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Prudential Financial, Inc. (NYSE:PRU)

Q3 2008 Earnings Call Transcript

October 30, 2008, 11:00 am ET

Executives

Eric Durant – SVP of IR

John Strangfeld – Chairman and CEO

Rich Carbone – EVP and CFO

Mark Grier – Vice Chairman

Bernard Winograd – EVP, US Businesses

Ed Baird – EVP, International Businesses

Peter Sayre – Chief Accountant and Controller

Analysts

Suneet Kamath – Sanford Bernstein

Nigel Dally – Morgan Stanley

Jimmy Bhullar – JP Morgan

Andrew Kligerman – UBS

John Nadel – Sterne, Agee

Mark Finkelstein – Fox-Pitt Kelton

Tom Gallagher – Credit Suisse

Jeff Schuman – KBW

Eric Berg – Barclays Capital

Darin Arita – Deutsche Bank

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Prudential third quarter 2008 results conference call. For the conference, all the participant lines are in a listen-only mode. However, there will be an opportunity for your questions, and instructions will be given at that time. (Operator instructions) as a reminder, to this call is being recorded.

With that being said, I will turn the conference now to the Senior Vice President of Investor Relations, Mr. Eric Durant. Please go ahead, sir.

Eric Durant

Thank you, John. Good morning and thank you for joining us. We appreciate this opportunity to meet with you and to address 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 third quarter of 2008 which can be found on our website at www.investor.prudential.com.

In addition, in managing our businesses, we use a non-GAAP measure we call adjusted operating income to measure the performance of our Financial Services businesses. Adjusted operating income excludes net investment gains and losses as adjusted and related charges and adjustments as well as results from divested businesses. Adjusted operating income also excludes recorded changes in asset values that will ultimately accrue to contract holders and recorded changes in contract-holder liabilities resulting from changes in related asset values. The comparable GAAP presentation and the reconciliation between the two for the quarter are set out in our earnings press release on our Web site. Additional historical information relating to the company's financial performance is also located on our Web site.

Our first speaker today is John Strangfeld. John?

John Strangfeld

Thank you, Eric, and good morning. We have a great deal to discuss with you today, so I will be brief to allow more time for Rich and Mark and for your questions.

We have three headlines. First, underlying performance of our businesses continues to be solid, even though third quarter earnings are depressed. Second, we are confident that the level of risk in our investment portfolio is not excessive, and is manageable. Third, our strong balance sheet and flexibility will enable us to emerge from this challenging period with a competitive position intact or enhanced.

I will walk you through these points in order, the numbers that I cite are for the Prudential's Financial Services business. First, underlying performance of our business is solid. Sales and flows remain positive. The decline in third quarter earnings was driven by adverse market conditions. Unfortunately, as market conditions have worsened since September, our earnings remain under pressure. That said, this too will pass. We continue to have a set of businesses that are diverse, healthy, and competitive in their markets. We feel that our business models are intact and we are confident that Prudential is well positioned to achieve our long-term goals. However, given current market volatility, we are uncomfortable providing earnings guidance for the fourth quarter.

Second, we are confident that the level of risk in our investment portfolio is manageable. We have had a cautious view of the credit outlook in the US for at least two years, and as a result, our portfolio is defensively positioned. Our holdings of public and private corporate debt are significantly underweighted in financial institutions. Our largest sector overweighting is in consumer non-cyclicals, particularly food and beverages. Our commercial mortgage portfolio is well diversified by property type and by location. Rich will share the primary quality indicators of this portfolio with you in a few minutes. Suffice to say, the quality of this portfolio is extremely high. Our commercial mortgage-backed securities portfolio is 94% AAA, with favorable loan to value and debt service coverage ratios, as well as high subordination.

Finally, sub-prime asset backed securities are a manageable exposure for Prudential, just under $6 billion on a cost basis. We have reduced this exposure by $2.4 billion in the last year, primarily through repayments and to a lesser extent, through impairments. Two thirds of our remaining exposure carries AAA and AA ratings. We are in a credit cycle, and we will suffer losses, but we are confident that our portfolios will perform relatively well.

Third, financial strength. Equity on the books at September 30 is sufficient for the AA ratings objectives we have had for our insurance companies. Bear in mind that we hold a valuable stake in Wachovia Securities that is only partly reflected in equity on the books. As for liquidity, we have it. Mark will run you through the details but I will anticipate his conclusion, which is that we have sufficient liquidity to meet our needs of the parent company and at each of operating subsidiaries.

What that, I will now hand it off to Rich Carbone and Mark Grier, first to Rich.

Rich Carbone

Okay, thanks John. I will begin with an overview of our third quarter adjusted operating income, and then I will discuss our investment portfolio. All references and descriptions I am about to make are for the Financial Services business.

As you have seen from yesterday's release, we reported common stock earnings per share of $0.74 for the third quarter, compared to $2.13 for the year ago quarter, based on adjusted operating income. Our current quarter results are within the range we expected in our pre-announcement. As we pointed out then, operating results of our businesses were substantially impacted by various discrete items, which are in most cases closely tied to the unfavorable market conditions of the past few months.

Now first, I'm going to start with the negative items. In our Individual Annuity business, we increased our reserve to guarantee minimum debt benefits and increased amortization of deferred policy acquisition costs, producing a charge of about $0.65 per share. About one third of the charge came from modifying our assumptions to recognize policy holder tendency to keep their contracts in force, when debt benefit guarantees are in the money. The remainder of the charge came almost entirely from the substantial market related decline in account values over the past year, leading to lower expected fees, and higher expected benefit costs. Now also in the annuity business, we had a spike in our hedging breakage, resulting in a net charge of about $0.06 cents per share.

In our Financial Advisory business, the Wachovia joint venture absorbed the cost of a settlement relating to auction rate securities. Our share of these costs amounted to $0.41 per share.

And lastly, our Asset Management business, mark-to-market of fixed income and equity investments within our proprietary investing activities resulted in losses equal to about $0.19 per share.

They were a few positives. Our individual life business benefited from a favorable unlocking of DAC, mainly due to favorable mortality experience amounting to about $0.14 per share. Individual life also received compensation based on a multiyear profitability of certain third party products distributed by our agents contributing another $0.09 per share. Updates of reserves and DAC in the Group Insurance and Retirement business and mark-to-market of securities in international investments contributed a total of roughly $0.06 per share.

In total, the items that – had a net unfavorable effect of about a $1.02 on our earnings per share for the third quarter. In addition, our financial advisory segment absorbed $0.06 per share of transition costs for the A.G. Edwards integration into Wachovia Securities. Now bear in mind, markets have been extremely volatile. So adding back all the items I just mentioned to report our results to derive or arrive at a near-term run rate would not be useful in these markets. Nonetheless, stripping out the market related impacts, the underlying results of our businesses continue to be on track as Mark will discuss in a moment.

