Ladies and gentlemen, thank you for standing by, welcome to the Prudential fourth quarter 2010 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given to you at that time. If you do need assistance during the call today, you may press star 0, and an operator will assist you offline. As a reminder, today's conference call is being recorded. I would now like to turn the conference over to Eric Durant. Please go ahead.
Thank you, Cynthia. Good morning, thank you for joining our call. Representing Prudential on today's call are John Strangfeld, CEO; Mark Grier, Vice Chairman; Bernard Winograd, Chief Operating Officer of Domestic Businesses; Ed Baird, Chief Operating Officer, International Businesses; Rich Carbone, Chief Financial Officer; and Peter Sayre, Controller and Principal Accounting Officer. In order to help you to understand Prudential Financial, we will make some forward-looking statements in the following presentation. It is possible that actual results may differ materially from the predictions we make today. Additional information regarding factors that can cause such a difference appears in the section titled Forward-Looking Statements of Non-GAAP measures of our earnings press release for the fourth quarter of 2010, which can be found on our website at www.investor.prudential.com.
In addition, in managing our businesses, we use a non-GAAP measure we call adjusted operating income to measure the performance of our financial services businesses. Adjusted operating income excludes net investment gains and losses as adjusted, and related charges and adjustments as well as results from divested businesses. Adjusted operating income also excludes recorded changes in asset values that are expected to ultimately accrue to contract holders, and recorded changes in contract holder liabilities resulting from changes in related asset values. Our earnings press release contains information about our definition of adjusted operating income. The comparable GAAP presentation and the reconciliation between the two for the quarter and year-end December 31st are set out in our earnings press release on our website. Additional historical information relating to the company's financial performance is also located on our website. John.
Thank you, Eric. Good morning. Thank you for joining us. Now that we've closed the books on 2010, I'll kick things off with some high-level comments regarding the year as a whole. First, earnings. Our earnings per share for 2010 increased 14% from 2009, based on after-tax adjusted operating income of the financial services businesses. Return on equity was 11%. Excluding from earnings the items we consider discrete or market-driven, the full-year result would equate to just under a 10% return on equity. These returns reflect the drag from significant capital capacity, roughly half of which was redeployed on February 1st when our acquisition of Star and Edison closed. Net income for the year amounted to $2.7 billion, down from $3.4 billion in 2009, which included a $1.4 billion gain on our sale of our investment in Wachovia Securities. Second, capital.
As Rich will share with you in a moment, our capital position remains exceedingly strong. We are well-positioned to pursue business opportunities, and we have capacity to remain strongly capitalized even in severe stress environments. Book value per share on a GAAP basis increased by 22% during the year and amounted to $63 at year-end. Excluding unrealized investment gains and losses and pension and post-retirement benefits, book value per share increased 10% to $59.48 at year-end. Our commercial momentum has never been stronger. Strong sales and flows in our key U.S. retirement and international insurance businesses attest to their market leadership. In individual annuities, gross and net sales were both at record levels. In Prudential Retirement, which includes our full-service business as well as our institutional investment products activities, we had a 24% increase in net flows for the year.
In asset management, net institutional long-term inflows exceeded $28 billion for the year, a record high and more than double 2009 inflows. Our international insurance operations had record annualized new business premiums, which increased 25% from the prior year in constant dollars. About 85% of our sales for the year in international insurance came from Japan. Japan is a market that continues to present attractive opportunities for Prudential to build on our success in protection products and increasingly to address retirement needs. The acquisition of Star and Edison, which closed on February 1st, broadens our distribution, increases the scale of our operations, and expands our client base by roughly 50%. This is a rich opportunity. We expect this acquisition to be accretive to enterprise ROE and to EPS based just on the value of the in-force we're acquiring and the expense synergies we expect to achieve after an integration period.
Our opportunity is significantly greater than this. Prudential has a highly successful record of acquisitions in Japan and a management team in Japan that knows how to improve the operating performance of traditional Japanese insurance companies such as Star and Edison. We've shown we can improve sales productivity, policy persistency, and product mix. With the acquisition of Star and Edison, we will be applying capabilities that are well established to a new and attractive opportunity. Just as we improved the performance of Gibraltar, too do we expect to improve the performance of Star and Edison. Before handing it off to Rich and Mark, I'd like to make some brief comments on Prudential's leadership. This Tuesday, Bernard Winograd announced his retirement, which will be effective shortly. Bernard has made a huge contribution to Prudential as Chief Operating Officer of our U.S. businesses over the last three years.
Before that, Bernard led our asset management business with great distinction. Before that, he played a central role in developing Prudential Real Estate Investors, our outstanding real estate investment advisory arm. We will miss Bernard as an executive and as a colleague. We will also miss his sense of humor. He leaves our U.S. businesses in the best shape they have ever been in terms of performance, momentum, and quality and depth of leadership. We wish him well in retirement. Charlie Lowrey will succeed Bernard as head of our U.S. businesses. Charlie has done an outstanding job running our asset management business for the last three years, and we are enthusiastic about him in his new leadership role. He has a great team. I'll turn it over to Rich. Rich?
