Aug 7, 2009
Operator
Ladies and gentlemen thank you for standing by. And welcome to the Second Quarter 2009 Earnings Call.
At this time all participants are in a listen-only mode. Later we will conduct the question and answer session.
Instructions will be given to you at that time. (Operator Instructions).
And as a reminder today's conference call is being recorded. I will now like to turn the conference over to Mr.
Eric Durant. Please go ahead.
Eric Durant
Thank you Scythia. In order to help to understand Prudential Financials, we will make some forward-looking statements in the following presentation.
It 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 of non-GAAP measures of our earnings press release for the second 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 measures, we call it 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 and asset values that will ultimately accrue to contract folders and record changes in contract folders and liabilities, resulting from changes in asset values. The comparable GAAP presentation and the reconciliation between the two for the second quarter are set out in a earnings press release on our website.
Additional historical information relating to the companies financial performance is also located on our website. Okay.
Now that we're legal John Strangfeld Jr., will lead off with his comments followed by Rich Carbone and Mark Grier, will walk you through the second quarter after that, John, Rich and Mark will be joined by Peter Sayre, Ed Baird and Bernard Winograd for your Q&A. We expect to wish you a good day around noon today.
John.
John R. Strangfeld Jr.
Thank you, Eric. And good morning everyone.
And thank you for joining us and we appreciate your interest in Prudential. As Eric mentioned as is our practice Rich and Mark, will walk you through the specifics on the quarter, but first I would like to kick things off with some high level comments.
I'd like to begin by saying that we remained very positive about our mix of businesses, the quality of the businesses that make up the mix, and the momentum we see even in the face of what remain a difficult business environment. Overall and because of these factors we believe there is ample evidence that we are gaining grounds in the marketplace.
Second quarter results obviously reflect improvements in financial markets though in many ways more importantly indicating clear trends that we are improving our competitive position. In some areas it's absolute in others it's relative, but the signs are unmistakable.
Adjusted operating income in the quarter nearly matched the strong result of the year ago and several of our businesses had never been healthier. We consider the earnings performance of our businesses respectable under the circumstances and we believe we are well positioned to do better overtime.
Sales inflows are even better measures and the progress that businesses are making. They were solid virtually across the board in the second in the quarter and the first half overall.
Our individual annuities business posted record variable annuity sales in the quarter, DA sales were up 23% from the prior year and net variable annuity sales topped 2 billion, more than thee times our previous record. US individual life insurance also registered favorable sales result a year-over-year increase of 17%.
Importantly our sales through third party distribution increased by 35% and now represents roughly 75% of total sales of the business. In the group insurance annualized new business premium increased in the second quarter.
For the year-to-date sales are up 48% persistency has also improved. In Group life persistency is 96%, in Group disability persistency is 94%.
We believe it is a strong indicators of extraordinary client satisfaction. Full service retirement had modest but positive net additions, one quarter after posting a record increase.
Unlike like the first quarter full service return had landed no large cases in the second quarter and new business opportunities were more scarce. As in previous quarters persistency remained strong at 95%, another important indicator of client satisfaction.
Institutional investment products at a net addition or cap values of 1 billion our first net addition in more than a year benefiting from strong sales in several classes of guaranteed products. In our asset management business third party institutional and third party retail flows were both positive.
Finally international insurance achieved solid sales result although annualized new business premium declined modestly from the second quarter of 2008. Last year's, second quarter benefited from a new product introduction at Gibraltar.
In addition the Japanese economy has weakened in the last year hampering Prudential's Japans sales to it's business clientele. Continuing growth in Gibraltar's backchannel was a partial offset.
Overall as you can see business fundamentals meeting underlying drivers will remain relatively strong. We are no, by no means immune to these markets, these are tough times but we are holding up well and as evidenced by our sales and flows we believe we are gaining ground on our competition eventually across the board.
Our strong fundamentals provided a positive backdrop for our recent capital raises as you know we issued 1.4 billion of common stock and 1.0 billion of public long-term debt in June. And at the same time we declined the opportunity to accept CTP funding.
These capital raises give us greater resources to pursue organic growth and intangibly validate the concept of strengthening a strong company. We believe we are seeing and benefiting from a flight to quality and we want to have the resource to support the growth that's associated with this flight to quality.
And at the same time having recently been through a challenging environment we want to fortify ourselves against the scenario of the markets once again going into this. Simply put we want to maintain distinguish strengthen in event of another adverse environment.
So we can benefit from the like to quality in that environment as well. That said we've recognize the challenges remained with respect to the economy in the market.
Our earnings guidance continues to reflect a cautious approach to setting expectations including the deployment of cash and market conditions. Considering results for the first half as well as financial market conditions we now believe that Prudential Financial will achieve common stock earnings per share of $5 to $5.20 based on after-tax adjusted operating income other financial services business.
This guidance compares to our old guidance of $4.80 and $5.20 per share. This expectation assumes average appreciation of 2% per quarter and the SMP 500 index commencing with quotes as of December 31, 2008.
This is the same assumption for full year market depreciation as we remain in May when we last updated our guidance. What is difference, is that this guidance incorporates the effects of our June capital rates.
Both the incremental interest cost associated with the debt any additional share associated with the equity. To sum up, we like our business mix, we like the quality of the businesses that make up that mix.
Business conditions are tough but improving and we're gaining ground in an absolute sense or relative sense or both. We have the resources to pursue our business opportunity in favorable and unfavorable economic environments, and we're feeling very confident about our prospects.
Now, Rich and Mark will walk you through the specifics and then we welcome your questions. So, Rich over to you.
Richard J. Carbone
Thanks John and good morning everyone. As you've seen from yesterday's release, we reported common stock earnings per share of $1.88 for the second quarter.
This compares to a $1.96 for the quarter a year ago, and is based on adjusted operating income for the financial services business. Now, we ended the quarter on a very high level, we benefited from good performance at major businesses, offsetting some cases by cumulative market decline and account values over the past year, reducing fee income.
