Good morning. Christmas is in July this year, but as you all know, Prudential observes strict radio silence in July. So even though today is the 9th of June, today is Prudential's 2011 Investor Day. An agenda is inside your binders. I'll take you through it very quickly. John Strangfeld will kick off with an overview. John will welcome your questions at the end of our program, so please hold them until then. Mark Grier is up next. Mark will discuss capital management, broadly defined, which includes stuff in addition to share repurchases. Mark will take your questions. We will have a break. After the break, Ed Baird will give you chapter and verse on our Japanese insurance operations. Ed will also address your questions. We'll have another break. That's the last break of the day. Charlie Lowrey and Steve Pelletier will present.
Charlie will take you through our asset management business. Steve will give you a deep dive into our annuities business. Charlie and Steve together will take your questions. Finally, John Strangfeld will pull it all together. He and Mark will have at your questions. We expect to conclude around 12:30. Speaking of pulling it all together, a lot of hard work by a lot of people goes into an Investor Day, as those of you in the room are well aware. My colleagues in investor relations play a central role in this whole process, so I'd like to acknowledge them briefly. Neil Stern. Neil, please stand up. Sean Kerwin, Ruth Hyatt. That wasn't much of a stand up there, Ruth. Ron, none of you is doing very well.
Rhonda Martin, who is our assistant and handed out names to each of you, I hope she gave you your name, is outside of the room now, so she can't stand up here. I'm trying to get a forward-looking statement. This forward-looking statement is in your binders. I will not read it to you today. You should read it. Here is the usual non-GAAP reconciliation. Actually, the second page of this has some information that I think you will find useful, in the context of Steve Pelletier's comments about baseline earnings in the annuity business. This will reconcile the baseline earnings to AOI. That said, we hope your time with us today is productive. Our first speaker will be John Strangfeld.
Thank you, Eric. Good morning, everyone. Welcome to our 2011 Investor Day. We're delighted to have you with us. We're delighted to have this opportunity to speak about our businesses. I'm going to introduce some broad themes about Prudential. My colleagues who follow will develop these themes into greater depth. In many ways, we've emerged from the challenges of 2008 and early 2009 a stronger company than before. We've clearly gained ground in most of our businesses. Our commercial momentum is strong and continuing. Sales and flows drive our financial results even more than in the past. Conversely, market conditions, while certainly still important, are less of an influence on our performance. The quality of our earnings, meaning their predictability, sustainability, has improved, as have our growth prospects.
On the other hand, our return on equity is below, significantly below our peak levels, albeit at a lower risk profile. We are confident that we can improve our return on equity without a significant increase in our risk profile, and we will spend more time on that later on today. We have very good businesses with attractive return opportunities, and our financial strength is an important supporter and underpinning to those businesses. As a financial institution, we take risks, and these risks are selected and managed with care. They're well-balanced by design, not by chance. We have become more selective about the risks that we choose to take, and our overall risk profile is strong and improving.
We're a market leader in distribution across multiple channels, and we are very well-positioned to serve the retirement, accumulation, and income markets, particularly in the U.S. and Japan, the two largest markets which offer strong growth potential for us. We have a balanced approach to capital management that encompasses both investing in our businesses and returning our capital to investors through cash dividends and share purchases. I'm sure you've noted the $1.5 billion share repurchase authorization for the next 12 months that we announced on Tuesday. We remain receptive to M&A that meets our strategic and financial targets. We view M&A selection, negotiation, and execution as important skill sets that we think we have an exceedingly strong track record in each of these dimensions. Finally, we believe that talent is the single greatest source of differentiation in financial services.
I'm talking about leadership, broadly defined, meaning those that you see and those that you don't. We expect to do a superior job in talent management and to be recognized for the caliber of our people by our customers, by our regulators, by our shareholders. We're obsessed with this, and we expect our success to be reflected in the performance, the quality, and the sustainability of our results. Some of the people you see, all of the people you see today are a reflection of that. As you can see in these rankings, we are a leading player in each of our markets, each of the markets in which we've chosen to compete, and we have focused this area of choice of competing over the last few years.
I'd especially note two items on the chart, the first and the last, namely our leading position in variable annuities and our top five standing among insurance companies in Japan. By the way, the only non-Japanese company among that group. This slide shows how Prudential has transformed the business mix since 2002, bearing in mind that we went demutualized in late 2001. You can see large increases in capital committed to international insurance and to annuities, retirement, and asset management. These increases were primarily funded with capital previously attributed to corporate and other, including amounts associated with businesses we've divested, such as our investment in Wachovia Securities. The last bar includes the Star Edison acquisition, which closed on February 1st. International insurance now represents 43% of our equity, just above our U.S. retirement and investment management division.
This has been a purposeful redeployment of capital to position us in good markets with high value-added business models and an attractive risk profile. Mark Grier will go into this more extensively in just a few minutes. We believe the return on equity is the most telling measure of financial performance, both the absolute level, the quality, and the sustainability. We manage to this yardstick more than any other. In November, we stated an ROE objective for 2013 of 13%-14%. This remains our goal for 2013, and I would add, it's not a goal for all time. How do we get there? There are three primary things that will drive our achievement of this. Number 1 is the continued strong performance of our high ROE businesses. I'm referring here to asset management, annuities, and international. Number 2 is the successful integration of Star Edison.
Number 3 is effective capital deployment, either in the businesses, either through organic growth or acquisitions, or through the return of excess capital to investors. Quite probably, it will be a combination of all. This slide compares 2013 ROE potential for our businesses with 2010 baseline ROEs, they exclude the effect of largely market-driven discrete items. Keep in mind that the business unit returns that we're showing here are unlevered, while the ROE for the total enterprise reflects the benefit of capital leverage. For example, annuities, retirement, and asset management have 2013 potential, namely the orange box on the right, of 14%-15%, compared to a 2010 baseline ROE of 11%-12%, which you can see on the left.
International insurance, which has attributed equity of $12.8 billion or 43% of total business unit equity as of March 31, has 2013 ROE potential of 17%-18%. This includes the impact of Star Edison, whose ROE in 2013 is not expected to be fully mature. We also expect ROE improvement for individual life and group insurance, these businesses account for a relatively small proportion of business unit attributed equity, as you can see. To complete the math, we've assumed that capital capacity will be redeployed to produce a 12% ROE, either through share repurchases or acquisitions. I can assure you that we are really intent on achieving our 2013 aspiration of 13%-14% ROE. We recognize we will get there only with the appropriate capital deployment and through a balanced approach of investing in the business and the returns of excess capital to investors.
That, combined with our business portfolio, is what drives our confidence in achieving our aspiration. That the priorities I've just mentioned a couple of minutes ago really create the context for the day and the agenda that Eric Durant has described. Namely, we'll begin with capital deployment for growth and return that Mark Grier will speak to, then we'll have three featured areas that are the primary drivers of the attainment of that 13%-14% ROE. International by Ed Baird, annuities by Steve Pelletier, and asset management by Charlie Lowrey. That's the context, that's the rationale for the agenda. With that, I'd like to turn it over to my colleague, Mark Grier. Mark Grier?
Excuse me. Thanks, John. Good morning, everyone. I've got a lot to talk about this morning, and I'm going to try to hit on topics that I know are of contemporary interest, but we're going to have time for some questions. Keep in mind that you'll have a chance to ask about some of the issues that are particularly hot right now. Let me start off with a comment on the title. The first word in this title is deployment, it refers to the deployment of capital.
One of the things that we think is important is that as we think about the prospects for the company as you like to look at them, growth and ROE and business performance, and also as we think about the risk dimensions that are extremely important as we look at how those earnings are going to be produced, the idea of deployment to us refers to investing money in businesses. As time passes, you sort of have to go down the path of after-the-fact attribution and after-the-fact allocation. We do that sort of because we have to.
Keep in mind that with respect to the way we think about risk and the way we think about where this company's headed, the word deployment, referring to investing in a business and actually putting money in and building infrastructure and getting something going and selling products to clients, is the starting point for everything and it is a very key concept. In fact, if you look at the crisis, a lot of the after-the-fact attributions and allocations as it related to risk and capital, didn't turn out to hold water. We pay a lot of attention to the idea of deployment in the sense of really investing as opposed to allocating or attributing. One of the questions that comes up frequently is, what's changed and how are we thinking about capital generally now as opposed to maybe a couple of years ago?
Let me go through some of the thought processes and some of the external developments that are guiding us in terms of how we're managing capital today and what we've been thinking about over the past two years. If you go back to 2009, we talked about having what was described by Rich on our earnings calls as a capital cushion. I think everybody did. This was pretty common in the market. We were just coming out of the financial crisis. Nobody really knew how linear that recovery might be and what risks might still be out there to capital. Everyone was saying, "Whatever the old standard was, we think the new standard is higher, so we're holding more." Everybody was talking about cushions on the balance sheet.
In John's comments about where we were in 2009, though, he added the dimension of the ability to play offense. The phrase he used on earnings calls was, we toggle back and forth. We think about defense. We think about offense. We think about defense right now in the context of an on-balance sheet cushion. We think about offense in terms of the potential deals that may come up and the advantage that we get as a counterparty to a deal from having the financial flexibility already in place. In other words, we didn't have to depend on what at that time may have still been a highly uncertain market to finance a transaction. It served us well. As we dealt with AIG, for example, on Star and Edison, it was very helpful to be able to say, "Stick with us. We can get there.
We've got the money. Let's try to get this deal done." We were toggling back and forth between defense and a cushion on the balance sheet, and offense and the strength and the flexibility that we thought was important as we considered transactions. Relative to other companies, that offensive dimension at that time was kind of unique. Not many were talking about deploying capital into new businesses or acquisition opportunities. Most were talking about that cushion dimension and the defensive component. In addition to talking about the cushion and defense, Rich also on our calls, made the point that it was temporary. We had a lot of to-ing and fro-ing with some people in the audience about what that cushion was and how we were thinking about it and how big it should be and how long it might last.
As I said, Rich made the point that it was temporary. The thinking there was, yeah, right now that's the right thing to do, there's a more efficient way to address the defensive component of capital management. When I say it that way, what you should be hearing is protection in the stress scenario or protection in the tail outcome. We thought at the time and said in meetings that there are more efficient ways to do this. We're going to look at better ways to manage capital than just holding that on-balance sheet cushion as kind of the brute force approach to playing defense.
We came out of 2009 with the idea that defense would migrate to a more efficient way of addressing the stress scenario risks. Offense was still on the front burner because we were looking at deals. We were working on things, for example, like Star and Edison, that ultimately came true and allowed us to deploy a substantial amount of capital, partly as a result of where we started in the second half of 2009. Fast-forward to today. Let's update some of those thought processes. Now we've got offense on top. We're still thinking about growth. We're still thinking about doing deals. We're still thinking about access to the market and how we might address the deal environment if something big came along. Our thoughts there have changed a bit.
We generally think that deals are less likely. This is a comment on the state of the world, not a comment on our aspirations. As John said, we still have an appetite. We'd love to be investing in our businesses, and we'd love to be doing good deals. The fact is that some of the stress has been relieved, markets come up, credit results have generally been better overall in our industry than most might have thought 4 years ago. Interest rates have come up a bit, although now they're back down. Interest rates are a source of stress that does lead some companies to think about maybe making strategic-type changes in their portfolios of business. All in, the combination of events in the market, we think, has taken some of the pressure off of potential sellers.
We also believe that there are more interested and more capable buyers than there were 2 years ago. We would generally expect a more competitive environment for properties that come on the market. In addition to that, I'd say that our comfort level with the ability of the market to finance attractive acquisitions is higher. We don't have some of that uncertainty that we had back in 2009 about how the world might work on the day in which we happen to be trying to get something done. Overall, we're feeling a little bit less optimistic about doing deals, and we're feeling more comfortable that we don't need to keep the offensive component of capital on the balance sheet to the extent that we did back in 2008 and 2009.
That's changed a little bit of the thinking about offense, and I think if anything, that our thoughts on that may have accelerated a bit in the past 6 months relative to the overall past 2 years. On defense, we have been implementing what we call a capital protection plan, and it's designed to do exactly what I said we wanted to try to do, which is find a more efficient way to address managing capital and having the appropriate capital in the stress scenario or the tail outcome. We've looked at a number of structured equity transactions. The phrase I've used is that these aren't very interesting when the S&P is 1,300 or 1,350, but they get really interesting when the S&P gets down to 800, 700, 600. We've got some of that stuff going on.
We have some committed lines with an explicit agreement that those funds would be available if we needed capital in a stress scenario. I said it that way because commercial paper backup lines have a real stigma attached to their use. If you draw on a commercial paper backup line, it's the same as running up a white flag and putting a for sale sign on the door. Everybody thinks it's absolutely the end. While we have a capital plan that does include financing, it's in the context of having it very clear that that financing would be available and used if we needed it in a stress scenario. We're also looking at reinsurance opportunities, not annuity reinsurance and some of the things that people would have thought about maybe in the earlier part of the decade.
Something that's more connected to our life business, but that would also be very helpful to us, in a stress scenario affecting either the equity markets or the debt markets. We've got a package of things that we're putting together. The execution is underway. Some things are done, some things are in the works. We're feeling like the maturity of our thinking around capital protection plans is pretty healthy now, and we're in a good spot. We can think about defense a little bit differently as well. We don't need the brute force approach to capital on the balance sheet. We can take a more aggressive approach to protection and relieve some of the less efficient balance sheet-oriented capital strategies. By the way, I think we're sort of unique in this respect.
A lot of other companies are still talking about those cushions like it's the only solution. I credit our team of Rich and Rob in particular, for being creative around the capital protection strategies. That's the transition of thinking, defense and offense and defense. Why we're feeling like we're more flexible now. As John pointed out, why we've recently announced an authorization to buy back $1.5 billion worth of stock over the next year. This is a good place to comment on regulatory issues and capital and SIFI. I prefer to call it sci-fi, by the way, SIFI designation or not. I'm assuming we'll get questions on this. Let me just make a couple of points. One is, this landscape is highly uncertain. The regulatory face-off is very fragmented.
There's thinking going on in a lot of different pockets. It hasn't really come together. In fact, a frustration for us is that we don't really have a focal point to go to address this at the federal level. There's a wide range of outcomes possible. Second point is that if we wind up regulated by the Fed as a SIFI, the Fed has broad latitude with respect to the metrics that are set and the calibration of those metrics for managing Prudential as a SIFI. Bank holding companies have prescribed rules, and if you're under the Fed as a bank holding company and a SIFI, like the top 50 or top 33 with $50 billion or more in assets, you're in an environment that's pretty much already defined and rules-driven.
If a company comes in because they're designated as a SIFI but not a bank holding company, the Fed has a lot of room. You get into issues like the role of the functional regulators, meaning states and RBC world and regulated insurance company world. You get into questions about the right way to look at group or holding company-type financial ratios and financial dynamics. Insurance companies or others, hedge funds or anybody else, that comes under the Fed as a SIFI will be in an environment where it's at least in some respects a clean slate in terms of how metrics are going to be set and calibrated and managed going forward. Even if that happens, there'll be another round of work to do on exactly what it's going to mean.
I don't believe it will mean that we will just be pounded into a bank holding company framework and try to look at ourselves the same way the Fed looks at J.P. Morgan or Goldman Sachs. There's an issue there. With respect to the probability of being designated a SIFI, there are two sides to it. One is the quantitative side, the intellectual arguments that we're not part of the payment system or the other broadly defined settlement systems that are out there. We're users. We don't depend heavily on particularly short-term wholesale liabilities, and we don't have a liability structure that's subject to a run on the bank. Those things suggest that the intrinsic nature of insurance business models would not be systemically risky.
We face what I call the yeah, but clause, which is we can have all the intellectual arguments we want to have during the day, and everyone nods and says, "Yeah, I get it." Over cocktails that night, they say, "Yeah, but no more AIGs." The idea of something falling through the cracks or a holding company like Prudential not winding up as a SIFI, I think is swimming upstream in the context of that, yeah, but no more AIGs kind of issue that just floats around qualitatively among all the regulators, U.S. and overseas. Finally, just one more comment, which is the quality of statutory capital is an important consideration that's overlooked. One point that people ought to understand is that statutory capital is the second-level issue on that statutory balance sheet. The first-level issue is reserves.
When we do our cash flow or asset adequacy testing, we're basically putting a mini stress test on every liability line item on the balance sheet, including level of interest rates, credit losses, and anything else that affects the future cash flows to support those liabilities. If you think about regulatory capital and the statutory balance sheet, there's a lot there, and we need to make sure that that gets in front of everybody who's worried about SIFI capital standards the right way. Because for us, it's not just RBC. That's kind of what's left over. The core capital for us is really embedded in the way in which those reserve calculations are done. Again, there's a mini stress test in every line item on the liability side of our balance sheet. I'm sure we'll come back to that one, but let's move on.