Thanks, John, good morning, everyone. As you've seen from yesterday's release, we reported common stock earnings per share of $1.78 for the fourth quarter, that's based on adjusted operating income for the financial services businesses. This is an increase of nearly 50% from the $1.20 per share in the year-ago quarter. ROE for the quarter was 12%, based on annualized after-tax adjusted operating income. I'll start with some high-level comments on the quarter, then discuss the impact of some discrete items. Our enhanced competitive position has driven strong sales and net flows over the past year. In the annuity retirement and asset management business, leading growth in account values and assets under management, and in turn, higher fees. In our annuity business, significant recovery of account values in our in-force block has led to lower benefit costs, which has attributed to higher fees as well.
In the asset management business, credit-related charges were modest in the current quarter, in contrast to a year ago, when declining commercial real estate values had a significant negative impact on our results. In our U.S. protection businesses, results were down modestly from a year ago, reflecting a lower benefit from favorable mortality in individual life. Our international insurance businesses turned in a strong performance. Gibraltar Life benefited from a greater contribution from fixed annuities serving the retirement market in Japan, along with the expansion of the life insurance business sold through the bank channel, which is beginning to make a noticeable contribution to reported results. Continued growth of our Life Planner business also contributed to the increase in international insurance results for the quarter. The list of significant items this quarter affecting the quarter is short.
In the annuity business, we had a benefit of $0.15 per share from the release of a portion of our reserves for guaranteed minimum death and income benefits, a further benefit of $0.07 per share from an unlocking that reduced the amortization of the third policy acquisition and other costs. In international insurance, Gibraltar Life had a benefit of $0.10 per share from the partial sale of our indirect investment in the China Pacific Group. In total, the items I just mentioned had a favorable impact of about $0.32 per share on our earnings per share for the quarter, fourth quarter that is, of course. Our results in the year-ago quarter benefited by about $0.12 per share from favorable reserve true-ups and unlockings, which were largely market-driven.
Taking these items out of both the current and year-ago quarters would produce an increase in EPS of about 35%, pardon me. As you know, we issued 18 million common shares and $1 billion of debt in mid-November as part of financing for the Star Edison acquisition that we closed last week. The financing cost and dilution from the new shares had a negative impact of about $0.04 per share on the current quarter results. With the closing of the acquisition now behind us, we are in the process of determining the purchase accounting adjustments to be reflected in our reported results. Under GAAP accounting, valuation of the investment portfolio and related adjustments for policy reserves and value of business acquired, or VOBA, are done as of the closing date.
As of June 30th, the companies had a combined $41 billion general account portfolio consisting of about $17 billion of Japanese government and corporate bonds, about $10 billion of U.S. dollar-denominated bonds, and the remaining $14 billion was comprised of other investments, structured products, real estate, and equities. We estimate the average duration of the portfolio to be between 6.5 and 7 years. From June 30th, 2010, to February 1st, 2011, interest rates from 10-year securities have increased about 15 basis points on Japanese government bonds and about 50 basis points on U.S. Treasuries. Directionally, rate increases reduce the fair value write-ups on securities that we are required to make under purchase accounting. However, there will be an offsetting impact on policy reserves and VOBA. Also as a result of the change in the market.
Given we are early in the purchase accounting process, it would be premature to estimate the net impact on the results for the acquired companies. We will report results for Star and Edison on a one-month lag. As a result, the February 1st closing date means that our 2011 results will reflect 10 months of operating earnings to Star and Edison. Star and Edison, of course. Moving to GAAP results for the financial services businesses, we report a net income of $213 million, or $0.45 per share for the quarter. This compares to net income of $1.8 billion, or $3.78 per share a year ago, which included a gain from the sale of our interest in the Wachovia joint venture of $2.95 per share. GAAP pre-tax results include amounts characterized as net realized investment losses of $912 million in the quarter.
Of this amount, $581 million represents changes in the value of derivatives and other items on our balance sheet that are driven by changes in interest rates and fluctuation in foreign currency exchange rates during the quarter. About half of the $581 million relates to the strengthening of the yen during the quarter, and the remainder came mainly from an increase in interest rates. An additional $211 million came from product-related hedges, differences, of course, including NPR. We now report these items outside of adjusted operating income. Impairments and credit losses were at $161 million in the quarter, primarily related to subprime holdings. Our total subprime holdings at amortized cost were $3.4 billion as of year-end, down from $4.3 billion a year ago. Paydowns during the quarter were about $600 million.
The realized losses I just mentioned were partially offset by net gains from other general portfolio activities of about $40 million. Book value per share on a GAAP basis amounted to $63.11 at year-end. This compares to $51.52 a year earlier. Gross unrealized losses on the general account fixed maturities were $3.1 billion at year-end 2010, compared to $4.4 billion a year ago. We were in a net unrealized gain position of $5.7 billion at year-end 2010, compared to a net gain, unrealized gain position of $1 billion a year earlier. Excluding unrealized gains and losses and pension and post-retirement benefits, book value per share increased by $5.30 from a year ago to $59.48 at year-end 2010. I'll give you an update on where we stand on capital. First, I'm going to focus on the insurance companies.
We are continuing to manage these companies to capital levels consistent with we believe are AA standards. The Prudential Insurance Company of America began last year with an RBC ratio of 577. This included the benefit of about $2.7 billion of statutory capital that came from the sale of our increase in the Wachovia joint venture at the end of 2009. That was the sale, of course, of the Wachovia joint venture at the end of 2009. Given PICA's excess statutory capital position in relation to our target, PICA paid dividends to Prudential Financial of $3 billion in 2010. While these dividends had no impact on our overall capital position, they did enhance our financial flexibility in funding the Star Edison transaction. Favorable equity markets had a positive impact on PICA's statutory capital during the year, and credit migration and impairments were also modest.