Now moving on to our GAAP results. We reported a net loss of $108 million or $0.23 per share for the third quarter. This compares to net income of $860 million or $1.88 per share a year ago. Current GAAP pretax results include net realized investment losses of $547 million. This compares to net realized losses of $180 million a year ago.

Now the impairments included in our realized loss number this quarter reflect a change we feel is necessary in the way we apply our impairment policy. With the current state of the financial markets, the SEC, the FASB and the public accounting firms have provided further guidance on how to determine fair value of securities, and re-emphasized the need for application of judgment in the determination of other-than-temporary impairments. In a recent statement, the SEC's Office of the Chief Accountant specifically pointed to the lack of bright line rules for impairments under GAAP, and emphasized the need to exercise reasonable judgment based on facts and circumstances of each investment in deciding whether to impair. Given these comments from the standard setter, as well as the current extraordinary market conditions, we have taken a fresh look at our approach for recognizing other than temporary impairments and decided to no longer use a 20% six month test as a presumptive shortcut. We have therefore changed our approach. Commencing with the current quarter, we will continue to use declines as filters and apply heightened levels of security as the extent and the duration of decline in value increases. However, for securities which we have intent and ability to hold until recovery of value, our determination of whether a decline in value is other than temporary now places greater emphasis on our analysis of underlying cash flow, whether we believe this security is money good. As of September 30, we had about $500 million of unrealized losses on general account fixed income securities that we consider money good and continue to hold, what would have impaired had we continued to apply our policy in the same way as the first half of the year.

Turning back to the $547 million of net realized investment losses. $502 million were impairments and losses on sales of credit impaired investments. Credit related investments was $321 million and losses on sales of credit impaired securities were $12 million for a total of $333 million. This is within the range of $325 million to $375 million that we disclosed in our pre-release. The credit-related impairments included $310 million for fixed maturities and derivatives of which $38 million were on sub-prime paper and about $200 million were on our exposures to Lehman and AIG that we disclosed in our 8-K previously.

We continue to take accounting driven impairments to securities that we don’t intend to hold until recovery, which in this quarter amounted to $169 million. These impairments include write-downs on equity holdings of our Japanese insurance companies, which reflect equity market declines in Japan. For equities, we are continuing to impair when there is a decline in value of 50% or more for six months or for any decline that persist for 12 months.

Now, looking at the unrealized losses. Total gross unrealized losses on fixed maturities in our general account stood at $5.9 billion at the end of the third quarter, up roughly $2 billion from June 30. Almost 90% of the $5.9 billion relates to investment grade securities, where values have declined from the widening of credit spreads to unprecedented levels, rather than credit deterioration. About $1.5 billion of the $2 billion increase in unrealized losses came from corporate securities across virtually all sectors. Roughly $1.2 billion of total gross unrealized losses relate to subprime, an increase of $300 million from the second quarter.

Total subprime holdings were $5.9 billion at the end of the quarter. Our holdings, based on amortized costs were down nearly $500 million from the second quarter this year, reflecting about $400 million of pay-downs in line with our expectations, and $91 million of credit impairments, including the $38 million of credit impairments that I previously mentioned. Virtually all of our subprime holdings were priced as of the end of the quarter using third-party pricing services. Rating agency downgrades affected $400 million of our subprime holdings this quarter. However, nearly 95% of these holdings are investment grade and about one-third of the portfolio roughly $2 billion, and amortized cost represents AAA securities.

We are continuing to monitor delinquency rates and cash flows for collateral underlying our subprime. Our current estimate of potential loss of principal from subprime holdings under stress scenarios, and again, assuming no recoveries from monoline bond insurers, increased $50 million to about $550 million after tax over a 5-year period. This estimate is based on our current evaluation of expected cash flows, considering incident and severity of defaults under stressed scenarios, which imply a decline in housing prices underlying these securities of 40% from peak to trough.

At September 30, the general account fixed maturity portfolio included roughly $8 billion of commercial mortgage-backed securities. Over 94% of these holdings have AAA ratings, and gross unrealized losses of $584 million. Our exposure to CDOs is limited.

General account holdings at September 30 are about $500 million with virtually no underlying subprime exposure in the CDO mix. Non-investment grade securities comprised 6.5% of the $116 billion portfolio at September 30, essentially unchanged from last quarter and from last year end. Gross unrealized losses on the fixed maturity portfolio were $2.3 billion at September 30, up from $2.1 billion a quarter earlier, bringing net unrealized losses on our total $116 billion fixed maturity portfolio to $3.5 billion at the end of the quarter.

One last comment on the investment portfolio. We have $22 billion of general account commercial loan holdings as of September 30. While there is good reason to believe the commercial real estate holding is in a down cycle, we believe that our holdings are well positioned to be less vulnerable to overall market conditions than a broad brush view would suggest. Our mortgage portfolio is seasoned, well diversified by geography and property type. At September 30, the average loan to value ratio for our commercial mortgage holdings was 57%, and the average debt service coverage ratio was 1.9 times. As of the end of the quarter, about $60 million, less than 0.5% of the entire portfolio was delinquent or in for closure.

In summary, while our current results and values in our investment portfolio reflect unprecedented market conditions, our underlying business performance remains solid, and we remain comfortable with the level of risk in the investment portfolio.

Now, I am going to turn it over to Mark, who will make some comments on capital liquidity, and review the bulk results of all of our businesses of the quarter. Mark?

Mark Grier

Thank you, Rich. Hello, everyone. Before I go into the business discussions, I would like to comment on some key elements of financial strength and flexibility that have been receiving great deal of attention.

Our capital position is consistent with our AA ratings objective for our insurance companies as of September 30. With the current state of the financial markets, we are reluctant to quantify a measure of excess available capital, which would include our capacity to issue additional hybrid securities in more normal markets.

We have robust sources of liquidity, including $3.8 billion of cash and short term investments on the parent company balance sheet as of September 30. While commercial paper markets generally have become less active in recent weeks, demand for our commercial paper, especially the top tier rated paper issued by Prudential Funding, the funding arm of Prudential Insurance, has continued. At September 30, we had $7 billion outstanding under that program and a further $761 million outstanding under our parent company program. Both of our programs qualify under the federal government’s recently announced commercial paper funding facility, which would accept up to $9.8 billion of Prudential Funding paper and $1.3 billion of parent company paper under the guidelines.

The membership of Prudential Insurance in the Federal Home Loan Bank of New York, which commenced in June, provides us with a substantial further source of liquidity. Under this program, Prudential Insurance can pledge up to 5% of its admitted assets, excluding separate accounts for collateralized borrowings. As of September 30, our unused borrowing capacity under this program, considering this statutory limit and holdings of qualifying securities at Prudential Insurance, is about $6.5 billion. Among the qualifying securities are AAA rated subprime paper held by Prudential Insurance.

