May 7, 2009
Executives
Eric Durant - Senior Vice President of Investor Relations John R. Strangfeld - Chairman, Chief Executive Officer and President Richard J.
Carbone - Executive Vice President and Chief Financial Officer Mark B. Grier - Vice Chairman Bernard B.
Winograd - Executive Vice President, U.S. Businesses
Analysts
Suneet Kamath - Sanford Bernstein John Nadel - Sterne, Agee & Leach Nigel Dally - Morgan Stanley Thomas Gallagher - Credit Suisse Jeffrey Schuman - Keefe, Bruyette & Woods Edward Spehar - BAS-ML Eric Berg - Barclays Capital
Operator
Ladies and gentlemen, thank you standing by, and welcome to the Prudential First Quarter 2009 Earnings call. At this time, all participant lines are in a listen-only mode.
Later, there will an opportunity for your questions. Instructions will be given at that time.
(Operator Instructions). As a reminder, today's conference call is being recorded.
And for opening remarks, I'd now like to turn the conference over to Head of Investor Relations, Eric Durant. Please go ahead.
Eric Durant
Thank you, Liam. Good morning, everyone.
Thank you for joining us. In a few minutes, we'll begin with John Strangfeld's comments on the quarter.
And then, Rich Carbone and Mark Grier will weigh in. After that, we'll have answered your questions.
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 could cause such a difference, appears in the section titled Forward-Looking Statements and Non-GAAP Measures of our Earnings Press Release for the first quarter of 2009, 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 assets values that will ultimately accrue to contract holders and recorded changes in contract holder liabilities, resulting from changes and related asset values.
The comparable GAAP presentation, and the reconciliation between the two for the first quarter, 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.
With that, here is John Strangfeld.
John R. Strangfeld
Thank you, Eric, and good morning, everyone. Thank you for joining us.
We appreciate your interest in Prudential. I'd like to begin with some macro comments on business mix, performance and momentum.
First quarter results were decent, all things considered, and our business fundamentals were strong, which bodes well for our future. Our results reflect our diverse portfolio of businesses and their varying sensitivity to equity market conditions.
Retirement, Group Life and International Insurance, each reported record first quarter earnings. Asset Management and Annuities were heavily affected by unfavorable market conditions.
Yet, both of these business rebounded from significant losses in the fourth quarter. So, while far less dramatic than in the fourth quarter, unfavorable market effects on our equity-sensitive businesses has somewhat overshadowed the fact that most of our non equity-sensitive business, have produced pretty darn good results.
In fact, businesses representing nearly half of our normalized earnings, actually produced record results. Its not just the arithmetic mix of businesses that important.
It's also the quality of the businesses that make up the mix, that give us confidence. Our businesses are good businesses.
They help people manage risks and uncertainty. And that's more relevant today than ever.
They serve attractive markets, and we are highly competitive in each of those markets. A reflection of that is the fact that our business fundamentals, meaning underlying drivers, remain strong despite the environment.
We achieved record sales results in Retirement, strong sales in Group, Individual Life and Annuities, and continued strong results in International Insurance. We are by no means immune to the challenges of the markets, and of the economy.
But we are holding up well, and we believe, as evidenced by our drivers, gaining ground. Considering first quarter results as well as financial market conditions, we are reducing our guidance for the year.
We now believe that Prudential Financial will achieve common stock earnings per share for '09 in the range of 480 to 520, based on after-tax adjusted operating income of the Financial Services Businesses. This expectation assumes average appreciation of 2% per quarter in the S&P Index, commencing with its close as of December 31, 2008.
This is the same assumption for market appreciation as the one we made in February, when we last updated our guidance. On a bigger picture basis, our response to this challenging environment remains as we have previously described, not to simply honker down and raise us out, but to actively manage through it, and use a lot of judgment.
We do not foresee that everything is going on as a trend that will go on for ever. And as such, we want to manage the short-term in a manner that does not undermine the long-term.
And on the other hand, where we have thought appropriate, we have reduced the risk profile of certain products and activities, in what we believe are very material ways that will reduce volatility in the future. The most notable example of this is our Annuities product redesign, which we had discussed previously.
In these times, we recognize investors' interest and concerns with asset quality, capital and liquidity. As for asset quality, credit losses are significant, but within expectations.
And unrealized losses are essentially unchanged from year-end. We have positioned our portfolio defensively, with risk limits in place to avoid undue concentrations, and we remain comfortable with the overall risk profile.
Rich will walk you through the details in capital and liquidity in a few minutes. But headline is that we believe we have resources to maintain solid RBC and solvency margins for our insurance companies, even under stressed equity market and credit scenarios.
We also believe we have ample liquidity to meet our commitments. While I am discussing capital, I should acknowledge that there has been speculation once again about the possible availability of capital for insurance companies, and market conditions in general have been improving.
In this environment, we continually evaluate capital market and other financing alternatives. And just as we have taken an opportunistic approach to acquisitions, we will opportunistically consider our access to capital as well.
And that's really all we have to say on this subject. Bottom-line, we're weathering the storm, and we're doing it by attacking our way through it, not simply battling down the hatches.
And behind the fog of market gyrations, we have strong businesses that are producing strong results. This bodes well for the inevitable time when that fog lifts and the environment improves.
So with that, I'd like now to turn it to Rich and Mark, who'll walk you through the details and then we welcome your questions. So, Rich?
Richard J. Carbone
Thank you, John. As usual, I'll begin with an overview of our first quarter adjusted operating and net income.
And then, I'll discuss our capital and liquidity picture. And Mark will deal with the investment portfolio.
The references and descriptions I'm about to make are for the Financial Services Business or the FSB. As you've seen from yesterday's release, we reported common stock earnings per share of a $1.5 for the first quarter, compared to a $1.57 for the year-ago quarter, based on adjusted operating income.