Also the cost of holding excess liquidity, which is showing up with a negative spread was a drag on results for the quarter. On the other hand, improving financial market conditions, contributed to favorable results, mostly through unlocking adjustments.
As in past quarters, operating results of some of our businesses are affected by these great (ph) items, I will go through the major ones right now. At our individual annuity business, we released the portion of our results for guaranteed minimum debt and income benefits, resulting in a benefit of about $0.46 per share and we had a positive unlocking of debt also in annuities.
Reducing amortization of deferred policy acquisition and other cost, reducing benefits of $0.24 per share. Our individual life insurance business, also recorded a reduction in net preservation of debt and related cost of $0.04 per share reflecting that recovery of account values.
Now going back to annuities. It gets complicated.
In the annuity business we include the impact of hedging breakage in our adjusted operating income. The hedging breakage represents the difference between the change in the value of the derivatives we used to hedge our annuity living benefit guarantees and the changes in the value the embedded derivative liabilities for these guarantees.
The change in the fair value of the embedded derivative liabilities includes an adjustment for a measure of our own credit or non-performance risk, which was a benefit to results in the first quarter of 2009. But it's a negative to AOI for this quarter.
The impact to the adjustment to non-performance risk at our overall embedded derivative liability became less significant in the second quarter. As the liability for living benefits guaranteed decreased and as such in substance the estimated cash flows all those guarantees went down.
And our spreads narrowed reducing the discount rate we apply to those lower cash flows. As a result the negative spread of our non-performance risk more than offset the favorable breakage in the net mark-to-market of the embedded derivative liability and the related hedging instruments resulting in a net charge in AOI and related debt amortization of $0.09 per share.
It's get little easier. Our retirement business had a similar charge for re-measurement of non-performance risk of about $0.02 per share.
In our international insurance business refinements from the implementation of the new policy valuation system partially offset by the technology improvement cost, resulting in a net benefit of $0.02 per share. In total all the items, I just mentioned had a net favorable impact of about $0.65 per share on our earnings in the second quarter.
Now moving to GAAP results and once again of course to the financial services business, we reported net income attributable to Prudential Financial of 538 million or $1.25 per share for the second quarter as below the line items partially offset our operating results. This income -- the net income attribute to Prudential Financial was 566 or $1.32 for the comparable period of the prior year.
Our current quarter GAAP pre-tax results including amounts characterized as net realized investment losses of 877. This loss includes a mark-to market loss on derivatives of 519 mainly used in our duration management programs and was driven by changes in interest rates.
The remaining net realized loss of 358 for the quarter reflects impairments on credit losses of fixed maturities of 353, impairments of equity securities of 64 million. All of which were partially offset by gains in other portfolio holdings.
The 353 of impairments and credit losses for fixed maturities includes about 30 million for sales of credit impaired securities, about 200 million of fixed income credit losses of sub-prime ADS. And about 120 million on corporate holdings, mainly in the manufacturing and services sectors.
Now as you may recall, for equity securities, we recorded impairments that declined in value of 50%, that is fixed for six months, over any decline in value that exist for 12 months. We also impair equities for declines in value if we don't expect to hold them until recovery.
The 64 million of equity impairments came in from declines in value reaching the 12 month mark and for identification of securities that we intend to sell primarily in the Japanese equity portfolios. Now, let's turn to capital and liquidity.
We began the year with a solid capital position and our position was significantly enhanced during the quarter, during the first half of the year particularly in the second quarter. We issued 1.4 billion of common stock in early June at the same time issued 1 billion of long-term debt.
Both the debt and the equity issuances were over subscribed with substantial interest from high quality investors. The issuance has increased our ability to take advantage of growth opportunities in our businesses as well as to continue to a see a flight to quality in both the domestic and international markets or as we see a quite flight to quality in both the domestic and international markets.
They also provide a substantial buffer against market deterioration. In the near-term we're retaining most of these proceeds at the holding company.
Also at the time of these issuances we announced our decision not to participate in the government's capital purchase program on the top. As you've seen in the past -- especially in the past several quarters our equity sensitive businesses statutory capital decreases in the equity markets decline and increases when the equity markets are up.
The 15% increase in the S&P index for the second quarter reversed the proportion of the capital erosion that was reflected in the last quarter. Now, for our capital position.
First, RBC in Prudential Insurance, we began the year with RBC ratio, as we have reporting RBC Prudential Insurance at June 30. We believe it would above 400, keep in mind this is somewhat hypothetical since RBC is an annual calculation, we have not done the bottoms of estimates, a 400 in a pretty good benchmark.
Now the proceeds from the securities, we issued during the quarter, were downstream to Prudential Insurance to bolster that RBC, I just mentioned. In addition, the estimate of RBC includes no benefit for the gain we expect to realize on the sale of our investment in the Wachovia joint venture.
We believe the benefit from the gain, with add over a 100 points to RBC including certain tax benefits. We are on track for closing Wachovia transaction in 2010.
In evaluating our capital position, we also take a look at stress scenarios including another sharp drop in the S&P 500 index, combined with investment portfolio of credit losses and impairments, that will be significantly more adverse than our base case, another scenario with S&P closes 2009 at 600 and were investment portfolio credit losses and impairments amount to 2.8 billion or 2% on the fixed income bonds and mortgages of Prudential Insurance and it's insurance subs for the full year 2009. We believe that we would end the year with a RBC at Prudential Insurance in excess of 300, this considers the use of actions, that we believe will be available to us, but not the expected gain on the Wachovia joint venture or any use of proceeds from the June capital raises.
Another scenario where the S&P 500 closes the year 2009 at 600 and stays there thorough 2010 and assuming the total of 4.3 billion in credit losses and impairments we expect to able to manage to an RBC level that is at or above 300. This includes the expected gain of the Wachovia joint venture put.
Remember the investment in Wachovia is held in Prudential Insurance. What does not include -- so this 300 does not include any use of proceeds from our June capital issuances.
We consider this RBC levels to be acceptable in that stress outcome. Of course as time goes on or actually as we look further out in time things get more uncertain.