The next slide I'm not going to spend a lot of time on. It is a graphic portrayal of the calculation that Rich Carbone went through on our last earnings call, and it gets in front of you in print, the numbers that he talked about on the phone. I think, based on my interaction with you guys over the past couple of months, everybody's pretty familiar with this. This goes from the statutory capital in the insurance company, to the amount consistent with our benchmark, 400 basis points RBC, and gets to an excess in Prudential Insurance Company of America of $3 billion. We add to that other excess of $1 billion-$1.5 billion and get to $4 billion-$4.5 billion of excess on balance sheet capital. As Rich said on the call, we view $2.2 billion-$2.7 billion of that as readily deployable.
I don't want to harp on this because Rich made the point that the majority of the difference is attributable to the deferred tax asset, which will be realized, and as it's realized, we'll consider it to be deployable. This is just a timing difference. We've got an unusually large deferred tax asset because of the dynamics of the combination of the financial crisis and our large gain on the Wachovia Securities transaction, which was booked in PICA. There's a substantial admitted deferred tax asset. We'll realize that, and we'll stop talking about this issue, as that asset is realized. That just puts in front of you the numbers that we've talked about in public. This is a slide about the general approach to capital management, and you can also put risk management in there, in the left-hand box.
As you know, we don't view ourselves as a flavor of the month company. We focus on building the execution skills to deliver value propositions to clients that have staying power. We seek credible diversification in all dimensions: geography, product, legal entity, distribution channel, and type of risk. We have established strategies focused on what you know as Grow and Protect, and our positioning in the market around financial security and the traditional sense of the stability that Prudential brings to the client, combined with product innovation is really where that comes together to make Grow and Protect the underlying theme behind a consistent execution in deploying capital. We make sure we know what we're doing. It fits with proven execution and risk management capabilities. Finally, we're focused, as John said, on ROE as the benchmark measure of how well we're doing.
As we consider deploying capital, we do things that are accretive to the story that we have consistently had in front of you around a better ROE than most of the companies that we would compare ourselves to. This next picture is my favorite picture. It's a stylized view, so don't get out your rulers and your compasses and start measuring and calibrating. There are four pieces of information on this slide. The vertical axis is growth potential. The horizontal axis is ROE prospect. The size of the balloon is the amount of capital deployed in that business, and the color is a measure of volatility. When we've said before that we have an attractive business mix, this kind of puts everything on one page in front of you. Now, obviously, big green balloons in the top right are good.
That means a lot of capital at low risk with good ROE prospects and good growth prospects. This is a portrayal of the deployment of capital as we see it. Again, this is a stylized view, but as we see it, that I think has a lot to it in terms of the messages that we've been sending about the attraction of our business mix. You see individual annuities shaded between medium to higher risk. We believe that the risk profile of that business is migrating toward medium as more and more of our sales are in the products that have the protection features embedded in the products. I'd also remind you about some very strong statements that I've made in the past about the divergence between real economics and accounting in the annuity business.
I think if you cleaned this up and took out some of the accounting noise, you might feel even more comfortable about the annuity business. This is a great picture. I like the messages it sends. I like the fact that we have a really big green balloon in the top right corner. It also looks like it makes sense in terms of the lower risk businesses, also aligning well with return and growth prospects. Nice portrayal of the business mix of Prudential. I want to go through some comments on each of our businesses before I turn to questions. These are themes that are in many respects familiar to you. We've been very consistent as we've thought about our execution challenges. Let me hit a few highlights. Individual Life, we've said repeatedly that we don't want to go out and play the market share game.
We face a combination of competition from mutual insurance companies who are coming from a different place, as well as public companies who have different views of pricing and different standards with respect to business conduct than we have. We have focused very heavily on efficiency and capital management, on returns, and on managing the business model, which you should think of as aligning products and channels so we can succeed at the things that we're good at and not wind up chasing our tails in a market that's, in some respects, very competitive and doing things that we really wouldn't necessarily consider to be appropriate, either for Prudential or for a public company. Significantly, the point about avoiding inappropriate financing is important. You see more and more now about the wheels coming off of some of these stranger-owned life insurance programs.
You've seen some pretty big fluctuation in some companies' sales as financed insurance, and particularly financed insurance fed into the stranger-owned life insurance pipeline has fluctuated over the past few years. Jim Avery deserves an enormous amount of credit for his stand against those kind of products and his actions to make sure that Prudential didn't get involved inappropriately, and it served us well. You don't see us in those headlines or in some of those stories that are, as I said, increasingly visible about some of those products. Group Insurance, very micro-driven, heavy focus on case selection and pricing. Again, more business model-driven than competition-driven. I know this is a business where if you walk down a hallway full of insurance companies, everybody's pointing at everybody else and saying they're all underpricing. We're the only responsible ones in the market, and how can we live with all these lunatics?
We would be in that hallway saying exactly the same thing about everybody else. We believe that the results, though, in terms of our hit rate and winning cases and our performance over time, is consistent with what we have described as our focus on execution and profitability and quality. Retirement, our historical emphasis has been on full service, where we're almost unique in the market, certainly distinctive. I would acknowledge at this point that there are strategic issues around earnings power and business models in the Retirement business. They're strategic issues. This is not the house burning down tomorrow morning.
There's some things to think about with respect to what the future business models will look like and where the earnings power will be with respect to this market as it changes as a result of competition and regulation and other influences on unbundling, moving further down in the market. Our historical record here is good. We have good client relationships and good execution skills. Importantly, on the bottom point here, we have a world-class team in the field of what we consider broadly to be pension risk transfer. We recently announced the first pension buy-in deal that's been done in the U.S. It's coming slowly, we believe that we're extremely well-positioned when that market and by the way, higher rates would be a big lift to the pension risk transfer market. We believe we're very well-positioned when that market changes.
Asset management, I think the headline here is that the risk profile has been changed, you're going to hear more about this one. It looks a lot now like the way you guys like to look at asset management businesses, driven by the connection between assets under management and fees and operating leverage. You'll hear more about it from Charlie. We've been very successful. We like what we're doing here. The results are good. As volatility has come down, that more linear view, easier view for you of this business has kind of moved to the front burner. With respect to annuities, you're also going to hear a lot more about this. Let me answer a question that I've had in a number of meetings over the past few weeks, which is: what are you thinking about market share?
The catalyst for that is the avalanche of new product introductions, where I believe at the last count, there were nine new products filed that look like our auto-rebalancing product in one form or another, meaning they're attempting to embed the risk management of the product in the account and in the product, leaving less of the exposure for the insurance company as principal. That's the catalyst for the questions, let me just give you a little context around annuity market share and the risks of extrapolating our recent performance. The starting point for this is that we're good at it. We have good products. We have good execution skills. There's a platform there that day in and day out works very well. You've got to look at a couple things on top of that.
One is that going back to 2008, 2009, this market turned upside down. You had massive changes in the league tables. Participants who were number 1 in the business through many of the top 10 almost totally or totally got out of the business. As that huge shakeup occurred, you saw Prudential, Met, and Jackson National rise to the top. Now, again, it's in the context of a platform that works very well, there was a market dynamic there that was shaking up market shares and redistributing sales in a way that went way beyond the ideas of aggressive competition or aggressive compensation. That wasn't what was happening. There was an appetite in the market for protected products. There were some players who had been really, really big who became really, really invisible. You can't extrapolate that kind of market dynamic going forward.
The market became much more concentrated. You go back to the first part of the decade, our market share was 6%, 7%, 8%. Recently, it's been more like 20-plus. The market became much more concentrated. I think you have to assume that now that the second wave is coming, credible brands with credible business systems will come in, and the pendulum will swing back a bit. The market will dilute some of those big market shares now, and it'll be the natural order of things. It won't be something that we're going to want to fight against. It's going to be something that I think we ought to expect.
One other point on this for us is that over the past four or five years, we've also seen the maturity of our wirehouse channel, and some of that reflects the fact that when we had Prudential Securities, we didn't distribute Prudential products through wirehouse channels. We were competitors. Even when we had Wachovia, we were a little bit of a competitor. I remember on calls back in 2004, 2005, saying that the market sells a little more than 20% of variable annuities through the wirehouse channel, Prudential sells about 6%. At some point, we'll get our fair share. What I said at the time is it's not an entitlement. We'll have to execute, but we're underrepresented in a very important channel. That's behind us, too. We were number 1 in the wirehouse channel in the first quarter, and that channel has matured for us.
Again, keep in mind that we're not going to go from six to 20 to 80. We're going to go from six to 20, and we're going to stabilize. Just think about context. When you look at the annuity business and what's happened to us, extrapolation isn't the right way to think about it. There has been a market share dynamic, and there's been a particular channel dynamic that have both partly driven the kind of gains that we've seen in our business. We expect in a more competitive environment that the natural order will be a little more fragmented, and some of that will be given back. Just a little context around annuities. Finally on international. For a long time as a public company, we had to dissect the Life Planner model to explain what was working.
I think now there are two headlines over the international insurance business. One is that you can step back now and identify with this as multi-channel, high-margin products with the ability to sell a lot of those high-margin products. Whether you understand all the details of the bank channel or the Life Planner channel, now the macro view is something that's a little bit easier to understand, which is the multi-channel approach to selling high-margin products and being able to do a lot of it. The second point is that the retirement opportunity for us is coming true in Japan, in a way that's spectacularly successful. If you think about what we're trying to do here, all we're trying to do is get in between the mattress and the retirement outcome with a product that's a little better for the client.
We only have to do some of that. That market is $10 trillion. We only have to do some of that to produce a lot of attractive business results for Prudential. As we insert ourselves between the mattress and the retirement outcome, and we do it with high-margin insurance-oriented products, that's a theme that's paying off very well for us. It's low risk, it's high margin, and it's a market where we feel like right now we've really got the wind at our backs. A notch below the macro dynamic of Japan, but there's a lot of potential in there at that more micro level. I'll stop there on my prepared remarks, and I've got time for some questions. We'll have other opportunities on questions, by the way.
Webcast.
Oh.
Can I have the mic, please? Turn me on? Thank you.
Oh, we're webcast. If you could wait for a microphone.
Let me just go through the Q&A protocol. First of all, stay out of the mattress. Secondly, please wait for me to identify you. Please state your name and your firm. Please don't be a hog. Be respectful of your clients and don't hog the mic. I have to apologize in advance. If I fail to recognize a high school classmate, it isn't that you've changed, it's just that I can't see you. The lighting here is very challenging. Now we can start.
Darren Arita.
You just took all the time we had allocated to questions. That's strategic. Darren, yes.
Darren Arita from Deutsche Bank. I was hoping if you could try to quantify the amount of capital you expect to utilize over the next year, just as you invest in your business for growth. Then secondly on that, if we go to slide two of your presentation, Mark, just you showing the capital position. What would the on-balance sheet capital be if we think a year out, and maybe we can simplify it, just assuming no buybacks and no M&A?
The second question, Eric's already given me a dirty look as I was even thinking about possibly answering it. On the first question, which is the use of capital, we've talked about a rule of thumb being that about half of our after-tax operating earnings are reinvested in the business, and about half would be available for other purposes. Keep in mind that for capital purposes, it's really net income that matters. That's what affects the capital accounts. Part of the theme here is that it's over time, assuming net income and adjusted operating income converge over time. We think of roughly half of our earnings as being available.
One other protocol here. Most of you know us pretty well, and you've got a pretty good sense of the kinds of questions we're not going to address. I would suggest that you try to ask questions that you think we are likely to answer. Okay, Randy Binner.
Thanks, Eric. Randy Binner, FBR Capital Markets. Mark, I'd like to pick up on the SIFI conversation, you said two things. You said there's a fragmented approach by people in Washington, then you said that if you were dragged in, there'd be a wide range of outcomes. I guess we see a lot of potential ranges for Tier 1 capital. 7%-10% was a more comfortable range, now it's higher. I'd like to get a sense from you on how much you think that the regulators in the industry are posturing here, meaning, can we expect to get more in the middle of where everyone's posturing? As far as the wide range of outcomes go, do you think that whatever that range is, that Pru could be at the lower end of it? Again, assuming that you were to become a SIFI.
It's not even a given that Tier 1 capital would be the measure. One big issue in all of this for us is the role of the functional regulators and the regulated insurance companies and RBC. When I talk about a wide range of outcomes, on one extreme, you say, "Forget about any differences. We're just going to look at you like you're a bank and pound you into a consolidated group level holding company Tier 1 capital framework." At the other end, you have a much lighter touch at the holding company level, but you have more of a focus on the regulated entities and RBC standards. That's unresolved. Part of the wide range of possible outcomes is we don't know which end of that spectrum we'll wind up at.
The Fed has acknowledged an interest and a willingness to have a constructive engagement around how we look different from banks and how that might affect thinking about things like capital standards. In fact, last weekend, in all the fuss around what Tarullo said about potential SIFI standards, one of the comments that was made a little more quietly was we may have to think differently about insurance companies. I think as a starting point, it's more important for us that they think about us differently than which bucket we wind up in. I'm assuming that our holding company is going to have some regulation somehow. They won't let Prudential go unregulated at the group level.
Whether it's in the SIFI world or whether it's for some other reason, I think the more important question for us and for our industry is will we just be pounded into a bank framework and looked at that way, or will there be more of an understanding of things like statutory reserves that I mentioned earlier, things like RBC, and things like the lack of fungibility across regulated entities of capital, particularly in a crisis? In a sense, group standards for us are meaningless because it matters a lot for us where it is. The local nature of that insurance company regulation has a big impact on the conclusions that you can draw from consolidated capital pictures, whether it's Solvency II or Basel III or any of those.
Anything that has as a premise that group level capital is a meaningful concept is starting in the wrong point for a company like us. Our local capital in Japan and our local capital in New Jersey, for example, matter a lot. The more important thing to me is that we have a chance for constructive engagement around how we're different and that standards are set, meaning the definition of the metrics and the calibration of the metrics are set in that context. One other point on this is that financial strength is part of our value proposition. We don't go into the regulatory discussions with the idea that we're looking for loopholes and we're trying to skate right on the edge. We want to have the solvency regime be a message to the market around financial strength and quality.
We don't want it to impair the efficiency of the deployment of capital and the opportunities that we have in our business models to provide attractive returns to the equity market. That's the balance. I think the real key issue is that we get a chance to be looked at differently, because those bank things, Solvency II and Basel III aren't even going to work. If there's a crisis, everybody's going to go back to doing stress tests because no one's going to believe those things. When everything's fine, anything works, and we're about to prove that if they implement all this other stuff. If we get in trouble, they're all going to go back to stress tests anyway because that's going to be the only thing that works in a real crisis. It's especially true that they won't work for us.
I think, again, the more important issue is that we're differentiated, that we have constructive engagement around what's right, and we want a quality outcome. That's in our best interest, and it's good. We don't want an inefficient outcome with respect to the things you guys are worried about. That's the argument that I carry when I go to Washington.
Thank you. Okay. Margot?
The gentleman just a couple rows back in the dark jacket. John Nadel.
Thanks. John Nadel from Sterne Agee. I was hoping you could update us on 2011 guidance and maybe preliminary 2012. I'm just kidding.
You're going to make him give another speech now.
More importantly, I was thinking about the $1.5 billion of capital management here with the buyback authorization, and I was hoping you could put that in the context of when you guys gave us the preliminary outlook for the 13%-14% ROE. Obviously, deploying excess capital was an important component of that. Where does the $1.5 billion, how does that relate to the total amount of deployable capital that you expect to have to implement to get to that 13%-14% range?
Well, let me start with the point that when we think about starting this, when you say capital management, you always just mean buying back shares. We mean more than that.
Just as easy
Starting capital management now reflects exactly what we perceive to be the need to stay on the glide path toward that ROE objective in 2013. It's the beginning of part of what we think we need to do because we, for example, didn't do a $1.5 billion deal yesterday, there's $1.5 billion that we're going to put back into the market. It reflects the need that we perceive to stay on that glide path and to deploy capital so that we don't get to December 31, 2012 with a massive capital deployment problem. It's the glide path. We have not disclosed how much total capital has to be deployed to get to that objective, but I'll tell you that this is a starting point that is consistent with and driven by that ROE aspiration and what it's going to take to get there.
That's helpful. Just my follow-up question, Mark, I think your comments on the retirement business, setting aside the institutional products portion of that segment, that the 401 piece of that business, your comments, I took as a bit more tepid around that business, the outlook for margins. Could you expand on that? I'm not sure if I heard you, if I was reading too much into your commentary.
You're probably not, maybe I'll ask either Charlie or Chris to comment if they want.
I actually think that's a good question, we're happy to answer, I think that may be better done after we go through the business presentations rather than now.
Okay.
One more on this side of the room. Jay, you're right next to John.
Thanks. Jay Gelb from Barclays Capital. John, can you talk about or expand your commentary a bit on the potential for acquisitions with regard to geographies and-
You know, Jay, that's a question that, as I mentioned at the start, John would be delighted to take at the end of the day, but we don't want to take it now.
All right. I'll turn to the macro environment. Low interest rates seem to be back, and you'd mentioned initially that you think the business prospects are driven more by sales and flows, which I understand, but you still do have some macro headwinds here. Can you talk about the impact of low rates on the business and also volatility elsewhere in the financial markets?