The operating results of our business once again, are affected by discrete items, closely tied to the unfavorable financial market conditions, which I'll go through now. In our Annuity business, we increased our reserves to guaranteed minimum debt and income benefits, resulting in a charge of about $0.39 per share.
And we increased the amortization of deferred policy acquisitions and other costs, producing a charge of about $0.20 per share. The market decline and account values for the quarter, lower expected fees, higher expected benefit costs, and unfavorable experience in the quarter, were all responsible for these charges.
As you know, we no longer apply carter (ph) for market performance in the Annuity business. So, update of reserves and amortization take into account the entire market decline and account values for the quarter, as we project future fees and benefit costs.
In addition, while we use a reversion to the new approach in this projection that assumes some recovery in account values over a four year look-back... look-forward period.
The benefit to our calculations is limited, because we apply a cap to the overall gross returns on our account values. Our Individual Life insurance business also recorded increased net amortization of debt, and related costs of $0.06 per share as a result of market declines.
The mechanics are similar to the Annuity business. Going back to Annuities, the valuation under GAAP of our embedded derivative liability, mainly for living benefits, requires us to recognize our own market-based non-performance risk.
This resulted in a partial offset to these charges. This benefit is reflected in the net hedge results.
And this gets complicated, so let me explain this further. In the Annuity business, we've we have consistently reflected the impact of hedging breakage within adjusted operating income.
The hedging breakage represents the difference between changes in fair value of the embedded derivative liabilities to our living benefits, and changes in value of the derivatives we use to hedge these liabilities or guarantees. And saving the fair value for our embedded derivatives, we are required to consider our own non-performance risk, based on our current market measure and determining the interest rates to be used in discounting the projected cash flows associated with the estimates claims under the guarantee.
Prior to the first quarter of this year, we discounted these liabilities, using forward LIBOR interest rates, with a view that these rates captured market-based non-performance risk, consistent with our AA claim split paying rating at the time. During the quarter, we increased our discount rates by about 300 basis points, across the various durations reducing current discount rates generally in the range of 5.5% to 6%.
The impact of the higher discounts rates on expected claims was the main driver of the benefit from hedging breakage in our quarter's results. This amounted to about $0.47 per share in total.
Our Retirement business had similar benefits from using our current measure of non-performance risk, which amounted to about $0.02 per share. In total, all the items I just mentioned had a net unfavorable impact of about $0.16 on our earnings for first quarter.
In addition to the discrete items, the unfavorable market conditions also have had an impact on corporate and other results, where we are maintaining a negative spread to support strong liquidity position, and bolstering the capital of some of our regulated businesses, by converting intercompany debt to equity in those subsidiaries. Now, moving to our GAAP results.
We reported a net loss attributable to Prudential Financial of 5 million for the first quarter, compared to net income attributable to Prudential Financial of 68 million a quarter ago. Net income per common share was $0.01 for the current quarter, versus $0.18 last year.
Our current quarter GAAP pretax results include net realized investment losses of $666 million. The net realized loss of 666 million for the quarter, include credit losses of 465 on fixed maturities, and impairments of 253 for equities.
We adopted FAS, the new FASB accounting for impairment... for other than temporary impairments as of January 1, 2009.
Under this guidance, when there is other than temporary decline in value, for our fixed income security that we don't intend to sell, and believe that we don't have to sell before recovery of book value, we separate the decline in value into two parts, the credit loss and the remainder of the market decline. Only the credit loss remains in net income.
The remaining decline in market in value winds up as an unrealized loss and accumulated other comprehensive income. The new guidance also requires us to restore our retained earnings for previously recognized after-tax losses that don't represent expected credit losses.
This has the effect of adding 1.1 billion to our pretax gross unrealized losses at January 1, 2009, and about 700 million to retained earnings. The difference being the tax effect.
Now, this is important. Had we applied the accounting rules, the old accounting rules that is no change to our opening retained earnings.
We estimate that we would have had additional pretax investment losses for fixed income impairments of approximately $500 million. The 465 million of credit losses for fixed maturities, include about 40 million for sales of credit impaired securities, 240 million of those fixed income credit losses were on sub-prime paper, with the remainder primarily on corporate holdings and in manufacturing, and in the services sectors.
The 253 million of equity impairments came mainly from declines in value reaching 12 months in duration. And relate primarily to Japanese equities and domestic mutual fund holdings invested in high-yield bonds, where we apply our equity rules.
For equities, we record other than temporary impairments when there is a decline in value of 50% or more. Or for any decline in value, it persists for 12 months.
We also impair equities for declines in value, but we don't expect to hold them to maturity. Now, on to the capital and liquidity section.
First, risk-based capital for Prudential Insurance. We began the year with a solid 452 at Prudential Insurance.
So, where do we stand now, that is at the end of the first quarter. If we were reporting RBC for Prudential Insurance, at March 31, we believe it will be above 400.
Keep in mind that this is hypothetical. We really don't do a bottom's up calculation during the year.
So, since RBC is actually an annual calculation, one way to think about this is just where will it stand at year-end 2009, given no change to the S&P 500, from its March 31 close of 798. And assuming our base case for credit losses and impairments, which amounts to 1.4 % of the fixed income portfolio of Prudential Insurance and it's insurance subsidiaries, or about $2 billion of credit losses for the full year, plus anticipated credit migration for the remainder of the year.
Though in the other way, or adding to surplus, we settled loans to domestic insurance companies during the first quarter, bolstering their capital position by about $300 million. I'll assume and projecting forward, under this scenario, we will continue to make use of available actions to maintain adequate capital in Prudential Insurance throughout the year.
Under this base scenario, that is a flat 800 S&P more or less, and $2 billion of credit losses in total, we believe that we would enter... end year with RVC of Prudential Insurance above 350.