Recent changes in guidance or the rules for capital charges on commercial mortgages and CMBS are not expected to have a material impact on our RBC ratio. We are still finalizing the RBC calculation. Considering everything I mentioned, we expect the 2010 RBC for PICA, that's of course, The Prudential Insurance Company of America, to be above 450. Prudential of Japan and Gibraltar recently reported solvency margins as of September 30th, 2010. Both companies were well above their benchmarks for a AA rating, and we are confident that at the end of this current fiscal year, which ends March 31st for them, their solvency margins will continue to be strong in relation to our targets. Star and Edison were adequately capitalized at the closing. Looking at the overall capital position for the financial services business, we measure, and you've heard this several times in the past, nothing's changed.
We measure our on-balance-sheet capital capacity by starting with the capital we need to run the company, which we call required equity, and compare that to the sum of our actual GAAP equity, hybrid securities on balance sheet, and long-term debt that we classify as capital debt also on the balance sheet. At our Investor Day presentation in early November, we estimated that net on-balance-sheet capital capacity after giving effect to the Star Edison acquisition, it would be in the range of $1.8 billion-$2.3 billion. When we closed the transaction last November, we funded the purchase price of $4.2 billion, with $2 billion of proceeds from our November 2010 financings, and the remainder with on-balance-sheet capital, including a combined $800 million from Gibraltar and POJ.
At year-end 2010, giving effect to the closing of Star Edison, we estimate that net on-balance-sheet capital has not substantially changed and is still at $1.8 billion-$2.3 billion. Turning to the cash position at the parent company, also giving effect to the Star Edison acquisition, cash and short-term investments at the parent, net of short-term borrowings and commercial paper, amounted to $3 billion at year-end. We would expect to use about $1 billion of this amount for tax payments and operating purposes during the year, leaving a remainder well in excess of our $1 billion liquidity target, which represents approximately 18 months of fixed charges. Now Mark is going to take you through the quarter's results for the business.
Good morning, good afternoon, or good evening. Thank you all for your interest in Prudential during what I know is a very busy time for insurance company earnings. Let me start with the U.S. businesses. Our annuity business reported adjusted operating income of $345 million for the fourth quarter, compared to $197 million a year ago. The reserve true-ups and DAC unlocking that Rich mentioned had a favorable net impact of $146 million on current quarter results. This includes a benefit of $100 million from the release of a portion of our reserves for guaranteed minimum death and income benefits, and a further benefit of $46 million from reduced amortization of deferred policy acquisition and other costs, in both cases, reflecting favorable market performance. Results for the year-ago quarter included a net benefit of $79 million from a favorable DAC unlocking and reserve true-ups.
Stripping out the unlockings and true-ups, annuity results were $199 million for the current quarter, compared to $118 million a year ago. The $81 million increase in what I would consider underlying results reflects higher fees due to an increase of more than $20 billion in average account values over the past year, driven by over $14 billion in net sales, coupled with about $10 billion of market appreciation over the past year, bringing total account values to $106 billion at year-end. The recovery of account values for our earlier vintages of business has also contributed to profitability by lowering the cost of guaranteed benefits. All of the variable annuity living benefit features we offer today come packaged with an auto-rebalancing feature, where customer funds are reallocated to fixed income investments to support our guarantees in the event of market declines.
Given the popularity of these features over the past several years, driven by our Highest Daily Income, more than three-quarters of our account values with living benefits at year-end are subject to auto-rebalancing, reducing our risk profile and limiting our exposure to potentially volatile costs of hedging equity risk. Our auto-rebalancing algorithm has functioned well, producing net transfers of about $7 billion from auto-rebalanced fixed income investments to funds that clients have selected since the market trough in early 2009. As of year-end, less than 12% of account values subject to auto-rebalancing remain in the designated fixed income accounts. Put another way, 88% of the account values for auto-rebalancing products are now in client-selected funds, providing participation in equity and fixed income markets. At the trough of the market, more than three-quarters of the account values were in auto-rebalanced fixed income accounts.
Our gross variable annuity sales for the quarter amounted to $6.1 billion, compared to $4.8 billion a year ago. Our Highest Daily Income products have fueled growth in each of our distribution channels and supported development of significant new relationships, especially in the bank channel, where quarterly sales passed the $1 billion mark for the first time and are up more than 70% over the year-ago quarter. In late January, we introduced the next generation of our living benefit product feature, called Highest Daily Income, or HDI. This feature continues the basic design of our HD6 product, including auto-rebalancing and other product-based risk management, such as minimum age at purchase and asset allocation requirements. This product offers a 5% annual roll-up for protected value rather than the 6% offered by our HD6 product and lower payouts at some age bands.
Fees for the rider were increased by 10 basis points for individuals to 95 basis points. We believe our updated product allows us to continue to offer a superior value proposition while enhancing our return prospects in the current interest rate environment. The retirement segment reported adjusted operating income of $147 million for the current quarter, an increase of $15 million from $132 million a year ago. The increase was driven mainly by higher fees reflecting growth in account values, both in full-service retirement and in the remainder of the business. With total account values reaching $205 billion at year-end. In full service retirement, we focus on the mid to large case market, where both sales and lapse activity are lumpy from one quarter to another. Gross sales and deposits were $4.4 billion in the current quarter, up from $4 billion a year ago.