With respect to low interest rates, let me put it in two buckets. One is the balance sheet and the potential for big hits on reserves as a result of low rates. We've been staying on top of that. In fact, we have about $900 million in what you might think of as excess statutory reserves that reflect the results of our cash flow testing, the reserving process that I mentioned earlier, and the consideration of the low rate scenarios with respect to those reserve decisions. I think we're staying on top of it. We're watching it. We don't want a balance sheet surprise, and in order to make sure we avoid it, we're keeping up with it as we go along.
In terms of the earnings impact, we are not all that sensitive to the level of interest rates and probably less sensitive than most of our competitors. We don't have a big fixed annuity book, for example. We don't have a big spread lending activity. We don't have some of the embedded product exposures on the life insurance side. Our asset management business, which is heavily weighted toward fixed income, actually sees an increase in account values as rates come down. That's a positive dynamic. We don't see much of an impact on the operating earnings side of the company, not a particularly big concentration or vulnerability anywhere. Remember, we make almost half of our money now in Japan, and interest rates have been low there forever. The profit dynamic there is very heavily driven by mortality gains.
The mix of our profitability is also favorable relative to considering the impact of lower rates. Balance sheet, we're staying on top of it. Business mix is just intrinsically not as vulnerable to lower rates as some lines of business for other companies.
All right, thanks. Separately, the pace of the buyback, should we expect that ratably over the next four quarters, or is there some type of timing sensitivity on that?
He's giving me another dirty look. That's an annual authorization, we'll manage within the timeframe.
The one thing I'd add, Eric's comment that we'll speak to this more towards the end, is when you're hearing these business presentations, keep in mind when you're thinking about M&A that we feel very good about the organic prospects of our businesses and the organic growth rate. I think that'll come through clearly with the international presentation, with asset management, and with annuities. Therefore, from our point of view, M&A is like to do, not have to do. We have some ideas about scope and the areas that would be of greatest interest, but it's not essential as a tool to take an underperforming business to performing or to achieve scale where we're subscale. We feel very good about our business mix.
Although we certainly have a preference for M&A as a means of deploying capital, we realize we can't rely on that entirely and achieve our ROE objectives. Hence, you're seeing the announcement earlier this week of achieving a balance to get there.
Okay, let's give some guys on the other side of the floor a chance. Josh, the gentleman on the aisle there, Eric Berg.
Thank you. Eric Berg from RBC Capital Markets. Mark, I'm sure Ed will talk about the retirement market, or the Japanese market and the retirement market in particular in Japan in some detail, but just at a very high level, from a strategic point of view, how do you think the retirement market in Japan will evolve differently from the U.S.? How will products be different? What big picture observations could you make about how that market will develop there in contrast to the major trends we've seen here?
Hey, Eric. Ed is about to present in another 15 minutes. That's a great question for him, I think, but not really for Mark.
I have a really good answer. If he doesn't get to it, ask it again.
Okay. John Hall. Lisa, there he is.
John Hall with Wells Fargo. Mark, I was just wondering, I'm going to link two things a little bit together, SIFI-ness and the potential designation as a SIFI in the future and capital deployment in the present. How do you think, does that potential of designation change how you manage capital now?
The short answer is no. The expression that I've used is that we're not in the fetal position anticipating what might happen. There are a couple of reasons for that. One is that we're very well capitalized by any standard. The second is we generate a lot of capital. If there are some changes that require us to think differently, we have the capacity and the strength right now, I believe, to manage whatever comes along. It's also not going to be a massacre that happens in one day. We're not going to wake up some morning with a whole new array of balance sheet targets. There will be time to migrate to whatever capital standards are set, as I said, I think there's going to be a process where we have the opportunity to work with the Fed on exactly what gets set and how.
The combination of current financial strength, the ability to generate capital, and the time it's going to take to work through this, suggests to us that we ought to be doing what we think is right today, in a sense, cross that bridge when we get to it, but understanding that we've got a lot of horsepower to address whatever issues come up.
Yeah, one thing I'd add to Mark's comment on this, particularly contrasted with the banking community, is our business models are intact and our revenue streams are intact. There's not something that's gone on in these forces that affects the numerator and the denominator simultaneously as you see going on in the banking industry right today that makes it so problematic. There could be some forces at work here that have some effect on the denominator, but in terms of our revenue streams, our business models, we think they're in very strong shape, we don't envision that they'd be subject to material change coming through any additional forces in the landscape.
Ed Spehar, you're next.
We'll get to Andrew at the back.
Yeah.
Thanks. Ed Spehar from BofA Merrill. I guess, John, Mark, the S&P 500, I think is where it was in 1999. The 10-year treasury is at 3%. Everybody's hungry for yield and understands that that's an important component of returns for equities, I think, going forward. Those strategies have been rewarded in the market. Why wouldn't your dividend yield, your dividend payout, be substantially higher than it's been? I don't mean 30% higher, I mean 50%-100%, considering the fact that you say 50% of earnings are free cash flow. To John's comments, the business model's intact, the revenue model's intact, et cetera.
Our view is that the market has tilted somewhat more in favor of dividends and less in favor of share buybacks and thinking about capital management, to use the term. We took what we thought was a fairly aggressive dividend action in the fall when we raised our dividend to its pre-crisis level. The point you're making is part of our consideration. At the margin, I think we do view dividends as more important to the market and more valuable. As we think about our capital strategies, we're going to be thinking about exactly that point. It's not all or nothing, though. Not every investor would agree with the point you just made. A lot of investors still favor share buybacks over dividends, so it hasn't gone from 100 to zero. It's just tilted.
We want to reflect that tilt, our historical mindset has been to pay careful attention and be reasonably aggressive about dividends, we'll continue to do that.
We've got time for one more, Andrew, it's you. Hand up, please.
Yeah, just a couple of quick ones. With regard to M&A market, sounded to me like you didn't feel like there was much going on right now. It's just a tough market for M&A. Is that the right read in the near term, you really shouldn't expect much?
Well, I tried to balance it by pointing out that we still have an appetite and we're still looking. I think purely looking at the external environment, it's become more difficult. I wouldn't be surprised to find we might do a deal because we're trying to look for opportunities. The point of that was we think the external assessment is, as you said, harder.
You could do something in the near term?
Well, we'd still like to invest in our businesses and do attractive deals, yeah.
Okay. You mentioned in another slide that you have $2.2 billion-$2.7 billion of readily deployable capital. If a deal were to come along in, say, the $3 billion-$4 billion range, would you be interested in something like that, something bigger than what you readily have now?
Yeah. We don't feel constrained with respect to size. Obviously, deals that are cash flow and capital friendly are a little easier, but we're thinking expansively about opportunities.
Got it. Just lastly, I didn't quite understand when you were talking about structured equities, if the S&P were to go to 600 or 700, you were talking about some things with regard to the credit facility. It sounds like you've done some derivative purchases. Could you clarify that a little bit more and how they work?
Well, without getting into too much detail, there are structured transactions that have, well, in some cases, for example, a corridor where the market might be between 600 and 800 and the thing might have a lot of value peaking at 700. It's just a matter of mixing and matching different kinds of derivative structures so that by buying and selling, we're going into it with a lower net cost and having a payoff that's bigger in the stress environment, but not so much at the in-the-money type levels.
Got it. There's some material payoffs if we were in some big stress scenarios.
Yeah.
Super. Thank you.
That's right. Okay. Thank you all.
Let's take a break and try to be back in 10 minutes, please.
Thank you.
Well, it's about that time. It's going to take a couple of minutes to get people to come back in, I'm afraid. Okay, even though I think there are still some stragglers straggling in, we need to get started again. We're already falling a little bit behind schedule. The next speaker is Ed Baird. Ed is the head of all of our international businesses. He will speak to international insurance with emphasis, not surprisingly, on our businesses in Japan.
Good morning. What I'm going to try to do this morning is to provide you with a look inside the Japan organization post the acquisitions of Star and Edison. What I hope to make clear are a couple of things. First, what I'll call the more observable characteristics of these businesses, but probably more importantly, the underlying dynamics and drivers of the business, so you can see what is causing that behavior. As a result, hopefully position you better to form your own judgment as to how these businesses might perform going forward. Let me start with an admittedly very simplistic set of definitions of this business. You might think of this as sort of awards that go along with the big green balloon that Mark referred to. Today, as a result of these acquisitions, this is a very big business in Japan by any measures.
It's truly a market leader there. These next 3 attributes and the interplay between them are what I hope to really be able to explain to you. Namely, this is a business with high margins, low volatility, and yet very strong growth. I think it's fair to say that's a very unusual combination, and I'll try to explain to you why that has existed and why we believe it can continue to exist going forward. Let me start with the big part. What exactly does that mean? Let me start with the number of policies. What you see there in the blue, the number of policies that we've had in Japan, about 6.5 million. The red is the number of policies we have outside of Japan, another 1.5 million.
In the green, another 3.5 million that we added with the acquisitions of Star and Edison. This has a couple of consequences that are worth understanding. The first might be fairly obvious, and that is that with a 50% increase in the number of policies in Japan from roughly 6.5 million to now 10 million, you get obvious benefits in terms of the economies of scale that go with that. Possibly less obvious is the marketing opportunity that's embedded inside that. Let me explain that. There's an old saying in the insurance business that the best prospect is a current customer. I can't give you a better example of that than POJ. In POJ, year after year, with remarkable consistency, they write about 40% of all of their new business by selling to their in-force customer base.
An addition of 3.5 million new customers to us represents a tremendous opportunity, not just to steadily improve our expense margins, but also to build a whole new rich pool of prospects going forward. We see comparable growth in the premium revenue and similarly in the new business, where now we're getting up to what I think is a fairly serious number of about $2.5 billion of new business premium. Again, this is the total for the division, but as you can see through the blue and the green, it's really about Japan, and that's where I'm going to focus most of my comments today. Here we focus on the distribution and the 3 major components of that. The first is the captive agency system, and you know this is where our historical strength has been.
The blue being the number of salespeople that we have in POJ and in Gibraltar. To refresh your memory on that's about 6,000 life advisors inside Gibraltar, about 3,000 inside POJ. We have in the red, the number outside of Japan. The green is the number we've added of over 7,000 as a result of the Star and Edison acquisitions. Those 7,000 will be integrated inside Gibraltar, so there'll be a total of 13,000 salespeople there. That's a number that I'm going to refer to later on because it has considerable significance in terms of our reach, both geographically as well as from a production perspective. I'll point out at this time, you may recall from our discussions about the acquisition that we put in very little value for the new business in the pricing model.
In fact, we assumed that for the next couple of years, sales would probably decline even off of their relatively low base in Star and Edison. That base being low because of what had transpired over the several years through the financial crisis and the loss of credibility in AIG. The opportunities I described to you emanating from those two companies are really additive to anything we've put into our pricing model. The bank relationships, this is the newest part of the growth story that we've had in the last couple of years in Japan. As you can see, because it is new, we've had a relatively small number of bank relationships through whom we've been distributing.
In fact, for quite some time, the biggest relationship, at one point constituting 90%, now down to still about 50%, is the relationship with the Bank of Tokyo-Mitsubishi, the number one mega bank, still a dominant part of our distribution in the banks channel. Through the acquisitions of Star and Edison, we've been able to significantly speed up our natural organic growth of our infrastructure in bank channel. They got into bank distribution earlier and in a more serious way than we did. They have a number of wholesalers. They have a number of banking relationships. The acquisition of those will meaningfully speed up the growth that we have already started to have in the last few years inside bank distributions. This is one graphic portrayal of that. Even more novel for us is the addition of the independent agent.
This has been a dramatic change for us, which we haven't talked a lot about, because in the first quarter of 2010, that had a sale of about $2 million in the quarter. In the most recent first quarter, that was up to $25 million in the quarter. Starting to move. This is an area that both Star and Edison have been in for quite some time, as you can see from the numbers, there's a meaningful addition here in terms of the number of independent agents with whom they've had relationships. Both their bank channel, and to a lesser extent, the independent agent channels, diminished their production substantially during the financial crisis because as you can imagine, any third party was going to be hesitant about recommending a company whose reputation was as tarnished as AIG's was during that period of time.
We think the reactivation of these relationships, both in the bank and in the independent agency channel, will substantially speed up the development that we had coincidentally already launched fairly recently. Here's a quick context look at what the growth has been over the last handful of years relative to the marketplace. You can see that if you look back at about six years ago, we had a market share just under about 5%. As of last year, on a pro forma basis, that number had roughly doubled. The bulk of that, by the way, which is embedded in a footnote, really came from organic growth. In other words, even without Star and Edison, that number would be about 8%. That increment is the result from there to the resulting number of 9.7, is the product of acquiring Star and Edison.
This is the factual basis upon which Mark made the comment that he did about us having now a truly strong position in this marketplace, particularly relative to any of the foreign-owned companies. As you can see, a strong and growing position even relative to the big domestics. If you look at the top of the scale in both of those periods, you'll see how much the big domestics have been losing market share on a new business basis, so that as we're growing, the target that we're being compared to is coming down. Interesting to speculate as to where that might be if you look out a few years, given the momentum that's embedded in some of these numbers. There's a similar growth taking place inside the AOI, the earnings of these businesses.
I want to spend a moment or two on this to emphasize not just the big part of the description, but this is where you see the reason for the low volatility. As you know, there are three classic sources of earnings inside any insurance company, the underwriting gain, the expense margin, and the investment return. You'll notice when you combine those first two, the jargon being the M&E charge, that constitutes the vast majority of the earnings that we get from the international business. The reason for that is that with limited exception, which I'll explain, namely those companies that went through bankruptcy, we don't make money off of investment income.
The reason we do on Gibraltar, and the reason we will on Star and Edison, is that those companies went through bankruptcy, which allowed, therefore, a resetting of the crediting rates and therefore a positive earnings on the investment income. It is the relative independence from that that allows us to have that stability on the earnings year after year. Keep in mind, inside the mortality, you have a steady improvement, a steady secular gain year after year. The long-term trend is very much to our advantage in that. If you look at the expense margin, that too is a significant contributor for us and one that continues to benefit through the economies of scale as we grow through acquisition as well as organically. I'll comment briefly here as to how this informs our M&A strategy. Our strategy differs somewhat from others.
It's exceedingly difficult, one could argue almost impossible, to get meaningful economy of scale when you go wide. Therefore, we tend to concentrate on going deeper in the markets where we are so that we can extract the benefits of the scale by leveraging that base. That informs, does not limit, but it heavily influences our strategy, and one of the reasons we are so interested in the acquisitions there at Star and Edison and continue to look as a first priority, not the only, but as a first priority in markets in which we already have a presence so that we can leverage that key source of earnings. Let me shift gears a little now, having spoken about the substantial earnings power, the low volatility. Let me talk about what might be the least obvious part of this, and that is the growth opportunity.
Keep in mind, it's been for the last seven quarters where we have had growth that's exceeded 25% a quarter. I would argue to you that that goes well beyond what might have been an initial flight to quality stemming from the financial crisis, which caused us to start to stand apart from some of the more impaired companies in Japan. I think what you see happening here is the emergence of an opportunity, which I see as the early stage of a second S-curve of growth that's embedded inside the demographics of Japan and that are not obvious from an initial superficial point of view. Let's start by just reviewing a few aspects of the Japanese market, and then I'll drill down. It's a big market, almost $400 billion. Second largest market. Substantial wealth. Expanding retirement opportunity.
As Mark has referenced, we have growing distribution capability. Let me focus on each of those in a little bit of detail. First, you'll note the top two countries on the chart are the two countries where we have our biggest presence, the U.S. and Japan. You'll note that it's a fairly steady and rapid drop-off after that in terms of the other markets. The next several markets there are European markets, very mature, in which we don't have any meaningful presence. When you see a cluster there of Asian markets, where we have a presence of varying degrees in every one of them. We see the top of the table as the opportunity for us to harvest in the short, medium, and to some degree, the long-term, substantial meaningful growth.
The lower part of the table where we see opportunities, but candidly, much further out, to be able to fuel the growth. Let's take a look at one of the better known aspects of the Japanese marketplace, namely, the population. If we look at the numbers in the red, in the circle at the top, it highlights what is well known, which is that the population of Japan has essentially peaked at about 128 million. I will point out this is about 50% bigger than the biggest country in Europe, Germany. Nonetheless, it has peaked. As you can see, over the next 20 years, that number is going to drop to about 115 million.
Still a big number, but legitimately causes people to stop and analyzing there and simply say, "This is not a growth market." You know for a lot of products, that would absolutely be the case. If one drills down a little deeper, you can see an opportunity. This gets to the question that Eric Berg was starting to ask. If you look inside the one segment of that aged group, you'll see that where the growth is taking place is in the oldest part of the population. Over the next 20 years, that group aged 65 and over is going to move to one out of every three Japanese. That's a growth not just in a percentage, but a substantial growth, as you can see in the absolute number. A substantial number. Let's start with that as point one.
This, by the way, is characteristic of any advanced industrialized nation. What's different is the next part, and that is the accumulated wealth that exists in Japan. What you see here in the green bars is a graphic display of the financial assets of the households, and the U.S. far out front, Japan number two. Then again, you see a dramatic drop-off from there. We put in an almost unreadable small red dot that represents population with the axis on the far right, just so you can get some sense of the relationship between the wealth and the population. You'll note that with the exception of China, there is indeed a certain correlation there. China does not yet have that because of course, it's much further behind in terms of GDP or wealth per capita, in spite of a substantial savings rate.