This includes no benefit. We expect to realize in our investment in the Wachovia joint venture, which we believe would add over a 100 points, including tax benefits to RVC when it is realized.
Our International Insurance companies are also expected to report solvency margins above AA standards as of their fiscal year-end, which is March 31, 2009. As expected, we bolstered the capital of these companies, with a current capital contribution of roughly $400 million during the first quarter.
And that was split roughly 200 million each, POJ and Gibraltar. In evaluating our capital position, we've also taken a look at stressed scenarios...
several stress scenarios, with the close of the S&P 500 at 700 and 600 at the end of the year. Under a scenario where the S&P 500 closes at 700, and where investment portfolio or credit losses add impairments, increased from 1.4% in the base case to 2% of the fixed income bonds and mortgages of Prudential Insurance and subsidiaries over the full year or $2.8 billion.
We believe that we would end the year with an RVC ratio at Prudential Insurance in excess of 350 points. After the use of actions that we believe would be available to us other than again, other than the expected to gains on the Wachovia put.
So, under a scenario where the S&P closes at 600 using same assumptions regarding investment portfolio losses that was at $2.8 billion, plus the additional impairments. We believe that we would end 2009 with RVC ratio at Prudential Insurance above 300.
Again, after the use of additional actions other than the expected gains on the Wachovia put. In both stressed scenarios, some of the potential actions have execution risks or have economic costs associated with them.
And it is possible that we would choose not to pursue, in light of the expected gain on Wachovia. To sum up, under these adverse scenarios for equity market levels and credit losses, we believe we can manage the capital position of our insurance companies to a high standard, without giving effect to our expected gain on the Wachovia put.
I have one more stressed case to talk about. In a more extreme environment, in which the S&P goes to 600 at the end of 2009, and stays there through the end of 2010, credit losses are even higher, and we have realized a gain on the Wachovia put.
Remember now, this is 12/31/2010. We expect to be able to manage an RVC level that is at or above 300, which we consider to be acceptable in this somewhat extreme stress outcome.
Of course, there is more uncertainty as we look further out. Now despite recent actions of the rating agencies, we are currently continuing to manage our insurance companies to a capital level that we believe is consistent with the AA balance sheet strength.
We continue to believe that it is ill advised to qualify, and enterprise measure of excess available capital. With the financial market conditions still not stabilized, credit markets still not functional, and impairments in credit migration going forward somewhat of a wildcard, it would take a prophet that is p-r-o-p-h-e-t, to tell us how much excess capital a company has...
would need in these times or has in these times. Our liquidity position remains ample.
I would say, sound. At the end of the first quarter, we have 4.7 billion of cash and short-term investments at the parent company balance sheet.
When we look at the parent company cash position however, we net out any outstanding commercial paper, and also take another very conservative measure, and net out short-term into company borrowings. On that basis, we essentially have net cash on hand of $2.8 billion.
Of the 3 billion convertible issued in 2007, 1.9 billion remains outstanding at the end of the first quarter. After repaying this in June, we'll have 900 million in cash at the parent company.
Again, excluding commercial paper and into company borrowings. As of June of this year, we have no significant debt maturities, or I should say pardon me, after June of this year, we have no significant debt maturities at the parent company until 2011.
Given the continued market instability, we've taken steps to reduce our exposure to short-term financial markets, including the planned run-off of commercial paper, and a reduction in our securities lending program. And I'll talk about those later on right now.
At the end of the first quarter, parent company commercial paper was about 700 million, down from 1.2 billion at year-end. Based on current short-term debt ratings, the parent company no longer qualifies the new borrowings under the Federal Government's Commercial Paper Funding Facility or CPFF.
About half of the borrowings outstanding at year-end, were under CPFF, and were repaid in April. Prudential Funding, the financial arm of Prudential Insurance, continues to qualify for new borrowings under CPFF, of up to 9.8 billion, based on current ratings.
At the end of the first quarter, Prudential Funding commercial paper borrowings were reduced 1.8 billion from year-end to 2.6 billion. This includes 750 million under CPFF, which roughly corresponds the amount of proceeds invested in cash equivalents as of year-end, which if you think about it, means we could wipe out the 750 within a week, or a day.
At March 31, the Financial Services Business had 6 billion of outstandings under securities lending programs, down from 7.5 billion at year end. We have generally limited the program to liquid securities that are requested by counter parties rather than pushing out securities to the market.
We estimate that at the end of the first quarter, our domestic insurance companies an addition of 57 billion of assets eligible to securities lending program, was about 19 billion considered readily lendable, including 14 billion within the FSB. Now, we have planned our cash flow for 2009 on the assumption that the dividend capacity from Prudential Insurance to the parent company would be constrained.
That would be better said as, no. Excluding capital markets availability, the parent company had sources of cash from continued repayment of intercompany borrowings, supporting subsidiary activities, so we can wind down as well as returns of capital associated with theses activities.
Now, let me turn to the Federal Home Loan Bank. The membership of Prudential Insurance in the Federal Home Loan Bank of New York, which commenced in June of last year, provides additional liquidity.
Under this program, Financial Insurance can hedge up to 5% of its admitted assets, excluding separate accounts to collateralize borrowings. As of March 31, our estimated borrowing capacity under this program, considering statutory limits and holding to qualified securities of Prudential Insurance, was 6.5 billion, an outstanding borrowings of 4.5, including 1.5 billion of short-term advances that we repaid in April.
So, our current balance is 3.5 billion with the FHLB. As a result of our ratings actions during the quarter, new borrowings under facility would be for initial term of 90 days or less, but are subject to low over at maturity.
