Prudential Financial, Inc. Q4 2007 Earnings Call Transcript

Feb. 7.08 | About: Prudential Financial, (PRU)

Prudential Financial, Inc. (NYSE:PRU)

Q4 FY07 Earnings Call

February 7, 2008, 11:00 AM ET

Executives

Eric Durant - Head of IR

John R. Strangfeld - CEO and Chairman-Elect

Richard J. Carbone - CFO

Mark B. Grier - Vice Chairman

Bernard Winograd - EVP, U.S.A.

Peter Sayre - Controller and Principal Accounting Officer

Analysts

Suneet Kamath - Sanford Bernstein

Darren Arito - Deutsche Bank

Thomas Gallagher - Credit Suisse

Jeff Schuman - Keefe Bruyette and Woods

Edward Spehar - Merrill Lynch

Dan Johnson - Citadel Investment Group

Eric Berg - Lehman Brothers

Tamara Kravec - Banc of America Securities

Andrew Kligerman - UBS

Operator

Ladies and gentlemen, thank you very much for standing by and good morning, good afternoon, good evening around the world today and welcome to Prudential's Fourth Quarter 2007 Earnings Results Conference Call. Now at this point and during management's prepared remarks we do have all of your phone lines in a listen-only mode. However, later, there will be opportunities for your questions. [Operator Instructions]. And as a reminder, today's call is being recorded.

So with that being said, let's get right to the fourth quarter agenda. Here with our opening remarks is Head of Investor Relations, Mr. Eric Durant. Good morning, sir and happy New Year. Please go ahead.

Eric Durant - Head of Investor Relations

Good morning, Brad. Good morning to all of you and thank you for joining us. I'll run the commercial. 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 prediction that we make today.

Additional information regarding factors that could cause such a difference appears on the section titled Forward-Looking Statements and Non-GAAP Measures of our earnings press release for the fourth quarter of 2007, 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 fourth quarter are set out in our earnings press release on our website.

Additional, historical information relating to the companies financial performance is also located on our website. Our program today is presentations by John Strangfeld, CEO; Rich Carbone, CFO and Mark Grier, Vice Chairman. For the Q&A, they will be joined by Bernard Winograd, Head of Domestic Businesses and former Head of our Asset Management Business and by Peter Sayre, Controller and Principal Accounting Officer. John?

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Thank you, Eric. Good morning and welcome. This is my first opportunity to speak with you as Prudential CEO and I welcome this occasion. As a whole, 2007 was an excellent year for Prudential. Earnings per share increase by 21%, based on after-tax adjusted operating income, return on equity for the year reached 15.7%, up from 14.3 in 2006, again based on adjusted operating income. These results are broadly indicative of our earnings power during the year. While unusual, where market sensitive items can distort results in any given quarter, the net effect of these items on results for the full year was minimal.

The fourth quarter stands apart from the year as a whole. Highly unusual dislocations in credit markets resulted in significant mark-to-market losses on investments we hold in Europe credit market instruments, and in our commercial mortgage securitization operation in the U.S. We also recorded an $18 million expense relating to the insurance guarantee fund obligations, stemming from the bankruptcy that occurred many years ago. These three items took a toll on our reported results in the quarter, but should not obscure the underlying performance of our businesses, which remains strong. In particular, I would say record sales in annuities, improved sales and flows in full-service retirement, strong flows in institutional asset management and continued growth in our international life-planner business.

The volatility of financial markets is a fact of life. We are weathering this storm well. Our portfolio of businesses is well balanced and diverse. While we do have challenges in some asset classes, we have the skills we need to manage through these challenges successfully. Difficult market conditions also create opportunities for us to attract talent to our company and perhaps investment in our business. We have to wear with all to do both, which brings me to another great strength of Prudential, our balance sheet.

Capital management has been instrumental to our efforts to achieve our financial goals and remains an important component of our plans. We still have dry powder, roughly $2 billion of excess equity on the books as well as roughly $4.5 billion in untapped capacity to issue capital debt and hybrids. We prefer to use this capital in expanding our businesses, including acquisitions. But it is not burning a hole in our pocket. On the contrary, we are committed to the financial and strategic discipline we believe we've demonstrated in past acquisitions.

Share repurchases remain on level we used to manage our capital; the Board authorization to purchase up to $3.5 billion is in effect for 2008. We believe that repurchase of roughly $875 million per quarter is a realistic base case for Prudential at this time.

And while we're on this subject, I should comment on our credit ratings. We recently completed our annual reviews with the rating agencies and have had our ratings affirmed by A.M. Best, Fitch and Standard & Poor's. And we are under review for a possible upgrade by Moody's. These opinions are very important to us and we are pleased with the outcomes.

Finally, I'll address guidance for 2008. We are reducing guidance for Prudiential's common stock earnings per share to a range of $7.50 to $7.80 based on adjusted operating income. To be clear, our expectations for the underlying performance of our businesses are unchanged. Rather, this new guidance reflects the impact of changes in market conditions, including equity market levels, interest rates and credit spreads that occurred late last year and so far this year. It is also predicated on an assumption that financial market conditions will be essentially stable; that is unchanging, over the remainder of the year.

The mid point of our earnings guidance equates to a return on equity for 2008 of approximately 15%. We continue to be confident that ROE will expand within the 16% to 18% range we have targeted for 2008 to 2010, as we rationalize our capital structure and as more normal market conditions return.

The key for us is strong execution along with a portfolio of businesses that I believe gives us the opportunity to achieve superior financial returns. I have great confidence in Bernard Winograd who has assumed responsibility for all of our domestic businesses and Ed Baird who has a similar role for the international division as well as Mark Grier and Rich Carbone who you all know.

After Rich and Mark walk you through the quarter in greater detail, I look forward to your questions. Rich?

Richard J. Carbone - Chief Financial Officer

Thanks John. I'll begin with an overview of fourth quarter adjusted operating income for the financial services businesses. As you have seen from yesterday's release, we reported common stock earnings per share for the financial services business of $1.61 for the fourth quarter compared to $1.65 for the fourth quarter a year ago, based on adjusted operating income. Results for a number of businesses were affected by short-term swings that are clearly linked to volatile financial market conditions.

Similar to the third quarter, several of our businesses recorded mark-to-market losses within adjusted operating income, amounting to $83 million pre-tax or $0.14 per share on externally managed fixed income investments in the European market.

The assets... the underlying assets are mainly European corporate bonds and asset-backed securities with about 90% at investment grade and no exposure to U.S. subprime mortgage paper. The changes in market value reflect continued widening of spreads in European credit markets, rather than defaults or impairments. These are not credit losses.

We hold these investments through structures that allow us to swap the underlying cash flows to currencies that are a good match for Japanese and U.S. insurance liabilities. And our accounting treatment is based on the structures.

Here is an important point. If the underlying volumes were held directly, the unrealized changes in value would have been in other comprehensive income under FAS 115 rather than in the income statement. To further this point, other comprehensive income includes approximately $60 million of cumulative gains, primarily interest rate-related on the underlying positions while the mark-to-market losses that reflects spread widening are included in adjusted operating income as I noted above.

