full range of our businesses.
Okay, let's take a 10-minute break. Don't worry, David, I won't collapse your business. Am I on? Good. Let's resume. Try to stay on schedule. Kindly take your seats. Our next presenter is John Hanrahan, the Chief Financial Officer of International Insurance. John?
Thank you, Eric. Good morning, everyone. I feel a little pressure this morning since I'm filling in for one of my bosses, Charles Lowrey, and my other boss, Rob Falzon, gave such a great introduction earlier and raised your expectations. The challenge is on. Many of you have followed our international business for a number of years, and you've heard a consistent story. We have a proven business model, provide superior service mainly through our proprietary distribution. This model generates high ROE with low volatility and returns substantial capital to our shareholders. Japan is where the story began and where we continue to see opportunity. Earlier, Eric provided the required disclosures, and he always stops us from making any kind of projections. He's retiring. I'm going to give some projections. Here's the situation. Interest rates are very low in Japan.
The industry experiencing low growth, poor profitability. Prudential has acquired a large, formerly insolvent insurance company. Japanese population is aging. The Japanese economy is struggling. Here's my two projections. Over the next 6 years, life insurance sales, as measured by face amount, will decline by 50% before beginning to recover over the next five or six years. Despite that, Prudential's AOI in Japan will rise steadily, essentially quadrupling over that 12-year period. I did forget to tell you that the base year was 2002, and that's what happened. There are some similarities. Star and Edison now, Gibraltar back then. I wanted to make this point because I wanted to show how important this business model is, how resilient it is through different cycles. This is talent management at work. This is how PII was built. It was built around quality people, developing them.
That's what makes this model work through different cycles. Now, I had to get that part just right because I was given a projection. Eric and I go back a few years. First, back to this proven business model. It is, as I said, it's built around life planners to start with, but quality. It's built around quality every step of the way. I'm going to talk a little bit about this model as I go through, just to remind you. First, we began selling in our own wholly-owned subsidiary, Prudential Japan, in 1988. Prior to that, we had a joint venture that started actually around 1980, with Sony, and now we had a chance to get our own license. The foundation, our core model, was built around this life planner model. We differentiated ourselves by having professionally trained life planners.
Again, back to talent management. Carefully select them, commit to their success. We focused on life insurance protection, right? We were focused on needs-based selling. That meant we weren't selling products, we were selling solutions. First, we had to understand what the customer needed, then we provided a solution that met that need. Throughout this model, disciplined execution matters each step of the way. In a few minutes, I'm going to show how our model has expanded from a life planner model only to other distribution channels. The key was that we had to maintain disciplined execution each step of the way, and that was done because of the quality of the people that we had in our organization. The people in the organization were committed to the success of the company.
The other day, John Strangfeld mentioned about low, I forget the exact wording he used, but no controversy. Let's get the job done. Let's get the company to be successful. That's the type of people that we have executing these models. Disciplined execution in whatever business model we're following, whether it's a life planner model, a life consultant model, which is a more traditional type agency, or in our other bank distribution or third-party distribution. As I said, we start life planners. We're focusing on the affluent customers, the mass affluent, death protection products. Here we're meeting their needs with whole life policies, term policies. A little different, because at the time, the industry was focused on a higher, more of a savings element, product pushing. Over time, we've expanded the business.
The small business market in Japan became a very good market for our life planners because a lot of their customers own small businesses, and they started realizing that those businesses had needs for their employees that also could be met. We expanded into the retirement products as well, because as our life planners worked longer in that market, some of their customers were thinking more and more about their retirement needs as well as their protection needs. We acquired Gibraltar in 2001. The Gibraltar acquisition brought us a traditional sales force, for one. It also brought us an association relationship that I'll talk more about in a few minutes. The traditional agents were historically, primarily salary-based compensation as opposed to productivity-based. They focused more on product sales as opposed to needs-based selling. We knew we could not turn that operation into a life planner operation.
What we could do was enhance the professionalism of those agents, improve productivity, teach them needs-based selling, change the compensation system. Those types of things could be done to raise the overall quality of that operation. We reached another part of the market. Finally, third-party channels. We added the bank channel and the independent agency system is growing in Japan. Gave us new opportunities to reach very high, wealthy individuals through some of the banks. We now have relationships with all the major banks in Japan. We're able to reach another additional market that complements the businesses that we have with our life planners and our life consultants. Throughout this, we focused on death protection. That's the core. Whenever you hear more and more about price competition and other types of things, that's primarily related to demand products.
Products that are in demand by customers can be met through various distribution channels. They may go on the internet to go find those products. They may go to their post office to buy those products. There's many ways that you can meet the products that customers are looking to buy. Debt protection products still need to be sold after doing a needs analysis and helping the customer understand what their needs are. Debt protection is one of our competitive advantages. That's what allows us to continue to generate sustainable earnings. Our customers, in meeting the protection needs, our life planners, life consultants, do develop relationships. Their customers have additional needs and demands, and we can meet those either with riders or other products. We do sell other products as well.
The thing that we can do differently is sell protection products, and that's the one where it's a lot tougher for people to learn how to do. It takes a lot longer. This is one of our key sustainable advantages. The second key sustainable advantage is disciplined execution, and that comes back to having those people, the people that are committed to the company's success, the people that were carefully selected. I'll talk a little bit more about some of the things I've seen and how hard we work to select those really capable people, and the commitment that the employees, the life planners have to the company, and the commitment the company management has to the employees. Now you see when it comes with the acquisition, we start with this life planner model. Over time, we acquired Gibraltar.
The life planner model is a great model for the affluent market, where you can spend a lot of time. The sales in that product segment are done over multiple visits. They don't visit a customer, sell a product, and get out of there. They visit a customer, get to know them, understand their needs, come back maybe two or three times with the solution that fits that customer's needs. That's disciplined execution. When it comes to acquisitions, there are ways to execute where we have advantages, where the people that we have in the country understand the business model, so we can help retrain and make a sales force more productive than it was before. We have scale in that country, so we can acquire Aoba or other types of things.
We can actually pay a little more than it's worth to the seller, and it still returns a great deal to us because of those competitive advantages we have. Disciplined execution always matters. Over time, we have acquired Aoba, Yamato, more recently, Star Edison. The multiple that we've increased our size in Japan is amazing over that period of time. Always it was built around disciplined execution, whether it was when we selected and developed a life planner, or whether it was when we identified, acquired, and integrated an acquisition. This will be, I guess, the last session, the last year that we're going to talk about the Star Edison integration because it is essentially complete. When we started out, we thought there could be up to $500 million of integration costs.
We subsequently reduced that number down to about $400 million, and we've spent about $340 million so far plus there are certain amounts that were spent that will be amortized over the next several years. We think we will finish at under $400 million or about $400 million of integration costs. We had originally identified about $250 million of annual cost savings that we expected from that acquisition. We, I guess, as of last year, the fourth quarter, we had reached about $62 million of synergy savings. If you annualize that, we're there, so we're complete. The second there, I talked about the sales force. At Gibraltar, we took a sales force that had been not really doing as much needs-based selling and converted them. We're doing the same with Star Edison. We've converted the compensation structure, the product sales, and so on.
We now are getting the kind of productivity that we would expect from our life consultant channel. The product portfolio now selling a consistent product portfolio that's achieving the profitability targets that we have set. We've also de-risked the portfolio. Historically, we've had a more conservative investment portfolio in Japan than the majority of our competitors. We really have made our money on mortality and expense margins, on execution, a lot less on taking any excess risk in investments. I want to move on briefly to some of the financials. First, you can see the AOI. Actually, I hope you can see it because I'm having trouble. Anyway, you can see the AOI over this period of time. Remember, this covered a period, this was the beginning of the financial crisis was hitting.
If you were to go back several years, if we extended this chart, you would see record earnings right through the financial crisis. Did not affect these operations. What you do also see is the impact of the Star Edison acquisition. That would have been in 2011 is the first year of that acquisition. You see the increase in the top part. That including the synergies as we went forward. Also, there were a number of what I'll call tailwinds. For starters, you can see across the bottom that the foreign exchange rate was strengthening pretty significantly over that period of time. Later I'll talk about our income hedging, which has a smoothing effect, but it does not eliminate the effect of FX rates themselves. You see with the benefit of a stronger yen, our earnings are coming in higher.
We had the acquisition of Star and Edison. We had other tailwinds, things like with the currency changing, we had some additional surrender gains and other types of things that you've heard about historically. The way Charlie referred to it the other day, you can't take a ruler or something and sort of straight line these earnings up because we've benefited quite a bit from some of those tailwinds, but there's also underlying growth that's in those businesses. This model is sustainable. This model produces good solid AOI. In the future, we have some headwinds. We have things we've identified like the current exchange rate we're using for 2014 is JPY 82 to the US dollar. Currently, the yen rate is running over JPY 100. Over time, if that were to stay the same, that would phase in.
You can see that we talked about the consumption tax somewhere in the past. The consumption tax has increased to 8%. It was 5%. It's 8% this past April. It's scheduled to go to 10% at the end of late in 2015. That will have an impact on us. There's some headwinds going forward, but the underlying model is sound. On the ROE side, you can see when we acquired Star Edison in 2011 that the ROE dropped down. We paid a little about $4.6 billion or so, $4.8 billion for the Star Edison acquisition. Initially, we had to get some of those synergies and so on. The ROE has dropped down, but it has since recovered pretty much. You see as at the end of 2013, we're back in the range of the ROEs we've had historically.
I'm going to start breaking down a little bit more into the models themselves, into the business models we have, the life planner starting. As I said, affluent market, this business and individual consumers. I want to go through the build our virtuous cycle . This is something you have seen, so I'll go through it pretty rapidly, but it's built around, first and foremost, quality people. If there's one thing we do differently, it's we really are careful about selecting quality life planners, and then we're committed to their success. That, more than anything, matters. Quality product, what that really is saying, we're meeting the needs of the customer with the products. In reality, the products are similar to what other companies can provide. Quality service goes back to those quality people providing that. We'll go through all those types of things.