However, we believe that long-term borrowings may again be available to us in the very near future. Lastly, before Mark we have...
comes on, we have about 4.3 billion of committed credit lines that maybe accessed by the parent company, Prudential Insurance or Prudential Funding, subject to satisfaction of customary terms. These agreements expire in 2011 through 2012.
And then, Mark will comment, not Mac, Mark, on the investment portfolio and review our business results for the quarter.
Mark B. Grier
Thank you, Rich. Good morning, good afternoon or good evening.
I'm going to start with some comments on the investment portfolio and then I'll talk about the businesses. As we've stated in the past, we manage our investment portfolio primarily with a focus on its cash flow prospects.
Since our general account investments are mainly supporting long-term insurance liabilities. We continue to live with the substantial disconnect between the market values for many classes of investments, and their underlying cash flow prospects.
This has produced gross unrealized losses that we believe have little relevance to the ultimate economics we will realize as the long-term investor. I would now hear that our early adoption of new accounting guidance on mark-to-market, of fixed income securities that we expect all to recovery, did not have a significant impact on the values we are using.
And there has been no significant change in the portion of our holdings that we price based on models rather than market inputs, as a result of this guidance. With that said, let me start with the fixed maturity portfolio.
Gross unrealized losses on fixed maturities in our general account stood about $11.2 billion at the end of the first quarter. We expect the holding securities to recovery, and the market driven declines in value do not have a negative impact on our statutory capital position.
Gross unrealized losses are essentially unchanged from year end. As Rich mentioned, our early adoption of new accounting guidance for impairments, required us to restore previously taken impairments that don't represent credit losses back to book value.
And this had the effective increasing our gross unrealized losses by about $1 billion. This accounting change, essentially offset credit spread tightening during the quarter.
Said another way, our gross unrealized losses would have come down by about $1 billion in the first quarter had we not implemented the new accounting guidance. Roughly $2.6 billion of total gross unrealized losses at the end of the first quarter, relate to sub-prime holdings, an increase of $850 million from year end.
The vast majority of this increase, roughly $670 million, comes from the restoration of previous non-credit impairments to book value. This restoration of book value more than offset roughly $300 million of pay downs during the quarter, and the $240 million of impairments in credit related losses on sales that Rich mentioned, leaving us with $5.5 billion of sub-prime holdings at the end of the first quarter, based on amortized costs, compared to $5.4 billion at year end.
Substantially, all of our sub-prime holdings were priced as of the end of the quarter using third-party pricing services. At March 31, the general account fixed maturity portfolio included $8.1 billion of commercial mortgage-backed securities at amortized cost.
Over 94% of these holdings have AAA ratings. For commercial mortgage-backed securities, there are three distinct classes within the AAA category.
And Super Senior AAA securities with 30% subordination, representing over 80% of our holdings, stand at the top of the capital structure. Our exposure to CDOs is limited.
General account holdings at March 31 are about 500 million, the largest of which is our own CDO, with virtually no underlying sub-prime exposure in the CDO mix. We also have very limited exposure to hybrid securities, which amount to less than one-half of 1% of the general account portfolio.
Based on amortized costs, non-investment grade securities comprised about 8% of the $126 billion fixed maturity portfolio at the end of the quarter. This percentage is up slightly from year end, mainly as a result of rating agency downgrades on a portion of our sub-prime holdings.
One last comment on the investment portfolio. We had $22 billion to general account commercial mortgage and other loan holding as of the end of the quarter.
We continue to feel that we are defensively positioned for the down cycle in commercial real estate, with a seasoned and diversified portfolio of commercial mortgages that we originated with an emphasis on high underwriting standards. At March 31, the average loan-to-value ratio for our commercial mortgage holdings is 60%, and the average debt service coverage ratio is 1.9.
Delinquencies continue to be insignificant, at less than half a percent of the holdings. Now, I'll cover our business results for the quarter.
Starting with the United States businesses and beginning with Annuity. Our Annuity business reported adjusted operating income of $17 million for the first quarter, compared to $115 million a year ago.
Results for the current quarter, includes several discrete, largely market-driven items that Rich mentioned, with a net negative impact of $66 million. Current quarter results include charges of $215 million to strengthen our reserves for guaranteed minimum debt and income benefits, reflecting the equity market decline in the quarter.
Largely for our older products that don't contain the auto-rebalancing feature, we package with our current living benefits. This increase in reserves is based on our projection of where account values will be over time, starting with balances at the end of the quarter, and limiting the assumed growth under reversion to mean, to a 10.5% overall annual return.
In setting these reserves, we estimate the extent to which our guarantees will be in the money over time, and apply a dynamic lapse assumption that considers the tendency of contract holders to keep their annuities in force, when the guarantees are in the money. Since we expect more of the guarantees to turn into claims, than if these customers lapse at our average rates.
Current quarter results also include accelerated amortization of deferred policy acquisition and other costs amounting to $112 million, reflecting market performance. This charge is based on the same projection of where account values will be over time that drove our reserve strengthening.
Going the other way, the breakage between changes in the values of our living benefit guarantees and our hedging instruments, resulted a positive contribution of $261 million to current quarter results, after related amortization effect. As Rich mentioned, this was mainly driven by our update of the market-based measure of our non-performance risk.
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 benefits; nearly 60% of our account values with living benefits at March 31, are subject to auto-rebalancing, limiting our exposure to escalating cost of hedging in the current market.
Charges in the year-ago quarter for accelerated amortization and reserve strengthening to reflect actual experience, together with hedge breakage, amounted to $32 million. Stripping all of these items out of the comparison, Annuity results were down $64 million from a year ago, reflecting lower fees in the current quarter, due to the market driven declines in account values, with spread income from funds rebalanced to the general account are partial offset.
Our gross variable annuity sales for the quarter were $2.1 billion, compared to $2.8 billion a year ago. We feel that our gross sales have held up quite well in relation to the overall market, and net sales for the quarter were $665 million.