Secondly, in our asset management business, widening credit spreads resulted in a pre-tax loss of $49 million or roughly $0.08 per share from the commercial mortgage securitization operation. In addition to these market-related items, we recorded an expense within corporate and other results, for the insurance guarantee fund obligation amounting to $18 million or roughly $0.03 per share. The sum of these three items was a negative of about $0.25 per share to current quarter results.

In contrast, our earnings a year ago included net favorable contribution of about $0.04 per share for market sensitive or non-recurring items. Now Mark will review our business results for the quarter. Mark?

Mark B. Grier - Vice Chairman

Thank you, Rich and John and hello everyone. I'll start with the insurance division. Adjusted operating income from our Individual Life Insurance business was $125 million for the current quarter, compared to $132 million a year ago. The amortization of differed policy acquisition costs and related items was roughly $20 million higher than a year ago. Most of our Individual Life deferred acquisition cost is amortized based on actual and expected gross profits. And we update our expected revenues each quarter, based on the end point for account values. The current quarter downturn in the equity markets, in contrast to a strong quarter for the equity markets a year earlier, was largely responsible for the unfavorable swing in back amortization.

On the other hand, mortality experience for the current quarter was more favorable than a year ago. This partly offset the impact of greater back amortization on Individual Life results. Sales, excluding COLI amounted to $122 million in the current quarter, compared to $143 million a year ago. A $28 million decrease in Universal Life sales more than offset an increase of $7 million or 15% in term insurance sales.

Sales for the year ago quarter benefited from large Universal Life cases with substantial initial drop in premiums, mainly sold through third party distribution. These cases tend to have a lumpy sales pattern and the year ago quarter accounted for almost 40% of our Universal Life sales for the entire year. We continue to maintain our vigilance to screen out stranger-owned life insurance, and we've avoided participation in some premium financing programs that can generate substantial large case sales in order to stay clear of this market.

Our growth of term sales reflects continuing development of third party distribution relationships, including direct response agents who specialize in term insurance as well as national and regional brokerage organizations.

The prudential agent count stood at about 2400 at year-end, down about 150 from a year ago. The decrease reflects attrition mainly of lower producers coupled with selective hiring. The attrition tends to be concentrated in the fourth quarter, since we hold agents to minimum production standards on a calendar year basis.

Our annuity business reported adjusted operating income of $167 million in the fourth quarter, compared to $154 million a year ago. The $13 million increase came mainly from higher asset-based fees driven by market appreciation together with strong net sales of variable annuities, which amounted to $2.1 billion for the year.

Our hedging program continued to perform well through the volatile equity market conditions of the fourth quarter. The adjusted operating income that we report includes breakage between changes and the values of our living benefits guarantees and values of our hedging instruments. This breakage in our reported results has been no more than single digit millions in any quarter since the program began in 2005, and was insignificant in the current quarter.

Our gross variable annuity sales for the quarter were $3 billion, up 15% from a year ago. In a market that is increasingly focused on retirement income security, our innovative living benefit features have been well received by customers and their financial advisors. The value of this guarantee becomes dramatically clear when equity markets are turbulent. And we are the only company that offers income guarantees based on highest daily value, made possible by our product innovation and risk management skills.

Our overall take rate for living benefit was more than 80% and account values with our Highest Daily or HD Lifetime Five feature that we introduced just over a year ago, reached $3.7 billion at year-end.

Last week, we announced the enhancement of our annuity features with the addition of Highest Daily Lifetime Seven, a living benefit feature that offers a protected value for lifetime withdrawals, based on 7% annual comp growth of the highest daily account value until the earlier or first withdrawal for ten years. Like our earlier Lifetime Five benefits, risk management is an integral part of product design. For example, we think of the equity market risk on our HD features as essentially self hedging, since the guarantee is supported by daily rebalancing the funds between the customers' selected variable investments and fixed income investments.

Our sales are continuing to benefit from expanded distribution, including the new distribution that came to us with the acquisition of Allstate Variable Annuity business in 2006. Each of our distribution channels; insurance agents, warehouses and independent financial planners registered solid double-digit increases in sales for the quarter, compared to a year ago.

The Group Insurance business reported adjusted operating income of $62 million in the current quarter, essentially unchanged from $63 million a year ago. Results for the year ago quarter included expenses of $14 million from a regulatory settlement. Stripping that out of the comparison, adjustment operating income was down $15 million from a year ago, mainly due to the less favorable group like results. In addition, investment results were less favorable in the current quarter as group insurance recorded $4 million of the marked-to-market losses on the externally managed investments in the European market that Rich mentioned.

Group Insurance sales were $51 million in the current quarter, essentially unchanged from $54 million a year ago, bringing total sales for the year to about $350 million. Most of our Group Insurance sales are registered in the first quarter, based on the effective dates of the business sold.

Turning to the Investment division; the Retirement segment reported adjusted operating income of $117 million for the current quarter compared to $121 million a year ago. Less favorable investment results had a negative impact of roughly $25 million on the comparison. The retirement segment recorded $14 million of the mark-to-market losses on the previously mentioned externally managed investments in the European market. The remainder of the decline in investment results reflected lower joint venture income.

The lower contribution from investment results in the current quarter more than offset the benefit of higher fees due to growth in full-service account values and more favorable case experience on group annuities and other traditional products.

Gross deposits and sales of full-service retirement business were $4.3 billion for the current quarter compared to $3.7 billion a year ago. New plan sales were $1.7 billion in the current quarter, including three large cases that contributed a total of $700 million. Our total retirement services capabilities, which allow us to offer integrated solutions for DB and DC retirement plans, were key to each of these case wins.

Our new IncomeFlex product, offering a retirement income solution modeled after our successful Life time Five annuity features is also contributing to our value proposition and was an important selling point for one of the plans we landed this quarter.

Net flows contributed $450 million to full-service account value growth for the current quarter and just under $1 billion for the year, as we continue to enjoy excellent efficiency, at the 96% level for the full year. Our gross sales are still below targeted levels and our main focus is on the mid to large case market, where both sales and lapses tend to be lumpy from one quarter to another. But we remain confident in our long-term prospects to generate large case sales in this market, while continuing our strong track record of keeping business on the books.

In December, we acquired a portion of Union Bank of California's retirement business, adding $7.3 billion of full-service account values and nearly 170,000 participants and bringing our account values at year- end up to $112 billion. This bolt-on acquisition offers an opportunity to add scale and expand our presence on the West Coast with minimal integration costs and no expected disruption to our sales or product development efforts.

The Asset Management segment had adjusted operating income of $145 million in the current quarter, down $42 million from $187 million a year ago. As Rich mentioned, current quarter results included a loss of $45 million from our commercial mortgage securitization operation, compared to a contribution to adjusted operating income of $18 million a year ago, for a negative swing of $67 million. The current quarter loss came from realized and unrealized losses due to widening credit spreads, similar to what we experienced in the third quarter. Wider spreads benefit our yield over the long-term on loans that we hold, but those that we originate for securitization in the Asset Management business maybe subject to these short-term market swings. We continue to regard market conditions as highly unusual in comparison to the commercial mortgage market's historical performance.

On the other hand, the Asset Management business benefited from higher income, from real estate transactions and securities lending services, greater asset management fees and more favorable proprietary investing results in comparison to the year ago quarter. These increases more than offset the benefit to year ago results from $44 million of incentive fee income related to several institutional real estate funds.