What's even more intriguing is the composition of that wealth that's being held by the Japanese households. If we drill down deeper in it, we see the following. Of that number of JPY 18 trillion, here's the JPY 10 trillion that Mark referenced. There is no comparable pool like that because of the composition of this. You'll notice how small, if you look over on the southwest corner, the sort of purplish color. You see the very small percentage of about 6% in shares and equities. That number in the U.S. would be more like 30. The Japanese understandably don't have much of an appetite for that. Part of it is cultural risk aversion, and part of it is simply having observed the performance of the Nikkei over the last 20 years.
This is one of the reasons that the Japan Post and the Japanese commercial banks are among some of the largest depository institutions in the world. This is one of the reasons that Mark references the point that this is the big green balloon. What we can conclude from this, to state in admittedly somewhat simplistic and crude terms, is that like many advanced nations, the Japanese are old and getting older. What is distinguishing differentiation is they're old, but they're rich, and therein lies our opportunity. When you look at the JPY 10 billion that I just referenced, that's sitting in currencies and deposits, readily available liquid assets, this is the largest such pool in the world. Far bigger than you can say, even compared to the U.S., and the other countries don't even begin to come close.
In fact, you'd have to combine a number of them to get to this pool of assets. What's particularly interesting about this is as follows. We see that they have the money. How do we access this opportunity? The existential challenge of any business is to satisfy a customer's need better than the competition. We see the need, we see the resource. How do we develop a distinguished advantage over the competition, first as an industry and then as a company? Here, let me start at the macro level and address Eric's question. How will this opportunity evolve differently than the U.S.?
For those of you that, like myself, have been in the business for 30 or 40 years, you may recall the following saying that started in the U.S. in the late '70s and early '80s, "Buy term, invest the difference." At that point, the emergence of money markets, the emergence of mutual funds, started to pull assets away from insurance companies and into that sector. Whole life started to lose its appeal. Keep in mind an aspect of whole life, which I sometimes think of as a spectrum of opportunity. At one end, you have pure death protection, that's term. At the other end, you have very high cash value products, endowments, other kinds of products.
The relative appeal of that end of the spectrum on whole life was made less attractive by tax laws, which started to treat some of those products as modified endowment contracts, and took away some of the advantages of the inside buildup, and further fostered this movement of buy term and invest the difference. That right-hand side of asset accumulation that is necessary for an aging population to address their retirement needs did not come to a large extent, certainly not during that period of time, to the insurance companies. It went instead into the securities business, the mutual funds, et cetera. That is not happening in Japan. That money is sitting in the banks, as amply demonstrated by this slide. They don't have an appetite as a culture, and given their history, to move into the equities of the mutual funds area.
By comparison, in fact, they are much more comfortable in sitting with the general account portfolio returns of an insurance company, thus whole life, which remains our best-selling product regardless of the channel through which we distribute it. It's addressing a retirement need that works very well for them and yet preserves for us the high margins associated with an insurance product. Therein lies the core of the opportunity that we are seeking to address. Big need. Resources almost uniquely available readily to address that need. A competitive advantage because of the structure of the marketplace. This gets to the point about product evolution. On the left-hand side, at the younger ages, we provide products that are the typical products that lean more heavily towards death protection.
As the customer ages and moves closer into what today we're educating them to think of as the retirement red zone, not waiting till they retire, but starting sooner, they start to move more towards products at the right side of that spectrum with a much heavier savings component associated with it. That has enormous advantages for us, clearly, in terms of the average premium that can be produced. We have really just started to do this, take concepts and products from the U.S. and bring them into that market. Classic example would be the unusually logically named product Dollar-Denominated Retirement Income.
It's essentially a whole life product with a very high cash savings component to it, but it also allows them to get a higher yield than they're going to get in a yen bank environment, and they'll take the currency risk by moving into a dollar-denominated capital market and getting a higher return. To some extent, they do the same with the Australian dollar, a little bit with the euro, but they're also willing to take that even with the yen. I would observe to you that the events of the last few years, even the events of the last few months, are if anything, more likely to reinforce that conservative approach than it is to alter it.
This dynamic of higher premium as the group ages is borne out by this slide, which some of you may recall John Hanrahan showed a couple of years ago at a Tokyo Investor Day. What it demonstrates is how the average premium goes up as the age of the customer goes up. It's not simply because the mortality charge is higher, it's because they're buying a product that is further on that savings end of the spectrum in a whole life product. Now, some of you may have noticed, in fact, in the first quarter, if you looked at POJ's results, in spite of the fact that headcount didn't budge, the sales went up 14%. 13 of that 14% came from the increase in the average premium.
For years, we have stood up and told you, "Look at the growth in headcount as the leading indicator of the future growth in sales." That will always be a relevant factor, but it's less true today. That is because when you look at what's driving sales, it's always going to start with headcount, then it gets to productivity, which is hard to move, and then you get to the average premium. Here, for the reasons I mentioned, you have a long-term sustainable secular force that will steadily drive up, if we do the job right, what the average premium is. The first quarter of this year amply demonstrates that in the case of POJ.
Specifically for them, because keep in mind, we started there a little over 20-25 years ago at this point, almost in the mid-1980s, when we pulled away from the JV with Sony that we started in the late 1970s. Because the retention is so high there, a lot of those same Life Planners are still with us. They're not in their 30s now, they're in their 50s. Because the persistency of their clients is so high, a lot of those same clients are with us. They too have moved from 30 to 50. They are the ones who are now not buying at that lower premium. They're buying at the higher premium because they're not worried about dying too soon.
They're worried about how the long-lived Japanese customer is going to be able to fulfill that, especially now that there's probably reducing, not growing confidence in the social benefits otherwise provided by the government. Another example of this, just presented somewhat differently graphically, is to see how these products compare for purposes of the average premium. You notice here we see the retirement on the far right, death protection on the lower end. Our accident and health is a little different than you might be familiar with. It's not just paying for some hospital reimbursement. We have some of that as riders. We have a high premium product that is called a cancer whole life product. It's almost a COLI-like product that's purchased primarily by small businesses in order to fund a retirement, and at the same time address this disease specific need.
That has been an important recent development for us, again, being sold across distribution channels. Annuities, in our case, as you know, that's almost entirely simply fixed annuities. The goal here, for the reasons I've just explained, is to have a strong and diverse product portfolio, which we continue to evolve, leveraging our U.S. experience to further expand our capacity for distributing this portfolio, not just through our proprietary distribution, but now through bank channel as well as through independent agents. Key to a lot of this is having a strong relationship. This is a qualitative measure, but it has tangible, quantitative benefits. These aren't just bragging rights. These are economic value statements. This is, to my knowledge, the first customer satisfaction survey done by J.D. Power in Japan. There's a couple of things I would draw your attention to here.
One is it gives us third-party validation of what we've always believed and otherwise have been told, which is that our POJ organization has the highest customer satisfaction. Now, keep in mind some points I made earlier. One, the importance of persistency, because that gives you the stable base upon which to overlay new business that is sort of the hidden driver of growing revenue. Secondly, just persistence is not enough. If we're going to be as successful as POJ always is in generating 40% of their new business by going back to your existing customer, that's the economic benefit that comes from satisfaction. Not just keeping them on the books, but keeping them receptive to future purchases as we mature and as their needs age and grow.
I'd also just observe parenthetically that the number 2 on the chart, Sony, is the company that we started with as a JV 30 years ago. Maybe the biggest surprise is number 4, Gibraltar. This is an area where I give enormous credit to our Japanese colleagues. This is a company that 10 years ago, Kyoei, was the largest bankruptcy in Japan post-World War II, not just in our industry, but in any industry. We didn't do a customer satisfaction survey at that time. I can assure you, having had their crediting rates cut, in many cases, their face values cut, the cash values cut, these were not satisfied customers. Now 10 years later, you can see they have outstripped virtually the entire industry.
That gives me a factual basis for confidence in telling you that I believe that we have, as a core competency in Japan, the skills necessary to go into the three and a half million new customers that we have acquired who went through bankruptcy a decade ago and even further enhance not only the persistency, but the potentiality embedded there for future business. The acquisitions of these two companies have not meaningfully changed the profile, the size, but not the profile, either of our product or of our distribution. You will see here that the retirement and death benefits continue to constitute the vast bulk of the businesses we're selling. By the way, I'll candidly admit, you can easily redefine retirement and death benefit. This is relatively arbitrary as to where on that spectrum we choose to call one retirement and the other death benefit.
The fact is, it's in that core insurance spectrum where we're selling the bulk of the business. This shows that same information simply to show you from a growth perspective, as dynamic as that growth has been, that diversification of product and need being addressed is not meaningfully changing other than to see there is this built-in organic shift steadily towards the retirement end of the spectrum. The same can be true in distribution. Substantial growth here, as you can see, about a 50% increase in terms of the amount of new business, but not a big shift in where it's coming from. You continue to see about three-quarters of it coming from proprietary distribution, the other quarter roughly coming from what I'll call alternative distribution.
Although you do see some shifting in the relative share between the bank and a growth on the independent agent channel because of what we've acquired from Star and Edison. When we look at annual new business premium here and the steady growth of this in strong double digits, you do see one of the key drivers here is the green. The green, of course, is the bank. Let's take a deeper look at the bank. I've purposely broken it down here by quarter because this distribution has only been around in a meaningful way for the last two years or so. Prior to that, regulations limited us to selling either single premium or to selling just annuities, and recurring premium could not be sold until a couple of years ago.
One of the things driving this is the average premium; let me spend a moment on that. In most of our businesses outside of Japan, the average premium runs around $2,000, and that's ballpark true of Gibraltar. POJ is over $3,000. In the bank, it's running $10,000. There are a couple of reasons for that. One is we're selling quite a bit of limited pay, 3-5-year recurring premium. Even if you take the $10,000 and say, let's take the shortest period of time, 3 years, $30,000, we're not greedy. That's a good set of income over a short period of time, and with a high renewal persistency rate, a tremendous opportunity. The other thing it indicates is the wealth inside that bank clientele that's capable of writing a check of that magnitude for this kind of a product.
We're tapping into a segment here, which heretofore it would seem we've not been getting to because there's no cut in effect. During this period of time of growth, you see POJ growing very dynamically. This bank channel is truly additive, and one of the reasons, as I mentioned, we've now had 7 quarters of growth in the mid-20s kind of range. The breakout here by product is also notable. Candidly, this has surprised me. Growth in the bank channel would not have stunned me; I would have predicted it would have been on things like annuities, particularly fixed annuities, where I could have seen a comfort in the bank. Here, however, you'll see the vast bulk of it is in whole life insurance-related products. This has been a surprise, at least to me.
One of the reasons I think it's been successful is we have been able to leverage the unique caliber and skills inside POJ. Our first relationship, meaningful, the one with Bank of Tokyo-Mitsubishi, utilized an almost unique model. The traditional model for a carrier through a bank channel is you send a product. We do that; we send a person with the product. Specifically, we send a Life Planner because even in POJ, they struggle with the classic 3 fundamental challenges that any insurance agent anywhere in the world struggles with, prospect, present, and close. By far, the most difficult of those is prospecting. That's the reason that life insurance agents fail throughout the world at an extraordinarily high rate.
What we have done is we have taken some of these very carefully selected Life Planners, removed them from a situation in which they must continually prospect, and moved them into the bank environment where they don't have to prospect at all. Because of the high degree of care that was done in recruiting and training and developing them, we were able to bring into that bank a caliber of individual that you're not going to be able to create by retooling a bank teller. They have played a role, quite interesting, sort of a player coach.
They've done a lot of sales themselves, increasingly, they are acting as player coaches, training thousands of people inside the banks to gradually move up the curve here because the bank wants to be exceedingly careful that they properly utilize this newly delegated authority and preserve their client base, particularly of the caliber that you can see is represented by these kinds of average premiums. That has given us a real jumpstart, I think, and allowed us to distinguish ourselves, certainly at a reputational and results level vis-à-vis some of the more traditional purveyors of product into the bank channel. What we are doing here is targeting both the affluent and the mass affluent, utilizing a genuine needs-based selling, not selling to friends as a favor, utilizing both proprietary distribution, but increasingly supplementing this with a complementary distribution.
Let me spend just a moment on Life Planner because while it's exciting to talk about new channels, I never want to lose recognition of the foundation on which this is built. POJ is a company that makes $1 billion a year. It grows its Life Planner system slowly and carefully so that even today, after over 20 years as an independent company, still has only a little over 3,000 Life Planners. Increasingly, as you can see, they're starting to decouple their results from just the pure headcount by focusing not only on productivity, but increasingly on the average premium as well. As I mentioned earlier, as they grow and mature, so too does their client base. There is a built-in almost geometric compounding here that goes with whatever growth we can get in terms of the headcount, which is admittedly always a daunting challenge.
Inside Gibraltar is an unusual opportunity. We've spoken about this before, but I'd like to take you a little deeper into the dynamics that cause this result. This is a relationship that KOA had for years and that we have helped to foster. There are about 950,000 active teachers in Japan. A fair number of them are members of this association, although we can market to all of them. We have an exclusive sponsorship from the association. Into this pool, every year, moves in 20,000-30,000 new teachers. A comparable number moves out into retirement. Both are great opportunities for us. Life events are triggers for the sale of life insurance. That first group, they are classic candidates for the death protection, the term, the lower-cost products to protect based on the needs of a young professional.
The flip side of that is where there's the opportunity for the richer average premium for someone who's retiring. These individuals on the right get a lump sum settlement that at today's exchange rate is over $300,000. Traditionally, we would simply take a small piece of that and put it in an endowment or a comparable product. As you can see through an enhanced development of the products, we're targeting that pool not only at that time with a richer array of product opportunities, but starting to get to these individuals before they're in receipt of that to cultivate that relationship during the period we refer to, as you know, as the red zone. The success of that, even on a historic basis with a less rich portfolio of opportunities, is borne out by that number on the upper right. 87% of the 120,000 retirees are Gibraltar policyholders.
If we continue to develop this capability, that steady flow gives us a rich opportunity for very regular growth into the retirement market. Not to mention, obviously, targeting during the flow the 950,000. The specific relationship, because sometimes we've gotten questions about the tenure of the contract, this relationship is now coming up on 60 years. Of the 950,000 teachers, 600,000 of them are members. We have the exclusive right to enter the grounds of the school and to have meetings with them during the day. I'll also draw your attention to a minor item here, but a major opportunity. You'll see 37,000 schools listed. One of our challenges when we had 6,000 life advisors was how do you service 37,000 schools?
I think you may have heard me mention on an earnings call that when we have acquired 7,000 Star and Edison, more than double, it gives us a tremendous opportunity. Even now, each of these salespeople can have to themselves three whole schools. It gives us a chance to balance between applying quality standards as to how demanding do we want to be in terms of minimum performance requirements, but at the same time, having a chance to deepen our penetration into just this specific opportunity, not to mention broader opportunities as well.
I've mentioned this phenomenon early, that is we are getting what I have never seen before, that is not channel conflict, but rather channel synergy, where we are able to leverage the quality of our salespeople by infusing them into the bank channel and thereby building a reputation that is virtually unique inside of those relationships with the banks. Excuse me. It's the culmination of all of these factors that has allowed us to produce this very high rate of earnings, very low volatility. Year after year, you see record earnings. That's in spite of the fact that during this period of time, as we know, you have financial crisis, you have movement in exchange rates, you have recessionary periods. This machine just keeps moving steadily.
In summary, I think it's fair to observe that this is now Prudential's largest business, truly a leader in the Japan market, has that, what I think almost trifecta set of characteristics, namely high margins, low volatility, and what I believe is an opportunity for sustaining the kind of growth that we've seen in this business over the last couple of years. Not because of the assumed traditional death protection only, but now supplemented by the retirement opportunity. Let me stop at this point, I'd be more than happy to try and respond to any questions you might have.
That was long, but it was rich, to coin a phrase. We have time only for a few minutes of questions. Sunny, why don't you take the first one?
Thanks, Eric. Suneet Kamath from Sanford Bernstein. I guess a question on the Star Edison deal. Clearly, one of the hallmarks of Pru that we've learned about for years is the persistency of the product because of the quality of the advisor. You're adding these, what are 7,000 advisors. How long is it going to take you from a training perspective to get them to sort of the level that you desire, which presumably is above kind of where they are right now?
Great question. The two companies, and I want to emphasize, sometimes we say Star Edison like it's one word. These are two distinct companies that we're acquiring. The productivity, at least of one of them, was pretty close to the Gibraltar. The Edison one, and Star, both a little bit different. They both took a hit during the crisis, as you can imagine. Their pre-crisis was not terribly much below some of the productivity. I'm focusing on productivity for a second. I'll also emphasize the fact that in our pricing, we assign extremely little value to new business, and in fact, we assume that for the next couple of years, for the reason you just stated, that that productivity would actually drop. We've given ourselves room to go through this transformation.