Our Japanese insurance companies Prudential of Japan and Gibraltar each reported solvency margins for the most recent fiscal of March 31, 2009 comfortable above their benchmark or AA balance sheet strength. Despite recent action of the rating agencies we continue to manage our insurance companies to a capital level that we believe is consistent with the AA ratings.
To sum off on the capital points we believe we can manage the capital position of our insurance companies to a high standard on the stress scenarios in both the equity and credits markets. Our capital position gives us a buffer in these stress condition and flexibility to support growth of our businesses and take advantage of market opportunities.
However, with the level of impairments in credit migration over the reminder of this credit cycle still uncertain, financial market condition is still volatile and the future level of leverage or are future leverage level is still up in the air. We continue to believe that it is ill advised the qualify measure of access or available capital at this point in time.
Now lets look at liquidity, our liquidity position is strong and provides us with considerable flexibility. At June 30, we had 4.7 billion of cash and short term investment at the parent company, PFI.
When we look at the PFI cash position were we lead out any outstanding commercial paper in short term into company borrowings. On that basis we have net cash on hand of 3.5 billion.
This is a somewhat conservative view because the short term and the company borrowings that I just netted out are fairly consistent and we believe with the available to PFI even under the stress scenarios that I just went through. The 3.5 billion net cash position compares to 2.8 billion at the end of the first quarter and reflects the June repayment of substantially all of the 1.9 billion outstanding from our 2007 convertible debt.
And proceeds retained at PFI for our June issuances of 1.4 billion common and 1 billion in of long term debt. We have no remaining significant debt maturities at PFI until 2011.
At the end of the second quarter PFI commercial paper borrowings are about 500 million and invested in short term assets essentially cash, down from 1.2 billion at year end. We are not dependent on commercial paper for PFI liquidity needs but to keeping this program active to enhance our flexibility in the future, or to maintain our flexibility in the future.
Financial funding the financing of prudential insurance and commercial paper borrowings of 1.7 billion at the end on of the second quarter down from 4.4 billion at year-end. Based on short term debt ratings Prudential Fund continues to qualify for new borrowings under the Federal Government's Commercial Paper Funding Facility or CPFF of upto 9.8 billion.
Due to no borrowings under CPF outstanding as of the quarter end. We have planned our cash flow for 2009 under the assumption, the dividend capacity for Prudential Insurance for the parent company would remain constrained, given the continued market instability -- given the consistent market instability or uncertainty.
Our current intent is to maintain a cash cushion and short term investments at PFI representing 18 to 24 months of cash requirements or about 1.5 billion of course, this is subject to change based on our ongoing assessment of capital requirements of our regulated annuities, we will retain these levels, until we feel the environment has stabilized to the point, that normal cash flows from these regulated subsidiaries to the parent, can resume. Over the next few quarters, we expect to deploy the remainder of the cash, now held at the parent in our businesses as needed and in 2009 with about $2 billion of PFI as I just mentioned, that's the 18 to 24 month cash flow cushion held at the holding company.
At June 30, the Financial Services business had 6 billion outstanding onto securities lending program, down from 7.5 billion at year end, and now Mark will comment on the investment portfolio for the financial services business and review our specific individual business results for the quarter. Mark.
Mark B. Grier
Thank you Rich, Good morning, good afternoon, good evening. Thanks for joining us on the call.
Let me start on the investment portfolio. We managed our investment portfolio primarily with the focus on its cash flow prospects, since our general accounting investments are mainly supporting long-term insurance liabilities.
Despite un-recovery of values with credit spreads narrowing on many asset classes during the second quarter we continue to live with a substantial disconnect between the market values for many classes of investments and their underlying cash flow prospects. With that said I'll start with our fixed maturity portfolio.
Gross unrealized losses on our fixed maturities in our general account stood at $7.8 billion at the end of the second quarter. This represents a recovery of about 3.4 billion in comparison to the first quarter driven by credit spread narrowing across nearly all asset classes.
Roughly $2.1 billion of total gross unrealized losses at the end of the second quarter relate to sub-prime holdings. This compares to $2.6 billion at the end of the first quarter.
Market trading in sub-prime securities has been limited and is not exhibited the characteristics of an orderly market. In fact there have been virtually no recent transactions in the securities we hold.
Given the lack of an active market, our pricing as of June 30th, considers market assumptions applies to our cash flow estimates in combination with third party pricing. Total sub-prime holdings were just under $5 billion at the end of the second quarter based on amortized cost.
This represents a decrease of about 500 million from the first quarter reflecting roughly $300 million of pay downs during the quarter and the $200 million of credit impairments that Rich mentioned. At June 30th, the general account fixed portfolio included $7.9 billion of commercial mortgage backed securities at amortized costs.
Over 94% of these holdings have AAA credit ratings. Super senior AAA securities with 30% subordination, represent roughly 80% of our holdings.
Our exposure to CDOs is limited. With general account holdings at June 30, under $150 million.
We also have very limited exposure to hybrid securities which are not the less than one half of 1% of the general account portfolio. Based on amortized cost, non-investment credit securities comprised about 8% of the $127 billion fixed maturity portfolio at the end of quarter essentially unchanged from the first quarter and up from about 7% at year end.
Mainly as a result of rating agency downgrades on a portion of our sub-prime holdings earlier in the year. One last comment on the investment portfolio.
We had $22 billion of general account commercial mortgage and other loan holdings as of the end of the quarter. At June 30, the average loan to value ratio for our commercial mortgage holding is 62% and the average debt service coverage ratio is 1.8 times.
Delinquencies continue to be insignificant at less then 0.5% of the holdings. Now I'll cover our business results for third quarter.
Starting with the United States businesses. Our annuity business reported adjusted operating income of $432 million for the second quarter compared to $154 million a year ago.
Results for the current quarter includes several discrete largely market driven items that Rich mentioned, with a net favorable impact of $361 million. Current quarter results include a benefit of $274 million from the release of a portion of our reserves for guaranteed minimum debt and income benefits, reflecting the equity market uptick in the quarter.