The Financial Advisory segment had adjusted operating income of $43 million this quarter, down $10 million from $53 million a year ago. Our 38% share of the retail joint venture with Wachovia resulted in a $23 million lower contribution to adjusted operating income, as a higher level of expenses within the joint venture during the current quarter reflecting the beginning of the A.G. Edwards integration process, more than offset growth in commissions and fees.

The segment's expenses for retained obligations in the current quarter were $13 million lower than a year ago, partly offsetting the impact of the lower joint venture income. Wachovia completed it's acquisition of A. G. Edwards on October 1st and combined A.G. Edwards with Wachovia Securities on January 1st, 2008. The process for determining the ownership percentage that we will apply going forward is moving towards completion.

The International Insurance segment reported adjusted operating income of $297 million for the current quarter compared to $364 million a year ago. The segment's results include adjusted operating income of $114 million from Gibraltar Life in the current quarter, compared to $132 million a year ago. For Gibraltar, current quarter results include $8 million of mark-to-market losses on the externally managed investments in the European market. Excluding these mark-to-market losses, adjusted operating income for Gibraltar Life was down $10 million from a year ago. The decrease came from higher expenses, reflecting technology and other cost for development of bank distribution and less favorable mortality than that of the year ago quarter.

Sales from Gibraltar Life based on annualized premiums in constant dollars, were $99 million in the current quarter, up 18% from $84 million a year ago. Life advisor sales were $92 million in the current quarter, up 24% from a year ago. More than half of the increase came from sales of U.S. dollar protection products, the remainder came from sales of our U.S. dollar fixed annuities products.

While Gibraltar's main distribution focus will continue to be at life advisor, we believe that the bank channel offers a good long-term opportunity for complimentary distribution. Our First Bank channel product U.S. dollar fixed annuities enabled us to cultivate distribution relationships with several Japanese banks, including one of the country's largest banks. Sales of our U.S. dollar annuity product through Gibraltar's Bank channel contributed $7 million to sales for the current quarter and $25 million for the year. As I mentioned, we are investing in further development of this channel, and within the last few weeks, following the implementation of new bank assurance regulations in Japan, we began the roll out of some of Gibraltar's life insurance protection product in the bank channel.

Gibraltar's Life Advisor count stood at about 6,260 at year-end, up 320 from both the year ago and the end of the third quarter. During the early part of 2007, we held back on our life advisor recruiting, as we made adjustments to our selection standards in hiring based on our observations about critical success factors. With our reinforced hiring standards now in place for several quarters, we felt comfortable baling up our recruiting efforts in the fourth quarter, bringing more life advisors on board to take advantage of opportunities in Gibraltar's market.

Our Life Planner business, the international insurance operations other than Gibraltar Life reported adjusted operating income of $183 million for the current quarter compared to 232 million a year ago. Current quarter results include $49 million of mark-to-market losses on externally managed investments in the European market. Excluding these mark-to-market losses, adjusted operating income for the Life Planner business was unchanged from a year ago.

Holding all out the same, we estimate that continued business growth contributed about $20 million to current quarter results in comparison to a year ago. In addition, our Life Planner results benefited by $8 million from more favorable foreign currency translation, mainly related to our Korean operations. However, the benefit of business growth and the foreign exchange impact were offset by a higher level of expenses than a year ago, including some technology and advertising costs and lower investment margins, which reflected fluctuations from some non-coupon items outside of Japan.

Sales from our Life Planner operations based on annualized premiums in constant dollars were $211 million in the current quarter, compared to $203 million a year ago. Sales in Japan are $131 million for the current quarter compared to $125 million a year ago. Sales for the year ago quarter included $12 million or about 10% of an increasing term products that offered tax advantages and was popular in the business market in Japan.

Prudential of Japan essentially stopped sales of this product in mid-year because of an anticipated tax law change that could eliminate the tax advantages. We have modified some of our products and are in the process of developing new products to remain competitive in the business market, while the product transition continues to affect our reported sales we are starting to register sales of the alternatives we are offering in this market.

Our Life Planner count in Japan was about 3,070 at year end, up 4% from a year ago. We transferred about 80 Life Planners to Gibraltar Life during the year, mostly to the home office staff, where they will contribute to the expansion of Gibraltar's bank distribution channel. Adjusting for these transfers, Prudential of Japan's Life Planner count increase would be 7% for the year.

For our operations outside of Japan, which mainly represents our Life Planner business in Korea, sales were $80 million in the current quarter, up modestly from $78 million a year ago. The Life Planner count in Korea stood at 1600 at year-end, up 4% from the level of a year ago. The Life Planner count has stabilized over the last few quarters following our implementation of some fine tuning of our compensation structure in Korea, including features to encourage sales of Life Insurance to new customers. And we are starting to see less poaching of life planners than we experienced through most of 2006.

Before leaving International Insurance, I would like to comment on our investment in China Pacific Life, one of the largest life insurance companies in China. Our investment which is through Carlyle Group along with a consortium of companies, dates back about two years and has been carried on the balance sheet that our cost of about $75 million. Despite the limited size of our financial commitment, as the only investor with insurance industry expertise, we are benefiting from our strategic relationship with China Pacific's management.

With the IPO in December of the entity that holds China Pacific Life, the estimated value of our stake has increased to roughly $630 million as of year-end. This valuation takes account of a discount for liquidity. Under GAAP accounting, this increase in value, about $550 million, was reflected in other comprehensive income similar to FAS 115 adjustments on most equity securities. I think of this may be as the good cousin to ECM, where the structure of the deal resulted in an accounting treatment that's, in this case, for a large positive result outside of income.

Future changes in sale restrictions applicable to our stake in China Pacific will result in different accounting treatments, possibly leading to income statement recognition of changes in value. We are very pleased with this financial result and are looking forward to the further developments of our relationship with China Pacific.

The International Investment segment reported adjusted operating income of $40 million for the current quarter compared to $34 million a year ago. The increase came from improved results from the segment's asset management operations. Including the $18 million expense for an insurance guarantee fund obligation that Rich mentioned, corporate and other operations reported a loss of $46 million for the current quarter compared to a loss of $13 million a year ago. The increased loss also reflected a lower contribution from investment income, net of interest expense and less favorable results from our real estate and relocation business.

Now I'll turn it back to Rich.

Richard J. Carbone - Chief Financial Officer

Thanks Mark. I will now comment on net income and the investment portfolio. Net income for the financial services business was $792 million for the quarter compared to $893 million a year ago. Current quarter results include pre-tax realized net investment losses of $14 million. This compares to net realized gains of $130 million a year ago. The current quarter losses include $54 million of impairments on asset-backed securities collateralized by subprime mortgages. Only $4 million of the impairments represents expected lower cash flow or loss of principal. Credit related loses and impairments in total were $106 million in the current quarter.

We also recorded $9 million of realized losses on sales of subprime paper in the quarter, or roughly $80 million of book value sold... on roughly $80 million of book value sold. These losses were a function of widening credit spreads in that market, rather than credit deterioration or downgrades. Our estimated potential credit losses for our subprime holdings remains at around $150 million after tax over a 5-year period. In stress scenarios that imply housing prices underlining these securities declined 40% from peak to trough. This estimate assumes full recovery from monoline bond insurers who currently wrap $1.6 billion of subprime bonds.