Part of the timing answer will depend on how aggressively we apply minimum standards for the reasons I mentioned. We have already begun by moving in people from Gibraltar into the sales leadership of those organizations to begin that transformation. Some of you may recall, when we took over Kyoei, we took it from about 7,000 down to about 4,500 by applying these standards. Brought in productivity and have now brought them up to over 6,000. I suspect we will go through a very similar transformation here. Exactly the timing and pacing of it, yet to be determined. We're not starting with the kind of low base we started with Kyoei, which was bankrupt. They've already been through that transformation almost a decade ago. They're in much better shape. The gap that we're looking to close, much smaller.
If I could just follow up. If I think back to John's slide where he looked at the 2010 international ROE of 19%-20%, and then I think 2013 was 17%-18%, and I think it said that delta or at least part of the delta was this lack of maturity of the Star Edison. Is that really what we're talking about as opposed to something like cost savings that really explains the difference in terms of the ROE compression?
It's a multiple of those kinds of factors. The ROE on POJ and Gibraltar are very, very strong. The acquisition of these two will dampen that for a period of time. If we look at what will drive the improvement, it is in the two areas you have just alluded to. Going back to our three sources of earnings. It's going to be in the improved productivity, but it will also be, particularly in the early years, more dependent on the expense. There, we're very comfortable. We know precisely what it is that needs to be done. We had, as you know, invested quite a bit, for example, in a consolidated data center over the last two years. The overlay now of another 50% of policies, a rich opportunity there.
Because we've been through this multiple times, we know exactly what needs to be done on the expense side. The merger will be completed in the first quarter of next year. That's the legal merger. The full integration will take several years beyond that. I should point out at this stage, in spite of the crisis resulting from the earthquake and the tsunami, all 18 of our teams have reported that at no point did they fall more than a few weeks behind, and not one has asked for a delay in the target for the merger date.
Thank you.
Steven Schwartz. Josh, the gentleman in the red tie.
Thank you, Eric. I appreciate that. Ed, a couple of questions. You're talking about the legacy operations, 40% of sales were to current customers. I imagine it's very small, but is there a comparable number for Star Edison?
I don't know what that number is. The number I gave you was for POJ. I would be very surprised if on any of our other companies the number is comparable that high. POJ's is that high, I think, for a couple of reasons. One is because retention is so high and because their persistency is so high. In many cases, you have the original salesperson talking to their original customer. That fosters a particularly receptive opportunity for that kind of.
I'm sorry. Would it make more sense then to? Do you know what the number would be for Gibraltar?
I don't have that number, unfortunately.
Okay.
I wish I did. No.
Okay.
They have not tracked that the way POJ has.
Could you remind us, what does Star Edison sell or what products are they okay to sell through the bank channel?
The array of products they sell, regardless of the channels, are essentially the same products that we have sold and very much in the same proportion. In other words, it's death protection, retirement, which in this case is mostly whole life related products. Some of the A&H products I described and on the annuities, primarily on the fixed side. The footprint is very similar.
Okay.
Their bank sales, by the way, essentially evaporated. I think in the last quarter, $2 million-$4 million, very small, and for the reasons I explained. I can understand why a third party would retreat.
Okay, great. Thank you.
Sure.
Okay, my preference is to take a question from someone who hasn't asked a question yet. Are there any such people here who would like to ask one now? All right, Gallagher, you get it.
Thanks. Tom Gallagher, Credit Suisse. Ed, slide four showed how the big domestic Japanese insurers have lost enormous market share.
Yeah
over the last six years. Presumably, that's why you're growing, that's why the other foreign companies are growing. It's really a market share shift. Can you talk a little bit about why that's occurred, and do you see that changing at all, or do you think you'll still be able to grow, as you take share away from the big domestics?
First, I think your observation of the market dynamics is essentially accurate. Two, this dynamic has been going on for seven years now. They've been working very hard to change that dynamic. I think it's for a couple of reasons. As you know, when we first entered that market, it was, even in 1979, the most heavily insured nation on a per capita basis in the world, with some of the largest insurance companies in the world. At first glance, not a rich opportunity. What Kiyofumi Sakaguchi concluded, however, was the following, that it wasn't an under-insured nation, it was an underserved nation. He came in with a completely different model, whereas the traditional model was very large numbers of salespeople, some of whom were working part-time, a high percentage of housewives selling to friends and neighbors.
He inverted that model and said he would hire, at the time, almost all males, all only college-educated, who had never worked in the industry and would do only a needs-based analysis. This has contributed, although it took a long time to build, an unusual, unmatched degree of productivity, very high persistency, which as you know, if you put those two together, you have a virtuous cycle on which you can continue to build. I think that issue is especially true when you move from the traditional death protection into the somewhat more complicated retirement market, where the nature of the need and of the respondent product is even more complicated. There, I think the value of trust and relationship becomes even more important, and I think that's the nature of the challenge that you see them confronting.
One of the reasons that some of them are starting to move outside of Japan somewhat more aggressively to seek opportunities. That's one person's theory.
Do you see the situation changing at all? Have they maneuvered, changed their stripes at all on the competitive front, which you think will allow them to at least stabilize market shares, or do you think they'll continue to lose?
I don't want to forecast what will happen to them, but I will tell you this. They haven't waited until this year to make the observation you made and to try to respond to it. For example, a number of them have created separate entities to try to do a Life Planner model. They have failed. I'm sure they will continue with initiatives to try and stabilize the drop, but I think the momentum that you have observed, I don't see a reason in the marketplace to cap that.
We have time for only one quick question. Joanne. Josh, the lady right there on the end.
I'm interested to talk about this distribution synergy versus distribution conflict.
Yeah.
Are the banks on an open architecture platform typically?
Yes.
Okay.
In the following sense. What they traditionally will do is identify a couple of carriers for each product category. That will then vary by product category. Anyone they bring in as a salesperson sells across that spectrum, so they don't just sell the products of the companies from which they came. Increasingly, what we've seen over the period of time is, especially as they train thousands of the people inside the bank, that a smaller and smaller percentage of our sales, now way less than half, are coming from people that we sent into those organizations. For example, the total number of salespeople we have in these organizations at the moment is about 180. Clearly, the kind of numbers I'm showing you of $125 million in a quarter, it's not coming out of 180 salespeople.
I just want to understand how you do this. You put one of your own people into the bank?
Yes.
Are they training the people that the bank has on staff to sell these products? Then you take them back out? Is that how that works? I'm just trying to get a fuller understanding of that.
Sure. Quick answer is yes. Let me elaborate. We will work whatever model they want. At The Bank of Tokyo-Mitsubishi UFJ, it's our people go in, and initially, they did the bulk of the selling. They then started to spend more of their time training because there's thousands of people there the bank wanted to have trained. Thus, my use of the term sort of player/coach. Other banks have said to us right from the beginning, because we're in 30 banks, fewer than a handful utilize that model. Other banks have said, "No, that's fine. We feel confident based on the product we want to get from you, that we don't need that.
We can use the training, but we don't need the direct sales." In almost every case, we're utilizing some of these people as wholesalers, then we'll move along that spectrum to do training as far along as they want to go. Right now, as we develop more relationships, we have them scattered across the full end of the spectrum.
With that, we should take a break and please, 10 minutes, because we're falling pretty severely behind schedule. We'd like to get started in just a couple minutes, kindly come back into the room and take your seats.
Okay.
Wait up. Hold on.
Okay. We good?
Yeah, we're good.
Good morning. My name's Charlie Lowrey, and I'll be talking about the asset management presentation today. If there are only two points you remember from this presentation, I would hope they'd be, one, that this is a critically important business for Prudential, and secondly, over the past three years, we have made material improvements to the quality of earnings of this business. Everything else I'll say today is a proof point or proof points on these two points. As a leading manager of third-party institutional and retail assets, we have the ability to attract and retain talent. As you will hear during this presentation, this business is all about talent. This business also benefits from operating leverage, which combined with limited capital requirements, should produce high and sustainable ROEs over time.
Competing every day in the marketplace for third-party assets keeps us sharp, which inures to the benefit of the general account, and in turn, benefits our affiliates in retirement, annuities, and the insurance businesses. I'd like to articulate several key strategies of PIM. The most important of which is to attract, develop, and retain talent. Because if we do that, we'll be able to deliver performance, and if we deliver performance, we'll be able to grow our AUM over time. Another strategy is to grow high-quality earnings, primarily by growth in asset management fees, and we'll talk about that a lot later on in the presentation. We also focus on managing business risks, strategically and prudently employing proprietary investing. We take all these skills and use them for the benefit of the general account.
We do that because then we'll be able to have potential for growth in asset management fees, create favorable ROEs, which we think will deliver a competitive advantage over time for our general account. The business system must work externally for clients as well as internally for employees. We think we have a series of competitive strengths, and I'd just like to articulate some of those points. One is we have experience and a very good track record. Secondly, we have breadth and depth of capabilities, which allows us to produce products that clients want and need, and career development opportunities for our employees. We can provide access to seed and co-investment capital to align our interests with clients. I'd like to stop on the fourth point for a minute, which is brand and reputation.
Three years ago, I would not have stood here in front of you and argued that our brand was a competitive strength. By the way in which we came through the recession in terms of the stability of the parent, the stability of the investment management franchise, the performance of our funds, and the ability to attract professionals, I now stand in front of you and argue that it is a competitive advantage. During the crisis, we felt that it was a once in a generational opportunity to hire talent, to augment the existing talent we had, and to bring in new skill sets over time. We did this in every single group. I'll give you one example, which is in Prudential Real Estate Investors, and just go around the world quickly to tell you the kinds of people we brought in.
Not every person, but just the kinds of people. In Europe, we hired a new CEO of Europe. We hired a new co-head of global marketing located in London. We did two lift-outs of teams for a mezzanine team and a core U.K. team. In the U.S., we augmented our marketing department and did another lift-out of a mezzanine team. In Asia, we opened a Korea office. We hired a new senior portfolio manager in Tokyo. We opened a Beijing office. We hired a CEO of real estate for Asia located in Hong Kong. In Singapore, we hired a head of research, and finally, we opened an Australian office. I could go through every single group and tell you the exact same story of the kinds of people we hired. We also think that scale is a competitive strength.
Not scale for scale's sake, not just to be big, but because of what scale can do for you. It can allow you to invest in people when competitors won't, and products when competitors can't. What that's led to is a 13% annual compound growth rate in assets under management over the past five years. Of that 13%, 9% was from flows and only 4% was from appreciation. It also led to manager continuity. We have 220 portfolio managers with an average tenure of 13 years. Over the next five slides, I'll begin to talk about diversification. Diversification is important because it allows us to begin to talk about the idea of quality of revenues. I'll talk about diversification of clients, of asset classes, and of investment segments. Here you see the three legs of a stool in terms of clients.
We have the general account, where we manage money for our affiliates as well as our international insurance organizations, their U.S. dollar assets. In institutional, for institutional clients, we manage money for public, private, and Taft-Hartley pension funds, foundations, endowments, most of the major sovereigns around the world, as well as non-affiliated insurance companies. Finally, for retail, we manage money again for our affiliates, our proprietary mutual fund complex, and we have sub-advisory relationships. Looking at clients slightly differently, again on the left, this is assets under management. You see the three legs of a stool. Note that 62% of our assets under management are third-party assets. On the right-hand side, you see asset management fees, and you'll note that 77% of the fees are derived from third-party clients. Moving on to asset classes, I'd like to make a couple of points.
First, 71% of our assets are fixed income assets, that relates to about 48% of the fees if you look on the right-hand side. Again, if you look at the left, you'll see the blue part of the pie chart. Those are our private assets. They represent about 20% of assets under management. If you look on the right-hand side of the pie chart, they represent about 38% of the fees. When we think about diversification, you have about 50% in terms of fees. You have about 50% fixed income, 50% equity. In terms of fees, again, you have about 40% private and about 60% public. You have a good diversification of fees.
Finally, in terms of investment managers, what you see here in terms of diversification is six different investment managers managing money in six different disciplines, some of which are public, some of which are private, all of which add up to the $569 billion. Over the next four slides, what I'd like to do now that I've given you an overview of Prudential Investment Management, is take you to a quick tour around each of the investment managers. We'll start with public fixed income. Here we have two distinct managers. The first is Prudential Fixed Income. They've been making investments for a long time. Their first investment was in 1875. Their first investment for a third-party client was in 1928, and we actually still have that institution as a client.
They manage almost $275 billion, and they have operations around the world in the U.S., Europe through London, and in Asia through Tokyo and Singapore. They have an extremely comprehensive product line driven by bottoms-up credit research, and they do this for over 275 clients. They have an extraordinarily global client base with over 180 professionals servicing them. Now, contrast that to Jennison with 12 investment professionals. They manage about $50 billion in assets. Operations only in the U.S. with a very focused product line born out of servicing Jennison's clients with particular expertise in long-duration assets. And they, in general, have a higher tracking error than Prudential Fixed Income. Moving on to public equity. Again, we'll start with Jennison. $86 billion under management. They are fundamental, active equity managers focused on bottoms-up, research-driven analysis.
Born out of a very successful growth strategy, they have successfully diversified into other strategies and sectors, the most recent of which is a global growth sector through a lift-out of a team about a month ago from a firm in Boston. They manage money both domestically and globally for over 160 clients with 48 investment professionals. On the other side, we have Quantitative Management Associates. They're our quantitative manager with about $50 billion, $47 billion to be exact, in assets under management. This is down from a high of about $59 billion a couple of years ago. And that's due to rotation out of the quant space, which you all know about, and into either active or passive equity or into fixed income. I mention this because you'll see that in the net flows that I'll talk about in a few pages.
We believe QMA has fared better than most. We don't think we have lost money to other quant managers. It's just a rotation out of the space, and we think we fared better than most for a couple of reasons. One, again, is the stability of the franchise, and the second is the diversification of both domestic and international strategies. We manage money for about 140 different clients with 35 investment professionals. Now let's talk about fixed income, private fixed income, because we have a great story to tell here. First, we'll start with Prudential Capital Group, which manages $54 billion in private debt. They have operations around the world in the U.S. and in Europe, seven cities in the U.S. and three in Europe, and Paris, London, and Frankfurt. Their key competitive advantage, and perhaps a unique competitive advantage for them, is their direct origination network.
They originate directly, without an agent, over half the deals. During normal times, they'll originate between 50%-60% of the deals. During the recession, that was 60%-70% of the deals were directly originated, which enabled them to originate over $10 billion worth of transactions last year, which we think is about 20% of the market in the U.S. and Europe. Prudential Mortgage Capital Company, again, has been making loans for a long time. Their first mortgage was made in 1894. They have $34 billion in assets under management with operations in 18 cities in the U.S. and Tokyo and Japan. Again, through their direct origination network, which is very strong, they did $9 billion of originations last year, and they have a cadre of over 2,000 borrowers with whom they do business. And they do this with 105 investment professionals.
One of the questions you may have is, gosh, given the level of originations, are we giving away the farm? Are our terms lower? Are our terms different? Loan-to-value is wrong. I would argue they're not. Because we either originate directly or are lead in the agented deals, therefore can talk about and, in fact, direct the terms we want. We have the discipline from years of experience. As a proof point, the average annual realized losses from these two asset classes in the general account over the past 10 years has been between 12 and 13 basis points, which is an extraordinarily low loss ratio. Finally, last but not least, we have Prudential Real Estate Investors with $28 billion under management. This is our most global group. They have more employees outside the U.S. than they do in the U.S.
They are global with operations in the U.S., Europe, Asia, and Latin America, with 21 offices worldwide. I would argue a key competitive advantage for this group is that they're one of the few global real estate investment managers left. During the recession, we saw some of the other global real estate investment managers implode or be broken up and sold by their parent, and Prudential Real Estate Investors is one of the few that are left. They manage money for almost 500 institutional clients, again, an extraordinarily broad and global client base through 56 different funds. Look at the geographic distribution of those funds. I'll come back to that point later a couple of times when we talk about quality of revenues. They do so through over 200 investment professionals.
I can stand here and tell you how great we think these groups are, we do think they're great. At the end of the day, it's performance that matters. There are two ways of looking at performance. The first is what % of assets beat the benchmark. You all can roll your eyes and say that every investment manager always says that all their funds beat their benchmark. All I can do is show you the exact same slide that I present to the investment committee of the board of directors of Prudential twice a year, that's this slide. As you can see, our performance is strong, especially in the three and five-year period. In the one-year period, we've been hurt a little bit in the large cap growth space. That's a tough space in which to beat the benchmark.
Relative to our peers, we've been doing extremely well, given the risk-on, risk-off environment in which we've been, growth managers have been having a tough time. The acid test, however, of whether or not you're doing well is, are clients giving you money or are they taking money away from you? Let's look at net flows. This slide depicts net flows for institutions, I'll make a few points. If you look at the right-hand set of bar charts, that depicts flows over the past four years. Total flows have grown each year over the past four years. Second point, if you look at the next set of bar charts to the left, fixed income, flows for the past couple of years have all been about fixed income, reflecting strong flows into this asset class as pension funds have lowered their risk profile.