Our securities lending program is relatively modest amounting to $6.9 billion for the financial services businesses as of September 30. While this program allows us to modestly enhance our investment returns, it is not mission critical. We have generally limited the program to liquid securities that are requested by counterparties rather than pushing securities out to the market. And we have avoided significant duration mismatches. Nearly, one quarter of our securities on loan at September 30 are treasuries, where demand remained high and which would pose no potential liquidity issues if the positions were unwound. We estimate that as of September 30, we have an additional $10 billion of lendable securities within the financial services businesses.

Now I will cover our business results for the quarter. I will abbreviate my comments on business drivers in order to leave more time for questions and answers, but if I neglect to cover subjects of interest to you, we will be happy to address them in the Q&A session.

I will start with the Insurance division. Adjusted operating income from our Individual Life insurance business was $238 million for the current quarter, compared to $251 million a year ago. Current quarter results benefited from two items that Rich mentioned earlier, the DAC unlocking, which came mainly from updating our actuarial assumptions to give effect to mortality experience over a five-year period, contributed $79 million; and compensation we received based on multiyear profitability of third party products, distributed by our agents contributed another $53 million. Results for the year ago quarter included a similar benefits; $78 million from a favorable unlocking, and $57 million from compensation related to our distribution of third party products. Stripping these items from the results, Individual Life’s adjusted operating income was down $10 million from a year ago. Amortization of deferred policy acquisition costs and related items, based on current quarter experience and excluding the impact of the unlocking, was roughly $30 million higher than a year ago, reflecting the impact of the equity market downturn. This negative swing was partly offset by mortality experience, which was more favorable than a year ago.

Our Annuity business reported a loss of $307 million for the third quarter, compared to adjusted operating income of $205 million a year ago. Current quarter results include a $380 million negative effect from the unlocking. I will break this down into three pieces. When we reset our expectations for account value-based fees, and costs for guaranteed minimum death and income benefits, we start with the level of account values at the end of the quarter, and then apply a reversion to mean approach. Under this approach, we set expected future returns for a look forward period, currently four years, so that expected returns in combination with actual historical returns will average out to a long-term assumption.

However, we cap the expected returns for the look forward period, meaning that we will not assume returns greater than a maximum level of 10.5% overall. A portion of our business reached this cap, contributing about $130 million to the negative unlocking. A further $150 million of the unlocking represents the higher expected costs of guaranteed minimum death and income benefits, and lower fees associated with the remainder of the business where we assume that future performance will average out with historical performance to meet our long-term expectations, but nevertheless expect lower gross profits during the period while account values recover to ultimately reach the expected levels. The remaining $100 million of the unlocking came mainly from a change in our assumptions as to the tendency of contract holders to keep their annuities in force when guaranteed minimum death benefits are in the money, meaning that more of these guarantees are expected to turn into claims than if these customers lapsed at our average rates. We call this a dynamic lapse assumption, and introduced it this quarter following the completion of a study of customer behavior over several years.

Up to this quarter, we have applied a corridor for market performance in evaluating DAC related amortization items and guaranteed benefits, meaning that we have held out the impact of market performance until the annual review in the third quarter, unless the changes breached a materiality threshold. With the greater level of volatility we are seeing in the financial markets, we have determined to move away from the corridor approach commencing with the fourth quarter of this year and will therefore give effect to market performance each quarter.

The adjusted operating income we report also includes breakage between changes in the values of our living benefit guarantees and our hedging instruments. With the turbulent financial markets in the current quarter, we experienced negative breakage of $37 million after related amortization of DAC, resulting in a negative swing of $44 million in comparison to a year ago. The current quarter breakage is net of a positive from updating our living benefit assumptions for mortality and volatility as part of our annual review. To keep this breakage in perspective, I would note that we are hedging exposure on about $22 billion of account values as of September 30.

Results for the year-ago quarter benefited from a favorable unlocking, which amounted to $30 million. Stripping out the unlockings and hedging breakage from the comparison, annuity results were down $58 million from a year ago. Apart from the annual unlockings, we true up our amortization of DAC and other costs as well as our reserves for guaranteed minimum death and income benefits each quarter to factor in current experience. The challenging financial market conditions of the third quarter contributed to an unfavorable true up of $38 million, resulting in a negative swing of $53 million in comparison to the similar true up a year ago.

Our gross variable annuity sales for the quarter were $2.5 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. We are also continuing to enjoy positive net sales, which were about $500 million for the third quarter. With our transition to products with highest daily, or HD, features, a growing proportion of our account values with living benefits, 47% at the end of the third quarter compared to 35% a year earlier, are essentially self hedging as to equity market risks, since the customer agrees to our daily rebalancing from the selected funds to fixed income investments in support of the guarantee when there are equity market declines. In addition to reducing our risk profile and decreasing our exposure to changes in hedging costs, this rebalancing has protected our customers from substantial account value declines through recent financial market conditions. About $5 billion of account values were transferred to fixed income investments under this program in the third quarter, bringing the total to about $9 billion since the beginning of the year.

The Group Insurance business reported adjusted operating income of $101 million in the current quarter, essentially unchanged from $100 million a year ago. Results for the current quarter and the year ago quarter each benefited $13 million from group visibility reserve refinements based on annual reviews.

Turning to the Investment division. The Retirement segment reported adjusted operating income of $133 million for the current quarter, compared to $65 million a year ago. Current quarter results benefited by $12 million from refinements of DAC and other amortization items, including the impact of our annual review, while the year ago quarter included an $81 million charge reflecting payments made to clients who authorized us to proceed on their behalf to recover losses on several investment funds managed by State Street Global Advisors.

Stripping these items out of the comparison, results for the Retirement business were $25 million below the year ago quarter. This reflects both a higher level of expenses, as we continue to invest in client service and distribution capabilities on our full service platform and lower fees due to market value declines in customer account values. These market value declines more than offset the impact of positive full service net flows for the past four consecutive quarters. These flows amounted to roughly $400 million for the current quarter and $1.7 billion over the past year. Our full service persistency is over 95%, and in the current market environment, our stable value funds have proven especially attractive to plan participants, receiving over $500 million of customer funds for the quarter, and $1.7 billion since the beginning of the year.

The Asset Management segment reported a loss of $8 million for the current quarter, compared to adjusted operating income of $161 million a year ago. In proprietary investing, we co-invest with our institutional clients in funds we managed, including fixed income, public equity, and real estate strategies, and the record changes in the value of our interests in the investments. Current quarter results included mark-to-market driven losses of about $110 million, from fixed income and equity investments as Rich mentioned. This compares to income of about $10 million from these investments a year ago. In addition, performance based fees were down from the level of the year ago, when we benefited from a stronger commercial real estate market. We continued to register net inflows of third party institutional funds in the third quarter, amounting to $1.2 billion, with positive contributions from equities, fixed income, and real estate investments.