This benefits earnings represents the reversal of just under half of reserve increases we reported over the past two quarters, largely for our older products that don't contain the auto rebalancing feature we package with our current living benefits. The improvement in the equity markets also resulted in the release of about $500 million of statutory reserves for our annuity guarantees.
With corresponding restoration of the decline in statutory capital that came from the earlier equity margin decline. Current quarter results also benefited from reduced amortization of differed policy acquisition and other cost amounting to $142 million reflecting market performance.
Going the other way, the breakage between changes in the values of our living benefit guarantees and our hedging instruments resulted in a net charge of $55 million to current quarter results after related amortization of debt. Adjustments of amortization and reserves to reflect actual experience together with hedging breakage did not have a significant impact on results in the year ago quarter.
Stripping these items out of the comparison annuity results were down $79 million from a year ago reflecting lower fees in the current quarter due to the market driven declines in account values over the past year. With spreading come from funds rebalanced to the general account a partial offset.
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.
Give 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 June 30th are subject to auto balancing, reducing our risk profile and limiting our exposure to volatile cost and hedging.
As of the end of the second quarter we are hedging about $27 billion in annuity account values, with primary focus on the equity risk on our older living benefit features than don't incorporate our auto rebalancing feature. We feel that our hedging program is operating well.
In the first half of 2009, we've seen the reversal of most of our negative breakage through the highly volatile market environment in late 2008. We are now in the process of expanding our hedging program in order to adapt to the new statutory reserving rules for variable annuities that are coming online at the end of the this year.
And to enhance the protection of our statutory capital under various market scenario. As part of this process, we are beginning to implement limited hedging of our guaranteed minimum debt and income benefit exposure.
Our gross annuities sales for the quarter reached a record high of $3.4 billion compared to $2.7 billion a year ago. Our highest daily or HD living benefits coupled with our order rebalancing feature that protect the cap values in market downturn has provided us with the substantial competitive advantage in the current market.
Where other companies using more traditional product designs have pulled back at the same time that clients and their advisors are focused on retirement income security more than ever. Later this month we are introducing the next generation of our living benefit product featured of HT6 plus.
As implied by the name this feature will offer a 6% annual rollup for protected value rather than the current product 7% and a higher but still competitive fee structures. We believe that our product will continue to offer a superior value preposition in this market while further benefiting our risk profile.
Net sales were very strong in the quarter amounting to $2.1 billion. The retirement segment before at adjusted operating income of $99 million for the current quarter compared to $114 million a year ago.
As Rich mentioned current quarter results reflected a charge of $9 million from updating our market base measure of non-performance with the retirement product guarantees, that we account for as embedded derivatives. Stripping that charge out of the comparison results for the retirement business were down $33 million from a year ago, primarily due to lower fees resulting from market driven decline in full service retirement and account values.
Current quarter, full service retirement growth sales and dozen deposits were $3.9 billion, bringing the first half total to 14.4 billion including a $4 billion major case win in the first quarter. Large case sales follow a lumpy pattern and emerge after a lengthy bid process.
The pace of that bid activity in the market over the past few quarters has been considerably slower than typical, reflecting the challenges in the general business environment. Our full service persistency was over 95% and net flows were positive for the quarter.
Our stable value funds have been especially attractive to planned participants who remain vary of the volatile equity markets, growing nearly $3 billion over the past year and reaching $36.7 billion at the end of the second quarter. The asset management segment, reported adjusted operating income of $33 million for the current quarter, compared to $190 million a year ago.
Contribution to results from proprietary investing activities was down roughly $90 million from a year ago, reflecting less favorable results across several asset classes. Current quarter results also reflected unfavorable results from commercial mortgage operations including declines in value on interim loans, we hold in the asset management portfolio.
In addition, the contribution from performance based fees was down from a year ago, when we benefited from a stronger commercial real estate market. Adjusted operating income from our individual life insurance business was $138 million for the current quarter compared to $103 million a year ago.
Current quarter results benefited from a reduction in net amortization of differed policy acquisition costs and other items, driven by favorable separate account performance as Rich mentioned. We estimate that these market driven items had a favorable impact of about $24 million in comparison to the year ago quarter.
In addition, mortality experience was more favorable than a year ago. Our lower level of fees reflecting the market driven decline in separate accounts balances for our variable life business in comparison to a year ago was a partial offset to the favorable mortality.
Individual life insurance sales amounted to $98 million in the current quarter a 17% increase from a year ago. The increase was driven by strong performance of our universal life insurance products especially in our third-party distribution channels.
We are benefiting from market opportunities due to the retrenchment of some careers particularly in the Universal Life Insurance space and we believe we are seeing a flight to quality benefit as well. We implemented price increases and our universal life insurance products commencing in April and May and believe that our products will remain highly competitive given observed trends in these markets.
The Group insurance business reported adjusted operating income of $105 million in the current quarter compared to $80 million a year ago. Current quarter results benefited from more favorable claims experienced than that of a year ago on both Group life and Group disability.
Sales for the quarter were $61 million up from $47 million a year ago was increases in both life and disability. Turing to our international businesses, in our international insurance segment, Gibralter Life's adjusted operating income was $150 million in the current quarter, compared to $167 million a year ago.
Current quarter results include net charges of $7 million from retirements resulting from implementation of a new policy valuation system for Gibraltar post acquisition business. We expect to extend a new system to the remaining business including the older acquired blocks business in Japan over the next year.
Stripping these charges out of the comparison, results were down $10 million from a year ago, driven mainly by a less favorable level of expenses and a lower contribution from investment income. Sales from Gibraltar Life based on annualized premiums and constant dollars were $139 million in the current quarter compared to $147 million a year ago when our life advisor channel registered its all time high sales quarter with the benefit of about $20 million in sales of a recently introduced yen based endowment policy.
Bank channel sales were $24 million in the current quarter up from $22 million a year ago. Driven by sales of life insurance products that more than offset lower fixed annuity sales.
Our life planner business the international insurance operations other than Gibraltar Life reported adjusted operating income of $315 million for the current quarter, up $29 million from a year ago. Current quarter results include a net benefit of $21 million from true-ups resulting from implementation of the same new policy valuation system that I mentioned for Gibraltar, partly offset by cost to update our data processing system.