If you look at the far left, you see the equity flows, this is getting back to the point I made with QMA. We've had net outflows for a couple of years due to outflows in the quant space that have actually overwhelmed the inflows into Jennison. We had positive inflows into Jennison equity of about $1 million each year, but outflows from QMA. We think those flows are abating somewhat. That's what we're seeing, but we'll wait. We'll wait and see. The fourth point I'd make is that we had net positive flows each year into real estate. Hard to tell in 2007, but they were net positive. That's in part due to the diversification I was talking about earlier with the funds.
Finally, if you look back to the right-hand set of bars at the numbers underneath the bars, you'll see net flows as a percent of assets under management, which have gone from 6% to 7% to 10% to 19% last year, which we think far exceeded the industry average. If you look at retail net flows, there's a very different story to tell. If you look at the right-hand side again, you'll see essentially we had zero net flows in 2007 and 2008. In fact, if you had gone back a few years before that, you would have seen essentially zero net flows as well. In 2009 and 2010, something happened. We had almost $6 billion of net flows in 2009 and over $6 billion of net flows in 2010. The question is, what happened? I think there are four answers to that question.
The first is we had good performance, that always helps. The second is there was a flight to quality during the recession, which I would define as a flight to stability, we had an extraordinarily stable platform, both at the parent level and at the mutual fund level. The third is that we hired people, we hired a lot of people. We doubled the size of our wholesaling force to wirehouses, we quadrupled the size of our wholesaling force in the IBD channel. The fourth point is that we invested in new funds during the recession, which are now beginning to attract assets. Remember what I said back in some of the competitive strengths when I talked about scale. Scale is good in that it allows you to invest in people, it allows you to invest in products.
We did both of those things. What you see is the result of that. Now you have an idea of who we are. What I'd like to do in the last three slides is talk a little bit about the quality of revenues. What you see here is we will discuss asset management fees on this slide, then we'll look at ITPICM on the following slide. What you see here is the AUM at the top and asset management fees on the bottom. I have a few comments on each. First, looking at the top chart, you see we went from $439 billion down to $386 at the bottom and then had eight consecutive quarters of growth in AUM. Look at the parts of the bar and the different colors. Blue is fixed income.
That was quite steady and then continued to go up after the recession. Real estate lost a little bit in terms of assets under management. Remember, they had positive net flows, but there was depreciation in the markets. Those assets went down. The real volatility occurred in the green part of the bar, and that's equity. The volatility in assets under management really has to do with the equity markets. Now, look at the fees at the bottom. Again, 8 quarters of growth. Fixed income, relatively steady and then marching up. Real estate was quite steady, too. There are 2 reasons for that. First, again, the geographic diversification of the assets. Secondly, fees on most U.S. assets are based on cost, not on market, and therefore are far more stable. In terms of your fees, you have 70% of your fees, i.e.
the combination of fixed income and real estate, which are relatively stable. The volatility will come from the 30% of the fees associated with equities. There's a greater degree of stability by virtue of the composition of the assets in our fees. Let's talk about ITPICM, because that's where a fair amount of volatility was. Just to remind you, ITPICM stands for incentive fees, transaction fees, proprietary revenues, and commercial mortgages. What you see here in the 2 pie charts is asset management fees plus ITPICM. If you look in 2007, ITPICM was 32% of that. If you look in 2010, it was 14%. It was less than half. There are a number of reasons for that. One, obviously, as we just showed you, we grew AUM and therefore the asset management fees themselves.
Two, when you think about ITPICM, the 2 greatest sources of volatility were proprietary investing and commercial mortgages. In proprietary investing, we have lowered the amount of proprietary investment in this business by about two-thirds. We've grown it a little bit since then, but it is still less than half of what it was at its peak. What that means is that the average investment per fund has gone from $44 million down to $22 million. We've halved the investment per fund. When you lower the amount of proprietary investing and you halve the investment per fund, by definition, you'll lower the volatility. We've also exited the securitization business and as a result, are winding down the interim loan business. During the recession, we took reserves against the interim loan business, which obviously affected AOI and caused a significant amount of volatility.
We're getting out of that business. If you accept for a moment the premise that we have reduced the volatility of ITPICM, the question is then, what will the business look like going forward? We've tried to answer that on this page. If you look at the blue bar, the blue bar is the numbers that you will recognize. That's reported AOI. In 2010, it was $487 million, excuse me. The green bar is reported AOI less ITPICM. The difference between the 2 bars is the contribution of ITPICM. If you look at 2006 and 2007 and compare that to 2010, which is the next year in which ITPICM was positive, you see that the contribution in 2010 from ITPICM is far less than it was in 2006, 2007.
We would proffer that the contribution from ITPICM will be less going forward but with less volatility, and that's a trade-off we're willing to make. We'll make up the difference with asset management fees over time, hence the contention that we have a greater quality of revenue now than we did in 2006, 2007, all while printing a high ROE, which we did in 2010 of 20%. Let me end where I started. This business is entirely about talent, the attraction, development, and retention of talent, which should lead to good performance, which should lead to growth in AUM. Let me be clear, growth in AUM is not our ultimate goal, but can only be the result of good execution. We come to work every day trying to execute our business, and from that, hope to grow AUM.
Asset management fees should roughly track AUM, with operating leverage, AOI growth should exceed growth in asset management fees. ITPICM should continue to contribute to AOI, will contribute less and with less volatility over time. With this business model, we should be able to deliver both a high and a sustainable ROE. Thanks very much. Now I'll turn it over to my colleague, Steve Pelletier.
Thank you very much, Charlie. Good morning, everyone. It's been 18 months since I last spoke with you as a group. That's been a very eventful time for Prudential in the annuities business, and I look forward to this opportunity to review the business with you. By many accounts, an adequate and secure stream of retirement income is rapidly becoming the number 1 self-stated financial need of American households, and Prudential has become a market leader in fulfilling that need. We've done so by pursuing a highly differentiated strategy that's based on having the best all-around value proposition in the business, best for Prudential shareholders, best for the investors who purchase our product, and best for the financial advisors who sell it. Being number 1 in sales is not the objective of our strategy, although it has been a very welcome byproduct of it for seven straight quarters now.
Rather, our constant strategic objective is to deliver sustainable, profitable growth. Our very well-established identity in the annuities business is that of the Highest Daily company. That certainly describes the uniqueness of our product, I'll delve into that in much greater detail. It also refers to the high standards by which we manage all aspects of our business. That includes our financial risk management, where we've built a capability that we believe is truly world-class, our distribution, which is robust across all channels, as well as our marketing, that's consistently rated best in the industry, our investment platform, which offers investors and their financial advisors unparalleled choice and flexibility. All these factors have enabled us to grow the business dynamically, leading to significant scale economies that we'll discuss further in a bit.
We've done all this by being a consistent presence in the marketplace and a steadfast partner to our distributors. In doing so, we've built on Prudential's trusted brand and financial strength. As seen here, our industry standing is indeed that of a market leader. Second in assets, as you see on the left, and on the right, first in sales, once again. In regard to our first quarter sales of $6.8 billion, as Charlie mentioned in the first quarter earnings call, that is hardly a new run rate. We made a product change in the quarter, resulting in a surge in demand for the previous product before it was taken off the shelf. As we said on the call, we estimate that created a $1 billion lift to sales in the first quarter.
Looking forward, it's also natural following such a surge for sales to dip below the pre-surge trend line, at least for a short while. As Mark referred to before, the industry has become much more competitive in recent quarters, with several companies looking to be more assertive in the marketplace. We look for continued strong sales that, one, will continue to place us among the industry leaders, and two, will continue to enable us to deliver the progress in core earnings that I'm going to review with you in a bit. The other story that this slide tells, aside from our own industry standing, is again what Mark raised earlier, and that is what upheaval the market crisis has created in the competitive structure of this industry.
If I showed you this chart prior to the market crisis, the names on both sides of the chart would be the same. The rank ordering would be perhaps different, but the names would be the same. The firms with large books of business were also the large sellers. This year, we see a very different story. There are four firms that appear on the left, but not at all on the right Despite the fact that it only took $800 million in sales to appear on the right. You see them highlighted here. They're Hartford, Hancock, Pac Life, and ING. Conversely, there are four firms that appear on the right but not on the left. You see them highlighted: Nationwide, Transamerica, Allianz, and Sun Life.
These are firms that we call emerging competitors looking to, again, be more assertive in the marketplace to grow their presence in the marketplace, all part of that more competitive environment that Mark referred to earlier. Our robust sales reflect very strong distribution across all channels. You can see in the blue boxes here, from 2008 to 2010 our sales more than doubled from $10.3 billion to $21.8 billion. If you're looking for a leading indicator, I think the changing composition of sales may be even more important than their absolute level. The independent broker-dealer channel is the largest distribution channel for the entire VA industry. We've been perennially first in that channel, and as you can see on the left, it represented 57% of our sales in 2008. 2010 presents a very, very different picture.
Our independent sales again led the industry, and they were the highest they've ever been in terms of dollars. For the first time since our acquisition of American Skandia in 2003, independent sales represented under half of our total sales. A similar statement can be made about the purple wedge here, insurance agents. That's our sales through Prudential and Allstate agents. Even though those sales have increased in this time period in dollar terms, they've shrunk as a percentage of our total sales. The reason for this shift is the dramatic change in our standing in banks and wire houses, the yellow and green wedges, respectively, here. Those are channels where prior to 2009 we had, let's say, been in search of traction. In 2008, those two channels collectively represented only 19% of our sales. In 2010, that figure has precisely doubled to 38%.
We also lead the industry in those two channels, banks and the four national wire houses. Let's start to delve much more deeply into our unique product design. To do so, let me set the stage by talking about a key concept in variable annuity products that have protected withdrawal value. Let's first say what that's not. It is not a lump sum that the investor can ever cash in and walk away with. They can only do that with the account value. Rather, protected withdrawal value is a notional figure upon which future retirement income will be based. When we talk about an investor taking 4% income in retirement, that's 4% of the protected withdrawal value. It can increase in two ways. First, through the roll-up rate. That's a contractually guaranteed rate of increase no matter what happens to the account value.
In regard to the roll-up rate, we seek to be simply competitive. Our current rate is 5%. Before our product change, it was 6%, and even then there were a few firms that had a higher roll-up rate than ours. Following our product change, there are a few more. The second way protected withdrawal value can increase is through the step-up, which locks into the protected withdrawal value the appreciation of assets in the account due to investment performance. The key point here is how frequently does a product allow a step-up in the protected withdrawal value? Almost all products in the industry do so only once a year or once a quarter on the annual or quarterly anniversary of the contract issuance. Looking at the relationship between account value and protected withdrawal value just on that isolated day.
We are unique in allowing the investor a step-up opportunity every single day. You can see in the boxes on the right, according to S&P, an annual step-up has a 2% chance of capturing the best day in a given year, a quarterly step-up a 6% chance, and daily, of course, 100%. A lot has been written and said over the years about the complexity of variable annuity products. That's not without reason. At Prudential, we like to think our complexity is more in the inner workings of our product. Our proposition to the marketplace is actually quite simple and quite compelling. We offer an investor certainty. Certainty that future retirement income will be based upon the best single day that investor ever had in the market.
We can offer this certainty in a responsible and profitable manner because of the other feature that makes our product unique, auto-rebalancing or account value protection that's embedded in the product design. Every night, our systems analyze each and every one of our hundreds of thousands of auto-rebalancing contracts. They're analyzing for the gap between, on the one hand, the value of the future income stream that we've guaranteed, and on the other hand, the account values that support that guarantee. When that gap begins to widen, usually due to declining equity markets, and it reaches certain trigger points, we begin to transfer funds from the variable account to a fixed income account, keeping those funds out of further harm's way as markets continue to deteriorate.
When that gap begins to narrow again, usually due to improving markets, and those triggers are reached moving in the other direction, we transfer funds from the fixed back to the variable account. The outcome is conceptually illustrated here. The green line reflects account values with auto-rebalancing, showing protection in adverse markets while still enabling participation in market gains, albeit with some slight opportunity cost. I'll get into a much less than conceptual demonstration of this impact in just a short while. The reason that this preservation of account value is so important is that account value protection also equals protection for Prudential shareholders. That's because in a variable annuity, the investor who starts taking income pays himself or herself first. The payments are deducted from the account value. It's only when the account value is totally depleted that claims upon the insurer begin.
Let's illustrate this in a severe market scenario, one that makes the actual market prices look benign by comparison. Down 30% in year one, thereafter flat in perpetuity. You can see the green line here. The account value does dip in that first year. However, the impact is mitigated by the operation of auto-rebalancing. The orange line here indicates assets in the bond fund, the investment-grade bond fund that is the fixed income vehicle, and you can see that auto-rebalancing transfers 90% of the account value into the bond fund within year one, as I say, mitigating that market impact. The dotted blue line, the protected withdrawal value, continues to grow by virtue of the 5% roll-up rate. The gap between the protected withdrawal value and the account value appears significant, but it's far less so on the basis that matters, which is the cash flow basis.
To illustrate that, let's take this severe market scenario and compound it with highly efficient behavior on the part of the investor, much more efficient than we usually see. This investor takes maximum income every year once withdrawals begin. The example you see here is that the purchase is at age 60. Withdrawals begin at age 72, after the protected withdrawal value has doubled. You see on the right-hand side, as long as the bars are blue, the investor is paying himself. When it shifts to red, we're paying. We pay claims only when the account value is completely depleted, in this case, at age 81. Three points about this period in which we're paying claims. First, as a reminder, the investor does have to be still alive and in the product to be drawing the income.
This shift from blue to red doesn't represent an abrupt flipping of the switch in terms of our product profitability. We've been hedging and reserving for that risk all along. Finally, in this example, auto-rebalancing delayed by more than four years the date on which we begin paying claims. What does that mean? That means on this single $100,000 contract, a savings in claims on Prudential of more than $40,000. A couple of slides ago, I offered a conceptual illustration of how auto-rebalancing works. Now let's look at the actual proof points through the market crisis and its aftermath. Our flagship product entering the market crisis was HD7. It was launched in January 2008, and this slide shows the actual experience of an investor putting half a million dollars into the product at its launch.
From the launch of the product through the first quarter of this year, the S&P had a total loss, and you can see it on the red line here, of 2%. The account value in this product, if the living benefit had not been elected, and therefore auto-rebalancing were not operating, is represented in the blue line here. That did just about the same as the S&P, negative 3%. However, with the election of the HD7 benefit, and therefore the operation of auto-rebalancing, the gold line here represents that over this time period, the account value gained 26% in value. The operation of auto-rebalancing can be traced by looking at the relationship between the gold and the blue lines. As the market crisis began to gather full force, these lines diverge widely.
Auto-rebalancing was active in the early stages of the crisis, transferring the entire account value into fixed income. From the market trough in March of 2009 onwards, the upward slope of the gold and the blue lines is virtually identical. As fast as auto-rebalancing moved monies into the investment-grade bond fund, it also moved them back out, enabling this investor to have very full participation in market gains. The protected withdrawal value, the green line here, continues to increase. It increases 28% over the time period shown here. An interesting point. Speaking broadly, our risk profile can be looked at as the gap, the minuscule gap, between the green and the gold lines. The risk profile of the rest of the industry can be conceptualized as the gap between the green and the blue lines.
This is an update of information that I first provided you in December 2009, really the story is very much the same as it was then. I think this information has generally been well-received, over the past 18 months, some of you have quite fairly made the point that this represents only a single path. As some of you know, my response to that has been twofold. Not to be too argumentative about it, since this is a single path that has actually happened, and pretty recently at that, I do think it merits some special weight in our discussion. If the point in raising the single path issue is to say that, well, the market crisis, the worst market meltdown in 80 years, actually provided fertile ground for proving the viability of how Prudential manages risk in this business, I concede that point.
Quite gladly. In fact, I insist on it. Having made those two points, though, I do grant you this represents only a single path. Let's address that by looking at it instead through a lens that comprises 2,000 paths. To do that, we asked Ernst & Young to put auto rebalancing to the test. They did so by performing a Monte Carlo simulation on it, hence my reference to 2,000 different capital markets paths. The basis of their analysis was a single variable annuity product. They actually created a single product, a composite using features from various leading products across the industry, including ours. The reason I emphasize that is that that made their analysis such that the sole variable was whether or not the account value was subject to auto rebalancing and the algorithm that governs it. Their findings are illustrated on this chart.
First, looking at the left-hand side of the chart, Ernst & Young looked at the probability that the account value in a given 10-year period would experience a 20% loss. As you can see in the green line, without auto rebalancing, there's an 18% probability of such a loss. With auto rebalancing, that probability, the blue bar, contracts to 7.2%, or just a little bit more than one-third of the probability without auto rebalancing. As we move deeper into the tail, the effect of auto rebalancing becomes ever more pronounced. That's not surprising. That's how it's designed to work. The right-hand side of this chart looks at the probability of a 33% drop in account value in this 10-year period. You can see the green bar. Without auto rebalancing, there's a 6% probability of such a loss.