The Financial Advisory segment had a loss of $217 million for the third quarter, compared to adjusted operating income of $85 million a year ago. This segment reflects our interest in the retail brokerage joint venture with Wachovia. Wachovia combined the acquired retail securities brokerage business of A.G. Edwards with our joint venture on January 01. Prior to the combination, we had a 38% share in the joint venture, but our initial share of earnings and transition costs from the date of the combination with A.G. Edwards will be based on a diluted ownership percentage, which is still in the process of being finalized. We are now reporting results based on our estimate of the percentage, but we don't expect a material impact on results from any difference between the finalized percentage and our estimate. Our share of the joint venture results this quarter included the absorption of $235 million of costs of a settlement with regulators relating to auction rate securities, as well as $37 million transition costs related to the A.G. Edwards combination. Excluding these costs, our share of the joint venture contributed $57 million of adjusted operating income, compared to $97 million a year ago, reflecting the effect of current financial market conditions on both transaction and fee revenue.

Turning to International businesses, within our International Insurance segment, Gibraltar Life’s adjusted operating income was $167 million in the current quarter, up $10 million from a year ago. The increase came mainly from improved investment margins, as we implemented strategies to lengthen maturities and increase US dollar investing based on our economic investment in Gibraltar and continued to grow our book of US dollar fixed annuity business. Sales from Gibraltar Life, based on annualized premiums in constant dollars, were $112 million in the current quarter, up from $93 million a year ago, a 20% increase.

Our Life Planner business, the international insurance operations other than Gibraltar Life, reported adjusted operating income of $293 million for the current quarter, up $27 million from a year ago. The increased tracked continued business growth mainly in Japan. The Life Planner operations also benefited from improved investment margins, reflecting some of the same portfolio strategies as those I mentioned for Gibraltar. Sales from our Life Planner operations, based on annualized premiums in constant dollars were $180 million in the current quarter, compared to $186 million a year ago. The decline was driven by lower sales outside of Japan, including our business in Korea, where we continue to face difficult competitive conditions. Sales in Japan are $122 million for the current quarter, up approximately 10% from a year ago, reflecting strong sales of our US dollar-based retirement income product. 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 reported adjusted operating income of $37 million for the current quarter, compared to $114 million a year ago. Current quarter results included mark-to-market income of $14 million on securities related to trading exchange membership. On the other hand, results for the year ago quarter benefited from a total of $76 million from similar mark to market income, a sale of an operating joint venture interest and recoveries on a former investment. Stripping these items out of the comparison, adjusted operating income from the International Investment segment was down $15 million from a year ago, reflecting a lower contribution from our asset management operations in Korea.

Corporate and other operations reported a loss of $21 million for the current quarter, compared to a $12 million loss 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 a net loss of $58 million for the current quarter, compared to net income of $7 million a year ago. The current loss reflected less favorable investment income results compared to a year ago. The current quarter results include a $119 million of pretax net realized investment gains as mark-to-market on derivatives, together with realized gains on securities, more than offset $120 million of impairments and credit losses in the quarter. We measure results for the Closed Block business only based on GAAP.

To sum up, as Rich told you, while our current results and values in our investment portfolio reflect adverse financial market conditions, our underlying business performance remains solid, and we remain comfortable with our investment portfolio.

Current market conditions are challenging, like they are for the companies. But we feel that our core business models are intact and that the balanced mix of risks and businesses that we have built since becoming a public company leave us in a good position to manage through the current environment. We are continuing to enjoy positive net flows in our domestic annuity, retirement, and asset management businesses, as well as sales growth in our individual life, group insurance, and international insurance businesses in the current quarter. We take this as a vote of confidence. In this environment, clients value our expertise, innovative products and guarantees, and perhaps most importantly, our reputation built over 130 years as they focus more than ever on financial security. We strongly believe that our solid balance sheet and scale coupled with proven execution skills position us well to continue to earn that confidence and achieve our long-term goals.

Thank you for your interest in Prudential. Now, we look forward to hearing your questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Suneet Kamath with Sanford Bernstein. Please go ahead.

Suneet Kamath – Sanford Bernstein

Thank you. Few questions, the first on excess capital and I guess the lack of commentary around it. As far back as I can remember on these calls, you have done a good job of detailing your excess capital in a pretty consistent basis, in terms of the drivers, and now it seems that you have backed away from that. What should we take from that, have the rules of the game changed, where perhaps some of the things that you thought where excess capital are no longer available to you, or what is the underlying message there? And then I will have a follow up if I could.

Mark Grier

This is Mark. Let me start and then I will ask Rich if he wants to add anything. Obviously, given the volatility in the markets and the broader set of market circumstances around what's functioning and what's not, we are reluctant to spit out numbers that claim to have access to capital structures that in this market environment might not be realistic. So, part of the answer is, current circumstances are not consistent with assumptions that we have made in previous discussions of excess capital. I would also add that in this environment, we would be thinking very cautiously and very carefully about applying a year-ago framework to capital standards and capital flexibility. The level of volatility and the level of uncertainty are unprecedented, you know, everyone talks about how we are in a tail outcome. This is one of those things that never happens, and I think being cautious and being conservative is appropriate, and I think translating year-ago thinking into today's picture is probably not the right way to think about it. As we have said, we are strong with respect to capital, our capital is consistent with our objectives, and I will ask Rich if he wants to comment further.

Rich Carbone

I think you did – you covered it completely, Mark.

Suneet Kamath – Sanford Bernstein

Okay, and if I could just follow up. Clearly recognizing your strength in terms of your balance sheet, if for some reason the rules of the game did change, and if for some reason you were downgraded to A, A-plus, could you just comment on which businesses would be the most impacted and I don't know if you have done this sensitivity work, but quantify what the earnings impact might be? Thanks.

John Strangfeld

Suneet, Bernard Winograd will speak to that.

Bernard Winograd

Yes, I think that we have not precisely quantified it because it does depend upon the circumstances in which it occurs. It depends, for example, upon the availability of competitors with superior ratings, so if we were singled out, you would get a very different answer than if a downgrading environment sort of is widespread throughout the insurance industry. The most sensitive of businesses obviously are certain of the spread lending or institutional businesses inside Retirement, and I think to a lesser degree, in certain large case sales in Individual Life in the United States. Beyond that, it would be relatively modest in its impact.

Suneet Kamath – Sanford Bernstein

Thanks, just one very brief follow-up on that. When you talk about the Retirement business, would a downgrade impact your in-force business, in other words, would there be triggers that would allow put provisions to go into place or are you, Bernard, primarily talking about new business? Thanks.

Bernard Winograd

Primarily new business. There are very few examples in our business system of downgrade triggers, if you will, that lead to immediate consequences. For example, we have less than $10 million worth of puttable GICs on our balance sheet, for example.