You can see I'm not sure where you actually start because it is a cycle. We have very high life planner productivity. That high productivity gives that we have high life planner retention, and we have high policy persistency. If you were to assume, well, what exactly does that mean with some of the numbers? You can see these numbers are all well above industry averages, right? These are the kind of things that will make this model stay successful. If you keep these drivers at these levels, you continue to be successful. The way we would talk about it is the life planners come join us. We carefully select them. We intend this to be their final career. They are already successful in some other job. I've seen some of our managers, the way they recruit people, they may spend one year recruiting someone.
They meet someone, usually it's a customer, who is impressed with our products. We understand their background, we think they may become a good life planner, we begin to recruit them. After we're all done, we select just two out of 100 or so that will be life planners. A lot of them realize they're not right for the field, we realize they're not right, we work our way through. In the end, just selecting to those few people who can be successful because this is the right career for them, this matters. When you're all done, you get the superior returns, the steady growth that we've seen. Let me give you some outside views.
These are our own numbers, our own views, and I'm sure many companies will talk about the quality of their people as a great strength. This is one outside measure. The MDRT, international organization, I think many of you are familiar with. Our life planners are very heavily represented in this group. We have been the leading life insurer in Japan for the past 17 years in terms of the absolute number of life planners. That's despite the fact that many of the companies in Japan are very large, have much larger distribution forces. If you combine POJ, Prudential Japan, with Gibraltar, combined, they represent almost a third of the total MDRT members in Japan. This tells you. Again, it's about the numbers. It tells you some statistics.
These are some of the things that I learned when I was over in Japan. I learned the life planners are an integral part of their customers' lives. They attend the children's wedding many times. They go to the funerals. They go to the hospital when their customers are sick to make sure that they help them get their claims processed and everything like that. This is a trusted advisor. That's what's different. The fact that they become MDRT members, that's just because they're doing their job so well. They're getting the referrals. That's what drives this business. We don't advertise in Japan. The life planners get referrals from people that they've impressed, people that know that they can trust them. They're not going to be pushed a product.
They're going to understand a need they have, then they'll buy something from us because that's what makes them different. We can cover our customers over a lifetime because we keep them for a lifetime, and we keep our life planners. Over time, we started out very young. It's still a fairly young organization. A lot of our key target market is people in their 30s, young families. That also covers professionals, small businesses. Some of those are already meeting some of their protection needs, and they want to start meeting their retirement income needs. As people get older, typically, they're thinking more and more about outliving their retirement funds. They're thinking more and more about medical benefits and other types of things. A life planner that has sold them life insurance protection that they really trust, this could be an add-on product.
We can meet them over the cycle. There are times we sell a retirement income product to people in their 30s. We sell a lot at POJ at the younger ages, which provides protection at first, then over time builds up a savings development that will provide retirement income for them. The product spectrum is not absolute. What it comes down to is a life planner who's sticking around for 20 years, working with not only the customer, but the customer's children as their families take on. That life planner can sell products across that whole spectrum. Once again, let me go to an outside metric. We've been ranked number 1 four straight years. J.D. Power has said for life insurance customer support, Prudential is number 1 across the whole industry in Japan. You can see that kind of shows up in policy persistency.
Customers who understand what they bought, who are satisfied with the service they're getting, they keep their policies in force. That's when you get the best value for the customer. Right? The customer buying a policy, letting it lapse three or four years later is paying a lot of costs, a lot of acquisition costs. They're not going to get their need met. Customer who keeps that life insurance policy in force until the time of the claim, that's when they get value. High policy persistency in the first year is critical because that ultimately leads to ongoing high policy persistency into a claim being paid when it's needed. Those things tie together. The outside world recognizes it, or J.D. Power has verified it. We see it in our own policy persistency. Another measure, I was in Japan.
The head of our corporate planning got a call from the regulator, the FSA. They wanted to talk to us about our suitability, our compliance. That would shake up anybody, you get that kind of call. What they said was they wanted to talk to us because they found that our customer complaint ratio was so low relative to our size. They were trying to understand what were we doing, why were we able to have so few complaints relative to the size of our book of business. It comes back to those life planners. It comes back to people who are committed to the customer, making sure the customer understand there isn't something to complain about because the customers know what they're buying, and they're satisfied with it. It's not about price. It's about the service level. It's about needs-based selling.
Some of this manifests itself in repeat sales to existing customers, and you can see we've had a fair amount of that. A lot of our business is the life planners going back years later to the same customers and selling additional coverages to meet their changing needs or additional needs. You do see a jump up in 2012, then it drops down somewhat in 2013. Like all sales, there are things related to product changes, pricing changes. We increased prices on our dollar products in 2012. There were tax law changes that affected certain types of products. That can affect second sales. The trend of an increased amount, repeat sales to existing customers, that's another testament to the quality of the sales and the business model. Here, I want to talk a little bit about how this quality pays off to us financially.
The first is to show a typical type of sort of an average type numbers in Japan of how much business would be sold by an agent that's hired on average, say. This means over their lifetime. Typical industry numbers, I don't have any handy, but probably 50% or so is a first-year retention rate, something like that, a little bit lower. After a couple of years, you're down to 25% or so, give or take. It trails off pretty quickly because a lot of the people are not sticking around. Over a lifetime, for each agent hired, you might sell $200,000 of annual premium. Our life planners, if you strictly looked at just the fact that they're sticking around longer, they're selling almost three times as much.
Even if they had the same productivity, just the fact that they're sticking around a lot longer, all of a sudden, we're three times as productive. Think about what that means to us in terms of our recruiting. Yes, we spend a lot of time carefully selecting people, but once we've hired them and now that we're committed to their success, we're investing in their training, they're sticking around and producing a lot more business. In fact, three times as much business productivity wise. I'm sorry, retention wise, just sticking around longer than the average. When you compound that, when you take into account the fact that they're much more productive, they're selling larger size policies, they're selling more of them. All of a sudden you're getting to a multiple of almost 10 times the amount of business that's sold.
That will translate into efficiencies for us in terms of the ultimate payoff from the time we spend training and developing them. Again, the customers, the more satisfied customers, this doesn't even take into account how much premium revenue will be higher because policies are staying in force longer that have been sold. You can see a real value. This is the payoff from that quality. Get the right people, commit to their success, you'll see the benefits as a company. It's an outcome. That's some of the things David talked about. Outcomes. Focus on the things, your activities, focus on quality, you'll get the results. Here, once again, you'll see the annualized premium. This is more now collective. I gave you the individual agent numbers, individual life planner numbers, and you can see how much more they would sell.
If you look at the actual sales trend over the years, and once again, you'll see a drop off in 2013. If you emphasize that 2010, 2012, you see very nice steady increases those years. Whenever it came around to my performance review, I was trying to convince people that those were the years I was in Japan. They laugh too. They know it's really about there's other things going on. The people that are there, and by the way, most of the life planners that were selling were people I hadn't hired. They were there when I got there. This business has momentum to it. The quality of the life planners that are there is so high, they continue to sell right through the financial crisis. You will have volatility in sales.
You're going to have things, as I mentioned before, price increases that will drive some changes in sales. You'll have tax law changes. Products for some of the small business market had different tax factors. There can be some noise. If you sort of look past that, what you'll see is a trend where we've continued to grow our sales in that market all the way through. We move on now from the life planner model. The life planner model, I said, I love the model. It's an excellent model. It's the right one for that target market, but it's not the only model, and it doesn't address all markets that we can address that can use our services and needs. The life consultant model meets additional needs that we are very happy to provide. We're focusing now more on the mass affluent, the mid-market.
With the Gibraltar acquisition, we picked up a long-standing relationship with the Teachers Association, and I will come back to that in a few minutes. So affinity marketing is another factor there. We have also expanded from the life planner model, which was focused on the cities, we have now expanded throughout Japan. You can see that here. We are in pretty much every prefecture. Well, we are in every prefecture in Japan, meeting the needs of the customers. We provide all types of products across the spectrum. The Teachers Association is a very important part of our business, but as you will see later, it represents about a quarter of our new sales, particularly now including the Star Edison acquisition. In the teachers, this relationship went back with Kyoei all the way back to 1952. In Japan, relationships, long-term relationships really matter. We care very much about this relationship.
Through the affinity group, you can provide specific products that meet the teachers' needs, which we do. We continue to work closely with that association on identifying what their customers need and offering certain products to them. This is sort of a win-win, we think, for the association and for our life consultants. One of the things that also helped us with the Star Edison acquisition is that we picked up agents that could now be trained to help us cover areas, prefectures where our coverage was thinner. So we are able to provide even better service to the Teachers Association and maintain that relationship. If you look graphically, you can see every year there is about, we will say around 33,000 new teachers coming in, about 36,000 that are retiring.
In total, if you count the teachers and the associate support staff, there is about almost 1 million people that are our target market on an active basis. We sell them term whole life, some retirement income, some savings products. But the retiring teachers also need our needs. They get a few hundred thousand dollars upon retirement, and they put that money to work, some of it in buying, say, a multi-currency fixed annuity, retirement income product, other types of products. So we have products that meet the needs of those teachers literally coming and going. I want to just give a little bit of background before we talk about the Star Edison acquisition and what we are trying to do there because we are really in the middle of changing over that organization to be like Gibraltar now. So let me go back in time.
When we acquired Gibraltar, after the first year, we had declined from, I think we ended that year a little over 6,000 life consultants. We had started with, I think, over 7,000. So the number of life consultants was already beginning to drop down. It dropped down for a couple more years. But meanwhile, as we converted them to a productivity and persistency-based compensation plan, very similar to the life planner compensation plan, what we saw was we were able to elevate the productivity. While the number of life consultants came down, the productivity went up, and we reached about, I think it was around 7,400 or so of average premium by the time we sort of finished introducing the new compensation plan. That is about the level that we ended 2010, right before the Star Edison acquisition.