A spike in lapses reflecting business combination activity and transfers of record keeping on several cases resulted in net withdrawals of about $1 billion for the quarter in full service. Strong sales in the investment only market, where we have grown sales of stable value products to plan sponsors on a standalone basis, brought net additions for the overall retirement business to $4.5 billion for the quarter, compared to $2.4 billion a year ago, an increase of more than $2 billion. The asset management segment reported adjusted operating income of $132 million for the current quarter, compared to a loss of $6 million a year ago. The improvement came mainly from more favorable results from commercial mortgage activity. Results for the year ago quarter were negatively affected by credit and valuation charges amounting to roughly $110 million on interim loans we hold in the asset management portfolio.
Over the past year, we have seen evidence of improving commercial real estate valuations. These charges have largely abated. Credit and valuation charges on this portfolio were about $10 million in the current quarter. The remainder of the improvement in results came mainly from higher asset management fees, driven by growth in assets under management. The segment's assets under management increased by roughly $80 billion, or 18% from a year ago, reaching $537 billion at year-end, reflecting positive net flows in each of the last four quarters, as well as cumulative market appreciation. Adjusted operating income for our individual life insurance business was $131 million for the current quarter, compared to $141 million a year ago. Mortality experience was favorable in relation to our average expectations, both in the current quarter and a year ago.
The benefit from favorable mortality was greater in the year-ago quarter, resulting in the decrease in results. A greater contribution from investment results, reflecting growth of invested assets, tracking an increase of $28 billion or 6% in term and universal life insurance in force over the past year, partly offset the lower benefit from mortality. The group insurance business reported adjusted operating income of $69 million in the current quarter, unchanged from a year ago. More favorable group life underwriting results were essentially offset by a negative swing in disability results for the quarter. Group insurance sales for the quarter were $109 million, including $82 million for group life. This compares to a total of $62 million a year ago. More than two-thirds of the current quarter group life sales were voluntary business, representing coverage purchased by employees or association members rather than employer-paid insurance.
Turning to our international businesses. The international insurance segment earned $584 million in the fourth quarter and $2.1 billion for the full year. Gibraltar, its bank channel business, and our LifePlanner business all continue to perform extremely well. Business drivers and financial results are very strong, and the closing of the Star and Edison acquisitions last week adds meaningful distribution capacity, a profitable in-force book, and more than 3 million customers to our already significant international insurance business. Within our international insurance segment, Gibraltar Life's adjusted operating income was $256 million in the current quarter, compared to $151 million a year ago. As Rich mentioned, Gibraltar's results for the current quarter include income of $66 million from the partial sale of our investment in China Pacific Group by The Carlyle consortium.
As of year-end, our remaining investment in China Pacific has a cost of about $60 million, with market appreciation of roughly $400 million included in the $5.7 billion of net unrealized gains reported for our balance sheet. Excluding the China Pacific gain, Gibraltar's adjusted operating income was up $39 million from a year ago. The increase came mainly from higher net investment spreads, reflecting growth of Gibraltar's fixed annuity business. In addition, a growing book of life insurance protection business distributed through the bank channel contributed to results. Sales from Gibraltar Life, based on annualized premiums in constant dollars, were $242 million in the current quarter, up $85 million from $157 million a year ago. Bank channel sales were $104 million in the current quarter, up from $48 million a year ago.
The increase was driven almost entirely by sales of life insurance protection products, which have grown sequentially in each of the last 4 quarters. Sales from the Life Advisor channel and other distribution amounted to $138 million, up $29 million or 27% from a year ago, driven entirely by the sales of life insurance protection products. Current quarter sales include about $20 million from recently commenced production through independent distributors. Life insurance protection sales benefited from a recently introduced cancer whole life product. The closing of the Star and Edison acquisitions last week adds over 7,000 new captive agents, about 60 new bank distribution relationships, and over 5,000 independent distributors. Our LifePlanner business reported adjusted operating income of $328 million for the current quarter, compared to $302 million a year ago. Current quarter results benefited from continued business growth, mainly in Japan, as well as more favorable mortality.
Sales from our LifePlanner operations, based on annualized premiums in constant dollars, were $259 million in the current quarter, up $37 million or 17% from a year ago. The increase was driven by strong sales in Japan, where we are benefiting from increased demand for retirement income and life insurance protection products, especially in the business and executive market. International insurance sales on an all-in basis, including LifePlanners, LifeAdvisors, and the bank channel, were $501 million for the fourth quarter, passing the $500 million milestone for the first time with a 32% increase from a year ago. The international investment segment reported adjusted operating income of $14 million for the current quarter, up from $2 million a year ago, with stronger results from our global commodities operations. Corporate and other operations reported a loss of $231 million for the current quarter, compared to a $220 million loss a year ago.
The loss we report for corporate and other operations is primarily driven by interest expense, net of investment income, which was largely unchanged from a year ago. The greater loss in the current quarter was mainly a result of higher expenses. The expenses within corporate and other include nonlinear items such as benefit plans. To wrap up, I'd like to sum up where we came out for the year. Earnings per share based on after-tax adjusted operating income of the financial services businesses, $6.27, up 14% from a year ago. Pre-tax adjusted operating income for our three divisions was $4.9 billion for the year, up 21% from 2009. Strong sales and net flows drove underlying business growth in our U.S. retirement and international insurance businesses.