Stripping that net benefit out of the comparison, results are up $8 million from a year ago. The increased tracks, continued business growth mainly in Japan partly offset by a less favorable level of policy benefits which includes mortality, surrender activity and reserve refinements.
Sales from our life planner operations based on annualized premiums in constant dollars were $184 million in the current quarter compared to $188 million a year ago. Sales in Japan were down $10 million driven mainly by the negative impact of economic conditions on our sales and the business and executive markets.
This decrease was partly offset by sales growth outside Japan which mainly represents our operation in Korea. Foreign currency translation was not a major factor in the comparison of our international insurance results due to our currency hedging programs.
The international investment segment, recorded adjusted operating income of $16 million for the current quarter, compared to $26 million a year ago reflecting a lower contribution, from our asset management operation in Korea. Corporate and other operations reported a loss of $162 million for the current quarter, compared to a $20 million loss a year ago.
As Rich mentioned, our results are bearing the cost of our conservative management of liquidity in capital in the current environment. These costs primarily take the form of negative spread within corporate and other results.
Reflecting our management of liquidity in capital, interest expense net of investment income accounted for most of the negative swing in corporate and other results compared to a year ago. And briefly on our Closed Block Business.
The results of the Closed Block Business are associated with our Class B stock. The Closed Block Business reported net loss of $375 million for the current quarter compared to net income of $15 million a year ago.
Current quarter results included balance characterized at net realized investment losses of $857 million pretax. Of this amount $440 million represents negative mark-to-market on derivatives we use in duration management and hedging programs largely driven by changes in interest rates.
The reminder mainly represent impairments, we measure results for the closed block business only based on GAAP accounting. To sum up our business performance was strong this quarter.
We are registering solid sales and good product flows virtually across the board and feel that we are benefiting from an enhanced competitive position and value proportions that have become more compelling following the market dislocations of the recent past. Our reported results and capital position benefited from partial recovery of the accounting adjustments we recorded through the severe market downturns of late last year and early this year.
We remain comfortable with the risk profile of our investment portfolio. We have ample liquidity to fulfill our commitment and we taken action to bolster our capital position and enhancing our buffer against further market dislocation and increasing our flexibility to take advantage of business growth opportunity.
Thank you for your interest in Prudential and I'll look forward to hearing your questions.
Operator
Thank you. (Operator Instructions).
Our first question will come from the line of Suneet Kamath from Sanford Bernstein. Please go ahead.
Suneet Kamath
Great, thanks. Just two quick questions on capital.
First John I think you mentioned in your opening comments that the capital you raised would be only used for organic growth purposes. So is it fair to say that if you decided to pursue an M&A transaction that you would use sort of fresh capital newly raised capital and then how do you think about the what hope you could proceed meaning if once you get those dollars do you think that you want to whole that as buffer again to downside scenario or would you be comfortable putting that money to work in an acquisition if something came up.
And then separately for Rich just quickly on the 100 basis point improvement in RBC from the Wachovia deal does that number fluctuate depending on whether or you not get cash versus stock and how should we think about that? Thanks.
John Strangfeld Jr.
Suneet John, let me take the first part and then I will flip it over to Rich for the Part B. On M&A I think it's fair to assume that anything is significant we've assume would required external financing and we would not stretch ourselves with respect to leverage, and that's been our mantra on this and that's the way we continue to think about it that's how we represented we did the share raise recently.
Rich?
Richard Carbone
Yeah, the way we structured the ownership inside the Prudential Insurance of the Wachovia JV it would not make any difference between cash and stock. But it would be our intend to, to sell the stock within a very short timeframe.
Suneet Kamath
Okay. Thanks.
Operator
Thank you. Our next question comes from the line of John Nadel from Sterne Agee.
Please go ahead.
John Nadel
Hi, good morning everybody. A quick one real quick following up on the Wachovia put I was just want to go back and sort of think about you guys provided formal notification to well as about month and half ago.
As I understand it they were supposed to comeback to you within the couple of weeks after that and give you a sense for the cash and stock mix and just wondering if you got that notification and so can you give us a sense for what's going to common in terms of cash stock next?
Mark Grier
Yeah, John its Mark. Just as a general statement up front first both of us are complying with everything that we've agreed to and the process is proceeding.
I would say on an orderly basis toward making sure that we did through an orderly settlement of this in January. Their requirement was to notify as of either stock or cash or a combination of the two.
They notified us that they would be delivering a combination of the two. And we're working on how and when will be more specific.
John Nadel
Okay. And Mark is it fair to assume that some point and maybe we've already begun that prudential we began a sort of hedging or forward sales or some sort of transaction to remove the downside risk associated with the drop and well as the stock?
Mark Grier
Well, I don't to make too many specific comments on that at this point but we will have an objective to preserve the value of the consideration and also to satisfy the RBT objectives as Rich mentioned.
John Nadel
Okay. Great, and then the last one is just little bit higher level John instead of maybe going after the guidance and how it differs versus last quarter and what in what might have changed?
And sort of thought maybe take a step back and think about the ROE of the company that the guidance implies. If we strip out the negative effects, the negative one timers in the 1Q and the positive net one timers in the 2Q and look at the mid-point or maybe even the high end of your range of guidance for 2009 implies that an ROE on an operating basis normalized around 10%.
And so obviously there is a lot of drags here holding high cash balances, the SMP is clearly while re bounding nicely still down meaningfully year-over-year. Real estate related earnings are down, but X capital management X and M&A transaction, you know that sort of thing, if we just assumed reasonably stable macro conditions from here, where can that ROE go over the next couple of years?
John Strangfeld Jr.
Okay, John. Happy to address that, actually let me take that in two parts, both because it make references for the run rate earnings.
So why don't I address that and then we'll talk about ROE longer term.
John Nadel
Thanks.
John Strangfeld Jr.