The Retirement segment reported adjusted operating income of $159 million for the current quarter, compared to $124 million a year ago. As Rich mentioned, current quarter results benefited by $13 million from updating our market-based measure of non-performance risks for retirement product guarantees that we account for as embedded derivatives.
Stripping that benefit out of the comparison, results for the Retirement business were up $22 million from a year ago. Primarily as a result of higher net investment spreads.
These higher spreads reflected growth of our Full Service paper value balances, crediting rate reductions, and the maturity of a guaranteed investment contract dating back to before our demutualization that was generating a negative spread. Current quarter Full Service gross sales and deposits were $10.5 billion, bolstered by a $4.2 billion major case win.
Our Full Service persistency was over 95%, and net flows were $6.3 billion for the quarter. Our stable value funds are especially attractive to plan participants in the recent market environment, growing more than $3 billion over the past year, and reaching $36.6 billion at the end of the first quarter.
The Asset Management segment reported a loss of $1 million for the current quarter, compared to adjusted operating income of $119 million a year ago. The contribution to results from performance-based fees was down roughly $70 million from a year ago, when we benefited from a stronger commercial real estate market.
Results from proprietary investing activities were also less favorable than a year ago, mainly related to commercial real estate as well. In addition, asset management fees were below the year-ago level, as market value declines more than offset the benefit of net inflows, third party institutional funds of more than $8 billion over the past year.
Adjusted operating income from our Individual Life Insurance business was $40 million for the current quarter, compared to $96 million a year ago. Most of the negative swing in results came from the higher net amortization of deferred policy acquisition costs, and other items together with related costs driven by unfavorable separate account performance, as Rich mentioned.
We estimate that these market driven costs had a negative impact of about $32 million in comparison to the year-ago quarter. The remainder of the decrease came from less favorable mortality experience, and from a lower level of fees driven by the market driven decline in average separate account balances for our variable life business.
Group Insurance business reported adjusted operating income of $93 million in the current quarter, compared to $90 million a year ago. Results for the year-ago quarter benefited by $20 million from a cumulative adjustment of premiums on a large case.
Stripping that out of the comparison, results are up by $23 million from a year-ago, driven by more favorable claims experienced on both Group Life and Group visibility. Turning to our international businesses, within our International Insurance segment, to Gibraltar Life's adjusted operating income was $131 million in the current quarter, compared to $128 million a year ago.
Current quarter results benefited from improved investment margins, reflecting strategies we implemented, including increased U.S. dollar investing, as well as continued growth of our book of U.S.
dollar fixed annuity business. On the other hand, Gibraltar observed higher expenses than a year ago, including costs associated with the Japanese guarantee funds.
Sales from Gibraltar Life, based on annualize premiums and constant dollars, were $105 million in the current quarter, up 9% from a year ago. The increase was driven by sales of our life insurance protection products in the bank channel, which we were launched in that channel about a year ago, and contributed $13 million to current quarter sales.
Our Life Planner business, the international insurance operations other than Gibraltar Life, reported adjusted operating income of $294 million for the current quarter, up $9 million from a year-ago. The increase tracked continued business growth in Japan.
However, during the quarter, we incurred costs related to consolidating and enhancing back offices, which will have a substantial and rapid pay back. In addition, Japanese guarantee fund costs also partially offset the benefits of business growth.
Sales from our Life Planner operations, based on annualized premiums in constant dollars were $224 million in the current quarter, compared to $233 million a year ago. Sales in both Japan and Korea were negatively affected by market conditions and particularly during the early part of the quarter from continued concerns about American companies tracing back to well-publicized financial difficulties of one company late last year.
Foreign currency translation was not a major factor in the comparison of our International Insurance results, due to our currency hedging programs. The International Investments segment reported adjusted operating income of $10 million for the current quarter, compared to $26 million year ago, reflecting a lower contribution from our asset management operations in Korea.
Corporate and other operations reported a loss of 166 million for the currant quarter, compared to a $51 million loss a year ago. As Rich mentioned, corporate and other results are bearing the costs of our conservative management of liquidity in the current environment, as well as are bolstering of capital of some of our regulated entities, as required.
Mainly as a result of our management of liquidity and capital, interest expense, net of investment income, had a negative impact of roughly $100 million in the comparison of corporate and other results to a year ago. A $7 million gain in the current quarter on the early redemption of about $245 million of our 2007 convertible debt issue was a partial offset to our net financing costs.
In addition, our real estate and relocation business reported a $63 million loss in the current quarter, compared to a $23 million loss a year ago, reflecting continued unfavorable residential real estate market condition. Briefly, on the Closed Block Business.
The results of the Closed Block Business are associated with our Class B stock. The Closed Block Business reported net income of $19 million for the current quarter, compared to a net loss of $8 million a year ago.
Current quarter results reflect a decrease to the policy holder dividend scale for 2009. We measure results for Closed Block Business only based on GAAP.
To sum up, reported results for our U.S. businesses and market values and our investment portfolio, continue to be negatively affected by the difficult financial markets.
Our reported results are also bearing the cost of conservative liquidity management, and actions we've taken to bolster capital of our insurance companies as needed. Our business models are sound.
And we reported solid sales and net flows, both domestically and internationally. With value propositions that are highly attractive to clients who are focused more than ever on financial security and peace of mind.
We have positioned our investment portfolio defensively, and we remain comfortable with its risk profile. Finally, we have ample liquidity to fulfill our commitments.
And we continue to feel confident that we have the financial flexibility and capital resources to successfully manage through the current environment, while enhancing our competitive position. Thank you for your interest in Prudential.
And now we look forward to hearing your questions.
Operator
Thank you. (Operator Instructions) Our first question is from line of Suneet Kamath with Sanford Bernstein.