Mark Grier

Suneet, it is Mark. If you are asking whether or not there would be specific capital strains associated with collateral or puts or those kinds of arrangements, the answer is that would not be a material impact on us. Another observation is that we have been A for years, initially as a public company, before our upgrades.

Suneet Kamath – Sanford Bernstein

Got it. Thanks.

Operator

Our next question is from the line of Nigel Dally with Morgan Stanley. Please go ahead.

Nigel Dally – Morgan Stanley

Great. Thank you and good morning. First, just sticking on the capital issue, can you discuss the impact of equity market conditions on your capital? Markets are down, roughly 20% this quarter. Can you help us understand what impact that would likely have on your statutory capital? Second, given the market conditions and difficulty having debt markets, would it be fair to say that your appetite for acquisitions has decreased? And then just lastly, quickly on variable annuities, some of your peers have talked about changing the living benefit guarantees and/or pricing, can you discuss whether that is something you’re also looking at?

John Strangfeld

Nigel, this is John. Let us start with you first question. I will turn it over to Rich.

Rich Carbone

Okay, Nigel, I'm going to frame out that answer in terms of our rating. Our capital levels in our regulated entities at 9/30 were consistent with a AA rating, and a capital level at year end, assuming a 900 S&P is also expected to be sufficient to support a AA rating in all of our regulated entities. Now, to be fair, at a 900 level S&P, we would have to move some financial resources, internal financial resources from – mostly from the holding company, PFI, down to our US regulated entities to get to those AA capital standards. And we have those resources at the holding company at this time.

John Strangfeld

Nigel, this is John. On the second part of your question, regarding acquisition appetite, we continue to have an active acquisition appetite, we think we have financial flexibility to support it, and we look at this as an increasingly attractive environment to consider opportunities.

Nigel Dally – Morgan Stanley

Would it be – just a quick follow-on on that before we get to the variable annuities. Given the debt market conditions, though, would likely acquisitions more likely be financed by equity now, rather than debt in the past?

John Strangfeld

Yes, I would say that – well, firstly, if we withdraw from our internal resources of our opportunities internally, – but yes, it would be fair to assume that if we did something externally, offensively, we would be more inclined to tap into the external equity markets.

Bernard Winograd

Nigel, Bernard Winograd. To deal with the living benefit guarantees question, I think the short answer is that while we might make some incremental tweaks here and there, we have basically made the changes that we think these market conditions in the variable annuity business point to. In particular, the highest daily product suite, and it is a requirement that people rebalance to their accounts to fixed income in declining markets is for us the primary thing that you would want to do in the variable annuity space. It produces a product which is designed to narrow the range of possible results for clients, and therefore in a down market obviously has material benefits and we have already seen that in our own book, if we contrast how the highest daily value product sales performed compared to the other living benefits that we had written previously. We are much more comfortable with the degree of volatility and the returns and the client value proposition in the highest daily value space than we are in the traditional book. So, in the current environment, we basically feel like we have made the product design changes, anticipating that this risk was always out there in the provision of living benefits and we're going to look to take advantage of the current market and continue to market those products. We may find that there is also room to adjust charges, pricing and features, depending upon how others in the marketplace respond as well. But I think the primary point in response to your question is we feel pretty good about the products that we are currently selling in this environment.

Nigel Dally – Morgan Stanley

That is great. Thanks a lot.

Operator

Our next question is from the line of Jimmy Bhullar with JP Morgan. Please go ahead.

Jimmy Bhullar – JP Morgan

Hi, thank you. I have a few questions. The first one is on capital also. And you mentioned obviously the lack of access to the hybrid market or the credit market. But maybe you could differentiate between readily available excess capital and just looking at – you mentioned the cash on the balance sheet also, the credit dipper facility, but you have got about $14 billion of debt at short term, you have got – and converts [ph] coming due. If you could just give us some comfort around how – what the resources are to be able to meet those obligations? And then secondly, you did mention the change in accounting on DAC, what the likelihood of a charge is in the fourth quarter, given the severe market decline and to the extent you could quantify that. And then finally, just on trends in your PRU Japan business, sales have been negative the past couple of quarters, this quarter they were up almost 10%, if you could just talk about what is driving that besides just easy comps –?

John Strangfeld

Okay, so Jimmy, this is John. First, let us take the capital and DAC related questions. We will have Rich – Rich will take that.

Rich Carbone

Let me go the reverse order, let us take DAC first. If market levels continue at these levels, 900, 1000, whatever, there will be additional DAC write-off in the fourth quarter. I don't want to quantify it now, it is not linear and there are a lot of other variables that go into it. Secondly, let us go to the converts; we have got $1.9 billion of converts coming due in December, we have got $1.9 billion on the balance sheet right now at the holding company in short-term investments that mature on the day the converts have to be paid off.

John Strangfeld

Okay, and then on to the questions about the trends for PRU in Japan, I ask Ed Baird to respond to that question, Jimmy.

Jimmy Bhullar – JP Morgan

And then also just – resources that just sort of meet the short-term debt obligations that you have, I think it is about $13.8 billion in short-term debt that you have on the balance sheet.

Rich Carbone

Yes, sure. All of our short-term debt is matched off against assets that if we had to repay the short-term debt, we pay it off by selling the assets. But keep in mind, a lot of that is used in PICA. And PICA has availability for the Federal Home Loan Bank, a $6 billion plus liquidity feature in it. So PICA is the big life insurance –

John Strangfeld

PICA is Prudential Insurance Company of America, which has the Federal Home Loan Program; so, there is no liquidity squeeze coming out of our short-term or our long-term debt profile.

Jimmy Bhullar – JP Morgan

Okay.

John Strangfeld

Okay, over to Ed on Japan.

Ed Baird

Yes, on the Japan front, Jimmy, as you observed, it was a strong quarter. Much of that was driven by the US dollar denominated retirement income product, which as you know is a product we have had continuing success with, that tends to be particularly so when we see a strengthening of the Yen. It seems that Japanese consumer sees that as a good opportunity to buy a dollar denominated product. So, I think we can continue to see that kind of phenomena in the future as we have observed historically in recent quarters.

Operator

Mr. Bhullar, any further questions?

Jimmy Bhullar – JP Morgan

No, that is it. Thank you.

Operator

Thank you, and we will go to the line of Andrew Kligerman with UBS. Please go ahead.

Andrew Kligerman – UBS

Hey, guys. Good morning. You know, I just want to comment. Hartford did not provide great disclosure around capital yesterday evening’ Met did. And you can see the disparity in the way the stocks are behaving. So I would just suggest that any disclosure around capital that you could provide with some granularity would be a great help to us and I suspect, to the stock as well. So I have a few questions around capital. Where did RBC estimated – where did RBC end at the quarter? Number two, with the Wachovia Securities put, you mentioned it was partly reflected on the balance sheet. I think the last I remember it was on the balance sheet at $2.8 billion pretax. Maybe you should give us a little color around how do you think the rating agencies might view that in the scope of additional capital? Is that factored into potential excess capital, how is that viewed? And then I have a follow-up or two.