So if you look at the second half versus the first half run rate let me just explain that a little, I appreciate you keeping our low, earnings to spend a little I guess this questions about this. If you look at our core run rate earnings in Q1 and Q2 the rate around the dollar form in Q1 $1.23 in Q2, as we look to the second half, we were thinking about guidance, we're not factoring in more aggressive, investment returns we are also not factoring in the deployment of the recent capital raise into the businesses.
So you do have some of that dragged you were describing. What we are factoring in is the impact of the capital rates in terms of additional shares and also in terms of additional interest cost.
John Nadel
Yeah.
John Strangfeld Jr.
And we figured that those two factors, is the additional shares and showing through its cost account for about $0.10 to $0.15 per quarter in terms of their impact and hence when we adjust for the capital rates, therefore we see a lot of consistency between the first half and the second half. Now you're primary question -- so let me just clarify that but, your primary questions are long term our long term goal or aspiration is that ROE in the low to mid teens in normalized markets.
Now normalized markets has a lot of qualification to it.
John Nadel
Yeah.
John Strangfeld Jr.
Whether its the equity market, whether it's a level of interest rates whether is the commercial real estate markets, institutional retail buying behavior and also it presumed in that is it active management of capital and liquidity as well. So we think it's obviously pretty hard to find the time arising for that, given all the forces at work.
But what underpins our optimism long-term is the quality of our business mix. And we think that's what underpins our long-term aspirations.
So that's it that's my response to your two questions.
John Nadel
Yeah. That's great.
Thank you John.
Operator
Thank you. Our next question comes from the line of from Nigel Dally from Morgan Stanley.
Please go ahead.
Nigel Dally
Great. Thank you.
And good morning. First question annuity hedging, you mentioned that you started to hedge the GMTB on a limited basis with marked it up around 1000 want to give more aggressive and trying to eliminate some of that risk.
Second the loss on proprietary investment in asset management seems to a recurring item that we think for several quarter now. Can you provide some additional data along the total level of proprietary investments to keep back this driving net losses and also is it correct to assume that this losses are on legacy petitions which are probably difficult to unwind?
Thanks.
Mark Grier
I'll this is Mark I'll start with the first question. I don't want to go into a lot more detail about the whole annuity picture as you aware its fairly dynamic with respect to some of things happening on the statutory accounting front and we are examining everything that we do their with respect about stat and GAAP and hedging and products.
Factoring in the lessons learned over the past 12 months. You heard on investor day discussions around thinking about variable capital and how it comes back when the market goes up and we are experiencing the benefit of some of that right now.
And we're going to get back to you at some point I'm not sure it would be Investor Day with a broader story about the entire annuity picture for us. But I would say that we're looking for an efficient and effective ways to make sure that we're making the right decisions in the context of the market and the risk and particularly still considering the nature of the risk meaning some of it is genuinely is variable.
So, I don't want a go too much further than that in terms of talking about what we're doing except that we have become more active around guaranteed minimum death benefits.
Nigel Dally
Okay.
Mark Grier
And now let Bernard comment on the proprietary investment.
Bernard Winograd
Nigel the proprietary investing the principle driver there of trends that we've been seeing recently and particularly in this quarter has been commercial real estate market. We have been in a process of lowering the amount of capital we have committed to proprietary investing, it's down under a $1 billion and it that's cut roughly in half at its peak.
And I would just say here that the driver is a combination of things that in the commercial real estate market the way in which the performance manifests itself is that the you have initially weakness in asset values and subsequent weakness in mortgage portfolios. As the asset value impact on equity begins to make it's way into the performance approval the delinquency and Wachovia with the mortgage portfolios.
So, the underlying cause at the moment and since the beginning of the year has been primarily the real estate market and it will continue to be the real estate market but the mix is going to shift a little bit and then more of it will be a mortgage side going forward.
Nigel Dally
Okay. That's great.
Thank you.
Operator
Thank you. Our next question comes from the line Tom Gallagher Credit Suisse Group.
Please go ahead.
Thomas Gallagher
Hi, just a first of all for Bernard so, if I understood you correctly the you have two impacts here, one is the mark-to-market of the decline of value -- the second is the I guess the losses you would experience on the loans which are I presume you putting up loan loss reserves for senior loans that you have there and is that's right or we likely to see similar sized drags do you think for the next several quarters on the loan side because I presumed it called up on the mark-to-market stuff that's my first question.
Bernard Winograd
Well, we're trying to catch up on the mark-to-market stuff but some of this is not in the indirect in the sense that you have accrued incentive fees at risk for call back. So, it's not necessarily linear, you are can't necessarily get to the point where in turns around until the market itself begins to turn around, we are not there just yet.
Having said that yes what I do think that the next year and just to clarify the 900 million is what we had outside of the interim loan portfolio of 1.08 billion, but the mix of where those losses will come from is probably going to increasingly be driven by the recognition of problems in the loan -- in the mortgage loan world over the next 18 months. I will Rich speak to this if we need to but the we are not in a position to reserve what we think we the ultimate losses will be in the mortgage portfolio we have to reserve -- increase reserve as the experience actually arises.
And while we've taken our view of the ultimate loss into account in our stress testing another forward looks, we are in terms of current period recognition constrained is to what we've been recognized until the problems actually arise in the mortgage portfolio.
Thomas Gallagher
And one more quick follow up on that if I may, and as we think about this billion 9 loan book, is it all related to what you're doing in the general account in terms of the senior loans, I presume this is somewhat the lower quality a bit more speculative, but is that all connected, should we view this as an early indication of what we might see in the CRE loan book at Prudential Insurance company?
Bernard Winograd
No. If the general accounts have had appetite for lending of this kind it would be in the general account.
This is deliberately a more aggressive loan portfolio than we use to support the liabilities that the general account is supporting, the principal difference is while we're not all the way to the place, where the banks are, we're not doing construction lending (ph) and we're certainly not doing speculative lending, we're doing in effect redevelopment lending on established properties that are going through some kind of repositioning. And so the loan loss and the risk of loss is higher here, than what we've experienced in the -- or expect to experience for that matter in the general account portfolio.