Meanwhile, while originally the life consultant count dropped down as we were changing over, people who are more productive make out much better under our compensation plan. Obviously, people that aren't would be better off under a fixed salary plan, which we had discontinued. Now we fast-forward to 2010, and you can see we've got a higher level of productivity, and by that point, we've been rebuilding the life consultant count to back close to the 6,000 that we ended that first year. Now we want to just position that versus what we're doing with Star Edison. While it's not at the same scale, you can see the 2010 right before the acquisition, the productivity level, and the number of consultants. We acquired Star Edison. I guess we finished 2011 with about 12,000 or so life consultants after adding them to the Gibraltar.
The productivity was lower, and this is the average productivity, including the former Gibraltar plus the Star Edison. Introduced the same kind of compensation plan, moved everyone to that same plan over a couple of year period. What you've seen is the life consulting headcount has dropped down. Productivity is coming back up. We're in the middle of the same story. Now it's up to us. We're not exactly sure where this will bottom out. I think Charlie said the other day we're looking at the end of the year, maybe early next year for bottoming out on the life consultant count. We hope to continue to grow that life consultant channel, but at the higher quality level, needs-based selling of product, not product pushing. That's our goal. We've got the productivity level back to where it was before the Star Edison acquisition.
This is just another way of looking at some of that same information. You can see over time, the life consultant count has dropped down by around 27%, so substantially more. Meanwhile, the sales volume has only dropped. It was dropped about 10% since 2011. Again, some of this is tied back into those pricing changes that I talked about earlier as well. Overall, you can see there's an efficiency now that's been brought into this acquisition. We have fewer people, but they're selling almost as much business. That's again, with some noise that always goes into sales numbers. I want to talk just a little bit about the supplemental distribution channels. We specifically use that word supplemental. Our core is our captive proprietary distribution, but once again, we can reach additional customers through supplemental distribution. That's what we do now.
The bank channel has been one of our fastest-growing channels. There's also independent agents as well, but primarily it's the bank channel so far. That brings us a few things. It brings us access to customers that we really didn't have access to before. There are some very high net worth customers. There is so much money sitting in bank deposits in Japan, where different products could meet their needs more effectively than what it's doing. They're certainly not earning any interest. Of course, now in the U.S., neither are we. There, they have so much more proportionately sitting in bank deposits. The banks are certainly welcome to this because it gives them opportunities to earn some commission. The customers ultimately are open to this. We have access to more customers, but it brings some challenges that are a little different.
I talked before about the price competition. When you're selling certain products that must be sold, the competition is a little different. When you have more demand type products, savings type or other types of things, you have to be very sensitive to price competition. With the bank channel, we say it's supplemental. We're willing to cut back if we're not going to get our margins. You saw that historically with us when other companies were introducing variable annuity products in Japan, despite the very low interest rates, which made it a challenge. We didn't do it. We couldn't find a way to make it work for the customers and for the company. We said, "This doesn't work." We couldn't figure out a way. We didn't do it. Ultimately, that worked out very well for us.
The same when we introduced a low death benefit whole life product. As interest rates came down, there came a point where we were able to get our profit margin, but as interest rates started to come down, we could no longer do that, and there is a risk in those types of products, and we have to balance those things. We cut back those sales very dramatically. In fact, discontinued the product because at this interest rate environment, you cannot sell that product and cover it from a risk management perspective and a profitability perspective. We take the product off the market. We don't mind if sales from that channel will fluctuate. That's okay. We care more about bottom line than top-line revenue. That's the key. This is a supplemental channel, but it does provide some additional access that we don't want to lose.
Here you can see visually. The bright orange is that third party, in 2012, we had some very substantial sales there that we still have substantial sales in 2013. The kind of products we're selling, primarily a multi-currency fixed annuity that has a market value adjustment in it. We've added market value adjustments to a lot of our products. We're also selling a lot more recurring premium products, which have a different risk profile than some of the other types of products. Once again, if you go back to, I guess 2009, you'll see this is a very small channel. It's providing a sizable amount of premium, again, we focus on profitability and risk management, so it's supplemental. Meanwhile, the life planner, life consultant channel continues generally to provide steady growth in revenues and sales, product price changes, and other things excepted.
Here I want to talk about something that people look at the Japanese market and say, "Is that a sound market? I mean, it's low growth, it's aging, and so on." We talk about the Japanese market as an attractive market for us and for our products. Here's one measure. If you look at the size, the sheer size of the Japanese insurance market, you compare that to all the rest of Asia combined. There's some high growth areas, Southeast Asia, high growth, but very small. China, India, certainly down the road, these are going to be very large markets. If you look today at the size of the Japanese market compared to the entire rest of Asia, it's bigger. Japan has more premium sales than the rest of Asia combined.
Even, I guess Charles Lowrey talked about being wild and crazy and adding Latin America on top of the Asia ex-Japan market, and you still don't get to Japan. High growth is very valuable. It's very important, but the absolute size of the Japanese market is very huge, and it continues to represent opportunities to us. We're not leaving that market. As we think about other measures, I talked before about the wealth that's maintained in Japan. Their customers have a lot of liquid assets. There's a lot of cash that will be changing hands, passing from generation to generation, and there's a need for those types of products. However you look at it, the retirement needs for the customers there that are not being met by the government systems, that they're more and more going to rely on individuals to provide for themselves.
They have the money. They have the need. We have the products and solutions and advisors. This market is another market we can meet, and that's why we continue to feel very bullish about Japan as an opportunity for us to continue to grow. Here's another measure. When I talked to you earlier, when I shook Eric up about the projection I was providing, you can see the new business face amount. It dropped down from the $124 to $61 or so. Can't read it myself anymore. I have to learn that. I think I've been reading closely, but all of a sudden, I'm having a little more trouble. At any rate, the new business face amount dropped down to about half over that period from 2002 to 2008. That is, one, a true decline in sales. Second, there's other factors.
As interest rates come down, you're buying a lot less insurance. It costs more for the same amount of insurance because the interest is a component of the premium. That was some factor. The premium levels are a lot more stable than that, still, the face amount has gone down for the industry. If you look at the line going across, you see that wasn't the case for us. Despite the fact that we were raising premiums per dollar of insurance, we were still selling more insurance. The big jump in 2011 does include the product changes as well as the Star Edison and so on. What you can see is while the industry has now recovered and has had some modest growth, we've certainly been outpacing that, but we never had the kind of decline. This comes back to execution.
This is talent management at work. This means even despite cyclical trends and other types of things, if you execute, you can still be successful. Here's one more measure. This shows the number of agents, the captive agents, full-time agents across the industry in Japan. Once again, you see a very significant decline. If you superimpose people, the population in Japan has actually started to decline. It's going down about a million or so per year. The population is declining. Look at that agent decline. What that says to us again is opportunity, because there are so many more customers per agent or per life planner. They need the products. They need the services that our life planners and life consultants can provide, and there are fewer and fewer people, companies, agents that are meeting those needs.
We continue to see opportunity for us to grow in that market. The second part, even though, as you said, the aging population, if you look over a long period of time, you can see both the actual and then the projected trends. Japan is a shrinking population as of now, and it is an aging population. Older customers are actually buying more and more products. Not just the life protection needs. The estate taxes are going up in Japan, or scheduled to go up in Japan. It will now apply to a lot more people. I think the numbers they were saying were maybe about going from about 4% of the people to maybe 20%, that it will be applicable to, the inheritance or estate taxes, and the rates will go up. More and more people are thinking about how do they provide for that.
That's protection products. There are medical needs and other types of products that will be supplemental that we can provide. Our life planners have stuck around a long time. More and more of our life planners have customers that are in those markets that want those products and trust their life planners. Once again, we look at this aging population, not so much of a threat as an opportunity to us. We have achieved a nice scale in Japan. We're now, in terms of that new business face amount, and that's something very important to us because that's our core, that protection need, we're number three. These are some very large companies in Japan. We're number three in that market overall. In terms of the other measures, more like number five or six in terms of total size.
As I said before, this is a very, very big market. If you were to take the top four life insurance companies in Japan, the total amount of insurance sales in the U.S. for all the companies, stock and mutual companies, take the top four, add them together, we're selling almost as much business in our Japan operations as all four of them put together. This is a huge market. We can continue to sell in this market. Let's see. I want to talk a little bit outside. We do have other operations. We are primarily in Japan. That's where the bulk of our sales, our revenue, AOI. We do have an established operation in Korea that's producing about a quarter of a billion dollars of AOI. That market is very competitive, more and more so.
We're not very large in Korea, again, our emphasis is always on profitability. It's not on market share or size. We want quality, profitability. We care a little bit less about revenue, market share, those types of measures. We're getting about a quarter of a billion of our AOI out of Korea already. We have a life planner business that's been in place in Brazil for a number of years that is starting to show the significant growth in sales. We're seeing about 80 million, a little over $80 million of annualized premium. This is good protection type products, good margin products in Brazil right now. The drivers, the retention, those things are well above any competitor in Japan, whether it's persistency or retention, those type of measures. It's small. Last year for the full year, they made about $6 million.
First quarter, they made $7. These models take a long time to build. Properly executed, they can generate very substantial results eventually. Brazil, more of a near term, keep an eye on it. Longer term, we've invested in India, China. These are huge markets. International insurers really can't ignore them. These will be long-term opportunities. There's a couple of billion plus people combined in those two countries. Malaysia, we announced a joint venture earlier. Another factor, when we went, and I wasn't there, but I heard at the town hall, we introduced ourselves to the new partner. One of the things that impressed the people there was that our commitment to life insurance. They never really thought of it as a business and something that saw all the need, the missionary zeal, that other, that sort of the secret sauce. Why our life insurance businesses do better.
They were hearing that in Malaysia for the first time. We're going to continue expanding. We're not trying to plant flags in a whole bunch of countries. We're in a lot of the key countries. We're in most of the ones we want to be in. We do have near term. Japan will be our numbers for the next several years. We have long-term opportunities in some of the larger markets as well. Let me get to the last category. It's just a little bit about our risk management, capital generation, and so on. These businesses, ultimately, you wonder how does it get back to shareholders? How does it protect the bondholders and make sure we're making our payments? First of a risk, foreign currency is an obvious one, especially we've seen the yen move around.