In our prior characterization of potential credit losses on our subprime exposure, we did not look through the monoline wrappers, where they were attached to our holdings. We felt this was appropriate at the time. Now, in response to changes in the environment, it is improper to discuss the underlying credits with regard to the monoline wrap. Let me give you a couple of cuts on our monoline exposure.

First, from the perspective of credit rating; absent any support from the monolines, we estimate that about $600 million of our total subprime holdings would be below investment grade, mostly second leans. In total, $1.4 billion of our monoline wraps cover second lean exposures.

Second, from the perspective of exposure to credit related principal loss. Assuming no recoveries from the monolines under the stress scenarios I mentioned, we estimate an additional credit loss of about $150 million after tax over a five-year period.

Our gross unrealized losses on fixed maturities in our general account stood at $2 billion at year-end. Of this amount, roughly $680 million relates to subprime holdings of $8 billion at year-end based on amortized costs. 97% of our subprime holdings were priced as of year-end using third party pricing services. These unrealized losses essentially reflect widening of credit spreads. These holdings are substantially all investment grade, with roughly 90% at AAA and AA.

We experienced very little ratings downgrade in our subprime positions. During the quarter, downgrades affected 76 million par value of our total $8 billion of holdings and there were upgrades on par value of about $39 million. About half of the $8 billion in the portfolio that we used to invest proceeds from securities lending and repurchase activities and operating cash, essentially short-term funding used for short-term investments. We have virtually no exposure to subprime mortgage-backed CDOs and we continue to be comfortable with the level of risk in our holdings.

At year-end, the fixed maturity portfolio of the financial services businesses included roughly $7 billion of commercial mortgage-backed securities. Over 90% of these holdings have AAA ratings and gross unrealized losses are $25 million. The remainder of the $2 billion of gross unrealized loses on fixed maturities relates primarily to widening credit spreads on other investment grade securities.

Our fixed maturity portfolio remains at a net gain position at year-end and net unrealized gains of $1.3 billion. Net investment grades fixed maturities comprise... non-investment grade, excuse me, non-investment grade fixed maturities comprise about 6.5% of the financial services business fixed maturity portfolio at the end of the year, essentially unchanged from a year ago.

Now let me make some comments around the Closed Block. The results of the Closed Block are associated with our Class B shares. The Closed Block business reported net income of $79 million for the quarter compared to $144 million a year ago. The current quarter expense for dividends to policyholders was $30 million greater than a year ago reflecting an increase in the dividends scale. And the contribution from net realized investment gains was lower in the current quarter. We measure results for the Closed Block business only on a GAAP basis.

To wrap up, I'd like to turn back to the financial services business and sum up where we came out for the year 2007. Each of our divisions registered double-digit percentage increases in adjusted operating income compared to a year ago. Our after-tax adjusted operating income reached $7.31 per common share, registering a 21% increase over 2006 and translating to an after-tax ROE of 15.7%. Unusual and non-recurring items, including DAC, unlockings, significant one-time events and transactions, reserve refinements, and income and losses on mark-to-market investments amounted to a net contribution of roughly $0.05 per share to our results for the year. Absent the that benefited these items, our ROE for the full year would be almost identical to what we reported. Thank you for your interest in Prudential and now we look forward to hearing your questions.

Question And Answer

Operator

Indeed. Well, thank you very much gentlemen for that update and overview. We do appreciate that. And ladies and gentlemen, as you just heard, at this point that we are inviting and encouraging any questions or comments that you may have. [Operator Instructions]. And first in queue representing Morgan Stanley, we go to line of Nigel Dally. Please go ahead sir.

: Nigel Dally: Morgan Stanley: Hi, thank you and good morning. First with your mortgage conduit operations, mortgage spreads have continued to widen. So should we expect another loss in the first quarter and if so, is reflected in your guidance? Second is international insurance, even stripping out the abnormal loans, it's clearly the most disappointing quarter that we've seen for the full year. I think for the first three quarters on a core basis you were running around $450 million. This quarter striping out the European investment market it was below $400 million. So, perhaps if you can spend just a little more time explaining the sharp drop in the fourth quarter and how we should be thinking about the run rate from which to grow future earnings.

Last, just on the buy back, clearly your stock is under pressure, down about 30% from its highest, typically in buying back your stock you've stuck to a very methodical plan, buying back exactly one quarter of your full year expectations every quarter. Does the sharp drop in the stock price lead you to reconsider that? Thanks.

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Okay, Nigel, this is John Strangfeld. I think what we suggest on the first one on the mortgage continuity that we... I invite Bernard Winograd who heads up our investment... our US division and previously investment division, to specifically speak to that.

Bernard Winograd - Executive Vice President, U.S.A.

Nigel, the... we cannot give you an answer as to exactly what's going to happen in the first quarter obviously, but certainly our guidance for this year takes into account what the credit market conditions have done to all of our businesses, including the conduit business in the first month of the year. Let me just say about the mortgage business that our core skill here in our core activity is a credit skill and what... I want emphasis that what we are discussing in terms of the losses that we have been reporting here are not credit problems and in fact we continue to feel that the credit conditions for commercial real estate are pretty favorable, delinquency and default rates remain at all-time lows and we haven't seen any significant upward trend in those... in what might otherwise be indication of distress.

This is a business that originates mortgages for three principal consumers. One is our own general account, which roughly speaking takes up about half of what we originate every year and the rest is divided between what we originate for the agencies Fannie Mae and Freddie and so forth. And then the last piece is this conduit market. And the conduit market has been disrupted and volatile for a couple of quarters now and continue to be so far in the first month of 2008. Our initial approach to dealing with that volatility was, as I commented it Investor Day to limit our exposure to how much net position we had relative to that kind of volatility. And as you can see in the results of the fourth quarter that approach hasn't been adequate. So, we are continuing to assess the market conditions and the way to deal with this. We rule nothing out more complete hedging, more through lending, directing more of our origination capacity to the other consumers' mortgages and potentially even withdrawing for a time from the conduit market are all possibilities that we have take into account. But we'll do that based on the dynamic assessment of where the market is, as we go forward.

Mark B. Grier - Vice Chairman

Okay, Nigel, it's Mark, on the international question. First of all, I'd be thinking in terms of the year as a whole, as opposed to any particular quarter, when you take a longer term or strategic sort of view of international as you want to take. And I guess the headline is, I don't feel that we are in any respect derailed from the path that we have talked about for international. Just to highlight a couple of things Life Planner growth was around 7% which is about where it's been, and when I say about where it's been that's over the last number of years. And that Life Planner growth has been producing good results. We did have a dampening impact on sales from the discontinuation of our product in Japan but overall we feel like sales still generally are tracking Life Planner growth. We are investing for growth in international, and feel like there are more opportunities for us to think about somethings a little differently as I have mentioned on the Investor Day. Unfortunately we can't time the increases in expenses and investments with positive mortality or positive investment results. And in the fourth quarter a few of those things, the combination was a little weaker than it's generally been. But again I would be thinking in terms of the full year. I would be looking at drivers that are very much consistent with what has propelled us to the level and performance that we've seen recently, and in fact view our opportunities as still very attractive.