Please go ahead.
Suneet Kamath - Sanford Bernstein
Good morning, and thanks. Just two questions related to unusual items in the quarter.
On the discount rate related to the market-based non-performance risk, question is why did you make that change now? Is that something that the auditors required you to do?
Or was that your call? And are we going to be chewing this up now every quarter through the operating earnings line?
And then, the second question is related to the variable annuity reserve strengthening. Did I hear you right saying that what the reserve now contemplates is 10.5% market appreciation per year going forward?
So, if we missed that bogie, we may need to build more reserves ahead? Thanks.
Richard Carbone
Suneet, its Rich. No, the auditors didn't ask us to do this.
This is GAAP. We have to reflect our own credit standings in the calculation of reserves that we imply FAS 157-2 which is mark-to-market.
So, if we have a liability, we must reflect our own credit rating. It changed during the quarter from year-end and nearly used the updated data.
As far as the other question goes, the... we had a mean reversion assumption when we calculate our reserves.
Implicit in that mean reserve assumption is a 10.5% forward return assumption. And if we don't achieve that in any given quarter, there will be unlockings to both DAC and the GMDB reserve.
And I am sorry, you also asked if we could expect updates to the 133 reserve as a result of non-performance risk. And the answer to that question is, yes.
Going both ways. And obviously, as our spreads come in and our credit standing improves, it will result in a reversal of that roughly $240 million gain in the lock I should say in the first quarter.
And that will unwind itself as a charge through the P&L in the future.
Suneet Kamath - Sanford Bernstein
Got it.
Mark Grier
To make sure, something I have here. Just to say our on the mean and mainly where you can exit full year period 10.5%.
The long-term assumptions is lower than that beyond the four years, which is 8%.
Suneet Kamath - Sanford Bernstein
Okay, thanks.
Operator
And next we go to line of John Nadel with Sterne, Agee. Please go ahead.
John Nadel - Sterne, Agee & Leach
Hi, good morning. Thank you.
Hey John, I was interested in your comments about over half of the normalized earnings, the businesses were generating sort of record results this quarter. And it got me to thinking about your longer term ROE.
And obviously, there's a lot of market dynamics in effect here. But I guess, the way I'd ask the question is, as you look at the businesses that are actually underperforming, has there been any thing that you would characterize as you've review those businesses, as sort of permanent return reduction, in terms of the potential returns for those businesses i.e.
Annuities or Asset Management as you look out. And if so, what kind of overall impact do you think that has on your franchise ROE objectives?
John Strangfeld
John, hi. I think principally, one area where that I have some application is in terms of the annuity ROE, particularly on the old block of business, as opposed to on our new block of business.
But, there you have... there that force could be at work.
John Nadel - Sterne, Agee & Leach
Okay. And any way of sort of thinking about the quantification in that?
I suppose, the older business will over time just be muted further by new business growth. Correct?
John Strangfeld
Yeah. And then, we are in the process maybe Bernard can speak specifically, as to let us give you a current view on what that mix shift is, in terms of the mix of the old versus the new.
Bernard Winograd
John, its Bernard Winograd. I think the sales at this point are 100% in the new products and the auto rebalancing product, which has very different characteristic.
So, I think if you're trying to understand it, it's reasonably easy to extrapolate just by estimating what the impact of our sales are. The difficult thing to extrapolate is what is the persistency going to be of the old block that has the depressed ROE.
And the answer is highly dependent upon the level of the stock market. As long as people guarantee they are substantially in the money, we're expecting persistency there to be quite high.
John Nadel - Sterne, Agee & Leach
Got you. Okay, thank you.
And then, the last thing I'd ask is just, as you look at the performances especially of the credit markets, since the end of the quarter, obviously, April was a very good month. And it seems to be continuing through at least the early parts of May.
Any estimate you can give us on the impact that that might be having on your unrealized loss position relative to March 31?
Mark Grier
Well, we don't... this is Mark.
We don't comment on our interim financial numbers. But, I think our moves would be consistent with the improvement in the market.
John Nadel - Sterne, Agee & Leach
Okay, thank you.
Operator
And next we go to the line of Nigel Dally with Morgan Stanley. Please go ahead.
Nigel Dally - Morgan Stanley
Great, thank you, and good morning. First for Rich on the RVC ratio.
How are the scenario to articulate our change if we use the current level of the S&P, it was around 900. Just, if we could isolate the impact of the equity markets on how those ratios change?
Second, also happen to get an update on the Wachovia put option, given you solid liquidity capital. Is an early exit from the Wachovia put still on the table?
Also, is the final value being determined, if not, why not? Last, given the need for relative rate capital under the stress test, should we still expect that you'll floating cash towards equity more likely?
Thanks.
Richard Carbone
I think Mark will take the spilt question first Nigel.
Mark Grier
Yeah. The headline over the put would be that we have no reason to expect that this won't play out as specified by the contract.
And as we have been telling you, I would add that as we've said before, we would have an open mind about discussion. So, anything that anyone wants to talk about or willing to discuss.
But, our plan right now is reflected in the stress scenarios that Rich talked about is that this will play out according to the contract. We also will have the choice of our cash or stock.
And I can't speak to their capital plans or capital needs or intentions in that regard. Finally, with respect to the final value.
As you know, we will go through a process that includes the appropriate appraisals, and arrive at that on a calendar that will have that happening some time this summer, in anticipation of settling in January.
Richard Carbone
Yeah Nigel. On the S&P sensitivity.
There are so many moving parts. But, if I gave you a simple rule of thumb, and its not linear, which is the other problem.
But, in S&P move of a 100 points translates to more or less 50 points in RVC, ceteris paribus.
Nigel Dally - Morgan Stanley
Okay. That's very helpful.