In individual annuities, gross sales for the year were $21.8 billion, up 33% from a year earlier, and net sales were $14.6 billion, both record high levels. Account values passed the $100 billion milestone, ending the year at $106 billion. Prudential Retirement registered gross sales of $34.6 billion for the year, including $19.3 billion of full-service business and net flows of $10.8 billion, up 24% from a year ago. Account values surpassed the $200 billion milestone, reaching $205 billion at the end of the year. Our asset management business reported net institutional long-term inflows of $28.6 billion for the year, a record high and more than double the level of a year ago. These inflows, together with market appreciation, drove an 18% increase in assets under management for the year, with solid growth in each major asset class.
Our international insurance business registered $1.8 billion of annualized new business premiums for the year, also a record high and up 25% from a year earlier based on constant dollars. Double-digit sales increases in our LifePlanner and LifeAdvisor channels were complemented by our existing bank distribution, where our emphasis on protection products has proven a strong competitive advantage. About 85% of our sales for the year came from Japan, where we see continued growth opportunities in both life insurance protection and retirement. We look forward to expanding our success in those markets with the just completed Star and Edison acquisitions. Thank you for your interest in Prudential. Now we look forward to hearing your questions.
Thank you. Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touch tone phone. You will hear a tone indicating that you have been placed in queue. You may remove yourself from queue by pressing the pound key. If you are using a speakerphone, please pick up your handset before pressing the numbers. Once again, for questions or comments, press star and then one. Our first question will come from the line of Suneet Kamath from Sanford Bernstein. Your line is open.
Thanks. I have two questions. The first is on the variable annuity business. Just wondering if you can talk a little bit about how the changes that you made between HD6 and HDI have impacted the ROE of the new business that you're writing.
Hey, it's Bernard Winograd. Let me try to be clear about this. When we think about the pricing and given the pricing flexibility that our model gives us because of our relative lack of risk compared to the competitors, we are trying to balance our objectives for return on equity with the market environment. At each time that we restrike the mix here, we are aiming for a return that is in the high teens. We have, in this business, market cycles that are reasonably short, but nevertheless, typically six months between
Price adjustments. Sometimes the markets in the interim, in the initial period, move in ways that were not contemplated by our initial pricing. We're taking a long-term view of this while we're simultaneously trying not to ignore that. When we adjusted from HD6 to HDI, what we tried to do was to relook at what it would take at the environment as it had evolved over the following six months since our last price adjustment in order to get back to, in today's market, an expected return over a long time horizon that's in the high teens. That's what we did.
That's helpful. If we went back to the HD6 business that you added, I guess, in 2010, what would be the sort of the ROE differential if your new product is high teens, where did that HD6 end up shaking out?
Well, it's too early to tell is the answer to that question. Based upon the market environment it encountered, it obviously earned below that market return for the first 6 months of its existence, but it's well short of the period of time in which we can really know what the ultimate result will be.
Okay. I had a separate question, either for Mark or for John, on capital. At the end of last year, you increased your dividend pretty significantly. If I think about your capital redeployment pre-crisis, seemed like the mix between buybacks and dividends sort of skewed to buybacks with maybe 15%-20% of total capital return representing dividends. Should we think about maybe a different capital return philosophy going forward, where it's a little bit more of an even mix between share repurchases and dividends? Should we use that historical kind of relationship as a guide?
Suneet, it's Mark. Thanks for that question. That's a very good and interesting question in this environment. Our sense as we contemplated dividend actions last year was that there had been a shift in the market in favor of dividends, and I don't want to talk about what we may do going forward beyond telling you that we'll continue to evaluate what we believe is the market sentiment and the market view and the market sensitivity to the mix between dividends and share repurchases. In addition, obviously, in the context of our own capital position and capital redeployment thoughts. That's kind of a long way of saying it's an open issue about which we continue to be very thoughtful.
Okay, thanks.
Thank you. Our next question comes from the line of Mark Finkelstein with Macquarie. Your line is open.
Hi, good morning. I guess just on the capital outlook, $1.8 billion-$2.3 billion was the number back at the investor day. Equity markets are pretty strong. You've tended to be reasonably sensitive to rises in equity markets and freed-up capital. I guess, why wasn't the capital a little bit higher given the environment we're in?
That effect, Mark, this is Rich. That effect is going to be felt inside of PICA. As we look at the 2011 dividend from PICA, any benefiting from that will come in that dividend in 2011. It is also reflected in the number now as capital in PICA or the RBC ratio in PICA improved, but it won't get up to the holding company until 2011.
Okay. All right. I think I understand that. Just on asset management, I struggle a little bit to figure out kind of what the core earnings numbers in this area are. The earnings actually kind of went down sequentially despite relatively consistent IT PICUM earnings. AUM was up pretty strongly. The ROA were obviously down sequentially. Was the third quarter an anomaly? Were there other weaknesses in the fourth quarter? How should we think about asset management earnings adjusting for IT PICUM?
Well, it's Bernard. I would say that the right way to think about our asset management earnings is to focus on the breakdown that you have in mind, which is there's an IT PICUM component to the revenue, and then there is the asset management fee component to the revenue. I think if you focus on the asset management fees and apply reasonable industry standards to the margins that should be expected on that kind of revenue, then you can get to a pretty good understanding of what's going on. The noise in the fourth quarter, which is just basically the true-up of bonuses at the end of the year, is just that. It's noise.