Rich Carbone

All right, Andrew. On the RBC, we closed at June above 350 and between 350 and 400 at September. We closed at the end of September – and we anticipate to close between 350 and 400 at year end, okay. We’re only using internal resources. As far as Wachovia goes, that’s a little tricky. Let me give you how that base is built. The basis is about $2.8 billion on the books, but $2 billion of that is the actual cost basis in the investment, and the other $800 million or so, I may not have the numbers exactly right, is the write up or the mark-to-market on the options that we booked when the Wachovia Securities and A.G. Edwards combined. Remember, we have a put in the call, and under GAAP we had a fair value of the options. So, that’s about $800 million, it sits in equity, it sits in required equity, and it sits in the book value.

Mark Grier

Andrew, it is Mark. Just a reminder; at the end of the first quarter, we talked about the potential value of that put being in the neighborhood of $5 billion. That’s a look-back value that’s based on market conditions about 10 months ago now. And whatever turns out to be and we’ve said plus or minus $5 billion based on comparisons to other deals. Whatever turns out to be is set as of January 01, this year. So, the value of that put for us and the ability to realize whatever is agreed upon as that value isn’t affected by current market conditions.

Andrew Kligerman – UBS

Mark, do you feel any – with the rating agencies, in your view, need to see you negotiate something with Wells Fargo now in order to kind of get credit for maybe additional value above and beyond $2.8 billion or is it understandable to them that this comes due in early 2010. It’s not that far off from now. Are you getting credit for that now or do they view the liquidity of that as key right now?

Mark Grier

I don’t want to speak for the rating agencies. But from our point of view, we can exercise this put on January 01, 2009 and collect the money the beginning of 2010, as you pointed out. The resolution of the situation with respect to counterparties and the ownership now of Wachovia Securities is a positive aspect of what has been going on for us in this. We factored into our thinking about financial flexibility and available capital. Again, I don’t want to speak for the rating agencies, but it is an attractive aspect of what we’ve got to work with.

Rich Carbone

And let me just add one thing so it’s clear. When we compute the required equity against which we must hold capital, we use 100% of the $2.8 billion investment in Wachovia Securities as an equity requirement of the company. So, when that eventually put unwinds, it frees up not only the $2.8 billion, but the gain over and above the $2.8 billion.

Andrew Kligerman – UBS

Got it. And then just left with TARP; I mean, could you give us any update on how you think that is progressing with treasury, are we likely – do you have any sense of whether the industry is moving toward that or pushing for that with treasury? And if it were offered, would you be interested in participating? And this is from the equity infusion component.

Mark Grier

Yes. We are evaluating the opportunities to participate in any of the federal programs. You heard mentioned earlier that we did enroll in the commercial paper program at the parent company level. That’s actually a Fed program, not a TARP program. I don’t want to speak for treasury. This is an evolving situation, and we will have to wait and see what the options are and make a decision at the time.

Rich Carbone

And we will have to evaluate the economics.

Andrew Kligerman – UBS

Thanks a lot.

Operator

Our next question is from the line of John Nadel with Sterne Agee. Please go ahead.

John Nadel – Sterne, Agee

Hi, good morning. Thank you everybody. Just two quick ones. One, I think Mark, you just mentioned that the value of the put option was fixed with respect to Wachovia. Could just remind us exactly how that works?

Mark Grier

Yes. When I say it’s fixed, that’s a little bit hypothetical because we haven’t crushed the cheese and dotted the eyes on, agreeing to that value, our plus or minus $5 billion is our estimate of that. But here is the mechanic. We have the right in this contract to look back and sell our interest back to Wachovia as if the A.G. Edwards deal had not happened.

John Nadel – Sterne, Agee

And that’s the key there, right?

Mark Grier

And, yes, now there are two parts to that. We sell it for an appraised value of our interest in the LLC, but that’s also when we collect our control premium. We didn’t receive a control premium when we contributed PSI to Wachovia Securities, but the agreement was basically that we would receive our control premium when we exit. So, that $5 billion is based on, first of all, what that entity would look like as if A.G. Edwards had not happened, our 38% ownership stake in that, and then the payment to us of the control premium that we didn’t get when we set up the joint venture.

Rich Carbone

And again, what that entity looked at, at a specific point in time, that point in time being January 01, 2008.

John Nadel – Sterne, Agee

Okay. Got it. And just the last question for you is, in the asset management division, you talked about the proprietary accounts fixed income equity a little real estate. Can you quantify for us your outstanding exposure, where you are sort of investing side by side with third parties?

Bernard Winograd

John, it is Bernard Winograd. The total is $2.7 billion. It’s actually mostly real estate, about 60% real estate with the balance divided between fixed income and equities. We are expecting that number to come down, partly because as a SEED capital portfolio, the portion of that that is SEED capital, clearly, given the extraordinary market conditions we’ve had building track records that include this period of time isn’t terribly productive. And so, we are in the process of re-looking at how much we have committed there and my guess is that it will come down.

John Nadel – Sterne, Agee

Then the 2.7, Bernard is that PRU’s commitment or is that the total commitment.

Bernard Winograd

That’s our investment alongside clients. And it’s usually about 6 to 1, client money to ours.

John Nadel – Sterne, Agee

Terrific. Thank you. That’s helpful.

Operator

And your next question comes from the line of Mark Finkelstein with Fox-Pitt Kelton. Please go ahead.

Mark Finkelstein – Fox-Pitt Kelton

Hi, good morning. I guess, firstly just a confirmation. Just on the Wachovia put value, you said plus or minus 5% or $5 billion. But the amount has now been finalized. Is it fair to say that that value does not consider activity subsequent to January 01, 2008, so if it moved around the $5 billion it’s not taking into consideration those –

John Strangfeld

Yes. This is John. That’s a correct assumption, Mark.

Mark Finkelstein – Fox-Pitt Kelton

Okay, great. And then secondly, can you just talk about the (inaudible), down I think it was $49 million. And if you’ve addressed it in the opening comments, I think I missed it, but I guess what is driving that? And I guess how should we think about that line going forward?

Bernard Winograd

Mark, it is Bernard again, I think the (inaudible) line is primarily affected in this period by the results of co-investing of the portfolio we were just talking about that I am expecting will come down. And I think that the sort of extraordinary volatility on the downside that you saw here is simply the result of the impact of the market environment on those investment portfolios.

Mark Finkelstein – Fox-Pitt Kelton

Okay. And then – go ahead.

Rich Carbone

The reduction in incentive fees that we had in the quarter largely related to our real estate activities would also have been reflected in that line.