Thank you.
Mark Grier
Let me just overlay one thing which is to remind you that when we present our scenarios, we include the actions that we will take to achieve our RVC objectives. So, when Rich puts that number out, that's an unmanaged impact.
And we have substantial resources as you heard reflected in the RVC numbers that he talked about, even in the extreme scenarios, to ensure that we can manage to RVC targets that makes sense.
Nigel Dally - Morgan Stanley
I understand, great. Thank you.
Operator
Next we go to the line of Tom Gallagher with Credit Suisse. Please go ahead.
Thomas Gallagher - Credit Suisse
Hi, I guess, just on that last comment, a follow-up first. Then I had a few other questions.
But Rich, when you talk about the options available for you to bolster statutory capital under the stress test, can you articulate what those are, and try and give some kind of quantification of those?
Richard Carbone
Yeah, I'll tell you what they are. And the quantification, ends in flows.
But, look, let me give you some of the bigger one's, okay. The first one, we always talked about this before was if PICA owes the holding company $3,5 billion as of year-end in medium term notes.
We are repatriating or we're settling those loans between the holding company and PICA. And either downstreaming that back to PICA as capital or as PICA sends it back up, because PICA is a regulated entity of a holding company.
It has to done at arms length. And PICA is actually recording a intercompany gain, which has the same effect to surplus as to if they paid me the full amount, and I gave it back to them, will they book the gain down below.
So, that bolsters their surplus that way. And that's...
that train has left the station. We're running at through the rest of the year, and by year-end we will have settled between PICA and the holding company that entire $3.5 billion.
Another item is, we're moving our hedge positions for the FAS 133, the guarantees under our annuities back on to PICA from an offshore sub. And then, that bolsters the capital within PICA, because of the interplay between the liability...
mark-to-market on the liability, and the mark-to-profit on hedge asset. We also have...
we really don't use reinsurance a lot. And so, we have some reinsurance alternatives that are out there.
And we have some excess collateral in certain subsidiaries that are behind our XXX financings. And those are represented by surplus notes, between the parent company and the subs.
And the subs can pay back those surplus notes. And as we move down the plane from 800 to 700 to 600, we would trigger each one of these things along the way.
Thomas Gallagher - Credit Suisse
Okay. That's helpful.
And if we... trying to roll all those up, are we talking about a $5 billion potential contribution of surplus.
Is it anything and not ballpark?
Richard Carbone
No, I should see. No, I don't think it's 5 billion.
I don't think it's 5 billion. Let me think.
Wait a minute, with the hedge notes. With the hedge notes, it could be 4 to 5 billion with the hedge notes.
With the hedge notes, with the retail notes and the hedges, yeah.
Thomas Gallagher - Credit Suisse
Okay. Yeah, that certainly would explain why you have substantial buffer in those sort of scenarios you laid out.
That's helpful. The other questions I had were just on the holding company cash position that seemed to have gotten a lot better.
Just overall, if you think about it from a coverage standpoint, just want to know what's behind the scenes. Why are you now holding cash that's essentially two times the amount of short-term debt, if we include the converts that are due, as opposed to last quarter, it was about one times.
And also, what was the source of that cash build there?
Richard Carbone
Sure. The cash is real simple.
That's the retail notes. They are paying off the medium term notes throughout the year.
And why are we holding it, because it's a regulated entity. As they pay it back up to us, its going to still at the holding company.
And so, we have a cash cushion that takes us through well into 2010. I'm actually targeting a cash cushion that will take us well into 2011.
Thomas Gallagher - Credit Suisse
Got it, thank you.
Operator
Next we go to the line of Jeff Schuman from KBW. Please go ahead.
Jeffrey Schuman - Keefe, Bruyette & Woods
Thank you. Good morning.
Hoping to reconcile a few things. Mark and Rich and John, all made some comments about capital.
I think Mark closed by expressing comfort with capital position which he just told as a current market levels that the RBC is probably for 50ish in that, sort of downside market scenarios are manageable. And yet John I thought in your opening remarks, you made a comment about opportunistically considering access to capital.
I am wondering, if you could sort of clarify what you meant by that?
John Strangfeld
I guess, a couple of different things. I think we view this is being a time where there is lots of opportunities, in terms of organically growing our business and that could be other opportunities as well.
And what we recognize is that there could circumstances under which just as we're being opportunistic and opportunities we presume, there maybe opportunities with regard to financing alternatives as well, which is simply acknowledging that in this environment. So, really, there is not much to say.
Jeffrey Schuman - Keefe, Bruyette & Woods
Okay. So, I should think of it maybe, possibly more of an offensive context rather than a defensive context necessarily?
Richard Carbone
Yeah, balance. But that's...
that's balanced.
John Strangfeld
We don't think about it.
Jeffrey Schuman - Keefe, Bruyette & Woods
Okay. And then, one other clarification.
I thought I understood Mark just say that the appraisal related to the put was still in front of us. But, I thought that there had been historic appraisals that were long since done that were locked away to be examined on the contingency that you exercised the Wachovia put.
So, had I misunderstood that... were there no historical appraisals done?
Mark Grier
Well, yeah. Either I misspoke, or you got a little bit confused probably, I misspoke.
We've said repeatedly that we had appraisals done last spring based on 1/1/08 for this entity. So, there are appraisals that are out there that have been done.
And our process will work through those as we go through the formalities.
Jeffrey Schuman - Keefe, Bruyette & Woods
So, have you...
Mark Grier
Yes, you're right.
Jeffrey Schuman - Keefe, Bruyette & Woods
So, have seen those appraisal outcomes or not?
Mark Grier
No, we haven't.
Jeffrey Schuman - Keefe, Bruyette & Woods
When will you see them, because I would have thought when you exercised the put then everyone would have a look at that. Is that the case?