I think that if you're trying to do annual analysis of what's going on in the business, I think what you've seen since 2007 is a dramatic shift in the mix, where the asset management fees are growing quite strongly, along with all the net inflows from clients compounding the effect of improving markets. That's the most reliable annuity-like part of the revenue stream, and it's reasonably easy to model what the earnings impact of that growth are. Then, as you now know, it becomes a much shrunken share of the business, and it therefore makes it, I think, much easier than it used to be when it was a larger share to estimate the earnings on an annual or even a quarterly basis.
Okay. Just to clarify, the fourth quarter had higher bonuses, which kind of distorted the ROA in how we look at them.
Yeah. Inevitably, if you get to the end of the year, you have a strong surge in the business as we did in the end of the year, particularly in the items that drive some of the bonus pools, they'll have some catch-up in the fourth quarter. It won't happen every year, but every year that ends strongly, that can happen in the fourth quarter.
Okay. All right. That's helpful. Thank you.
Thank you. Our next question comes from the line of Nigel Dally with Morgan Stanley. Please go ahead.
Great. Thanks, and morning. Market conditions today are a lot better than when you issued guidance. I know you're not going to update your guidance or views on Star Edison accretion, but is it possible to provide some updated EPS sensitivities to market conditions? For example, how does a 10% change in the EP market impact your core EPS? Second, with the retirement outflows, I understand that sales can be lumpy, but also just interested in your views as to how competition has changed in that business as well. Thanks.
Nigel, it's Mark. I appreciate your sensitivity early in the question to our reluctance to update guidance based on the policy that we've established. That applies to also talking about some of the very complex and non-linear kind of sensitivities that you asked about. We will not be addressing those kinds of line item sensitivities. I'll ask Bernard to comment on the retirement business. I think that the lumpiness in the fourth quarter is just that. I would also say that, in general, what's going on in that business that's relevant to the top line is we are seeing improvements in consumer or, if you will, beneficiary behavior. People saving more again. We are beginning to see a meaningful trend towards increased company matches, the end of the suspensions of company matches, and things of that kind. The pipeline is still quite thin.
I don't think that the competitive environment against others is really driving what's going on there.
Okay. Very good. Thank you.
Thank you. Our next question comes from the line of Andrew Kligerman with UBS. Your line is open.
Great. Morning. A few questions. First, with regard to the Star Edison transaction, I think the last time you did give any sort of guidance around the earnings impact was early November. Of course, interest rates have come up a fair amount since that time. I guess you don't want to give guidance. That's clear. What was the unrealized gain in Star Ed's investment portfolio at the time of the last time you gave guidance? Where is that unrealized gain now? I'll try to do the work myself in terms of figuring out what the improvement is since interest rates have risen quite a bit since then.
Andrew, I get to respond to your question, as I think was the case last quarter. You're on your own. We're not going to update the unrealized gain on the Star Edison portfolio for you.
Okay. The question then would be, we're probably looking at some meaningful improvement in what we were thinking back in November. Is that fair?
When we say we're not going to update guidance, that means we're not going to update guidance, Andrew. I'm sorry.
All right. That's brutal, I'll move on. Asset management area. Per the press release, it states that the net credit and valuation charges of roughly negative $10 million versus approximately $110 million in the prior quarter. You mentioned improvement in commercial real estate. Why not a net gain there? Maybe a little color around that area.
Andrew, it's Bernard Winograd. Let me try to shed some light on that. I think that we have, as I think you know, a portfolio, not in the general account, but on the balance sheet of the mortgage business. That was originally supposed to be in support of a now-discontinued conduit business. That portfolio has been one where we've added reserves throughout much of 2009. The overall trend is very much down there from $240 million in 2009 to $50 million in 2010. We do still have periodically, an individual loan, or in this case, it was a portfolio of loans, that get to the moment of realization, and you find that there's a discrepancy between what you expected and what you actually recover.
I think what you've got here. I should say we've had some discrepancies in the other way, too, where on final liquidation, we've had a little bit of gains in this line. I think what you've got here is just sort of the statistical noise of the individual loans working their way through. Overall, as I've said before, we feel like we've got this portfolio well reserved for at this point.
Got it. Thanks, Bernard. It's been great just getting your feedback over the years. Last question, around Gibraltar. Do you think this pickup in bank sales is sustainable? The momentum was phenomenal, and I'm wondering if you can kind of sustain that with the banks continuing to grow in Japan.
Yeah. Andrew, this is Ed Baird. The bottom line answer is yes. I think it's sustainable. Let me give you a few observations and facts to support that point of view. First, as you know, we're still relatively new to the bank channel business compared to a number of our competitors. At this stage, we're still only selling through about 30 banks. That number will increase substantially quite soon as a result of the Star and Edison acquisitions. Both of those companies have been in the business of bank distribution quite a bit longer, and they have more than twice as many, 70+ relationships with banks. I think from a point of distribution perspective, there's a lot more that we can gain. Secondly, even within the 30 or so that we currently have, we're not even actively selling in all of them yet.
There's still, I think, upside growth opportunity as a result of deeper penetration into those organizations. The additional factor that I think will feed into this is that the most productive relationship we have continues to be our original one with Bank of Tokyo-Mitsubishi. At one point, that constituted virtually all of the bank sales. It's now down into the low to mid 70%. The reason it's been so successful, because it's growing in absolute terms, it's just that the percentage is not as concentrated as with these other banks. The reason it's been so productive is because, as you know from earlier discussions, we're able to use a different business model than the typical insurance company. We send not just a product, but we send a product along with a Life Planner, which makes this model, I think, virtually unique.