With it, with auto rebalancing, there's a negligible and just about impossible to see one-tenth of 1% probability of such a loss, or one-sixtieth the probability without auto rebalancing. Now, I have often made the point, and it's an important one, that auto rebalancing is not an account value optimizer, certainly not one that seeks to maximize total return. This type of massive downside protection has some opportunity cost, but as you see highlighted in the gray box, it's a very reasonable one. Approximately 40 basis points of average annual reduction in return across these many different paths. Our approach has gained a lot of attention and followers. More on the followers in a minute, but with the attention has arisen a debate. Is this approach for the benefit of insurers or investors? Our answer is yes, both.
For Prudential and its shareholders, this type of risk mitigation enables us to offer products with compelling benefits and to do so at a lower cost than that of our competitors, in particular, a lower cost of hedging. For retail investors, for whom loss avoidance is a paramount consideration, auto rebalancing affords attractive protection from highly adverse markets, attractive as long as it comes at a reasonable cost, reasonable as in 40 basis points. There is no such thing as a free lunch, but there absolutely is such a thing as a very good deal, and I think this independent analysis demonstrates that auto rebalancing is just that. I've said to you before that if I were limited to one picture to explain our strategy in this business over the past few years, this would be it.
Let's reflect back on the fourth quarter of 2008 as the market crisis is creating havoc in this industry, and every company in the industry is asking itself: how can we reduce risk in our VA product design? At Prudential, we asked ourselves that question, too, and we did make some changes in our product design. Although, since we had already long since gone the auto-rebalancing route, we were able to make changes that were much more precise and measured than our competitors had to make. We also asked ourselves another question, one with far-reaching implications for the business. We asked ourselves: how can we improve the risk profile of our total book of business in this area?
The answer to that question was, as long as we have a product with such a lower risk profile than the rest of the industry that operates so differently from products in the rest of the industry, we can improve our risk profile by selling a lot of that product and changing our business mix in the course of that, and that's precisely what we did. Each of these vertical bars represents our total account value. The blue portion represents with living benefits with auto-rebalancing. That's the only type of living benefit we sell, and this is basically all of our business now. 95% of the time that someone buys a variable annuity of any sort from Prudential, they are electing the living benefit with auto-rebalancing. The red portion represents account values with a living benefit without auto-rebalancing.
This is purely a runoff book since we have long since stopped offering such benefits. The green portion represents account values with no living benefit. This is, for all intents and purposes, a runoff book, given that 95% election rate that I just mentioned. You can see the change here. The blue portion here accounted for 12% of our total account values at the end of 2006, 29% at the end of 2008, and at the end of the first quarter of this year, almost 60%. That's not just a change in our business mix, it's a transformation of it and of our risk profile. I was often asked throughout 2009 and through a good portion of 2010 that if this is such a great idea, why isn't everyone doing it? Well, as Mark mentioned, with a rash of recent filings, many more companies are.
Nine out of the top 15 companies in the industry, including just about all of our mainline competitors, now either offer or have filed for a product that seeks to achieve some form of account value protection embedded in the product design. Many of these new products do so at the fund level, requiring investment in a very limited set of funds that are, for example, managed to reduce volatility. Our response to this development is, first, we welcome the validation from competitors who up until pretty recently were selling against our approach. Second, we're flattered by the imitation, and in almost all cases, it is just that, imitation, not replication. We believe our approach is superior, particularly to those that operate at the fund level.
Our approach operates at the individual contract level, responding on a daily basis to changes in the risk profile of that individual contract, offering superior risk mitigation to the insurer. As for the investor, our approach operates as an overlay on a highly diversified and flexible investment platform, offering investors and their financial advisors a wide range of sophisticated options for achieving their investment objectives, rather than limiting them to a handful of managed funds. Those two points constitute my belief, and I recognize you'd hardly expect me to be up here stating otherwise. This point, however, is indisputable fact. Our competitors are following suit because they see the merits in this approach. As for having this approach cover their entire book of business, they're at 0%; we're at just about 60%.
They'll have to have many years of dynamic sales success to achieve even a fraction of the coverage ratio that we've already achieved, and by then, we will have progressed that much further. Let's start to explore how our sales success has built our account value base and how that in turn drives earnings in the business. First, you can see in the gold arrow here. Over the past two years, account values have grown at a 30% compound annual growth rate. Impressive enough, but I think what's really noteworthy is that even in a two-year period in which the market has performed so strongly, most of our growth in account values has come from our own net sales. You can see the yellow box is net sales. The green is market appreciation and other activity.
From 2008 to 2009, those two things contributed evenly to our account value growth, each contributing about $10 billion. From 2009 to 2010, the contribution of net sales to our account value growth was almost double that of market appreciation. As for the outlook from here, I've already covered our outlook on gross sales. Continued strong sales levels, even if we do see in the short term some easing off from recent elevated levels. The other part of the net sales equation, of course, is lapses. I think this is an interesting point. Lapse rates in the immediate aftermath of the market crisis plunged across the industry for every company in the industry, almost every company. Investors had guarantees that were deeply in the money, and they were quite literally holding on to those guarantees for all that they were worth.
Following two years of market recovery with those guarantees less deeply in the money, it's our belief that lapse rates are going to begin once again to vary much more widely from company to company in the industry. In fact, I think we're already starting to see the beginnings of that trend. If we're right and if that trend continues, we are very well-positioned in regard to it. There we go. One of the main protections against lapses is the surrender charge, a termination charge that applies in the early years of a contract. Speaking very generally, the newer the business, the higher the surrender charge. The relatively recent vintage of our book, given our sales momentum, means that the bulk of it is still subject to surrender charges. You see that in the bottom row of numbers here.
75% of our overall book is still subject to surrender charges, with almost all of that being subject to the higher category here of 3% plus. If we take the analysis a level deeper, the picture looks even more attractive. The auto-rebalancing business that we've made the core of our franchise is almost entirely, see the 92% here, subject to a surrender charge of over 3%. In fact, that's kind of the understatement of the year. That 92% block, the average surrender charge on that block is 6.5%. Our legacy non-auto-rebalancing book presents a very different picture. Over half of that book is subject to zero or negligible surrender charges, and it won't be any surprise when I say that that's the block in which we are, for the most part, experiencing lapses.
I am not going to stand up here and say that we want our legacy book to lapse. You'll recall that auto-rebalancing coverage ratio that I mentioned earlier, the 59%-60%. We would just assume that that figure continued to trend towards 100%. It's clear that between this type of surrender charge structure and lapse outlook, and our sales momentum, we're building our business rapidly and in precisely the way that we want to build it. This sustainable growth in account values has driven significant growth in our core earnings. Our reported AOI contains certain disclosed items that reflect accounting entries that are driven purely by market conditions during the period. These would include items like DAC unlocking and movements in or out of death benefit reserves.
We certainly take those items seriously, and we seek to manage the risks they represent, but we also look at, as I say, our core earnings, our earnings absent these items. I should really point out in doing so, in the two-year period that I'm taking you through here, those disclosed items, those market impacts, represent a very significant positive number on a cumulative basis. This analysis hardly represents any effort at cherry-picking. Those disclosed items do make our reported earnings hard to model. For that purpose, and to track our progress in the underlying drivers of our business, we look at our earnings excluding these items, or as I call them, our core earnings. Here you can see the steady trend. Core earnings reached a trough, the second bar here, in the second quarter of 2009 of $73 million.
By no coincidence, that's when our account values reached a trough as well. Since then, core earnings have more than tripled to $233 million in the most recent quarter. The earnings growth has been even more rapid than the account value growth, leading to improved margins and improved return on assets. That ROA, the gold boxes here, has almost doubled from 45 basis points at the trough to 86 basis points in the most recent quarter. Let's break down that ROA expansion further. Think of this chart, if you will, as blue minus yellow equals green. The blue bar is net revenues as a percentage of average account values, the yellow bar operating expenses as a percentage of average account values, and the green is simply the difference between the two or the ROA.
Our improvement on ROA has been driven by positive trends in both the revenue and the cost efficiency side of the equation. You can see that the blue, the revenue yield of our business, has been increasing. We began price increases at the very start of 2009. Strong sales of this higher priced product, combined with lapses of the older, lower priced contracts, has driven our revenue yield up. The reduced yellow expenses as a % of assets is due to two things. First, improved economies of scale, especially in the distribution side of our business, where we have the lowest cost of sales in the industry. Second, reduced rate of amortization for DAC. That rate is a reflection of our expected gross profits in the business going forward. As our account values climb, so do our expected gross profits and the DAC amortization rate decreases.
The key point here is the close correlation between our account value growth and our core earnings growth. This provides the basis for looking at the business through the drivers that we can effectively manage and that, if I may, that you can effectively model. If market conditions are in line with our expectations and our actuarial assumptions don't change, we always have to state those givens, but given those things, account value growth will continue to drive expansion of ROA and growth in core earnings. Let me wrap up. We don't like zero-sum games, and we do not look at Prudential shareholders, our product investors, and our distributors as representing diametrically opposed interests. We know that all those stakeholders are best served by a strategy that always focuses on sustainable, profitable growth.
Our innovative and unique product design, combined with the strength of our entire business platform, makes for a market leading value proposition. That in turn leads to increasing returns on a growing base of business, and that enhances shareholder value. Thank you very much. Now I will take a seat, then Charlie and I will take your questions. Okay. Jimmy Bhullar. Josh, the gentleman right there on the aisle.
Thanks. The firm is J.P. Morgan. You mentioned the account value volatility, the lower volatility benefit in the 60% of annuities that have the auto-rebalancing feature. Could you also talk about if there's a capital benefit and do you hold more capital, less capital in that part of the business versus the one that does not have guarantees?
Yes, there's most definitely a significant capital benefit. The reduced volatility in account values leads to reduced capital strain, especially in shock scenarios.
On an ongoing basis, you hold the same level of capital for the same level of assets?
Within that block of business, yes. As we add to that block, because that's the only place where the business is flowing to is into that block, we maintain capital at a consistent level of assets.
You didn't discuss your 401 business in detail, but I think the comments that you've made in recent calls have been less positive on that business than in the past. If you could elaborate on that.
Sure. We actually have the CEO of our retirement business here. I'm going to ask Chris Marks to make a couple of comments on that.
Chris, would you hold your hand up so Margot can get you a mic?
Yeah. I thought I'd just add a little clarity to Mark's comments with regard to the full service retirement business. It's a matter of emphasis at this point. We're very happy with the margins we have in this business. If you look at the defined contribution and defined benefit markets, except for the micro DC market, there is not new plan formation going on. There is a trend towards commoditization of record-keeping, driven in part by some regulatory changes. Our focus is on expanding our business beyond our full service platform, specifically looking at opportunities to take our investment management and risk management capabilities into other market segments. You see that if you look at the growth in our Stable Value investment-only business over the last two years. That is providing Stable Value product to other record-keeping platforms, not only our own.
Similarly, on the pension risk transfer opportunity, that is also an area where we see significant growth driven by the Pension Protection Act regulation. We're looking at growth sectors in other parts of the retirement market beyond just the mid-full service market.
Okay. Nigel,
Great, thanks. Nigel Dally from Morgan Stanley. A question on the competitive conditions on the annuity side. You commented that there's a number of followers in the marketplace. I'm interested to see how their products compare to yours in terms of features and pricing. Is it fair to say that we've reached an inflection point with competitive conditions? Should we be concerned that we're beginning to see the beginning of another arms race across the industry?
Well, I can't speak for what other firms in the industry are going to do. We're going to continue to run our business on just the basis that I've mentioned and emphasized throughout my presentation of sustainable profitable growth. Mark talked about market share, and we've answered market share questions in the past, but it's really not relevant to how we think about the business. We want to have a sales level that, number 1, reflects that we're delivering a relevant solution to the marketplace, and number 2, delivers the financial progress, the progress in core earnings, that I took you through here. If that takes place at a reduced market share than what we've recently experienced, that's fine with us, and that's what we would expect to see as the business becomes more competitive.
In terms of our competitiveness going forward, Nigel, I think that some of the products following suit that you've mentioned have introduced certain features that are different from ours, like a higher roll-up rate. However, we remain completely unique as the Highest Daily company and the daily step-up. That, combined with the strength and diversity of our investment platform, are from a product standpoint, really the key messages that we deliver to the marketplace. Again, my preference is to recognize people who haven't yet asked a question. Gentleman right there with his hand up. Ian?
Hi, Ian Gutterman with Adage. Steve, I'm looking at page 10 where you essentially show a 0% chance of a 33% loss in account value. I understand what you're trying to show, but I guess I'm wondering how much you believe that when you price a product because the lesson of every bear market essentially has been what we thought was impossible ends up being very possible. My guess is something will come along, maybe if we sold this product in Japan in the '90s, maybe there'd be a number of people who were down that much. Are you really pricing product at this being a zero, or is there more conservatism in this than that?
Well, for a scenario of what people thought was impossible, I'd also take you to slide nine, which was the actual market crisis and how the product performed during that time period, which is actually far better than in the course of the Monte Carlo simulation. There was no opportunity cost during the actual market crisis. Account values performed much better than account values would have performed without auto-rebalancing. Yes, I do believe it. The auto-rebalancing is designed for this type of negligible risk of account values contracting more than 25%, in fact, is the key threshold that we look at. That's how we designed it. That's how it has operated. That's been proven by test under fire, and that's how we price the product. We do so with appropriate margins and appropriate leeway in our product design and pricing.
I absolutely believe that what we see in the Monte Carlo simulation done by Ernst & Young is what we would expect to see. That's how auto-rebalancing has been designed to work.
I think you sort of hit this in your comments, page nine benefited from obviously a strong bond market recovery, which if we repeated the early '70s here or repeated the Japan experience, we don't have that. How does a scenario like that turn out? Is that in that 7% on the 20%?
It would be different, but I still think we'd be well within the bounds of the risk of a 33% loss in account value being absolutely negligible.
Thank you.
Yep.
Okay. Edward Spehar, up in the front here.
BofA Merrill. I guess I'd like to follow up on Ian's question. If you believe that, why wouldn't you let this business get as large as it would naturally go? I think you've said in the past that you'd like to sort of limit this business in terms of earnings or account values or however you measure it in something in like the 20%-25% of earnings range. If we really believe that these numbers are right, why wouldn't you just let this thing grow as much as it can?
I'll take that. I think one of the things we look at, and Mark and John can talk about this at the end, is the business mix we have, and the calibration of risk and return to business mix. If you look at the businesses we have from group life to individual life, to retirement, to asset management, to annuities, and then add on international to that, we very consciously have a particular business mix, some of which relate more to markets and have more market volatility, and others which have less. What that does is allow us to have a more stabilized AOI during downturns and yet still participate in upturns. Mark and John can address that more when they come up. It's a very conscious decision as to how much of any particular business we want.
I would just expand on that, Ed, by saying that over time, that progress of the blue bar that I spoke about, we are creating a business that operates very differently from other variable annuity companies. However, having said that, it's still going to be the most market-sensitive business that Prudential operates by a considerable margin, hence the relevance of the business mix points that Charlie just made.
Just one follow-up. Could you give us some sense, given the mix of business that you have, the new product that you're selling today, assuming the market just went up in line with what your pricing assumptions are, where can the ROA go in this business?
I don't think we want to give you a number, but I think you can address the spirit of the question, Steve, if you like.
Up. No, seriously.
10? 20?
I think as long as the conditions that I spoke about are there, Ed, and you stipulated the same ones, our actuarial assumptions don't change and the market performs generally in line with expectations, we'd continue to see expansion of ROA in the business.
Okay, let's go across the aisle. Steven Schwartz again. Right there.
Steven Schwartz from Raymond James. Two, if I may. Steve, I know you've said many times, market share doesn't drive us. Does market rank concern you at all given requirements about specific product education? Does that occur to you? Do you need to be in the top three or four no matter where your market share is?
We want to be high enough in the tables to indicate to us that, as I said, we are delivering a solution to the marketplace that the marketplace finds relevant and compelling. For rough justice sake, you could talk about, yeah, being in the top tier of the industry matters, and top tier has been that top three. The number one ranking, as attractive as it is not what drives us any more than the market share that I referred to earlier.
Okay, great.
It's been, as I said, a welcome byproduct of our consistent strategy, but not the objective of it.
Okay. Charles, Mark talked earlier about capital deployment, and obviously, that's more than just share repurchase. I wonder kind of how asset management plays into that. Maybe you don't want to be an AMG, but maybe you want to acquire or attract more boutiques. Maybe you can address that within the context of capital deployment.
Sure. Happy to do that. Capital deployment can come from a number of forms. One is co-investing in the funds that we create or investing in seeding funds to create track record. We do that, and we invest a fair amount of capital in that. That's the organic growth that John was talking about. We made the conscious decision during the recession not to go after big acquisitions, right? There were a number of them on the market, but we didn't go after them because I think the degree of difficulty of combining two very large asset managers is huge. What we did is that we essentially went and bought people, not platforms.
Again, in every group, we went out and we either did lift outs of teams, or we went out and specifically targeted people or skill sets that we wanted in order to bring those skills into our groups. We're continuing to do that. I referenced the latest lift-out we did for Jennison for our global growth team. We have a number of other ideas, I will say, in mind. We will do that. We will also look, and if we see smaller, very targeted firms or groups of people that we would like, we may go acquire those, and assets may come along with those as well. What you won't see us do is go out and acquire a very large asset manager.