Richard J. Carbone - Chief Financial Officer

Okay, Nigel. It's Rich. On the share repurchase program, we run our buy back program with capital management as the objective. As such we are likely going to stick with our historical pattern of buying ratably throughout the year.

: Nigel Daley: Okay thank you.

Operator

And thank you very much Mr. Daley. Next in queue, we go to the line of Suneet Kamath representing Sanford Bernstein. Please go ahead.

Suneet Kamath - Sanford Bernstein

Thanks. Just a couple of questions on the guidance again. With respect to the equity markets, I think we can use what you said in the past and what you are saying now and sort of calculate what the delta is in terms of what you expect the S&P to close at by the end of the year. And somewhere in the mid-teens in terms of the delta. But can you provide any sense in terms of how significant you are thinking is in terms of the interest rate assumptions and the credit spreads versus what you were thinking when you originally gave guidance and what sort of metrics in the market that we can look at to sort of track that over time. And then related to that, the guidance question is, when you have done your modeling assumption, and John you had mentioned that there is no change in the underlying business prospects. Have you changed the buyback price assumption, in other words, your stock is now in the 70s. You are going to buy an $800 plus million a quarter which obviously you are going to be buying it in at much lower price. Is that been reflected in the guidance? Thanks.

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Okay, Suneet, this is John. Let me start with that and I will turn over part of this to Rich Carbone as well. Our stocks with regard to guidance is that given the amount... the convergence of unusual forces at work here between the equity markets and the credit markets, we made a judgment that this was... this will be appropriate to have a reduction in guidance at this time. We're... the assumptions we are making are not a prediction, but they're a basis that we think is a comfortable framework to look at 2008 which is basically unchanged equity markets from the levels at the end of January, unchanged levels of interest rates from the end of January and unchanged credit spreads from the end of January. And that from our point of view we think that's a solid and comfortable way to be looking at this... looking forward. Rich?

Richard J. Carbone - Chief Financial Officer

Well a couple of things. First yes we have reflected in the average a lower average of stock buyback price versus our original guidance and I want to give you a broader picture of how we have... came to where we are today. The guidance we provided you in December assumed that the S&P would end the year around 1,480 and then appreciate at about 2% per quarter throughout 2008. Our revised guidance today assumes the S&P stays flat to the 1/31 close of 1,387. Also five year investment rates for A and BBB corporate credits are down about a 100 basis points from the reinvestment levels we assumed in our guidance when we provided that in December. This also factored into our revised guidance. And lastly the results of the impact of continued spread widening on our new guidance.

Suneet Kamath - Sanford Bernstein

Okay, thank you.

Operator

And thank you very much Mr. Kamath, next we have Darren Arito with Deutsche Bank. Please go ahead.

Darren Arito - Deutsche Bank

Well thank you. I was hoping to get a little more information on your commercial real estate exposures within your general account. Can you just talk about how your appetite has change for commercial real estate either whole loans or commercial mortgage backed securities over the past two years?

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Okay, so Darin, are you speaking about debt commercial mortgage debt activities.

Darren Arito - Deutsche Bank

That's right.

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Okay, so Bernard.

Bernard Winograd - Executive Vice President, U.S.A.

Just to take one thing out of the equation for clarity sake before I get to that answer, the... our general account has a very low exposure to equity in commercial real state of less than $1 billion, most of which is invested alongside other institutional investors in co-mingled funds. So our appetite for real estate exposure has been largely in the fixed income marketplace. We have been growing the size of our exposure to commercial loans and we've been doing that in particular in the last six months in response to the market condition because we have seen as the... this is the flip side of developments in the commercial mortgage backed sector.

As the availability of credit to commercial real estate from securitized lenders has shrunk. The opportunity to make loans at attractive spreads and on good terms for traditional lenders such as our own general account has grown. And so we have stepped up our origination appetite inside our general account. That said I think our overall exposure to commercial loans inside our general account is probably somewhat lower than others.

The commercial mortgage backed security market on the other hand as an investment vehicle as opposed to our origination activity outside of the general account. But as an investment vehicle for the general account has been something that we found increasingly attractive as well as spreads have widened out and we have confined ourselves to the high end of the credit spectrum in the commercial mortgage backed securities market that we've... as we've invested.

So nearly all of what we own in that regards is in the AAA category. I would say in general with regard to the commercial real estate market, we continue to see spreads at very wide levels, delinquencies and defaults in mortgages at very low levels. In particular our home loan portfolio, the delinquency rates and the default rates are so low as to be somewhat hard to measure in short periods of time and are a fraction of what is generally been experienced in the commercial mortgage backed securities sector even though that is also quite low by historical standards.

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Darin, I'm just going to embellish Bernard's comment very briefly. The average new first mortgage LTV for us in 2007 was 62% which is about the same as has been over the last four years due to amortization and appreciation of the existing portfolio currently has an average loan to value of 53%. If you look at debt service coverage ratios for the portfolio as a whole, the average is 1.9 times and the debt service coverage over the last four years has also been very stable, very close to that level. So this is a very high quality portfolio.

Darren Arito - Deutsche Bank

Okay great. That's very helpful. Thank you.

Operator

And thank you very much Mr. Reid. And next we go to the line of Jason Zucher [ph] representing the Viva Capital, please go ahead. Mr. Zucher your line is open, if you are speaking we can't hear you, please check your mute key.

Unidentified Analyst

: Thank you. Good morning everybody. A couple of quick questions, most of mine were answered. Can you give us an estimate for 2007, risk based capital, and then could you perhaps talk about any direct benefits you get from a lower short term rates?

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Well I will play the heavy on the RBC, we haven't filed at our step blank [ph] yet, we will do so in March, is that right Peter? Step blank bar into the March and we will be happy to address your question at that time but can't do so today.

Unidentified Analyst

Okay.

Unidentified Company Representative

On the second question, there is a lot of offsets and a lot of variables that go on, so while we may benefit in some areas from short term rates, we have heard another some short term rates, and I really don't want to quantify which is which.

Unidentified Analyst

Okay thank you. Can I follow up?

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Of course.

Unidentified Analyst

I just wanted to follow up on the stock buybacks. I guess given that the stock is gotten a lot cheaper and you are committed to doing the $3.5 billion, you know how does it not make sense to accelerate it earlier, rather than keep it, keep the buybacks even over the course of the year?

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Jason, the reason is, when we do use it at the capital manage it and we put together capital management plans, they are connected to the capital markets in bottling. So we have got certain bottling plans in place through out the year and the timing of that company coincides with our buyback program.

Unidentified Analyst

Okay thank you.

Unidentified Company Representative

And just, one more comment on that, we have said from the beginning of our share repurchase program that it would be the implementation of a plan over time that we would roll out steady as she goes and we haven't responded to either perception of higher prices or perception of lower prices in our stock and I think overall it serves us very well to be predictable and consistent.

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

I just want another one of the thing as well. The capital market presented some unique opportunities we might change.

Unidentified Analyst

Okay. Thank you. That's helpful.

Operator

Thank you very much Mr. Zucher and representing Credit Suisse we have a question now from Tom Gallagher. Please go ahead sir.