I think everyone's familiar with the accounting remeasurement. This is really simple, that the change in value of the asset due to currency that's on our yen balance sheet, we have US dollar assets backing US dollar liabilities. The US dollar asset change goes one place, goes to equity. The change in the liabilities goes to the income statement. You have noise. Economically, there's no issue. You heard about that a lot. Asset liability management, in addition to the normal things where you're looking at the cash flows and duration, we also have, because we sell US dollar products, AUD products as well as yen products, we make sure that we back the AUD products with AUD assets, the US dollar products with US dollar assets, and the yen products with yen assets. We are currency matched on our liabilities.
In addition to that, as a U.S. company, we're focused on a more stable AOI. There's a little more predictability in our earnings as opposed to a more rapidly fluctuating yen. We have a three-year hedging program that smooths out the impact of the yen on our AOI, and we also protect the company's ROE. We are trying to make sure that the impact of a changing yen does not have a significant impact on overall company's ROE, and we're protecting more of the enterprise equity value. Oops. Try again. The income hedge I mentioned is a three-year rolling hedge. I think we were asked the other day what the rate will be for 2015, and it's going to be I was seeing if he was paying attention, but he wasn't. Just kidding. You know, we hedge this very gradually.
It's something we've been doing for many, many years, and it has provided a certain amount of stability and predictability to our AOI. You can see the impact. You can see the current rate this year is 82 JPY per dollar. Over time, all I can say is that the future exchange rate will if the rates were to stay exactly the same, eventually you'd get to a yen rate similar to the current rate, but that doesn't always happen. The interest rate environment. Japan is in a low interest rate environment, that is nothing new. We've been in a low interest rate environment almost our entire history. We have not made our money off of investment spread, generally. We make it off of mortality and expense earnings. We constantly are adjusting our prices to meet what the current interest rates are.
That can mean in a case of POJ, it can mean we have some older blocks that have some negative spread, our new policies are at positive spreads. All of them have positive overall because of the mortality and expense coupled with that. The restructured companies, all the Star Edisons were originally restructured, Gibraltar, all those blocks were restructured down to a very low guaranteed rate. We do get some positive spread there. The bank channel business, the multi-currency fixed annuity repriced very, very frequently. We're locking in spreads. We've been dealing with this low interest rate environment for a long time. Certainly, we can help us a little bit to come back up. It's been a bit of a headwind that we're facing, it's not something we haven't dealt with. Finally, on a risk measures side, our current solvency margin.
We maintain very high solvency margin ratios in Japan. When we talk about our equity, it's the actual equity we have there, which is exceeding all of our required measures any way we've looked at it. We tried to stress looking at stress scenarios, so whether real estate impact, changes in real estate, changes in equity markets, interest rates, and so on, all combined. We looked at what the effect would be on our solvency margin ratios. It still leaves our ratios well within what we consider to be the AA standards, although I guess I'd have to defer to some of you in this room to decide that. These are the kind of numbers that we see as we've heard. Even through these very serious stresses, our solvency margins remain very, very strong. One of the last categories, the investment portfolio.
We have a very liquid, people describe conservative investment portfolio. A lot of government bonds, both on our U.S. policies, we have U.S. Treasuries too, but the Japanese Government Bonds, the corporate bonds, almost all investment grade. If you throw in the investment grade rating of some of the other categories, you're looking at about 90% highly liquid, high investment grade, very few risk assets in that portfolio. Scott Sleyster is here today, he'll cover maybe more about the portfolios. Finally, the capital. What happens? We have these results. What happens for the shareholders and bondholders? How do you get your return? You can see this chart only goes back 5 or 6 years. We can go back a lot longer. We've been able to redeploy about 60% of our after-tax AOI through various forms, whether it's dividends directly from our subsidiaries, it's in the acquisitions.
Star Edison, a lot of the acquisition funding came from our own operations. There are many ways that we can access the excess capital. First and foremost, those companies are capitalized very strongly in Japan. We're going to meet those customers' liabilities when they come due. At the same time, we're generating a lot of excess capital because of these high ROEs and making that available to the shareholder. Here's the summary. This model has really been proven through a long series of years and cycles. The high ROE we've returned back with the start of this, and it dipped down some. It still is high, and it's back at the traditional levels. Protection products generate those types of ROEs. That's a key part. Captive distribution.
Not just captive, but captive professionals, people that are committed to the company, that understand their value to the company. They're committed to the customers. That's another beneficial cycle. That's one of our differentiators. We still believe the Japanese market has lots of opportunity. We're well-positioned there. We are ready for questions, apparently.
Actually-
Time? Maybe not.
In the interest of time.
No questions.
Why don't you stay up here, and we'll have Scott Sleyster , our Chief Investment Officer, up now to speak. We'll take Q&A for John and Scott together.
Okay. Thanks. Sorry.
Good morning. Nice to see many familiar faces here. As some of you know, I was in the retirement business for a long time before I stepped into this role, although I guess I'm coming up on seven years. It's great to see you. We've lived through a cycle, although I think we're in a pretty healthy part of the environment now. Thanks for your business. We appreciate it. I joked with Eric and Rob when I saw the agenda. You can always tell where we are in a credit cycle by where in the agenda the portfolio is and how much time is dedicated. I do recognize, and I know you recognize, that we're in a great part of the credit cycle, and we're not getting too many questions. I do think there's a couple things on your mind, and hopefully I'll speak to that.
In a very healthy environment, we talk about a low rate environment, quite frankly, we care about yields, we care about rates and spreads. We are in a low yield environment. I think some of you worry, are we chasing yield? What's going on with the quality of the portfolio? I want to speak to those as we go. David spoke a lot about our business model, and some of this chart is a little bit redundant. Let me start on the right side of this chart. I think the right side of this chart is table stakes. If you're going to run an insurance portfolio well, you're going to start with a liability driven model. The purpose of an insurance portfolio is to hedge the margins of the products that we sell throughout their life.
That's why it's a buy and hold portfolio. It's very different to the other portfolios that you might see in a Barclays aggregate core plus model. David has great public fixed income managers in his area, when they're running a core plus portfolio, their turnover is 8 to 10 times higher than the general account because we're largely buy and hold. We're locking in those margins, and we're hedging our risk. We're very well diversified. Rob Falzon was talking about the strong balance sheet and diversification that we have in the company and in our business mix. You also see that in the portfolio, and I'll point that out. Again, we're extremely well matched. That conservatism really comes in the asset liability management. That's really where you see it.
I think where Prudential benefits so much from the asset management capabilities that live in Prudential Investment Management, the business that David runs, is in these left 2 boxes. We prefer to underwrite our own credit. Those private asset classes that are close to 20% of the portfolio, the private corporates and the private commercial mortgages, are really unique to insurers, they're really unique to large insurers. Quite frankly, when I talk about the private corporate business, I think our franchise is so unique, it's not even comparable to anyone else. I believe it does give us a competitive advantage, because where we pick up margins, and I'll pick corporates here real quick. We historically have planned for 15 to 30 basis points of an illiquidity premium in private corporates. We've been picking up north of 40 the last few years.
If I'm picking up margin in well underwritten investment grade private bonds, I don't have to reach in the portfolio for yield elsewhere. I think when you look at some of the stats I show later, you'll see that. Finally, on the far left, you see the benefits that I think David has already spoken to of the quality of the franchise. I'll just focus on that last point, seasoned talent. By having such a strong asset management franchise, we're able to retain talent. I've been at Prudential, I'm going to just say over 25 years. My wife stopped counting at a different point, but I'll use that. When I look over in David's organization and I look at the head of PruCap and Public Fixed Income and the Private Placement group, they've got more experience than me.
I thought I'd pick up Brown when Dave Dordak retired, I didn't. We have a really high quality team, and those guys know what an insurance portfolio is meant to look like, and that's what they're wired to do on the private asset classes. This is a quick snapshot of the portfolio. Nothing new here. The big blue box is all of our public fixed income including governments. You see the privates down there in yellow on the big chart. That's about 76% of the portfolio. If you add in the light blue commercial mortgages, you're at 86, David talked about finally being successful moving from it pick 'em to it stick 'em to at least something other related revenue, I think that's better. I've been trying to get rid of TASL for a very long time.
I have been less successful than David, TASL means Trading Account Assets Supporting Insurance Liabilities. These are really separate accounts. They look a lot like the general account. If you add that number into the 86, you're comfortably into the 90s, that's what you would expect in an insurance portfolio that's matched to hedge those liabilities. It's primarily a healthy, high-quality fixed income portfolio. JGBs are heavy. I think John already spoke to that. I'll mention that a little bit more in this slide. This is a snapshot here of the two cuts we tend to give. We have the FSB general account ex-Japan, mostly U.S. in blue, we have Japan in yellow. That 56% for Japan JGBs really jumps off the chart. If you know anything about the Japan bond portfolio or the bond market, you'll know it's not particularly deep.
It's heavily banked. Historically, we haven't found much value in the public bond market, and quite frankly, even moving into the agency type securities and the railways and what have you, we don't get much of a lift. Consequently, we really do use the JGB market. That's factored into our pricing. We have more mortality and expense margin in those businesses. Now, with the acquisition of Star and Edison, we do have U.S. dollar flows and AUD flows that are not insignificant now, coming out of the Japan business. Where we have those, we are in fact using our U.S. dollar techniques to manage the portfolio. That's where you see the private fixed maturities in yellow. Most of those are against U.S. dollar liabilities.
On the commercial loan side, I guess we're coming up on at least five years now, David, that we've had a Prudential mortgage cap operation in Tokyo. Originally, we were only originating for Gibraltar, I believe we'll be originating for POJ next year. That's been a very successful activity and build out. I think when David was saying, "Hey, we're looking for new areas to serve other clients," that of course means third-party clients, it also means the general account, that's been a real benefit for us. Here's the fixed maturity portfolio of Prudential. This is the bond portfolio. It's the vast majority of the portfolio. This is on a stat basis, we can use NAIC one and two. 96% of the portfolio is investment grade. Only 4% is below investment grade.