Thomas Gallagher
Okay, okay, thanks. And then, just one last question, just generally, I guess maybe even for John, the does the big jump in variable annuity sales concern you at all?
And that may sound a bit kind of intuitive but, the reason I ask is when I see as dramatic an increase in sales and net flows in a preferred product like variable annuities, I guess I wonder, why are we seeing such a dramatic change and is that indicative of the fact that may be your products are more aggressive or is that something you've looked into and how overall should we be thinking about that?
John Strangfeld Jr.
I think, let me ask Bernard to elaborate on this, I think a lot of this has been with the fact that we do each product re-tooling well before the rest of the market has and we're quite comfortable in where we're at. Bernard.
Bernard Winograd
Yeah. Let me try to explain, why we're feeling comfortable with what we sell, which is a notable contrast, I think to a lot of our competitors in this space.
The auto re-balancing feature that Mark referred to earlier that we package with living benefits, you know transfers takes a lot of the risk of offering this guarantee out of the product and we wind up with what we think is a very attractive risk reward ratio. It is something which for -- where we remain the only significant player offering this kind of products in the annuity space.
There was more channel resistance to this product than there is now, and as the auto re-bouncing has demonstrated its virtues I think we found it easier to add new distributors -- we don't have final numbers yet but we think our market share is now 12 to 13% instead of 8 and I think the fact that some competitors are pulling back because they don't have similar risk reward products and that there is in general, an example here the kind of slides quality we talked about in generally the domestic markets it's a combination of all those things. The superior products, a good corporate sponsor and weakened competition.
Thomas Gallagher
Okay. Thanks.
Mark Grier
Tom another point there also is were this on the basis of the old book we would have about this on the basis of the new book which we've been writing to closing in on two years we're very comfortable with the risk profile.
Thomas Gallagher
Understood. Thanks.
Operator
Thank you. Our next question will come from the line of Dan Johnson from Citadel, please go ahead.
Dan Johnson
Hey thanks. Just a simple one can you remind us as to how much of the Wachovia gain has already been booked.
So depending on what the final number is we can figure out the remaining shareholders equity attrition? Thank you.
Richard Carbone
Yeah, the -- this is Rich. There was a gain booked on the options back a year so build sitting inside of stockholders equity but that is not benefiting the RBC ratio.
So I think you want to ignore that and if we use the benchmark of 5 billion the after-tax gain is somewhere a tune of 1.7 billion.
Dan Johnson
1.7 for on a GAAP basis but the whole -- I guess you'd call that 5 billion plus whatever tax offset would go to benefit the RBC which is where you get your 100 points?
Richard Carbone
Well, there is already -- remember now the investment is carrying in PICA. So PICA is already enjoying a $2 billion carrying value that's a good asset and was a surplus.
So the incremental add to surplus would be the 1.07 billion plus some incremental tax benefits upon a $5 billion assumption for gross proceeds.
Dan Johnson
Got it, and that gets you to your...
Richard Carbone
100 RBC.
Dan Johnson
Okay. Thank you very much.
Operator
Thank you. We have time for one final question and that would be from the line of Mark Finkelstein from Fox Pitt Kelton, please go ahead.
Mark Finkelstein
Hi. Actually one quick follow question on the asset management commercial real estate comments.
I'm curious what is the PRU exposure to unfunded commitments. I believe there is a fair amount that are cut in the funds.
I don't if there is co-investments on those. And in those scenarios if there is losses that you assume to occur in portfolio, do you take those today or does that occur actually when they are funded.
Just wondering if this is a relevant discussion?
Bernard Winograd
This is Bernard. We won't throw in the exact number on the unfunded comments but the short answer is that to the question that I assume is on your mind which is that when we fund the commitment we are buying in at current market values, not at some historical cost basis that is no longer in the occurred values.
Richard Carbone
But if -- this is Rich, if this got trapped inside of a FAS-5 contingent liability and there was a loss contract per se we would analyze it for recognizing the loss at that point in time.
Mark Finkelstein
Okay. All right, and then I guess just I think in the past you said that VA Carven (ph) is expected to have little impact I guess.
Can you just give an update on a current thinking on that and with the equity market up should that turn into a benefit, what are the sensitivities if anything you can disclose around that?
Richard Carbone
We haven't refreshed our calculations of the current markets, but because of the way we held reserves, we didn't take full advantage of lowering or lowering down our RBC because of the regulatory regime at the time, so we topped them up which is why when we implement VA Carven (ph) the numbers are going to be order of magnitude a 100 and 120 million bucks. And may be come down from there, but we haven't done that calculation that's the downside.
Mark Grier
Yeah, that answer's consistent with what we had said as of year end and as Rich said we haven't refreshed that but that's the downside, it's very small for us.
Mark Finkelstein
Okay. And then, just finally one last question, just looking at the corporate segment and I understand the comments on liquidity and excess liquidity and negative spread, should we be thinking about this level of loss, you know going forward is that, what's essentially embedded in guidance, I mean how should we think about the corporate segment for the back half of the year?
Richard Carbone
It's going to be pretty consistent with what you see, except that it doesn't have without bearing all the interest expense of that a billion dollars, that we issued in June, so if they can attack on another 35 million, 7% on the billing and 70 million, half of that's 35 million so you are going to have to add that right around.
Unidentified Analyst
Right.
Richard Carbone
The two quarters.
Mark Grier
And, I think with respect to the time horizon you've got in mind, we would say we expected a more or less looked the way its expect for the items Rich mentioned.
Mark Finkelstein
Right, okay great thank you.
Operator
Thank you. We have us on the line of Ed Spehar from Bank of America-Merrill lynch.
Please go ahead.
Edward Spehar
Thank you. I want to follow up on the liquidity question, just Rich could you tell me did you say that you are going to your plan was to put a $1.5 billion to $2 billion of the cash to work by year-end did I hear that?
Richard Carbone
No.
Edward Spehar
You didn't say that?