Thomas Gallagher - Credit Suisse

Hi. I just want to make sure I understand the short term portfolio for sub-prime and as it relates to the what's wrapped in that. Can you help me understand that $2.8 billion of '06 vintage AAA sub-prime. Should we still expect that that's going to run off within two years of the original maturity or has that extended based on how prepayment conditions may have changed. That's my first question on it.

Bernard Winograd - Executive Vice President, U.S.A.

It might have extended a bit because of the prepayment delays. It's an extension of prepaid.

Thomas Gallagher - Credit Suisse

Okay. So that may be around for a bit longer than the original two years, maybe another year or two. Would that be fair to say?

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

I don't think we calculated that.

Thomas Gallagher - Credit Suisse

Okay. The... and is this the portfolio where you had commented on there $600 million of below investment grade wrapped securities?

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

That $600 million is probably sprinkled between the two portfolios. Most of it is likely in the short term portfolio but I can't say for sure that none of it isn't into the 3 to 4-year portfolio which is more finance with general account liabilities.

Thomas Gallagher - Credit Suisse

Okay.

Eric Durant - Head of Investor Relations

Tom, one quick it's Eric. One quick comment. As you know under the investment policy the original effective maturity of investments and the short term portfolio is less than two years. Okay? And the average expected maturity of that portfolio today is well within that two year criterion?

Thomas Gallagher - Credit Suisse

Okay, thanks.

Operator

And any follow ups Mr. Gallagher.

Thomas Gallagher - Credit Suisse

No, that's all.

Operator

Okay, very good, sir. Thank you. We go to the line now of Jeff Schuman with KBW, please go ahead.

Jeff Schuman - Keefe Bruyette and Woods

Thank you. I wanted to just follow up on little bit more with Bernard, on the securitization and conduit activity. We don't have a large visibility into the financials there. I was just wondering just for illustration purposes if we assume that you did withdraw from the conduit activity, what is the fixed cost associated with that. How much of the loss could go away if you completely withdrew?

Bernard Winograd - Executive Vice President, U.S.A.

With virtually all go away because as I say this is the business system that originates mortgages for three different markets and the fixed costs is not associated with the activity in anyone of those markets.

Jeff Schuman - Keefe Bruyette and Woods

I guess it would seem then between... this is pretty easy to fix, if you just can solve part of the problem by withdrawing or part of it by profiling some more of the business and attractive rate environment, you would seem a fairly manageable situation?

Bernard Winograd - Executive Vice President, U.S.A.

We agree with you. We think it is a fairly manageable situation. We think the current market conditions have been brutal and we anticipated that they were not going to be decline and therefore limited the total inventory we'd have at risk at any moment in time. And found that was not an adequate solution that the markets were more volatile than we had expected. But we agree with you that there are more tools available to us to manage this risk and we are assessing which of those makes the most sense.

Jeff Schuman - Keefe Bruyette and Woods

Great. Thank you very much.

Operator

And thank you Mr. Shuman. And next we go to the line of Ed Spehar, Mr. Spehar representing Merrill Lynch. Please go ahead, sir.

Edward Spehar - Merrill Lynch

Thank you. I had a couple of questions just on the Life Planner business. Going back to the full year growth and the fourth quarter the full year I think was up 10% if you adjust out the European investments piece and flat in the fourth quarter. And Mark I think you comment on some of the things that may be led to lower than normal results but I guess Life Planner growth and sales growth; those wouldn't be things that I would think would be material from an earnings standpoint. So as certainly in one year. And so I'm wondering can you give us any more color on some of the comments you made on terms of investing for growth or timing of expenses and how to think about what impact that might have had?

Mark B. Grier - Vice Chairman

Yes. When I was talking about Life Planner growth and sales growth I was more in the context of the question about whether or not our longer term outlook is any different than its been. And the point of that was that I believe the drivers are consistent with the performance that we have been registering.

Yes in terms of things like higher expenses we are investing in technology, we are investing in products, we are investing in the brand. As you have seen in Gibraltar, we are investing in people to shore up the bank distribution channel. We do see opportunities to think a little more broadly beyond protection life. We do see geographic opportunities in international. So, the spending has come and accelerated through the second half of the year on initiatives, and generally what I would characterize as investing for the future as opposed to fixing something that's broken. We also, as I mentioned, had some variable income I guess you might call it in international that was lower this year. I referred to it in my prepared remarks as non-coupon items that was lower than it's been. So, we had some negative their relative to what we have seen in prior years. But again, overall, the drivers are in pretty good shape and the picture looks pretty good.

And the items this year, I think as I said in my remarks or early question, we might like to match the spending with the favorable positive nonrecurring items, but that's not the way it works, and we were spending more money and had a few things also squeeze us a bit. But the fundamentals are still very good.

Edward Spehar - Merrill Lynch

Okay, and if I could follow up on the guidance. It's still not clear to me, how much of the CMBS-related spread widening loss expectation is in guidance for '08. Did you... clarify that or can you give us anything on it.

Eric Durant - Head of Investor Relations

It's Eric, and no we didn't clarify. What we did say or intended to say was that the change in market conditions in the first month of the year is reflected in our guidance for the commercial mortgage conduit as well as our other businesses but we didn't provide a number for the result for that business which by the way lost $62 million pretax in 2007 as a whole.

Edward Spehar - Merrill Lynch

Okay, and I guess just finally a comment. I would content that nine times '08 earnings would fall into Rich's unique opportunity category.

Richard J. Carbone - Chief Financial Officer

Point taken.

Operator

And thank you very much. Mr. Spehar. Citadel Investment Group's Dan Johnson has our next question. Please go ahead sir.

Dan Johnson - Citadel Investment Group

Great. Thanks many have been answered, but just talk a little bit about three questions. In the mortgage commercial mortgage production environment, obviously, we've focused a lot on the pain side of that what's going on in terms of for business that we are producing and keeping for our own account. What's going on with the expected return environment and is that driven by just macro-credit conditions, lack of competitors versus the last few years, et cetera. So, a little bit of an update on the opportunity out of Venice [ph] at the moment. That's number one.

Number two, can you give us a little bit of sense as to what you're thinking about in Gibraltar, in terms of sales via the bank so far. Maybe some color on number of banks or branches you have existing relationships in, when you think that might bear fruit, and... let's go with those two.

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Okay, Dan, so on the first one, we'll turn it to Bernard to talk about the mortgage environment.

Bernard Winograd - Executive Vice President, U.S.A.

The mortgages that we are originating for our own account. We are originating at wider spreads and on better terms than we have been able to do for several years. And we have therefore accelerated the pace at which we are acquiring commercial mortgages of that kind for our own account. The principle reason that's happening is because of the disruption to the market, a part of the market, that has been available to borrowers, that is backed by securitization. Securitization has in the past few years represented take-up... a way to net consumer mortgage debt that has been two to three times the size of the combined appetite of insurance companies altogether for long-term paper. And so the disruption to that marketplace has caused a significant drop in their share, and therefore a considerable improvement, if you will, in the terms of trade for those of us who are lending for own account.

Obviously the benefit of that will be reflected in higher returns in the general account over the terms of those mortgages. It won't be the kind of periodic one-time gains that we experienced when the same, when the conduit business was functioning properly but that is exactly the good side of this environment that we find ourselves in.