This is a high-quality portfolio, it's meant to be that way. We don't need to reach for yield. We don't want to reach for yield. We call them credit cycles because we believe they are cycles, they come and go. While we're pretty well into a stable period now, we're starting to get some early indicators. When the next cycle hits, we don't want to be that long our exposure. If you look at the little red bar, we were about 6% or 7% going into the crisis. We were able to hold the 7, but we were doing some selling because there was credit migration, of course, in our private portfolio. We do have covenants, and that portfolio held up very well. Right now, we're only at 4%. We're about 1% higher on alternatives.
Really, we're pretty conservative, I think, I'll show you a slide versus peers here in a bit. When you look at the high yield portfolio, granted it's a small percent, but it's close to $9 billion, that's not insignificant. This is kind of the mix you'd hope to see. A very high concentration of BBs. Falls off a great deal to single Bs and then very, very much smaller below that. One of the things that is distinctive at Prudential is if you look at the light blue portion there, those are privately placed high yield bonds. I can assure you there's not a bond in there that is covenant light, we like that. We like to be able to place our high yield directly like that because when economies weaken and we go through cycles, covenants really protect you. It shows up in our recoveries.
You can't stop a cycle from happening. You can't not have weakness, you can't not have some challenges for those businesses. Through covenants, you can be in voice early in a private placement where you've got some rights. You can turn the coupon off. You can do all kinds of things to help partner with that company build upon those long relationships that we have, that portfolio held up really well. This is a comparison chart with competitors. This is stat data. That's the only way you get this kind of comparison. I know some of you watch the portfolio so closely, you actually look at quarterly flows in the stat data that comes up. Some of our new regulators I think are surprised at the amount of disclosure and insight investors can have into a life insurance portfolio.
I think this really makes the point that I made earlier here. We think of the closed block as distinctively different. It really is a participating account, we take a little more risk there because that's what we committed to the state of New Jersey. The risk, the good news and the bad news of that inures to those policyholders. We think you should really look at Prudential FSB, there we are at 4.7% in sort of risk assets, if you will. We're on the conservative side of the page, that's really where we want to be. I think that's highly consistent with what Rob mentioned in how we manage the company. This is our public bond portfolio.
I guess the way I think about our portfolio is we want Prudential Capital, our private corporate, and Prudential Mortgage Capital, our private commercial mortgage group, to underwrite insurance quality, high-quality loans. I'll show you a chart on the commercial mortgage side that's specific to that in just a bit. Then we want them to stop if the market is getting silly or they don't see good loans. Why do we want to do that? Because we want to benefit from that quality underwriting. We want to keep dry powder in that business when cycles run their course. One of the reasons our franchise is so strong in both of those areas is that we were able to continue lending throughout the financial crisis when so many banks and other lenders, and quite frankly, the public market, was really pulling back. We were able to lend right through that.
The reason we're so comfortable with them doing that is because we have a really high quality and a conservative public bond portfolio managed by our public fixed income team. This is a chart of that portfolio versus the Barclays aggregate. A couple of things should jump off the page to you there. One, we're very light financial institutions. We're at 18% versus 35% or more. We're almost 14 points below. Why? Well, I think you know. If we're in a financial crisis and Prudential is suffering, maybe in other parts of its business or our customers are, we're going to feel it. We don't need public bonds to aggravate that. We're under 20% and it's pretty conservative within there. We're also fairly short communication and technology sectors. It's very hard to predict what's going to happen in those areas. They're much more volatile.
We just don't need that in our public bond portfolio. You can see we're more overweight things like utilities, capital goods. We did move up through the cycle from being underweight cyclicals to being slightly long cyclicals now, which I think you would expect. Let me transition over to the commercial mortgage loan portfolio. Starting on the far side of the screen, the big pie chart, I would make the point that we're well diversified regionally across the U.S. At the end of the day, you can only make loans where high-quality buildings are being built. Yes, we do have a lot in California, and we do have a lot on the East Coast. We are everywhere, but we like to be in gateway cities. We like to be in strong markets. We like to know there's flow in those buildings.
If you're going to have some regional concentration, well, how do you get at that? You go to the bar charts, and you say, well, let me diversify within the region by location, but also by the type of properties that I'm investing in. That's through the FSB versus the ACLI index. Again, I would hope this is what you want to see in a conservatively managed life portfolio. We're light office. That tends to be one of the more volatile sectors. We're also lighter than the index for retail. Well, if you're light there, where are you long? We're long in senior living, we're long in industrial, and we're long in apartments. Again, I think that's exactly what you'd want to see in a conservatively managed bond portfolio. A lot of detail here.
I'll just take your eyes to the top grid, the lower boxes. This is a chart we use. This is a copy from things in our public disclosure. Where are you worried about your loans? You're worried when your coverage ratio is getting around one times or below that, or loan-to-value and coverage is the classic way you're going to look at these loans. On the far right, you'd see that half our portfolio is greater than two times. I'd really like to point to that bottom box on the right. At the trough of the cycle in the fourth quarter of 2009, we were at almost 6% of the portfolio being in that zone that you'd want to closely monitor. There we are now, less than 75 basis points, a fraction of 1%. That's where we are in the cycle.
That's why I'm here in the agenda, that's why this talk will be pretty quick. This is an important slide. Just as a reminder, I know some of our new folks are starting to look at us with the new G-SII and SIFIs regulation. While nobody thinks a life insurance portfolio might look like a CMBS portfolio, I think there's a lot of people that think a life insurance commercial mortgage loan portfolio might look more like a bank loan portfolio. That's why I put this slide in here. Not for many of you in the room, but maybe for some of you in the room. Look at the bottom of that chart at where the life insurance industry delinquency exposures went during the cycle. Yes, they moved around. I could blow that chart up and make it look a lot bigger.
To put it in context, the quality of the underwriting, not only that Prudential, and by the way, there aren't 20 people doing what Prudential are. There's probably three or four. The quality of the insurance underwriting and the fact that we stop and go public when we don't have it anymore is reflected, in essence, in a flat line compared to the kind of delinquencies that you see in a bank portfolio. This is another one of our vernacular items. A lot of times we refer to these internally as alternative investments, but I guess in our financial statements, they're now non-coupon investments. We have increased our commitment to so-called non-coupon investments, which is really private equity hedge funds and real estate. Why have we done that? There were really, I would say, two overarching themes for the reason that we did that.
After the last credit cycle, I don't want to get too much into tax planning, as a reminder, for an insurance portfolio, when we experience anticipated credit losses, those are capital losses. That's not true if you're a bank. It's actually not true in Japan. You can use other earnings to offset those losses. In the U.S. tax code for life companies, those are capital losses, so you need capital gains. Historically, we've cleaned up the portfolio. We'd harvested a lot of gains. We're trying to manage to a reasonably attractive ROE, we're trying to manage our volatility. We didn't want a lot of alternatives in there. Post-cycle, we'd really cleaned up the portfolio a great deal, and we needed to rebuild the capital gain portfolio. That was a portion of this. The real jumpstart came with the PRT transactions.
Those transactions came in, I would say, a fairly small amount of total assets, but nonetheless, right at our limit on those assets, and it came in very heavily in high yield. Over time, we're expecting to work that down, and actually, over time, we're expecting to shift that from almost all private equity on those accounts into 50/50 hedge fund private equity. The portfolio grew. We've grown our staff and our quality along with that, but I think it is important to look at that. That being said, our total number up there, 1.8%, I think that number could be close to 4% and we'd look average for the industry. We're not heavy. We are simply heavier than we used to be. There we are. This is the trough in the cycle. It's run about seven years or so at this point.
That doesn't mean another cycle is coming quickly. Last year, when I talked to you, I would have said we're at the trough of the cycle. I would actually say that if you're thinking about this like a U or a horseshoe, we're actually starting to move up the other side a little bit. We are starting to see some covenant-lite . We're starting to see a lot more M&A activity. We're starting to see leverage ratios move up a little bit. While I wouldn't say credit standards have greatly deteriorated, I would say every place you look, we're starting to feel it, and you're starting to get the seeds planted for another cycle to occur, which is, in fact, very natural. Busy slide here. It really makes a couple of points.
Between late 2012 and early 2013, we actually added $41 billion to our U.S. general account. That's bigger than some significant insurance companies. I make this point for a couple of reasons. One, the one on the slide simply shows that our unique capabilities in privates and mortgages are, in fact, unique. In the case of the PRT transactions, those were managed with third-party managers or in-house at General Motors to some extent. They don't have privates and mortgages. Those portfolios came over with none of those assets. In fact, our percent of those assets dipped, and the other long-term investments, which is the non-coupon investments, spiked up quite a bit. If you look over on the current side, I'll refer to the good work of our global portfolio management team. Tim Schmidt's here in the room with me today.
We've been working those portfolios with our mortgage and private corporate areas, and we're starting to get those portfolios to look more like we do. I would like to make a second point on this page because one of the things that's on a lot of people's minds are, well, what's happening in a low rate environment, and how is that going to play through? Look, we are not immune to low rates and low spreads. We have some guarantees in some of our products and things that are fixed. By being extremely well matched, we mitigate that. When we put this $41 billion of business on, the treasury rate was somewhere between, I think, 180 and 190. Believe me, every one of these pieces of business hit our underwriting hurdles. These were very carefully reviewed transactions.
When we locked these in in a low rate environment, we put our LDI strategy in place, we locked the portfolio in, and we locked in margins. When you're thinking about the performance of our business, it has a lot less to do, I'll go back to John's point, it has a lot less to do with where rates are and more to do with the margins that you locked in and that you ran a liability-driven strategy. I hate to show this slide, for the sake of full disclosure, I need to. It isn't just rates, it's spreads. These are spreads on publics. They're investment grade, below investment grade. It's true across the board.
Spreads are grinding in, until we move into really a more robust economy or people are feeling more risk in their bond portfolio, they're starting to sort of feel the other side of a credit cycle, these spreads are going to continue to grind in. Quite frankly, going back to the PRT discussion, there are a lot of institutions out there that are looking for long duration to hedge. While we're expecting short rates at some point with the economy and Fed easing to halt, slow down the tapering to move up, we wouldn't be too surprised if the curve actually flattened a bit because there's a lot of demand for long duration paper as it comes to market. Here are slides on what's going on with the overall yields in the portfolio. It's in your binder, you can look at it more carefully.