We'll continue to deploy capital, but it will be in a very targeted, specific way to augment the skill sets we have already. Having said that, within the context of what Mark said earlier, if we were to make a larger acquisition and assets came along with that, through that context, we would obviously assimilate those assets into our existing platforms.
Okay, my takeaway here is that a multi-boutique strategy is not on the table.
A multi-boutique, in terms of going and acquiring other boutiques?
Right.
That's correct.
Okay. Thank you.
Okay. John Nadel. Margot?
Thank you. John Nadel from Sterne Agee. Three quick ones if I can get them in. On the asset management business, I think I heard that rising rates impact on fixed income AUM, we'd be deriving fees off of the cost basis, not a market basis. Is that correct?
No, not for fixed income.
Okay.
That was solely for real estate.
Okay.
Mark's comment with fixed income is that in a lower fee environment, you would have higher assets under management and then higher fees. That was only for the U.S. portion of the real estate equity business.
Got it. Glad it clarified. Second is just if I can go back to 401k for a second. If we looked out five years from now, 401k business, whether it is Prudential's or just a commentary on the industry, and thought about a benign market environment, maybe modestly improving employment levels, are margins flat versus today? Are they lower? Are they higher? Can you give us a sense for your perspective?
Sure. I think that there is pressure on margins. If I had to say what they'd be five years from now, I would say they'd be lower. You have a couple of different trends going on. One, you have a regulatory trend towards transparency, and the other is unbundling. In both cases, that's going to put pressure on margins. Five years from now, margins will probably be lower than they are. I would say my bet would be that they'd be lower than they would be higher.
Thank you. The last question is on the annuity business. Your surrender rate has been among the lowest, I think, in the industry, at least among the companies that I cover, maybe 7%-8% annualized. I was wondering if you could give us a sense for what the surrender rate looks like if you were to break that down similar to your breakdown of the account values between HD with auto-rebalancing versus the legacy business, et cetera.
In general.
I guess my question really is at the heart, is the legacy business seeing a higher level of surrenders? I assume that it is.
Oh, yes. Most definitely.
What's the order of magnitude?
Virtually all of our lapses are coming out of the non-auto rebalancing book. There's very little lapsation in the auto rebalancing book. The other protection that the auto rebalancing book has against lapsation, I took you through the surrender charge.
Still on the surrender charge.
The other point that it has, obviously, is the nature of the Highest Daily benefit.
Yeah.
Protected withdrawal value in our HD product is always equal to or greater than account value. Let me quickly add, never by too much. That's the basic premise of auto rebalancing.
Thank you.
Okay, we've got time for two more. The gentleman over here with his hand up. John Hall.
Thank you. John Hall with Wells Fargo. I have an asset management question. When I look back to Mark's first bubble slide, the asset management business had about $1.9 billion of capital, and it seems not exactly intuitive that it has as much capital as is dedicated to the life insurance business in the U.S. I guess as you go through this process of reducing volatility in the asset management business, which means, I guess, scaling back your proprietary activities, is there a capital release opportunity associated with that $1.9 billion that we should think about going forward?
No, I don't think so. In other words, there's capital associated with the business for a variety of reasons. One is there's some capital associated with just the assets you have under management. The other is capital associated with investment you have in the business. Although we've scaled back that, we're actually growing it going forward. I don't think you'll see a capital release opportunity.
Can you break out those two buckets?
Not offhand.
Thank you.
Joanne, you get the last one.
Joanne Smith, Scotia Capital. You pointed out the advantages of your product with the auto-rebalancing feature at the actual contract level. I guess I'm just wondering why that is so difficult to replicate with other companies. Is it a systems thing? Is it a hedging thing? What exactly is it that makes that so unique?
I would say the core of it is a systems question. We have developed over years the systems that are necessary to, as I say, analyze each and every one of our HD contracts each and every night. That requires enormous investment in our systems to do so. Going beyond the systems, it's the way we built our entire business system around it.
That's right down to activities at the point of sale. Our entire franchise is built around telling this story. It certainly incorporates the hedging operation that you mentioned. The fact that we have to look at hundreds of thousands of contracts each and every night, then all the other requirements of the hedging operation means that we're doing about 10 trillion calculations a night in our hedging operation. That's part of that financial risk management capability that we've invested so significantly in. I would say it's systems plus our entire business platform being built around this value proposition.
Thank you, Charlie and Steve. We're now getting down to the short strokes. Our final speaker in just a moment will be John Strangfeld, then John and Mark Grier will have at your questions.
Are we freezing you out? It is cold. I only have one slide at the end, and then, as Eric said, Mark and I will open it up to additional questions. I thought I'd comment on one or two questions that have arisen that we've postponed till now. Just to sum up our thinking here, we're in high-value businesses that are well-led with strong fundamentals. We feel very good about that, both U.S. and abroad. Our mix of businesses is by design, not a happenstance of the past, and we feel very, very good about that as well. Our highest returning businesses are the ones we focused on today. Thanks, Eric.
Sure, John.
We focused on today, because they're going to be the ones that are going to drive the attainment of our ROE objectives. They're all important, but these are the ones who will create that incremental outcome by virtue of their continued growth and prosperity. We're in a strong capital position, and capital management, broadly defined, we recognize is an important part of our investor proposition. Finally, there's the leadership. We feel very good about our leadership team, heavily represented here, and this is a leadership team that is confident but not content. We feel very good about our prospects and that our best days are ahead of us. That's my summary. What I would like to do is just comment briefly on a couple things that came up, one about M&A and one about annuities, that already came up.
I thought I'd hit the M&A piece fairly broadly. Our thinking about M&A is to stay in scope, meaning protection and retirement, and to think of it in terms of U.S. and abroad. We're very happy with our decision vis-à-vis Star Edison, and that was something that took some time to come to fruition. We think we're an attractive counterparty, as demonstrated in the AIG situation, both because of our experience and our skills and our confidence in execution and therefore our credibility in execution. I think that reliability factor has a lot of value to a counterparty. Having said that, as Mark mentioned, it's less of a buyer's market today than it was a year or two ago. Sellers are less stressed, and there are more buyers than there were previously.
We have not seen things done away from us that we aspire to do. We expect over time we will, as the markets become more active and there's more participants in it. We remain optimistic that there will be opportunities, but we also don't want to rely that on our sole means of capital deployment. I'd also add that one thing you have seen us do that we've not featured or focused upon today is we continue to do selective opportunities to continue to focus increasingly on our core businesses. We've done a series of divestitures over the last 18 months, whether it's Korean securities business, Mexican securities business, global commodities, which we announced relatively recently.
Individually, they're not that large. In aggregate, they help contribute to the capital redeployment function and to the focus of our time and energy on the things we can do best. You can expect that we will continue to go along that way. As Charlie Lowrey said, while we don't focus exclusively on asset management as an area of M&A, it is an area for operating leverage. That was true with the acquisition of Skandia. It's certainly true with Star Edison as well, where we bring on the additional assets with a de minimis change in our investment organization or infrastructure. That provides another opportunity as well. That's how I'd sum it up, is M&A is like to do, not have to do. We think we're very well-positioned as a counterparty. The markets have more participants.
We also think this is a time where we have more confidence in our ability to access external financing should the right opportunity arise. Bottom line is we'll see. The other topic I wanted to mention is on the annuities topic, in terms of what proportion of our business would that represent. As has been described by Mark and Steve and Charlie, all three, we're very comfortable and very proud of where we stand vis-à-vis the annuity business, both the quality of the returns, the quality of the businesses being underwritten, and the risk profile. What we've stated previously is that we're looking for this business to represent no greater than 25% of our earnings mix. It's presently in the low 20s. We have other businesses that are growing in nice fashion as well, and we feel very comfortable with that kind of concentration thinking.
Keeping in mind that the actual risk profile within that 20-some percent is a lower risk profile than it was several years ago. When we first described that as a threshold, our new book represented roughly 30% of the total book. Today, as you can see from Steve's chart, that new book now represents 60% of our book. While still working within the same constraints, we're actually operating at a materially lower risk profile than we did at that time. Hence, even further comfort with where we stand. We like that business in terms of the quality and returns. We like the business in terms of the role it plays in the financial marketplace. We are very comfortable with the parameters in which we're operating. That's a little comment on the M&A piece, a little comment on the annuities piece.
We're happy to open it up to other questions and comments that people have. Eric?
Okay. Suneet, up in the front, we'll get the lady in the back whose hand is up after Suneet.
Thanks, Eric. Suneet Kamath from Sanford Bernstein. John, if I could follow up on the M&A. As we listen to your presentations about the U.S., my first question is, clearly on the variable annuity side, you want the Highest Daily value, that's organic. The margins on full service, obviously, there are some comments about that over the next five years. In terms of asset management, no big deal. My first question is, what in the U.S., just in terms of type of business, would you be sort of targeting with respect to M&A?
It varies, Suneet. Firstly, I agree with your characterization. We're not looking to acquire someone else's old book in annuities. We didn't go through all this to have that as a designed outcome. I wouldn't rule out the fact that there could be businesses that have some element of it that would not dissuade us from considering it. I think, if you look at some of the examples we've had in the retirement space in the past, you can see there's been different steps we've taken, whether it was scale related with Cigna, or whether it's been capability related with TG Moen, which is a smaller acquisition but very important to us from a capability point of view.
I think as we go through some of the further thinking about what are the long-term forces at work here, some of which provide real opportunities for us in terms of putting our products on other people's platforms, and others which may provide more question about the scale and record keeping, those are going to be drivers that are going to shape our thinking about what's attractive and what's not attractive in the space. I would say that there's certainly areas of opportunity that could manifest themselves, but it has to be done in the context of the evolving forces in the industry. Maybe it's less specific than you might be looking for, but it's with an acknowledgement that we have forces at work here that we want to be attuned to, not just lock in on a certain setting or thought process with a changing world.
Okay, my follow-up question is to take M&A abroad. I know you don't have the benefit of the slide in front of you, but slide seven of, I think, Ed's presentation showed the world's largest life insurance markets, U.S. and Japan, and then a whole bunch of other countries.
Yeah.
Is it fair to say that those would be the countries that you'd be focused on the most in terms of M&A abroad, or are there other countries that are, say, not on this slide that would make sense for you?
Well, I guess I'd look at in terms of the geography. We focus today on the U.S. and Japan because it's the 90/10 rule. It doesn't mean those are the only places we're in or the only places that would appeal to us. It's important to acknowledge that we have other markets in which we're active, whether it's in relatively new startups in China and India that we think have promising very long-term prospects or more intermediate-term markets like Korea, Taiwan, Brazil, where we've been in these markets for 10-15 years, and they are looking promising as well. I think we have an openness geographically beyond the U.S. and Japan marketplace, and as been demonstrated, we've had activity in those markets historically.
Okay. The lady just two rows back by the aisle, near the aisle.
Hi. Heather Takahashi from Fortress. I have a few related questions. Number 1, do you have a limit on the % of your capital that you'd be willing to allocate to Japan, and if so, what is it? Second, if you did find a highly compelling acquisition, say, once in a lifetime opportunity in Japan from both a financial and strategic perspective, and it caused you to go over that limit, would you go over it? Finally, how attractive do you find the LatAm markets from an acquisition perspective?
Do you want to take a shot at the first part of that?
Yeah. We don't have a specific limit for the amount of capital that we would put in Japan. We view Japan as very low political risk, stable country, and as you heard from Ed, extremely attractive market. We do, however, as we've considered everything we've done there, going back to Gibraltar and a couple more smaller acquisitions, more recently, Star and Edison, go through this conversation with the board about the deployment of capital and geographic and geopolitical issues. We are not currently concerned about Japan as a geopolitical issue with respect to deployment of capital. Again, if another deal came up, we would consider the questions of concentration and review any and all aspects beyond the specific business issues around the profile of our capital deployment.
Which is a long way of saying, as Ed described, a sense that the markets are very attractive in Japan, and we don't at this point feel a need to limit our growth in Japan. The other one was Latin America. We have a preference in general when we consider international expansion for markets that have either substantial or substantially emerging middle classes or mass affluent classes. You haven't seen us try to do a lot in the pure emerging markets where everything is on the come, and there may be an attractive embedded value story, but there's a lot of capital strain, and there's not much in the way of GAAP earnings.
Markets that have economic growth and are building middle-class or mass affluent client bases for us would generally be the kind of markets that we would consider, and to your specific point, there are some markets in Latin America that are probably starting to fit that bill.
In the case of Latin America, keep in mind we have businesses in Brazil, we have businesses in Mexico, and also in Argentina. We've had good experience with those activities, both actually in life insurance, but also the Afore business and also asset management in selected areas as well.
Okay. Eric Berg. The gentleman right behind.
Thanks. From RBC Capital Markets. Since the HD technology has been so strongly embraced in the U.S. market and since you believe so strongly in its effectiveness, why not bring it to Japan? Thank you.
Well, I don't know if Ed wants to comment on this. Our thinking about Japan in terms of variable annuity products is heavily influenced by the very, very low level of interest rates. It's hard to design a product there, even with HD technology, that has an attractive value proposition for us as a manufacturer, for somebody else as a distributor, and finally for somebody as an end user consumer. Our reticence to get into Japan in the variable annuity business is more based on the bottoms-up construction of the opportunity and the sense that because rates are so low, that pie is just not very big, and it's hard to make it attractive to everybody. We've clearly been pleased with the decisions that have been made to stay out of the market.
We didn't go through any of the meltdown issues in some of those product portfolios. We still find it difficult to put together an attractive value proposition.
Okay. I'm trying to be fair and balanced here.
You've only got one hand up.
Only one hand up.
It's an easy decision.
Okay.
If you don't call on him, we're ending.
All right.
Hi, Steven Schwartz from Raymond James again. Just a quick one for Mark. The $1.8 billion, the difference between readily deployable capital and not so deployable capital, you said was primarily DTA. How long will that take to become deployable?
Why don't I ask either Rich or Rob to comment on the difference between deployable and sort of face value?
Right behind you, Rich.
Richard Carbone, our CFO.
Hi. The DTA was driven by the credit losses that we took for books over the past three years. Including the closed block, we've got $3 billion of credit losses. 35%, that's over $1 billion of tax receivables. When that deduction is taken on the tax return, we'll get the cash. That deduction gets taken on the tax return as these companies go bankrupt or we sell this to security. It's not a forever thing. I'd like the assets to recover. I'll write off the DTA and collect all the money on the bonds.
All right. This is a mark-to-market thing. It's not necessarily an actually you've realized the losses?
Well, from an accounting perspective, the losses went through realized gains and losses, but they're not deductible on a tax return. Therefore, you get a DTA, right?
Right. Okay, you need to harvest gains. Is that the issue to get that?
No, no. We need to realize the losses on a tax return basis.
Okay. What I'm missing then is-
When GAAP says realized gains and losses, they're really not realized yet, right? They're a mark to market. I guess that's a fair way to think about it. They're an impairment or a mark to market.
Oh, okay. This is an impairment difference.
Yeah.
Okay, I got it. Thank you, Rich.
You're welcome.
Okay, we're down to our last question. Joanne?
I just want to go back to a question that Edward Spehar asked earlier. I'm going to ask it in a bit different way. Regarding the variable annuity business, have you had conversations, and obviously you've had conversations, what kind of conversations have developed with the rating agencies and regulators regarding how big that business becomes? Rather than from a corporate organizational perspective, from a ratings supporting or regulatory capital issue, where do the regulators and rating agencies come out in terms of how big they would let that business get?
Well, as many of you know, there has been a time period over the past few years during which there's been kind of an abstract dislike for the variable annuity business on the part of rating agencies. Obviously, a lot of that was based on what happened as we went through the 2008, 2009 equity market gyrations, the accounting volatility and the statutory capital volatility, again, in some respects as distinct from the economics, were pretty scary to sit back and watch. We are positioned very well with respect to the emerging risk profile of our variable annuity book.
We continue to make the case that Steve made today, that we look different, particularly in tail scenarios, because as you know, the auto-rebalancing routine will put all of the assets into fixed income and take the downside out of account values at a level in the 75%-80% of account value neighborhood. We continue to make the case. I would say we're making dents in the argument, coming out of 2008, 2009, there's a lot of baggage around variable annuities.
Just as a follow-up to that. When I look at the definition of excess capital above an RBC of 400%. If you're moving in the direction that you're moving in terms of diversification from both a product and a geographical perspective, why is 400% the real target? Why wouldn't it be like Principal Financial Group targets 375% or 350%? Why wouldn't it be lower?
At 400, we are benchmarking toward the higher end of the industry. Others use 350 or 375, we're conservative in a lot of respects. We're conservative in that benchmarking process. We're conservative in our statutory reserving and bookkeeping. It's an element of Prudential being conservative. We certainly would view the possibility of RBC going down as one of the ways in which we could manage in a stress environment. We're not necessarily committed to maintaining 400 in the tail scenario. We view the opportunity to let RBC go down from there as a source, in a way, of capital in a stress environment. For business as usual, we're benchmarking 400 as part of our conservative approach.
I'm getting a look from Eric that suggests we're wrapping up. We'd like to very much thank everyone for their interest and attention. We look forward to seeing you next year.