Dan Johnson - Citadel Investment Group

Can you give us a sense as to what sort of spread expansion we are getting as a result of this change?

Bernard Winograd - Executive Vice President, U.S.A.

Well it depends on the period over which you measure it, but you know it's certainly a 100 basis points in over the past nine months.

Dan Johnson - Citadel Investment Group

Great, thanks, and then on to Japan Bank, and then I wanted to follow-up with certain international expenses. And I'll have a question on that too.

Mark B. Grier - Vice Chairman

All right, on bank channel sales in Gibraltar, our largest relationship is with Bank of Tokyo, and so that will be a key. We also have a number of regional bank relationships as well as some smaller banks. We have a wide range of opinions about how this might go, and it's still too early. We have not talked specifically about what we think we can sell here. The bank channel has been pretty successful with respect to some of the annuity products that have been introduced. We are a little more cautious in extrapolating that experience to Protection, Life; which is why we feel like we need to learn a little more before we can layout real specific expectations. But I will tell you that a materially good outcome here would be a positive variance to the outlook that we have been talking about.

Now, again, you know that immediate sales in Life Insurance aren't necessarily current year earnings, but there is upside relative to the general things that we have discussed in international insurance if this goes well. And again we are still learning and don't have anything we are ready to talk about in public yet.

Dan Johnson - Citadel Investment Group

And the reason I ask is it looks like, both, in Gibraltar and the Life Planner business. We have fairly elevated expenses which we have touched on, including advertising expense. I mean how recurring is this level of expenses is going to be as we go into '08, because they are up from, especially in the Planner business, quite a bit?

Mark B. Grier - Vice Chairman

We expect to be returning to more normal level of expenses as we move through the year. Some of these are in the nature of one-time. We also... and I don't know if I can quantify it for you... have an impact on that line of the appreciation of the yen. And so there are, really... there are two things going on there, I didn't talk about the pure financial side, because I wanted to make the business case of investments. But there is an appreciation of the yen as we translate that line item. And maybe Rich or Peter can say something about that?

Peter Sayre - Controller and Principal Accounting Officer

I will just say in the current quarter... this is Peter... that the foreign exchange re-measurement between Gibraltar and Prudential Japan is about $15 million.

Dan Johnson - Citadel Investment Group

Okay. And just a reminder, our average yen for next year is --

Mark B. Grier - Vice Chairman

For translation of results?

Dan Johnson - Citadel Investment Group

Yes

Mark B. Grier - Vice Chairman

106.

Unidentified Company Representative

for that quarter general income. These are on these basically on the monetary asset that get translated at the current quarter's results. It's little disconnect between the planned head rate as to the foreign exchange re-measurement of the monetary assets.

Richard J. Carbone - Chief Financial Officer

Yes, let me just clarify that a little bit. Right individual line items in that financial statements are translated at the average exchange rate for the period. So with the appreciating yen, you're seeing all of the expense lines and all of the revenue lines going up as a result in part and parcel because of the translation rate adjustment. Okay, next year when we... and we get the hedge effect of translating the entire P&L at the hedge rate by marking that through to market through the other revenue line in those financial statements. So let me say that again. All the individual line items translated the actual average exchange rate, we net it down to the hedge rate by running the whole impact through the other revenue line. So the expense increase that Mark was just addressing, does... is impacted by the appreciation of yen. And I think it was like $7 million or $8 million, but I shouldn't be held for that. We didn't get that to your head... get that to you some other important time.

Dan Johnson - Citadel Investment Group

Thank you very much.

Operator

And thank you Mr. Johnson. Next we go to the line of Eric Berg with Lehman Brothers. Please go ahead.

Eric Berg - Lehman Brothers

Thank you very much. Bernard, in terms of the $49 million loss in the conduit, in the commercial mortgage backed securities... securitization area. Should we think of that as effectively the hedge ineffectiveness or the ineffectiveness associated with the hedge of the mortgages that were waiting to be securitized and were in the warehouse. Is that where the $49 million comes from the hedge ineffectiveness?

Bernard Winograd - Executive Vice President, U.S.A.

Well, Eric that's the part of it. But the bigger part of it would be whatever decision we made as to which exposures we were going to leave unhedged because we mistakenly judge the hedges to be uneconomic. So for example you may recall that at investor day that I said our policy was to not run more than a billion dollars of net exposure in inventory to... in this business. And we had roughly $750 million of net exposure at the end of the third quarter and roughly $750 million at the end of the year. We were at those levels through a combination of that which we had already closed on and therefore was an inventory and that which was in the pipeline where we had taken an application but not yet closed in a row with the borrower and which is harder to hedge. And where the hedges are more expensive.

So yes there is some hedge ineffectiveness there. It is not possible to perfectly hedge this exposure. But there was also as I said a policy of managing this risk by limiting it that proved to be inadequate because the degree of movement we got in the markets have made our judgment about where the right limits were to look inappropriate and with the benefit of hindsight.

Eric Berg - Lehman Brothers

And does the loss also have to do with the fact that even if you were perfectly hedged, to the extent that the market has shut down, you have these costs of inside the business that are not being absorbed by the profits on the business?

Bernard Winograd - Executive Vice President, U.S.A.

No that's really not as much of an issue because this conduit activity is merely an aspect of the overall lending activity. We originate upwards over $10 billion a year, of commercial mortgages and we can vary which of various mouths we feed, if you will with what we originate depending upon market conditions. And we judge the fixed cost structure relative to the total field force necessary to originate the overall level. Now you know if we thought we were going from upwards of $10 billion to less $5 billion, yes of course. We'd have to be reducing the size of the fixed overhead. But that's not our view, of what we will be doing in terms of origination activity. We will instead see a change in the mix of originations, activity rather than an absolute reduction in the level of origination activity. Well at whatever level of... whatever reduction we might have would not be large enough to trigger a significant change in our fixed cost infrastructure.

Eric Berg - Lehman Brothers

Last question maybe for Rich. How should we think of the impact on the profitability on your annuity business from the call it doubling over the last year in volatility in the stock market, at least in short dated volatility, in the cost of hedging?

Mark B. Grier - Vice Chairman

Eric it's Mark. Our hedging structures in the equity businesses are longer term. So we are not as subject to variations in near term volatility which is really where the big moves have come. We are exposed to long dated volatility in both the underlying benefits that are attached to the products as well as in the hedges that we design. If you recall, we take what we call a structural approach to hedging using long dated options that have various configurations. They would have at one point been called exotic options that we think match our liabilities very well. And experience has borne that out. So one reason that you don't see us talking a lot about difficulty in hedging is that long-term volatility has not moved as much.

Bernard Winograd - Executive Vice President, U.S.A.

I just want to add one thing to that answer, it's Bernard again. I think one of the intriguing things to watch in the annuity business for us, over the next few years is...the whether the nature of the annuity businesses, reaction to volatile equity markets will change in light of the increasing prevalence of guaranteed structures. Traditionally, the annuity business and its new volume has shrunk. When equity markets get volatile, we are not seeing that to the same degree at the moment. We can't... we don't yet have an update to know whether that's simply due to the timing of new product introductions on our part, market share gains on our part, or whether it reflects the fact that if the annuity is being sold as a vehicle that provides greater protection against the downside. It's sales performance will be considerably different in volatile market environments than it has in particularly down... downward equity markets, than it has been historically. Which is a way too early to render a verdict on that. But it is something worth watching.