The top chart right there in the middle, you see when the PRT and The Hartford transactions came on, the treasury during that period was 180, and we like that business. It has a lot to do with locking in your spreads and margins and putting in an LDI strategy over the life of the product. You can see the mortgage yield on the bottom. I ran through that pretty quickly, and I think we'll have time for questions. Like a good homily, I'll tell you what I was going to tell you. Hopefully, I told you. I'll say it again here. We really do believe that having our asset management business commercialized has greatly benefited Prudential Financial, not just as a shareholder but for the general account, as Steve Pelletier referred to.
We see great employees, we see terrific returns, and we have really good underwriting experience relative to our peers and a higher proportion of our portfolio in private asset classes and a higher proportion of those directly originated than our peers. All of that is really good stuff. We haven't moved away from LDI. It's always been what we are. The quality speaks for itself, and we're extremely well-matched in the ALM remarks that I think both Rob and Steve referred to remain critical. We do continue to prefer to underwrite our own credit risk. I think, David, you're managing 98% of the total portfolio. We do go outside when we need selected mandates or for markets that we're not in, and we'll continue to do that.
If it's an asset class that the general account wants to be in and that David wants to be in, we're going to pair up, and we're going to make that work. The high yield is high quality. You have seen the increase in non-coupon investments. I can tell you that's carefully underwritten. It's very well diversified across type and by manager, by vintage, if you will. Lastly, I just reiterate that we do expect to be in a challenging rate and spread environment for some time to come. We're well-served, I think, by really underwriting our business carefully, locking in those margins, and then, in fact, riding it out, keeping that portfolio in the middle of our corridors so that when rates and spreads do pick up, our risk appetite is still there, and we can move into other areas.
Why don't I quit there?
Okay. Questions for John and for Scott. Gentlemen on the right side of the room in the fourth row. Please keep your hand up so someone will find you. Up front here.
Alan Zancig, Lord Abbett. A couple questions for John. On page 46 with the solvency margin ratio stress analysis. Since I'm not as familiar with the SMR, could you let us know which of these four scenarios are most impactful to the lowering of the numbers in a stress scenario?
Actually.
You're okay.
Can you hear me okay?
Yeah.
I think in each of these cases, I think they're each contributing a certain amount. We don't have a lot of Japanese equity, therefore, even with a large decline down, and this is as steep as there was, that has some impact. Again, we only have, I think it's around 2% or so of our portfolio is in equity, so that's why it's not a larger impact. Same real estate, relatively low volume. I'm not sure which one of these in particular is dropping the margin down because the total amount. Again, this is an aggregate drop. This is all these scenarios at once that are impacting. You're seeing a drop of 80% say in POJ. That's with all four of these scenarios built in at once.
What we're trying to show is each one has a very limited impact because in each case, we have either a limited amount of risk in that area, or we're very well matched. I don't think there's any one large one. I'll go back and get the exact amounts, if you like. If you want it to be isolated.
Regarding interest rates, what's worse? Interest rates to go up 100 basis points, or if it's possible, clearly it can't go down 100, but to go down-
With respect to the solvency margin ratio, interest rates going up are worse because then you have some of the mark-to-market impact. Again, not all of it comes through, the interest rate up environment is a negative for us on the solvency margin ratio. Obviously, economically and otherwise, we would welcome a certain amount of interest rate increase.
One last question about Japan. I'm not sure who to direct this to, but in consideration of Pru being managed in a SIFI world, is there any talk about how Japan is going to be viewed by regulators, or is there any change in strategy of how the business mix is run?
Let me talk just about Japan. Japan has been regulated by the FSA from the beginning. The regulators in the U.S., the SIFI, they are working with our risk management team here to work with including analysis of our Japan operations.
Yeah, Rob may have more to say on that subject after Ken Tanji presents at the end of the day. Quiet group. I'm not saying Oh, there's a gentleman over here in the front. Blue shirt, third row. There we go.
Jukka Lipponen, independent insurance analyst. Scott, you said that in Japan, your portfolio is as conservative as it is because the credit spreads don't give you enough pickup in yield. I'm not up on credit spreads in Japan, but can you elaborate? If the picture changes, I assume that your portfolio could change over time as well.
Yeah. Let me make, I'd say, two points. I'll make several. One, this is almost true for the rest of the world, less so in Europe now than it was even 10 or 15 years ago. Most of the world is very heavily banked, and the businesses are a little more concentrated than in the U.S. market. People end up deeply banked, and the banking has gone pretty deep into their capital structure, and that has hindered the development of public bond markets, quite frankly. It's also hindered the market development of private lenders. That's part of the reason the markets aren't well developed. They've been bank dominated. We also, in Japan, don't think you're very well paid for moving out.
Spreads of five, 10, 15 basis points are relatively wide at the low end of the investment grade spectrum for moving out of a government bond. When you think about the kind of credit loss exposure you might experience, it doesn't really seem worth it. There is another point as well. We have a lot of long duration business in our product liabilities there, and the only place to really get duration in a narrow bond market is either by buying JGBs, which fortunately we can buy some strip JGBs going out to 40 years to get duration. I think we're one of the largest holders of that. Much prefer to be in the government bonds.
We factor that back into our pricing, and we're not going to underwrite business unless it meets our pricing criteria.
Thank you.
We have time for one more, if there is one more. We're on to our last speaker, Ken Tanji, our treasurer, and then Ken and Rob will take your questions.
I'd say good morning, but I think we just slipped into the afternoon. I have the privilege of presenting at the lunch hour, and the only thing worse than presenting at the lunch hour when people have food and they're trying to eat is when they don't have food and they wish they were eating. I will get right to this and be swift. As Rob mentioned in his opening remarks, financial strength, strong ratings, superior and sustainable returns are core elements to Prudential's value proposition. In this segment, I'm going to cover capital management, liquidity management, and I'll update you of our profile in these areas. As I looked through the registration last night, and by the way, it is up this year and it continues to increase, I saw a few new names but a lot of familiar names.
What I'll cover today, in general, will be trends and themes that are very consistent with what you've heard in the past. Again, our mix of high quality, profitable businesses generate capital and cash. We are able then to support our growth, reduce leverage, and make distribution to shareholders. We continue to have a very sharp focus on financial strength. These are the three areas that I'll cover today, and it kind of highlights our main objectives. In terms of financial strength, we calibrate capital and liquidity to Double A standards. Double A financial strength guides all of our capital and funding decisions. For liquidity, we maintain access to diverse sources of funding, and that gives us the flexibility to meet needs as demanded, support the growth of our business, and make consistent distribution to investors.
Lastly, our capital protection framework is designed to maintain competitive levels of capital under stress. Although market conditions have improved substantially, which you just saw illustrated in Scott's presentation, we continue to take the opportunity to strengthen our capital protection program. I'll get into the specifics in each of these three areas. This highlights our capital management philosophy. First, we focus on holding sufficient capital resources to withstand downside risks. We have rigorous capital and liquidity frameworks. We apply the appropriate amount of financial leverage. As you heard from Rob, Steve, David, and John, all of our businesses are well-positioned, profitable, and generate capital. This capital is carefully deployed. It's deployed to support growth and to pursue opportunistic expansion in M&A. We actively deploy capital to optimize the company's return, growth, and risk profile.
Lastly, in terms of distribution to shareholders, the cash flow from this portfolio of businesses provides a stable dividend. We pay dividends now each quarter as a way to distribute cash flow on a more regular basis. In addition to dividends, we have a share repurchase program. Ordinarily, free cash flow generated from our businesses will be sufficient to maintain that stable dividend but also has the potential to repurchase shares. Our current repurchase authorization will end at the end of this month. The decision for a new program will be made by our board. As opportunities arise, we deploy excess capital to M&A and outsized organic opportunities such as pension risk transfer. This may lead us to vary the level of share repurchases in any given period as you've seen us done in the past.
This slide shows you our capital position at the end of last year. I'll start with required capital. When we say required capital, it's the required GAAP capital needed to capitalize our financial services business, again, consistent with Double A rating objectives. At the end of last year, we quantified required capital for our businesses to be about $32 billion. We then compared that required capital to our actual capital outstanding. Our sources of capital include equity, capital debt, and junior subordinated debt, which we refer to and people refer to as hybrid debt. They call it hybrid debt because the rating agencies designate a portion of it as equity due to its subordinated position in the capital structure and the long-dated maturity. You can see our total capital outstanding was $35.5 billion.
The difference between our capital outstanding and our requirements was $3.5 billion, and we estimate that to be our on-balance sheet capital capacity at the end of last year. About half of that, or about $1.5 billion, we would consider readily deployable. What we mean by readily deployable, it's capital capacity that can be deployed in the form of cash to do things like acquire businesses, make dividends, repurchase shares, or finance outsized organic business growth. This is our current picture of our capital position and has not changed significantly over the last year. Capital generated was deployed to support business growth, pay shareholder dividends, share repurchases, as well as reduce leverage. This slide shows you our capital structure and our leverage.
You can see we continue to strengthen the composition of our capital structure and reduce leverage. The bars on the slide show the composition of our capital over the last three years. In the last two years, we issued over $4 billion of hybrid debt at very attractive terms in what we thought was a good point in the market. This debt has maturities of 30 to 40 years, and again, due to its subordinated credit position, the long maturity, rating agencies ascribe equity credit for hybrid debt when they measure leverage, and we do as well. You can also see here in the dark blue that equity as a portion of our capital base has also increased.
Down there in the footnote, you'll find that we've adjusted the way we measure equity to exclude certain items that we believe distort the underlying picture of financial strength. We exclude AOCI, which is typically done when most people measure equity for these purposes. We also exclude FX remeasurement and non-performance risk, which I think is generally accepted as accounting that is uneconomic. We've reviewed these adjustments with our rating agencies, and they believe the adjustments make sense and are appropriate. The dotted line here is our measure of financial leverage, and our definition shown here is the amount of debt in our total capital structure. Again, for hybrids, we consider 75% as considered as debt and 25% as equity. You can see that our financial leverage has declined six percentage points over the last two years and is below our target of 25%.