Mark Finkelstein – Fox-Pitt Kelton

Okay. And then Bernard, the $2.7 billion that you talked about, 60% being real estate, is there any lag in the valuation of the underlying assets, is it mark-to-market at September 30? How should we think about the valuation of those assets?

Bernard Winograd

The valuation of those assets is a bi-appraisal. Appraisals have an inherent lag effect to them because appraisers look back at market conditions in trying to estimate current market values. But they also have a bit of a smooth effect for the same reason. We do have at least an annual appraisal of everything that is in those portfolios and it is done by third parties. It doesn’t all occur at once. So, in any given quarter, while there is a little bit of heavy weighting towards the fourth quarter, in any given quarter, you’ve got a mixture of current appraisals and appraisals that could be as much as nine months old.

Mark Finkelstein – Fox-Pitt Kelton

Okay. Great. Thank you.

Operator

Our next question is from the line of Tom Gallagher with Credit Suisse. Please go ahead.

Tom Gallagher – Credit Suisse

Hi. I just wanted to come back to the capital question just so I am clear on what the message is. Going into the quarter, I believe the excess equity capital separating out over and above that capacity was north of $1 billion. Can you just update us on what that number stands at today?

Rich Carbone

Tom, you are right. It was a $1 billion-ish at the end of June. And that capital was what was absorbed inside of Prudential Insurance and a couple of other subs in order to keep their capital levels at above the 350 RBC.

Tom Gallagher – Credit Suisse

Rich, as of today then we are adequately capitalized. But you wouldn’t say you have excess equity capital?

Rich Carbone

On balance sheet –

Tom Gallagher – Credit Suisse

On balance sheet –

Rich Carbone

There is no on balance sheet. There is a point Mark made right at the beginning that we still have over $2 billion of hybrid capacity given our ratios. But the markets are frozen and if they were unfrozen even now, neither you nor I would be happy at the rates we would have to sell at, we would have to issue that at. So, we are keeping that drive. It is there, it is available, but we are not issuing at those rates.

Tom Gallagher – Credit Suisse

Okay. And next question just based on the equity market decline, credit condition so far into 4Q. Presumably your capital position has gone down further. Can you just – and I realize doing a month by month capital update is hard, but can you just give us some directional indication of whether you are now somewhat efficient, whether you are still above the line in terms of AA requirements or where you stand now with regard to excess equity capital?

Rich Carbone

All right. Well, on balance sheet, we have no excess equity capital on balance sheet. But we still have the resources to maintain our 350 plus RBC ratios in our US domestic entities and appropriate solvency ratios in our foreign entities. And we also have the – we talked about the potential capital we talked about in the Wachovia JV.

Tom Gallagher – Credit Suisse

Okay. So, then, I guess taking it to the next step, Rich, as we think about a put option on the convert in December and then also the put coming due potentially in mid-2009 and bouncing needing to potentially put money into the subs if the environment remains as is. Should we think about – I think you said there was 3 billion of CP capacity under the current government facility, I presume you are going to utilize that further just based on the rates available outside that being more onerous. Is that a good way to think about it or maybe just talk about how you are going to think about funding those various issues?

Rich Carbone

Okay. Right now we don’t need any external funding sources to maintain our ratios in our regulated entities. That CP program, which we’ve signed up for at the holding company is 1.3, Tom, not 3.

Tom Gallagher – Credit Suisse

I was adding the two together, both holdco and opco CP program.

Rich Carbone

Opco CP was $6 billion or $7 billion. And that’s in the Prudential Insurance Company of America. We'd probably access the Federal Home Loan Bank. I don’t know, we’d probably access the Federal Home Loan Bank before we went to the inside of Prudential Insurance Company of America for funding. But this is not capital. We are not raising capital there. It’s just operating debt. Did I answer your question, Tom? Ask it again and I will try.

Tom Gallagher – Credit Suisse

Sure. Well, I just want to get a real clear sense. And this is a question that’s come up time and time again from me; I think it’s on people’s mind. I want to get a very clear sense of how you are going to fund the $5 billion of puttable convertibles that are coming due within the next nine months, let’s call it.

Rich Carbone

Okay.

Tom Gallagher – Credit Suisse

Starting with that, and then secondarily if conditions remain as is, how will you potentially get more capital into the operating subsidiaries to make sure you maintain your AA? That – really, those are the two.

Rich Carbone

Okay. Let me cover the first one, the converts. The $1.9 billion convert in December, we've got cash on balance sheet to pay that off. The $3 billion convert in June, okay, all of that money is sitting in unregulated entities, in a bunch of activities that we are starting in early January. We will start to bring down those activities if the capital markets don’t unfreeze. So, assuming there is no hybrid capacity, there is no ability to roll over the convert in June, we’ll begin in January, maybe December to unwind the activities that are going on in the unregulated entities and bring that cash back up to the holding company to pay off the $3 billion. And, once again, I'm assuming the capital markets are still frozen, okay? And then your last question or your first question – wherever it came in order there, we have sufficient financial resources at the holding company today to put into our regulated entities between now and year end to hold the 350 to 400 RBC ratio. So they exist today in PFI.

Mark Grier

Yes, Tom, I think the way you worded your question earlier was are you above the line and Rich’s answer is that, as he said earlier, we are above the line.

Tom Gallagher – Credit Suisse

Now that’s great. Thanks a lot for the clarification.

Operator

Our next question is from the line of Jeff Schuman with KBW. Please go ahead.

Jeff Schuman – KBW

Good morning. Just wanted the circle back again on the, I guess, the capital implications of the joint venture put. I think Rich said that if you did the transaction you would release $2.8 billion of required capital. And then I guess there would also be the upside from the gain. So, just assuming that $5 billion is the number – understanding that number is not set in stone, – but if it is $5 billion is it a total of $5 billion and that drops to the bottom line in terms of sort of excess capital or is there a tax offset, or what really kind of drops to the bottom line of your excess capital position in that transaction?

Rich Carbone

Yes, Jeff. This is Rich. There is a tax, but the tax is a little quirky. And we're looking at this carefully now. The book basis and the tax basis are different. So, let me just give you a rough justice here. To answer your question, it is between $3.7 billion and $4 billion of capital drops to the bottom line. And that becomes excess capital upon the exercise of the put. The taxes get a little tricky. So, at a $5 billion gross proceeds, we pick up between $3.7 billion and $4 billion of excess capital, if you will.

Jeff Schuman – KBW

Okay. That’s extremely helpful. And then – I'm sorry – just once again in terms of the timing of when you can elect it and when you would realize that?

Mark Grier

Jeff. It’s Mark. We can contractually exercise the look-back put in January of 2009 receive the proceeds in January of 2010.

Jeff Schuman – KBW

And is there any reason why you couldn’t have extra contractual negotiations to adjust any of that?

John Strangfeld

No, there is no reason we couldn't.

Jeff Schuman – KBW

Okay, great. Thank you.