The success of that particular approach with BTMU has been noticed by other banks. We're now starting to get inquiries as to whether we could expand that model with them as well. The reason I cite that is that particular model produces an unusually high average premium. For example, even our highest producing Life Planner model of POJ sells about $3,000 per policy. Through the BTMU, that average premium is $10,000. To the extent that we're able to get this compounding of growth through expanded points of distribution, deeper penetration, that can be further supplemented by the utilization of Life Planners in other bank relationships, which to date, again, is extremely limited. If you put that whole package of factoids together, I think it's fair to say that we think we can continue what is already eight consecutive quarters of steady growth.
Very helpful. Thanks, Ed.
Sure.
Thank you. Our next question comes from the line of Darin Arita with Deutsche Bank. Your line is open.
Thank you. Just wanted to focus on Star and Edison here, and Prudential's been very successful with Gibraltar, and was wondering if we could compare your various productivity and profitability metrics to Star and Edison versus where Gibraltar is today.
Sure. First, just a reminder, the valuation model that we used for the pricing did not focus or weight to any measurable degree, revenue growth. I just want to contextualize that issue. Nonetheless, it's based entirely off of the value of the in-force book and expense synergies that will come from the scale effect that's intrinsic to this life insurance business. Nonetheless, in support of the point that John made, which I think is the trigger of your question, we think there is indeed revenue expansion opportunity here. Let me give you a couple of examples. Unlike Kyoei, which was a bankrupt company, these two are not bankrupt. They don't suffer to a comparable degree. On the other hand, they have undergone severe market stress in the last two years as a result of the overhang of the AIG reputational issues.
That's especially true in the arena of third-party distribution, which in those companies, it's more significant than it has been inside of our Gibraltar organization. We believe and have some degree of confidence, that with the reputation enhancement that will come about through the restabilizing of these companies now that they're closed, that we can get considerable improvement. For example, whereas in our independent agency system, which was pointed out earlier, started at zero at the beginning of the quarter and produced a little over $20 million in the fourth quarter. We do that with just a couple of hundred independent agents. They have well over 4,000 independent agents. That channel, particularly in the last two years, had substantial drop-off in productivity.
There's an area where we think we can, even if we just get it back to the productivity levels they were at pre-crisis, offers considerable opportunities. The other is, as you know, when you're managing a proprietary distribution system, you always have this a balance between scale and productivity. That's why you see quarter to quarter, the size of our sales force will fluctuate. Now that we will be more than doubling the size of the distribution force in Gibraltar, which is a little over 6,000, we'll be adding over 7,000. It gives us a rich set of opportunities to decide how we want to calibrate between expanding the reach geographically around the country or tightening up through standards to a higher level of quality and productivity. That doesn't lend itself to a precise number.
It just shows it gives us an array of options that I think is quite promising.
Great. That gives us a lot to think about. Then just going back to the bank channel, can you give us the number of seconded Life Planners that have gone over to the banks, and where do you think that could go? I'm wondering if the limiting factor is the number of Life Planners that can go over, or it's the number of banks that are willing to take these Life Planners.
It's a little bit of both. It's more the number of banks at this point. We've sent over well over 300 in total. Currently, there are about 170 that are active inside the system now because they go for a period of time, one to two years, and then they rotate back and either become Life Advisors or serve somewhere else within the organization. They serve multiple roles, I should point out. Some of them act as trainers. Some of them act as active player coaches, whereby they not only train, but they actively sell. So we give a set of options to the bank as to what role they would like our redistributed Life Planners to play.
Again, at the moment, that's primarily within the BTMU relationship, but these other banks are now in active discussion with us as to how they can utilize them, either as wholesalers, trainers, or as active personal distributors. I think an opportunity there is, as you say, we have within the Life Planner model, a steady source from which we can pull to feed into the bank system.
Thank you.
Thank you. Our next question comes from the line of Jamminder Bhullar with JP Morgan. Your line is open.
Hi, thank you. I had a few questions. First, just a clarification on Andrew's point on Star Edison, fee gap adjustment. When we look at the change in fee gap adjustment versus your guidance, we should be comparing the end of January of this year to the end of June last year, right? Not September. Because your guidance was based on their rates as of the end of June, right?
You should be comparing it from the end of June last year to February 1st this year.
Yes. The corporate bond yields are actually lower in some cases, even though government bond yields are higher. That's the reason I was asking.
This is Mark. Let me just stick in one point, which is there are a lot of moving parts in this.
Yeah.
There's the portfolio, there's VOBA, there are reserves. Just be careful about oversimplifying based on what you see in specific asset markets.
No, that's true. The reason I was asking is because in Richard's comments, I think he mentioned a couple of positives, which is Japanese government bond yields rising and U.S. government bond yields rising, but he didn't mention any offsets. 35% of the portfolio is actually corporate or non-Japanese corporate, which some of them are U.S. corporate. U.S. corporate bond yields are actually lower now than they were lower at the beginning of February than they were at the end of June. That would actually be an offset. That's the reason I was asking.
If that is the case, Jimmy, you're correct.