Richard Carbone
Well -- let me think about this well. So, yeah, I was going to bring the cash that the holding company down from the 3.05 billion which was net of CT and the inter-company borrowings and I was going to bring it down from the 3.05 to $2 billion and that 1.05 billion side would be put into the regulated entities.
Yes, Ed you are correct.
Edward Spehar
Okay, so if we have no ability to allocate among segments at this point and we were just using corporate as a catch wouldn't there be improvement in corporate if that was our cat hew from this type of an action?
Bernard Winograd
No, I don't think so I think I have got 1.5 billion seating in corporate making them in cash, making I don't know 1%. So, on the sure that down into the businesses its not going to improve corporate it may improve some of the business earnings modestly.
Edward Spehar
Yeah, I guess that's my point I just as a cat choral if we from the earnings overall earnings standpoint that there is a 5% let's say incremental investment income pick up as you move this money now?
Bernard Winograd
There should be at but that maybe ceiling yes, I guess the answer is going to be simple answer yes.
Edward Spehar
Okay, and then on the Wachovia if we did assume the $5 billion number in terms of the earnings impact which is near-term which is just be thinking about investing assuming you sale any shares you get you are going to be investing after tax proceeds or the cash that you go correct?
Bernard Winograd
Yes.
Edward Spehar
And what is that number if we said it was $5 billion that you get what is that means in terms of after tax cash to you.
Bernard Winograd
Think of a 7 billion -- I'm sorry that became think of 3 billion.
Edward Spehar
So 3.07 billion to investment, mean there is no earnings impact from anything related to the senior numbers today correct?
Bernard Winograd
Very small.
Edward Spehar
Okay. Thank you very much.
Operator
Thank you. Next we'll go to the line of Jimmy Bhullar from JP Morgan.
Please go ahead.
Jimmy Bhullar
Hi. I had a couple of questions on items that have been discussed before but first on verbal notice, on the order rebalancing obviously it's a positive when the markets decline but it's does limit upside in the rising market.
So I just wanted to get an idea whether you expect to see an uptick in withdrawals or just are you getting any push back from agents about that as the markets have been recovering. And then secondly on commercial real estate the losses are obviously been modest thus far and if Bernard could just address on what your view for commercial real estate on weather it losses are reflective of just improve fundamentals or is it expected that the losses would be lowed just given the lag versus the normal credit cycle?
Bernard Winograd
Jimmy the VA question we have -- we are not -- we are still as you can tell by the difference between gross and net flows in the VA business. We're still not seeing the level of redemptions that we used to see historically in this business.
We used to get maybe a 10% run rate redemptions it's looks like it's stabilized at about 8% at this point. Until the market get quiet a bit higher it's hard to believe that that pressure was likely to change.
Jimmy Bhullar
Have you gotten pushback from people on the fact of their account values might not had gone up as much, especially if they bought around the bottom of the market?
Bernard Winograd
Well, I think people bought at the bottom of the market but the short answer to your question is no, we haven't because there, they tend to compare where they are compare to what they could have been and they are feeling very good about this. I mean the general claim experience of people who are the beneficiaries of our auto rebalancing guarantees is that it is done for them exactly what they were told them what to do, which is limited their exposure in the downside and they willingly gave up and understood they were giving up offset in order to get that and that is what they want and that's what they are getting.
So no we have not have push back on that point.
Jimmy Bhullar
Okay.
Richard Carbone
With regard to commercial real estate I am not sure, I fully understood your question. As I said earlier that we do anticipate that of losses in the mortgage portfolio are going to be high over the next 18 months and that's a fact that there are very few delinquencies at all.
At this point in the general account portfolio should not be taken as an indication that they won't be
Jimmy Bhullar
That's basically what I was asking?
Richard Carbone
Yeah, it was so.
Jimmy Bhullar
Thank you.
Operator
Thank you. Our next question comes from the line Eric Berg with Barclays Capital.
Please go ahead.
Eric Berg
Thanks for extending the call. I actually just have one question which is also a follow up on the real estate.
Since you said Bernard that you expect losses in the general account in the mortgage portfolio to be high that's I think that's what you said. Is it correct to conclude from that, that you are expecting really dramatic reductions in commercial real estate values because I just think arithmetically has to be the case of the only way you would have a loss given your reasonably loan to value ratio, I don't have the exact number is it you have really is it if you are anticipating 30, 40% decline in property prices am I thinking about how you are thinking about the future, the real estate business correctly?
Thank you.
Bernard Winograd
What Eric what we tell our clients is that we expect a peak to trough decline in real estate values, I should say our equity clients -- equity real state clients. We expect a peak to trough decline in commercial real estate values of 45%, and that we think 30% has occurred already which means its about 20% more from here.
Eric Berg
And just one quickly, do you expect -- some in curious said what we effect that sort of magnitude of decline, but not for us because we're much better what are...go ahead.
Bernard Winograd
We're talking, we may be talking about apples and oranges or lets juts be clear about this. That's a decline in equity values, once that translates into in terms of losses in the commercial real state portfolio is a totally different matter.
I would say to you that we have an extrication that losses in our commercial real estate portfolio or -- mortgage portfolio, excuse me, are going to accelerate over the next 18 months. But I don't want to you to read into that, that we think they are going to be unusually high by historical standards.
In fact we think our mortgage portfolio is much better positioned going into this down cycle than it was say in the last down cycle, where our exposure to the office sector almost losses occurred was 40% and is now only 20%. So we're feeling very good about the relative performance of our commercial loan portfolio, compared to our peer group, but we're not feeling good about the way in which those losses will be recognized.
as to whether that it was -- excuse me we are feeling like the next 18 months will be worse than the last six and the fact that there has been very little in the way of delinquencies. So far it should not be taken as indication there won't be losses.
Eric Berg
So, just to be absolutely clear about this Bernard because as you point out it is easy to get it wrong. When you say that you are expecting the equity value peak to trough drop of 30 to 35, 45% do you mean owners a decline in the value of owner's equity and their building or do you mean a decline in the value of the building.
So, those are two very different things.
Bernard Winograd
The latter. We are talking about the decline in the value of the building.
Eric Berg
Thanks very much.
Operator
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