In terms of total leverage, if you were to include all forms of debt, both funding operating needs and capital needs, leverage has also declined over the last two years. Our capital base has strengthened and our debt leverage ratio has declined. As Rob mentioned, during this period, our ROE actually increased. Not only did our profitability increase, we think our capital base has strengthened and our leverage has come down. These are regulatory ratios. You've seen the ones that we just looked at, the ones for international. Those were as of March, but also for Pru Insurance. These aren't new ratios. They've been out for a while. I just did want to comment that they are above our targets, which you see, and those are targets that we would believe are consistent with double A ratings.
I'll turn to our capital protection framework. Again, while market conditions have improved, we continue to stay very focused on our capital protection plans. The objective of our capital protection framework is to measure the impact of various stress scenarios on our capital position. We identify sources of capital that keep our businesses well-capitalized at competitive levels during these stress environments. I'm going to go down the left side first and go over the stress parameters. For an equity market decline, we assume the S&P declines 50%. In terms of interest rates, we look at severe changes of interest rates across the curve in the U.S., Japan, and other markets in what we would consider pretty extreme moves. Again, we stress across the curve, but I'm going to give you the 10-year government bonds as a benchmark.
We assume the 10-year treasury rate declines 140 basis points. In the U.S., low rates would put pressure on our RBC and statutory capital, primarily due to increases in AAT reserves. As we just talked about in Japan, actually rates rising would put pressure on our solvency margin ratios. We assume rates rise in Japan 120 basis points for the 10-year JGB. In terms of credit shocks, we assume credit losses at levels that are similar to those seen during the three years of the Great Depression. We include not just the impact of credit losses, but the knock-on impact of downgrades. For a currency shock, we assume the yen strengthens to 50 over a three-year period. We put all of these stresses on our capital, and we apply modest correlation benefits. Now we turn. Whoops, let me go back.
Didn't mean to get ahead of myself here. We turn to the other side of the page, which is our protection toolbox. We start with on-balance sheet capital capacity. Recall, our stat capital ratios in the U.S. and in Japan are above our double A target. We have on-balance sheet capacity to absorb risks from the shocks. In addition to that, we have a derivative portfolio of both equity and interest rate macro hedges. We have a portfolio of short equity derivatives that begin to pay off when the S&P drops below about 1,100 and continue to pay off to about 700. The idea here is to have protection when we need it in the tail of an equity market decline. We also would have reinsurance that kicks in specifically related to our closed block. Finally, we have other contingent sources of capital.
We have a $2 billion credit facility from a group of high-quality banks, most of which I think have representatives here. In November, we also added a billion and a half contingent capital facility, I'm going to walk you through that. That's a new component of our protection plan, I'm going to take a minute to walk you through those steps. When we stress our capital to these market stress assumptions, we have capital sources that are in excess of what we think to stay competitively capitalized. Although I described the stress tail assumptions in a stress scenario or a tail scenario, we also look at more moderate and cyclical scenarios as well. Our objective is to keep our capital position of the operating companies strong, competitive, and efficient during various environments.
Although our capital protection sources are adequate and diversified, we took a step to strengthen it even further last year. In November, we put in place a contingent capital facility. I'll walk you through that on the next few slides. On the screen here, I'm going to break this down into steps or pieces and show you how it works. The first step is we have the Five Corners Trust, which issued debt to institutional investors. We call those securities PCAPS. It's 10-year debt with a coupon of about 4.42%. It provided investors in 10-year debt with a yield that would be slightly better than the yield on our senior debt. Let's go to the next step. The trust invested the proceeds in U.S. Treasury strips with a cash flow that matches the timing of interest and principal payments of the PCAPS.
Step 3, PFI pays a premium to the trust for the option to issue senior debt to the trust in exchange for U.S. Treasury strips. The cash flow from the Treasury strips, combined with the premium paid by PFI to the trust, matched the cash flow payable to the PCAP investors. Prior to Prudential exercising its option, the investors essentially received a senior debt-like yield for, again, essentially taking PFI credit risk. Also prior to exercising the put, the only impact to Pru is the cost of the put premium. We have no additional debt is reflected on our balance sheet. Now let's take a look at what happens should we decide to exercise our option to issue debt to the trust.
In exchange for the U.S. Treasury strips, Prudential issues senior debt to the trust with terms that mirror the PCAPS held by the investors. Our debt would have a yield of 4.42%, same as the PCAPS, and would mature in November of 2023, same as the PCAPS. The PCAP investors continue to have credit risk equivalent to PFI senior debt. Lastly, the last step 5, we could now sell those U.S. Treasuries and deploy the cash as needed. There are a number of reasons we like this facility. First, it provides us with a source of funding that we can access at our discretion for any reason at all. We can use it in times of stress, but we can also use it in good environments. It's completely up to us. It's a guaranteed source of funds. There's no counterparty or performance risk.
The proceeds reside in Treasury strips that we can access at any time. The terms are already established. We would issue our debt with a coupon of 4.42%, and it would mature in about 10 years. That's much longer than we could get from any bank facility. I think if I just started talking about a 10-year bank facility, a good portion of this room would probably get up and leave. If we draw from the facility. We also have a one-time right to unwind it by repurchasing our debt from the trust and restoring sufficient U.S. Treasury strips back to the trust. Lastly, until we draw on the facility, we do not incur any debt on our balance sheet. We like the protection and flexibility this facility provides. It was well received by investors, creditors, and regulators as well. Okay.
Now let me turn to liquidity. Here you see our philosophy around liquidity. First, we manage our liquidity profile legal entity by legal entity. As you heard from Scott, asset liability management is one of Prudential's core competencies. We regularly perform stress analysis for each one of our legal entities, and we make sure we identify sources of funding to meet the liquidity needs under the various scenarios. At the holding company, we always hold a cash balance of at least $1.3 billion. $1.3 billion would be sufficient to cover gross interest expense and fixed costs at the holding company for a year. We have only a modest amount of commercial paper outstanding between PFI and Prudential Insurance or PICA. There's just under $1 billion outstanding as of March. We seek to pre-fund all of our maturing capital debt 1 year in advance.
This slide shows the cash flow to the holding company from our operating subsidiaries, and the bars represent dividends and returns of capital, again, from the operating subsidiaries to the holding company. Over the last 7 years, if you added up those bars, that would total $21 billion or about $3 billion a year on average. The colors of those bars indicate the different businesses that generated the cash flow to the holding company. We talked a lot about the diversity and power of our business mix, and here you can really see one element of it, that you can see that business mix helps sustain fairly stable cash flows even during the financial crisis years. You can see that the level varies a little bit year by year.
In 2009, in the midst of the financial crisis, we didn't take capital out of Pru Insurance in the U.S. However, our international business, which you can see in the orange, continued to provide us with a source of cash flow. In 2010, we had excess amounts of dividend from PICA or Prudential Insurance in the U.S., and that's when we harvested gains associated with the exit of our securities joint venture. Also in 2010, you'll see that the amount of capital from international, again in the orange, was lower than typical. That year, our international insurance business retained about $800 million of capital to partially fund the acquisition of Star Life and Edison Life that John described to you. A few takeaways from this slide. Our mix of business provides a diverse source of cash flows to the holding company.
Aside from the financial crisis, dividends and returns of capital are typically about $3 billion a year. Rob mentioned that cash flow relative to earnings is one of the very key metrics that we look at. Generally in normal markets, over time, we've been able to redeploy capital from our business that is equal to about half of our reported after-tax AOI. This shows you at the holding company, what we have on cash on hand as well as alternative sources of liquidity. As of March, we had $3.2 billion of available net cash at the holding company. This excludes any outstanding CP or other intercompany short-term borrowing. That $3.2 billion is $1.9 billion more than our minimum cash level of $1.3 billion. Next, you have the contingent capital facility of $1.5 billion, which I just described.
That's available at any time at our discretion with no performance or counterparty risk. We have $3.8 million of committed lines of credit in two facilities. We have a $2 billion, five-year facility that we actually renewed last year, and that expires now in November of 2018. We intend to use this facility from time to time for working capital needs. You may see us draw on this temporarily if needed. We have another $1.8 billion of a committed line of credit, again from a group of banks, and that's shared by PFI, the holding company, and Pru Funding. That's intended for general corporate purposes and CP backup, and that's a three-year facility. We renewed that last year, that expires in November 2016.
Borrowings under both of these facilities are not contingent on the company's credit rating, and they are not subject to any material adverse change clauses. Next, we estimate about $1 billion of internal sources that would be available to the holding company. We have a cash consolidation facility that gathers excess cash across the companies of Prudential Financial, and that would be available for use at the holding company. We've estimated the amount of CP that could be readily available based upon market demand to be about $1 billion. We don't count on CP in times of stress. Our CP program at PFI has authorized capacity of $3 billion, it is available to meet short-term needs. We only had about a little over $200 million outstanding at the end of March, and that's typically the level we've been running.
If you add that all up, that adds up to $10.5 billion, $9.5 billion if you excluded the CP. Here you see a very similar look at cash and sources of alternative liquidity for Prudential Insurance or PICA. That's as of March 31st. We had $5.5 billion of cash and cash equivalents. That excludes any CP that's outstanding. We have net borrowing capacity from the Federal Home Loan Bank of New York of $4.7 billion. We're a member of the Federal Home Loan Bank of New York, and that gives us the ability to obtain collateralized loans. We had $2.2 billion outstanding at the end of March, the remaining capacity would be just under $5 billion. As I mentioned before, we have $1.8 billion committed credit facility, and that's shared between PFI and Pru Funding, available for general corporate purposes and CP backup.
We've estimated we have $3 billion of commercial paper that would be readily available based upon market demand. We don't count on CP in times of stress. The total authorized capacity for PICA is $7 billion for CP, available for short-term needs, and we had about $750 million outstanding at the end of March. Adding it all up, total liquidity resources of about $15 billion, $12 billion if you exclude CP. All right. That's the story in sum. Our approach to capital and liquidity management is aligned with Prudential Financial's value proposition. Our financial profile is strong and continues to be enhanced by the capital generated from our well-positioned and balanced business mix, and we continue to take additional strength in our capital and in liquidity resources. Hopefully a very consistent story aligned with what you've heard from us in the past.