Anyway, a couple of questions I had. The first one was on POJ LifePlanners growth. It's been slower recently than it's historically been, even adjusted for the transfers to Gibraltar. Just wondering what your long-term expectation or aspiration is for growth in the POJ LifePlanners. Obviously, the base is a lot larger than it used to be, but what's your growth and growth expectation is? I have another one.
It's an interesting issue you raise. As you know, that number has been slowing down steadily over the years, but I would observe the following to you. It's increasingly less relevant, and let me explain why. First of all, you'll notice that the year-over-year is a very small, it's essentially flat, and if you give credit for the transfers to the banks, it's about 3.5%. Yet you'll see that sales are up in POJ about 25%.
Yeah.
That reveals what I think is an important lesson for us to keep in mind rather than focus too singularly on headcount. That is that headcount is one of the drivers, but frankly, of equal, if not at some times greater significance is we want to also look at productivity measured both the number of policies sold per person, which has gone up. The retention, which is improving. The related persistency, which has been improving. Most importantly of all, relative to doing business is the average premium. Which in the case of POJ, has gone up about 10% quarter-over-quarter from a little over $2,700 to a little over $3,000. Frankly, those are the factors that we tend to look at more than just the headcount. Again, I think tracking headcount, that's fine, but I don't weight too much on it.
As long as we can see sales going up 25%, even though headcount's flat, from my perspective, that's a positive result. Having said that, we always will push to steadily grow
Life Planner, as long as we don't have to sacrifice the quality.
Lastly, just on your annuity sales in the U.S., I'm assuming there was a little bit of a fire sale element in your production since the new feature was a little less generous than the old one was. I think the new one was rolled out in January or at the end of January. Should we expect the same phenomena? Because for part of the quarter same phenomena in the first quarter this year, since part of the quarter you were selling the previous HD products.
Jimmy, it's Bernard Winograd. I think you know that applications for the old product have to be in our hands by the end of January to be honored. We will have some of this, but not a lot of it. We don't really know with precision what percentage of our fourth quarter sales were driven by this. We did make efforts to make the filing with the specifics of the changes in the product as late as possible in the quarter. Didn't actually happen till December 6th. We estimate, best guess, it's probably no more than $200 million or $300 million of the sales experience in the fourth quarter.
Okay. Thank you.
Thank you. We have time for one final question, and that will come from the line of John Nadel with Sterne Agee. Your line is open.
Hey, right under the wire. Thanks, everybody. John, I guess I was hoping you could give us an update on the overall M&A environment and your appetite for additional deals, especially just in light of the fact that obviously your international team is busy and you've got some transition going on in the leadership of the U.S. businesses. I was wondering if you could give us an update.
Sure, John. Well, a couple thoughts on this. First, as you correctly identify, in our eyes, success isn't in announcing a deal. Success isn't in closing a deal. Success is in making it work. We have a lot of people and a lot of resources focused on ensuring that the Star Edison experience is reflective of our own expectations and of the potential that we see. We're feeling very confident about that. We don't underestimate the importance and the resource commitment necessary to make that happen. Now, having said that, as we referenced before, let's also recognize that Star Edison is entirely a one-country situation in a market environment that we've been in for 30 years and with a management team that's done this in the past.
Our feeling is that we're not taking anything for granted, but we're feeling very good about our capacity to execute. That also makes us feel that we do have the management capacity as well as the financial resources to consider other alternatives. When we think about other alternatives, it's a nice to do, not have to do.
Yeah.
Because you look at the success we're having in our organic lines of business and the opportunity cost and the intrusion and the like. We believe we have the capacity, but we don't feel like it's something we have to do. It has to be darn compelling to be prepared to do it. We recognize, to kind of lead that question a little bit, that our ability to achieve our aspirations in our ROE have to do with how we deploy the capital, either in the business or giving it back. We keep that in our mind as well. We also recognize we're still in an environment where the quality of the counterparty in terms of the financial capacity, breadth of business, and so forth, is still very relevant as it relates to some potential franchises in flux.
It's a situation where it hasn't fully played out yet. We're keeping our options open. At the end of the day, we'll either deploy the capital in the business or we'll give it back, and we'll just have to stay in the course.
Okay. Just finally, if I could just go back to Nigel's question around EPS sensitivity. Eric, please don't cut me off immediately. I guess I'm wondering what makes your businesses so difficult to quantify that sensitivity to macro factors when so many of your peers are able, or at least willing to try to do so for us. During the crisis, you guys were able to give us sensitivities despite the nonlinear issues on your risk-based capital ratios at lower S&P levels. I guess I'm not sure how this would be so different from that exercise.
Well, John, this is Mark, and thanks for that question. One thing that we've emphasized in the past is the nonlinear nature of the impact of markets on us. That continues to be true for a variety of reasons related to the nature of the calculation of DAC, for example, and unlockings and some of the other aspects, particularly of the insurance products. The other thing is that we're focused on the holistic outcome and don't want to get particularly tangled up in a line item influence when there are many other things going on to produce the financial results that we report and talk about.
Yeah. If I can interject, I'm thinking about it holistically, too. I'm thinking about it from the perspective of not necessarily can I get my first quarter 2011 earnings estimate right on target. I'm trying to figure out your company is worth more when market conditions are better, and I'm trying to figure out how much more your company is worth.
Yeah. Again, I appreciate that view. Our sensitivity to this relates to both the narrower issue around nonlinear moves and getting it right.
Yeah.
Secondly, the broader context.
Yeah. Okay. All right. Thank you.
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