Operator

And we go to the line of Eric Berg with Barclays Capital. Please go ahead.

Eric Berg – Barclays Capital

Thanks very much. I was hoping to sort of put the pieces together regarding several comments, Rich, that you’ve made on capital. What I am taking away is that at the end of the September quarter the risk based capital ratio of flagship Life company was 350 and that to get there you essentially absorbed the $1 billion of excess equity capital that existed at the end of June. Do I have that right?

Rich Carbone

It is above 350. And we didn't effectively absorb it to get there. It was absorbed on – down to there.

Eric Berg – Barclays Capital

Okay. So, since it was absorbed, since it was needed to maintain the risk-based capital ratio of the Life company at 350 or above, wouldn't the right inference be that since the stock market has fallen 20% since the end of the September quarter or above that, that you have taken subsequently a further reduction to your risk based capital ratio?

Rich Carbone

That’s correct. What I said was we took financial resources – or if it stays where it is today, we will take financial resources from the holding company, put them into the flagship life insurance company, and the RBC rate, which we have at holding company and the RBC ratio will be between 350 and 400 at year end – at a 900 S&P.

Eric Berg – Barclays Capital

Okay. My next question relates to real estate and the value of CMBS. Yesterday, the Hartford began writing down the cost basis of its – not the fair value but the actual cost but the actual cost basis – taking other-than-temporary impairment on its CMBS saying that it was modeling into its analysis a real estate recession in – a recession in commercial real estate as bad as that in 1980. What is your sense of what is happening right now in the commercial real estate market? And what sort of forecast do you have embedded in your valuation of your CMBS securities, and in your allowance for loan losses on your whole loans? Thank you.

John Strangfeld

Eric, this is John. Bernard will take that question.

Bernard Winograd

Eric, the view we have of the commercial real estate market as to what is happening right this minute is very little. There are very few transactions going on and the industry and the lending activity is almost in a state of suspended animation because of the absence of liquidity, which makes it a little difficult to judge values. I think our view on the other hand is to be quite cautious about what a restrictive credit environment does to a capital-intensive industry like real estate. And while we don’t have a specific view that is uniformly applied to our thinking about the CMBS by security, our view generally is we would not be surprised to see commercial real estate values drop by 20% over the next few years. And if you do that, we believe that the portfolio that we have, which is at the moment 94% AAA and has debt service coverage well in excess of 1.5 times and a loan-to-value ratio of almost 70%, will incur relatively modest losses.

Eric Berg – Barclays Capital

Last question, very quick for Rich about the DAC and the DAC accounting. Rich you mentioned your use of the reversion to the mean approach and a corridor. My question is, the corridor is part of that reversion to the mean approach, right? It is part and parcel of the same discussion, is that correct?

Rich Carbone

I guess you could –

Peter Sayre

Let me take it?

Rich Carbone

Sure. Peter, the Chief Accountant and Controller will take that question.

Eric Berg – Barclays Capital

Thank you, thank you very much.

Peter Sayre

Let me separate it in two pieces. There was a corridor that we used to apply, which going forward we are no longer, around when would update market performance assumptions. And we would do that once a year. Now we are going to a quarterly update and that quarterly update will take into account the reversion to the mean methodology.

Eric Berg – Barclays Capital

Okay. So, you are going to no longer use a corridor approach, instead you will be using a reversion to the mean approach with a cap and floor?

Peter Sayre

Well. We’ve always used a reversion to the mean in annuities. It also was overlay of a corridor of an annual update. In the Life business, we’ve always used a quarterly update of market performance assumptions, so we are moving to what’ve done on the Life side. And in both businesses, we’ve used a reversion to the mean approach historically. So, that’s no change there.

Eric Berg – Barclays Capital

Thank you.

Rich Carbone

There is a corridor –

Eric Berg – Barclays Capital

No, please, Rich, go ahead with your final comments. Go ahead.

Rich Carbone

The corridor was just a mechanism. So, we wouldn’t be creating immaterial impacts quarter to quarter to quarter. And so we stored stuff, whether it was a gain or a loss, we stored stuff up in the corridor and we unlocked it in the third quarter as long as it didn't exceed an amount that we felt was material. And I think you would recall from the second quarter, we disclosed that we had stored in the corridor $57 million of losses that if the markets didn’t turn around, we would have to write off in the third quarter. Well, the markets got worse and we wrote off more than $57 million. But we are not going to use that storing mechanism anymore. Whatever happens in the quarter is coming through just like we do for the Life business.

Eric Berg – Barclays Capital

Thank you.

Operator

And we have time for a final question and that will be from the line of Darin Arita with Deutsche Bank. Please go ahead.

Darin Arita – Deutsche Bank

Thank you. Question on the RBC ratio. Can you give us what the major drivers of the RBC ratio moving from 551% at the end of ’07 to the 350% to 400% range at September 30?

Rich Carbone

Well, Darin, the biggest item was a $1.5 billion dividend that we took out of PICA and paid up to the holding company that we used to repurchase stock. And then the next is going to come from the stuff we've been talking about, the annuity stuff mostly. Those are the two big items.

Darin Arita – Deutsche Bank

Okay, that’s helpful. And given that Prudential had operated as a A company for years. Now how important would it be to defend the AA rating, if those requirements became unreasonable and the cost of capital was too high?

Rich Carbone

Well, I think the way you worded it when you said too high might be sort of a leading question. I think Bernard gave a good answer to the potential impact on us; it depends on the industry setting and it depends on market conditions. So, there is not a short crisp answer to that question. It would depend on the context. We feel like we are strong, we have good businesses and we are doing well.

Darin Arita – Deutsche Bank

Okay, great. Thank you.

Operator

And for closing comments, I will turn it back over to Mr. John Strangfeld. Please go ahead.

John Strangfeld

Yes, thank you. Well, I just want to offer a couple of observations. There has obviously been a lot of focus today on capital, liquidity, portfolio quality. And obviously, given the times, it is very understandable. We don’t however want to lose sight on the business fundamentals and the long term implications. We like our positioning. We like our business mix, whether it is international versus US, or retirement versus protection or equity market sensitive versus not. We like the quality of the businesses that make up the mix, they remain very attractive and you see momentum in our businesses reflected in the drivers. And we think this bodes well for our growth prospects in the inevitable and eventual improvement in the business environment. And our investment portfolio is defensively positioned and our financial position remains strong. So we feel good about our prospects. And we thank you for your time today and appreciate your interest. Have a good day.

Operator

Ladies and gentlemen, this conference is available for replay. It starts today at 1 PM Eastern and will last until November 06, at midnight. You may access the replay at any time by dialing 800-475-6701 or 320-365-3844. The access code 904644. Those numbers again 1-800-475-6701 and 320-365-3844, access code 904644.

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Source: Prudential Financial, Inc. Q3 2008 Earnings Call Transcript
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