Thank you very much for your time and attention. If there are any questions, Rob and I would be happy to address them. Thanks.
Lady on the aisle over here, Raymond.
Hi, Donna Halverstadt from Nomura. Pru's talked for a while now about its constructive engagement with the regulators and discussions you've had around educating on the differences between banks and insurers, particularly around risk and risk absorption. Two questions related to that. Have those general discussions gravitated yet towards topics about what are the appropriate capital metrics for insurers? What is the appropriate capital stack? Second question, when the regulators get there, do you think that they will take bank capital and liquidity models and say, well, let's strip away X, Y, and Z because it's not relevant. Let's change A, B, and C, and basically try to squish and squeeze the bank box to fit it on an insurance company?
Do you think they'll take a clean sheet of paper and develop what is most appropriate without the constraints inherent in trying to squish and squeeze something that wasn't really made to fit you in the first place? Thank you.
Would you like me to paraphrase those questions so I hear you?
Good questions. On the first part, no, it has not gotten nearly to the level of granularity that you just asked about. Our discussions to date with the Fed and frankly, with the international regulators as well, have been much more around the conceptual foundations to an appropriate capital framework as opposed to the granularity around calibration of that framework. I think we are well off calibration. When I've been asked about this before, I've said that this is going to be measured in years, not months. It's going to be some period of time before we're going to have clarity around that. I think even when they come out, it'll be subject to commentary and industry feedback.
It's going to be quite some period of time before we're going to have calibrated capital standards in place for whether they be the SIFIs or frankly, for the other insurers that are affected by their bank holding company status. On the second, it's sort of an interesting question. There are ways you could think about the Basel framework, which is really sort of they have an adjusted Basel framework that the Fed now uses. There are ways that you could think about further modifying that or adjusting it or what we call applying it such that it does reflect the realities and the economics of an insurer's risks and capital in the way that I described them earlier.
It's not unthinkable that you would take something that on the surface looks a lot like Basel change it substantially or substantively such that it works for an insurer. I wouldn't necessarily call that jamming it into a bank box per se. I would say it's looking at trying to get an output that would allow a regulator to calibrate across the financial services industry in a way that would be consistent, yet the inputs to coming up with that metric would be substantially different or tailored. I don't think we would be unhappy if we came out with that kind of result.
I think it would be in some ways easiest to come up with that result because it's a framework that's established, it's familiar, and adjusting it in a way that appropriately reflects insurer economics might be a more expeditious path than starting with a white paper from ground zero. Having said that, I think at this point in time, all things are on the table.
Let me ask a follow-up to that. You talked a lot about your junior sub-debt hybrids. If you look at bank land and if you look what qualifies for Tier 1, if it shows up as debt on a balance sheet, it doesn't qualify for Tier 1. How do you personally think about your junior sub-debt, and how would you position it vis-a-vis the regulators in terms of being good capital? You clearly think it's good capital given the way you've spoken about it.
Yeah. We didn't issue that debt in anticipation of any regulation that may come our way because of our SIFI designation. However, it does qualify for Tier 2 capital should we end up in an environment where that matters. That's why we did it, and that's kind of where we would see it would fall if something does develop in that direction.
Okay. Thank you.
Where do you see a hand? Oh, yeah. The gentleman on the aisle here. In front of you, Susan. Hand up, please.
Thank you. Ryan Buckus from Citi. I was wondering maybe if you could just talk a little bit more about the Five Corners contingent capital facility. Just given where we are in the market, how do you feel about your contingent capital facility in terms of size? Are you looking perhaps to increase that? Additionally, if you look at the contingent capital facility versus maybe your committed credit lines, if you were to draw down on either, do you have a priority of using one versus the other? Thank you.
Yeah. First, let me sort of why did we do the facility that we put in place? It wasn't to address any particular issue specifically. We have, as I mentioned, robust and adequate resources. We thought it made sense given the opportunity to diversify. Again, it is much longer term than we could get in other forms. It has no counterparty or non-performance risk. We thought the time was right, and it gave us a lot of flexibility that we liked, and it's just a piece of our overall program. Again, it wasn't intended for any specific purpose in general. In terms of more, we're always looking at our whole program, and we'll continue to size it given the needs of the company.
I saw some more hands over here. Is there a hand over here, too? I see Mr. Lipponen over here again. Near the front. Jessica?
Jukka Lipponen, independent insurance analyst. A question that sort of has a couple of different parts to it. Your actual capital levels are obviously clearly well above your target, why is that? Is that because of uncertainty relating to SIFI rules as you're trying to get your ratings to double A-minus? Or are there some other reasons? Since your on-balance sheet capacity is based on the targeted capital levels, are you saying that you'd be willing to take them down if there was a need for an acquisition or whatever, if you needed that capital? Then lastly, given your capital levels, given your financial performance, given your liquidity position, et cetera, what do you think are the issues that are holding you back from getting the double A-minus ratings from all of the agencies?
Okay. I think we're going to tag team on this. Let me take the first couple parts of this. The level of our RBC and solvency margin ratios are actually not in any way reflective of the designation as a SIFI or as a G-SII for that matter. I think the way in which we have run the company and the way in which we've approached our balance sheet has always been with a target to double A standards. We think we've prudently done that, we don't believe that there is any reasonable regulatory standard that can come out of this process under which we would not show very well.
There's not a hoarding of capital because we're concerned about some metric that could be developed and applied to us under which we would not show well, therefore, we need to hoard the capital in concern for that. We say we have a target of, in the case of the U.S., a 400% RBC, in the case of Japan, 6 to 700 because those are the levels at which we believe are appropriate for double A. We generally are running with levels of capital above those, that really comes about for several reasons. One, the timing at which we take capital out of our subsidiaries is not monthly by any means. We take it out of the domestic subsidiary on an annual basis for the most part, except under unusual circumstances. Similarly, we have dividend policies coming out of our Japanese subsidiaries.
You'll always find that our capital is running up above our target levels. We dividend out. The dividends we take out generally are based on a fiscal year. By the time we actually take the dividend out, we've had additional earnings that are in there. You're going to find that as a result of just the frictional mechanic of getting cash out of our subsidiaries, that there's always some level of cushion in it. We leave capital in there to the extent that we think that there are opportunities for it to be redeployed in the places where it exists. Whether it be pension risk transfer within PICA, or whether it be other interesting things like we did with Star and Edison down in Japan.
Finally, the capital that we have down in our subsidiaries is not always what we call monetizable and readily deployable. We have capital that's there that's available to absorb risk, but that doesn't always exist in the form of readily translated into cash which should be dividended out. Until it can, it needs to sit down there. For those variety of reasons, you're always going to find some noise between the level at which we target, which we think is appropriate to double A, and the absolute level of capital that exists down there. Ken, you want to talk about double A?
Yeah. The ratings, it is mixed, and I don't want to speak on the behalf of those rating agencies. If you do read the reports, I think you'll find two concerns of one of our leverage. Our business mix does take a little bit more operating leverage given some of our products. We think it's well supported. Our leverage has been coming down, as you saw through the slides that I provided. The other would be earnings volatility. Some of our market sensitive businesses have had some earnings volatility. I'd say some of it was accounting related. Those are the primary areas that they cite, and we think we're making good progress in both those fronts.
Thank you.
Is there anyone who hasn't yet asked a question who would like to? Yes. Gentleman near the front, middle of the row. Thank you, Raymond.
It seems that in the low rate environment, the majority of life insurance put yourself managing low rates well, ALM, et cetera. What kind of risk is there of a significant spike in rates to the upside disintermediation, both in Japan and U.S. JGBs or domestically?
Let me start. You want to jump in?
Yeah.
I don't think either Ken or I are going to be comfortable forecasting what the probability of that occurring is. I think what you're trying to get into is perhaps how do we think about the risk of that as contrasted to low. Yeah. It's interesting you bring that up because I think we've as a firm have frankly always had more of a concern about a dramatically rising interest rate environment. While we think higher rates are healthy for the insurance industry and for our company specifically, getting there very rapidly would create some indigestion along the way. As a result of that, when we look at managing our interest rate exposure, we actually look at managing the risk of that rising interest rate environment, recognizing that there's convexity to our liabilities because of the behavioral components of those liabilities.
We look at the hedging that we put in place against interest rates, both for declining and rising to reflect the risk that we do have risks of that in the event that rates rise dramatically we could see results from both the mark in the portfolio and then the realization of those marks to the extent that you have to liquidate the portfolio in order to meet redemptions that could occur under that scenario. We're cognizant of that. We pay a lot of attention to it, and we look at managing that risk as we look at both the amount of capital we hold and the way in which we've gone about hedging against interest rate risk. Ken, if you want to add anything to that.
Yeah. I'd just add business mix matters a lot. There are some products that would be more sensitive to higher rates than others. If you look at our business mix, we like the insurance products that are serving a fundamental protection need and would be less sensitive to rises in rates. Again, we think while we may have some of those things, generally higher rates would be very good for the company, and our business mix would serve us well.
Yeah, I think it's a good point, which is that whatever pain you suffer in the transition, going to a higher rate environment long term is a healthy thing for the industry and for the company.
Okay, we're now into extra innings. I'm going to invite Chris Marks up to wrap things up.
Thank you, Eric. It's my privilege to do a very quick wrap up. First wanted to thank Deutsche Bank for sponsoring us today and thank all of you for participating. This is really a great opportunity to engage in dialogue and to answer your questions. I hope today's agenda was helpful to you in understanding where we see opportunities from both a domestic and an international standpoint, as well as how we manage from on the risk side and investment management side and our capital and liquidity strategies. We also hope you took away the fact that we are very excited about our opportunities for growth in this market and the fact that we are a very strong and very focused company in terms of delivering on our promises.
Thank you for coming, and thank you for the important role you play as partners and investors in helping us deliver on financial and retirement security for millions of Americans. Enjoy the rest of your day. Thank you.