Mark B. Grier - Vice Chairman

Eric it's Mark again. Just two more technical things. Just to remind you that we do put our hedging results through AOI. They have included in the business along with the other side of the deal, which is the valuation of the living benefits. And secondly, our hedging cost today is still within the range that we have assumed in our pricing strategy.

Eric Berg - Lehman Brothers

Thanks to both of you. That was helpful.

Operator

And thank you very much Mr. Berg, representing Tudor Investment Corporation we go to the line of Peter Monaco [ph] now. Please go ahead, sir.

Unidentified Analyst

Good morning everybody. Thanks for your time.

Mark B. Grier - Vice Chairman

Hi Peter.

Unidentified Analyst

Against the backdrop of the last few several months and particularly on days like today, I find myself meeting a regular sanity check. So I was wondering, if you'd help me. I presume you'll absent circumstances truly beyond your control have confidence in your ability to grow adjusted operating income of your businesses, mid single digits on a consolidated basis. I presume that, that $10.5 billion over 3 years in buybacks, will be done absent a truly compelling acquisition opportunity. I presume it will probably happen somewhat above the current price. If all of that is true adjusted operating income will be 20% or so higher in 2010 relative to 2007. And the average share count in 2010 would be approximately 25% below the year-end '07 share balance. The combination of the two simple math is EPS in 2010 that is some 60% higher than the adjusted operating EPS in 2007. Am I doing anything wrong?

Mark B. Grier - Vice Chairman

Well without commenting on the merits of your assumption, the direction that you are going is the direction that we have talked about for the company since we went public.

Unidentified Analyst

Thank you.

Operator

Thank you very much Mr. Monaco. And next we go to the line of Tamara Kravec representing Banc of America Securities. Please go ahead Tamara.

Tamara Kravec - Banc of America Securities

Thank you, good morning. Most of my questions have been answered. I just wanted to see if you could touch on the effective tax rate in the quarter, given that it was much lower than what we have seen in first nine months of 2007?

Peter Sayre - Controller and Principal Accounting Officer

Let me talk to that basically, it's primarily driven by the lower pre-tax income and the effective tax rate drops as a result of that. It does have a slightly more foreign tax credits in the quarter.

Tamara Kravec - Banc of America Securities

Okay and those were generated by losses or...

Peter Sayre - Controller and Principal Accounting Officer

No, no just in our investment portfolio.

Tamara Kravec - Banc of America Securities

Okay. All right. Okay, thank you.

Operator

And thank you very much Ms. Kravec. Well Mr. Strangfeld and our host panel taking a quick look at the clock, it looks like, we have time for one more question. So next in queue is Andrew Kligerman with UBS. Please go ahead.

Andrew Kligerman - UBS

Oh my gosh, I made it. Anyway couple of quick clarifications. One when John talked about an unchanging market is that... in guidance does that mean that you are expecting the market to stay flat for the year as January to flat till the end of the year that's the first question?

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Yes, I would say Andrew this is John, I would say that's not a prediction, that's an assumption.

Andrew Kligerman - UBS

That is an assumption, Okay, great and then Rich, with regard to those investment marks, that went through the income statement on those European... from that firm in Europe or assets that are based in Europe, I am not quite sure. Could you quantify those assets? How big is that asset base? I think you said it, but I want to make sure.

Richard J. Carbone - Chief Financial Officer

$1.8 billion.

Andrew Kligerman - UBS

$1.8 billion, and then the next item in the retirement division you talked about $11 million lowering... $11 million less of investment income from joint venture income. Could you give us what the asset base is in terms of joint venture income and what the return was in the quarter?

Richard J. Carbone - Chief Financial Officer

That's something Andrew we do not have at our fingertips here right now.

Andrew Kligerman - UBS

Okay. I'll follow up. Maybe and then just lastly Mark, I thought it was pretty exciting to see that retirement went to a positive net flows of $454 million. Mark you gave a little color around the income flex product and three large cases. Do you feel like this positive flow that we saw in the fourth quarter, is that sustainable into 2008? Or are you somewhat cautious on the outlook for flows?

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Andrew this is John. I'll take that. This has been a situation where when we talk about the floor we have been acknowledging a trend line that we thought was the right one but a slope that wasn't as steep as we'd like, namely negative flows during integration in '05, a push in '06 and positive flows in '07. And that's indeed what we have here. The fourth quarter clearly reflected encouraging progress, and we are confident in this business system. This is the business that will have some variation quarter by quarter because of the size of some of the large accounts. But this is not a fluke. We are feeling good about where this business is going, the steps we are taking and in the long term prospects that flows.

As for IncomeFlex that is still the product is in the pilot phase. What I can say is that we believe in it. When you look at the need of plan participants we think this makes a lot of sense. We have had 20 DC plans signed up for that IncomeFlex option at this stage. We are still piloting it with those plans. But we believe this is going to have... considerably more potential and more measurable potential as we move out over time.

Andrew Kligerman - UBS

Thanks a lot.

Operator

And thank you very much Mr. Kligerman. And well, with that Mr. Strangfeld and our host panel, I will turn the call back to you for any closing remarks.

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Thank you. I would like to make one or two closing remarks but Rich has one comment. Clarification he wanted to make.

Richard J. Carbone - Chief Financial Officer

I want to clarify the change in G&A expense as a result of the translation. So in the plan model, in the Life Plan model, G&A expense is up year-over-year by $12 million as a result of translating at a higher yen. And in the Gibraltar G&A line, G&A expenses up $7 million from translating at a higher average yen for the period.

John R. Strangfeld - Chief Executive Officer and Chairman-Elect

Thank you Rich. So this is back to John. I just want to sum this up briefly. I know he is talking an awful lot about markets and assets and the like. But as we think about it, we think 2007 was an excellent year for Prudential. Underneath the noise in the fourth quarter, it's clear that our businesses are continuing to perform well. Market conditions are challenging. But the sky is not falling, and we will manage through this environment. And we will see opportunities to add talent and perhaps to strengthen our business in other ways. Our balance sheet is exceptionally strong. It undercuts our ability to pursue opportunities and return excess capital to our shareholders.

We are confident that our guidance for the '08 earnings per share of $7.50 to $7.80 is achievable even if conditions in the financial markets do not improve over the balance of the year. So, thank you for being with us today and we hope you will be able to join us in May.

Operator

And thank you very much everyone and ladies and gentlemen, Mr. Strangfeld is not [ph] in today's conference available due to ties. Replays will be starting at 1 p.m. Eastern Standard Time, February the 7th all the way through 11:59 p.m. February the 14th. To access AT&T's executive replay service, please dial toll free 800-475-6701 and at the voice prompt enter today's conference ID 904641. Internationally you may access the replay as well by dialing 320-365-3844 again with the conference ID of 904641.

And that does conclude our earnings results for this fourth quarter 2007. Thank you very much for your participation as well as for using AT&T's executive teleconference service. You may now disconnect.

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