Mark Grier
We haven't exercised the put yet. We've declared our intention to exercise the put, but the legal process will begin by June.
Jeffrey Schuman - Keefe, Bruyette & Woods
Okay.
Mark Grier
We are still a little bit ahead of the legal process. So, when we do exercise the put with the formal notice, then we'll see those, and we'll tell everybody what the answer is.
Jeffrey Schuman - Keefe, Bruyette & Woods
Okay, that's helpful. Thank you.
Mark Grier
Yeah. But, you're right.
There are appraisals that have been done based on 1/1/08.
Jeffrey Schuman - Keefe, Bruyette & Woods
Great. Thank you.
Operator
Next, we have a question from the line of Ed Spehar with Bank of America. Please go ahead.
Edward Spehar - BAS-ML
Hello, can you hear me?
John Strangfeld
Yeah, we can.
Edward Spehar - BAS-ML
Okay. Thanks.
Rich I was wondering if we could get maybe just a little bit more on these other actions. And specifically, when you talk about settling the medium term notes, should we be thinking about somehow like at 80% a par, or something in that neighborhood.
Is that... or is it more than that?
Richard Carbone
Ed, you can think about at that way. But, I tried to make the point before probably not very clear, it doesn't matter.
The own the holding company in $3.5 billion. They can pay the holding company $3.5 billion.
They have the wherewithal to do that. And the holding company would downstream roughly a $1 billion down to PICA to supports PICA's capital in some of the stressed scenarios.
But because it is an intercompany transaction, it requires an arm lengths (ph) pricing. We have to settle those notes.
And I am going to go the whole nine yards here at 2.5. So, if I can pay the holding company 2.5, books an intercompany gain of the billion.
All gets eliminated in consolidation. But, that billion sits in surplus of PICA.
Could get their two ways? I could give it back to them, or they could book it on the sale.
Edward Spehar - BAS-ML
Okay. But that's roughly, the number is a billion?
Richard Carbone
Yeah.
Edward Spehar - BAS-ML
Okay. And then...
Richard Carbone
I passed today, Ed, not today, when we're all done with the 3.5.
Edward Spehar - BAS-ML
Right, right, okay. And the next question is that you gave us these various impacts, and I am assuming that is the biggest one of the other actions, is that correct?
Richard Carbone
Yeah.
Edward Spehar - BAS-ML
Okay. But, now when we move to this issue of hedges, moving the hedges back to...
moving them under PICA from an offshore sub. How much of the hedge gain that you have there in this offshore sub, is really kind of an economic...
what would you consider an economic gain versus just the mismatch in timing of asset liability valuation under stat?
Mark Grier
Ed, this is Mark. I would consider most of that gain to be economic.
We've over hedged the volatility in these living benefits. So, lot of the valuation of the hedge asset reflects high volatility that is not really a direct benefit to the liability holders.
So, I think of it as more economic than accounting.
Edward Spehar - BAS-ML
Okay. And then...
but then, that leads to the next question, which is, we've obviously had very high, extraordinarily high implied valves for long-dated options. And so, to the extent that those come in even a little, I'm sure they have some already.
But, how much... how sensitive is that sort of...
that surplus in terms of the fluctuation implied valves?
Richard Carbone
I can't give you a number, Ed. But, it's very sensitive.
The implied valves on that embedded derivative liability will and they've blown out, which is really put this thing at where it is. When they come back down, the liability will reduce accordingly.
Mark Grier
We've done some things to mitigate the potential impact of falling volatility on that statutory gain.
Edward Spehar - BAS-ML
Okay. So, I mean, I guess, the assumption is that if we get back down to those low levels that volatility is going to be high, right?
Mark Grier
You mean... in the...
yeah, I... now, I see what you're saying.
Yeah, I think it's likely that if the S&P goes to 650, we'll be back in an environment of very high volatility.
Richard Carbone
Oh, I am sorry, Ed is that what you...
Edward Spehar - BAS-ML
No, no. I guess, this is (Inaudible) kind of snacking a different question.
Mark Grier
But yeah, I think there seems to be a pretty strong correlation between the massacre scenario in the market, and the implied volatility in these long-dated options.
Edward Spehar - BAS-ML
Right. And can you just give us some sense of the dollar amount of the benefits you would get now, if you move the offshore underneath PICA?
Richard Carbone
It's in the order of the magnitude of $1 billion.
Edward Spehar - BAS-ML
Okay. And then finally, I am assuming the RBC scenarios that you've talk about take into account the hit to the equity portfolio on the Closed Block as well?
Richard Carbone
Yes, they do.
Edward Spehar - BAS-ML
Okay. Thanks a lot.
Operator
And our final question is from line of Eric Berg with Barclays Capital. Please go ahead.
Eric Berg - Barclays Capital
Hi.
Mark Grier
Eric, we can't hear you?
Eric Berg - Barclays Capital
Hello?
John Strangfeld
Hello Eric, is it a mute run out.
Operator
He must be on a cell phone. We must have lost him.
His line is still open.
John Strangfeld
Hello. Eric.
All right, I think given that we seem to have lost Eric, it's time for us to wish you all a good day. So, thank you for your interest in Prudential.
And we look forward to seeing you in the near future or listening to your questions, pretty much from now. Thank you, again.
Operator
Thank you. Ladies and gentlemen, this conference is available for digitized replay after 1:30 PM Eastern Time today through May 14, at Midnight.
You may access the AT&T Executive Playback Service at anytime, by dialing 1-800-475-6701, and enter the access code of 986903. International participants may dial 320-365-3844.
Those numbers again are 1-800-475-6701 and 320-365-3844, with the access code of 986903. That does conclude your conference for today.
Thank you for using AT&T Executive Teleconference Service. And you may now disconnect.