Prudential Records $618 Million Loss on Derivatives

Prudential Financial Inc. (PRU), the second-largest U.S. life insurer, swung to a loss in the third quarter as derivatives weighed on results.

The net loss of $618 million compares with a profit of $1.59 billion a year earlier, Newark, New Jersey-based Prudential said today in a statement. Operating profit, which excludes the results of policies sold before the firm went public and some investments, was $1.53 a share, missing the $1.67 average estimate of 17 analysts surveyed by Bloomberg.

Chief Executive Officer John Strangfeld is trimming expenses and deploying cash for deals and buybacks as he targets a return on equity of at least 13 percent next year. ROE, a measure of profitability, was 11 percent to 11.5 percent last year, Strangfeld said Feb. 15. The insurer uses derivatives to guard against market risks such as interest-rate drops and currency fluctuations.

“The U.S. business, with the low interest-rate environment here, is going to be somewhat challenged,” Edward Shields, an analyst at Sandler O’Neill & Partners LP, said before results were announced. “They’re either going to have to cut expenses generally speaking, accelerate share buybacks, or increase the bottom line contribution from the international segment,” to achieve the ROE target.

Prudential boosted its annual dividend to $1.60 a share from $1.45, the company said in a separate statement. The insurer plans to begin making payouts quarterly in 2013.

Derivatives Loss

The insurer fell 42 cents to $54.97 at 4:48 p.m. in New York after the announcement. It declined 4.6 percent to $55.39 earlier in regular trading. Prudential has climbed 11 percent this year, outpacing the 4.5 percent advance of MetLife Inc. (MET), the largest U.S. life insurer.

Prudential recorded a pretax loss of $684 million from derivatives, including contracts used to hedge risks from products it sells. The insurer also lost $521 million before taxes on foreign currency derivatives, primarily from fluctuations in the value of the yen.

A $698 million charge tied to long-term-care insurance reflects updated loss projections, the firm said. Prudential stopped selling group and individual policies this year, joining rivals including MetLife in retreating from the industry amid rising costs and low interest rates.

Prudential agreed in September to buy Hartford Financial Services Group Inc.’s individual life-insurance business for $615 million as Hartford focuses on property-casualty coverage. The deal may help Prudential reach the ROE goal, Eric Berg, an analyst at RBC Capital Markets, wrote in a note in September.

Unit Results

The international insurance segment adjusted operating income rose to $783 million in the quarter from $660 million a year earlier. Prudential said in September that return on equity in the international business may be as high as 19 percent next year, compared with 17.5 percent in 2011. Prudential is working to cut expenses after its 2011 acquisition of two Japan-based life insurers from American International Group Inc. (AIG)

Adjusted operating income at the U.S. retirement-solutions and investment-management unit surged to $504 million from $42 million. The business sells annuities and oversees funds for investors. Gross annuities sales rose 32 percent to $5.93 billion.

Prudential was the largest seller of the retirement products known as variable annuities in the first six months of this year, while MetLife was No. 3, according to industry group Limra. Low interest rates can weigh on profits from the savings products while rising stocks can boost them.

Goodwill Expense

MetLife reported a $1.6 billion goodwill impairment in its U.S. annuities unit in the third quarter as low interest rates reduced expectations for future profits. The New York-based insurer reported a net loss of $954 million as the impairment and derivatives weighed on results.

The write-off “does not bode well for the industry” and other insurers may report similar charges, Neil Strauss, a senior credit officer at Moody’s Investors Service, wrote in a Nov. 5 report. “A prolonged period of low interest rates is bad for insurers, resulting not only in lower investment earnings and profit compression on spread-based products, but also higher reserve increases and meaningful writedowns of goodwill.”

Strangfeld, 58, is also boosting Prudential’s pension business, agreeing last month to assume $7.5 billion of retirement-plan obligations from Verizon Communications Inc. General Motors Co. paid Prudential a premium of about $25 billion to take on pension obligations for about 110,000 retirees, the insurer said Nov. 2.

Book value was $79.51 a share at Prudential’s main business as of Sept. 30. The measure of assets minus liabilities was $78.07 three months earlier.

Prudential is in the final stage of a regulatory review to be designated a non-bank systemically important financial institution, the company said last month. Firms in that category could see dividends and buybacks curbed as regulators try to prevent a repeat of the 2008 financial crisis.

To contact the reporter on this story: Zachary Tracer in New York at ztracer1@bloomberg.net

To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net

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