Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Prudential Financial (NYSE:PRU)

Q3 2012 Earnings Call

November 08, 2012 11:00 am ET

Executives

Eric Durant

John Robert Strangfeld - Chairman, Chief Executive Officer, President and Member of Executive Committee

Richard J. Carbone - Chief Financial Officer, Executive Vice President, Chief Financial Officer of Prudential Insurance and Senior Vice President-Prudential Insurance

Mark B. Grier - Vice Chairman

Edward P. Baird - Chief Operating Officer and Executive Vice President of International Businesses

Charles Frederick Lowrey - Head of Asset Management Business, Executive Vice President, Chief Operating Officer of Us Businesses, Chief Executive Officer of Prudential Investment Management, President of of Prudential Investment Management and Executive Vice President of Prudential Financial & Prudential Insurance

Analysts

Ryan Krueger - Dowling & Partners Securities, LLC

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Eric N. Berg - RBC Capital Markets, LLC, Research Division

Suneet L. Kamath - UBS Investment Bank, Research Division

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

Randy Binner - FBR Capital Markets & Co., Research Division

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Sean Dargan - Macquarie Research

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the third quarter 2012 earnings teleconference. [Operator Instructions] Later, we will conduct a question-and-answer session. [Operator Instructions] And as a reminder, today's conference call is being recorded.

I would now like to turn the conference over to Mr. Eric Durant. Please go ahead.

Eric Durant

Thank you, Cynthia. Good morning. Welcome to Prudential's expanded third quarter call, covering the third quarter results and our financial outlook for 2013. Slides supporting the financial outlook presentation are available at our Investor Relations website, www.investor.prudential.com.

Representing Prudential today are the usual suspects, John Strangfeld, CEO; Mark Grier, Vice Chairman; Rich Carbone, Chief Financial Officer; Charlie Lowrey, Head of Domestic Businesses; Ed Baird, Head of International Businesses; and Peter Sayre, Controller and Principal Accounting Officer.

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 2012, which can be found on our website at www.investor.prudential.com.

In addition, in managing our businesses, we use a non-GAAP measurement 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 are expected to ultimately accrue to contract holders and recorded changes in contract holder liabilities, resulting from changes in related asset values.

Our earnings press release contains information about our definition of adjusted operating income. The comparable GAAP presentation and the reconciliation between the 2 for the quarter are set out in our earnings press release on our website. Additional historical information relating to the company's financial performance is also located on our website. John?

John Robert Strangfeld

Thank you, Eric, and good morning, everyone, and thank you for joining us. We appreciate your interest in Prudential. I'll be reasonably brief to leave more time for Rich and Mark's expanded comments, as well as for your questions. So let me begin.

In the third quarter of last year, EPS, based on operating income, increased for the third quarter of this year 82%, reflecting -- compared to last year, which is a reflection of weak equity market performance last year and favorable equity markets this year. Excluding the effect of market-driven and discrete items, such as DAC unlockings, from the results of each period, earnings per share increased by 17% from $1.49 in the third quarter of 2011 to $1.75 in the third quarter of 2012. On the same basis, our annualized return on equity for the third quarter reached 11.8%.

Core earnings for each of our businesses improved in the last year. In short, our underlying operating performance for this quarter was very solid. We've expanded our call today to give you our outlook for 2013 earnings and ROE. I don't want to front-run much of what Rich and Mark will be telling you, but I will provide a few comments to provide context for their remarks.

Last week, we completed our pension buyout transfer with General Motors. Prudential has received approximately $25 billion in premium from General Motors for the purchase of a group annuity contract, and we have assumed responsibility for approximately 110,000 salaried GM retirees. We're certainly proud to have completed this unprecedented pension transfer agreement with GM. And since we last met, Prudential announced a second large pension transfer agreement, this time, with Verizon. This transaction, which is expected to close next month, covers the transfer of approximately $7.5 billion of pension obligations to Prudential. These transactions speak to our capabilities, our culture of multi-disciplinary collaboration, as well as our -- to our financial strength.

On Investor Day last May, we spoke of opportunities for outsized organic growth, that is growth over and above business growth in a normal course. These pension risk transfers transactions exemplify what we had in mind. They represent innovation and scale. They also nicely complement our organic growth in M&A.

Speaking of M&A, late in September, we reached an agreement with the Hartford to acquire its Individual Life business through a reinsurance transaction. We view this acquisition as similar to outsized organic growth because we are accelerating growth that would have taken years to achieve organically. Our financial evaluation of this investment was driven by the value of the in-force block and expense synergies. That said, we believe the acquisition will lead to significant additional financial benefits in terms of new business.

First, we're gaining distribution strength in the bank and wirehouse channels. Second, we're gaining increased scale. Third, we're adding talented people, who make our company stronger, most notably, in product development and sales.

Now we all know that success is not in the announcement but in making it work and proving it out. But as we've shown in the past, most recently with Star/Edison, we're pretty good at that. As these large transactions demonstrate, capital deployment remains an integral part of managing Prudential to achieve our financial goals, and we recognize the importance of balancing investments in our business with cash dividends and share repurchases to ensure appropriate capital structure and attractive returns. The Hartford transaction is scheduled to close early next year. And as I mentioned, GM pension transfer closed on November 1 and the Verizon pension transfer is expected to close next month.

Now we also declared a cash dividend yesterday of $1.60 per share, a 10% increase from last year, as well as our intention to pay quarterly dividend starting next year. And finally, we repurchased $150 million in common stock last quarter. In combination, these actions will deploy capital between July 2012 and June 2013 as well in excess of the $3 billion we have told you we expected to deploy in that period.

Our strong capital position, liquidity and sound asset quality continue to serve us well. We view them as supportive of our ability to achieve our return on equity objectives. And as Rich will show you in a few minutes, we continue to believe we have a strong prospect of achieving an ROE next year within the range of our stated ROE objective for 2013, which we first announced 3 years ago, of 13% to 14%.

And frankly, for us, it's not just obsession with a mathematical number. To us, the achievement of this is a manifestation and validation of the uniqueness of our business mix, the quality of the businesses that make up that mix and the talent of our people. We take this goal very seriously, and we are intensely focused on both making it happen and making it sustainable. And yet, I'll hasten to add that we'll get there in the right way or we won't get there at all.

With that, I'll stop and turn it over to Rich. Rich Carbone?

Richard J. Carbone

Thanks, John, and good morning, everyone. So last night, we reported common stock earnings per share of $1.53 for the third quarter. That's based on adjusted operating income for the Financial Services business, and this compares to $0.84 per share in the year-ago quarter. Market-driven and discrete items, including the impact of the annual update of actuarial assumptions, which have significant impact this quarter as they did in our last quarter -- or the third quarter of last year, I should say. This year's annual review of actuarial assumptions included reductions in the long-term fixed income and equity returns. While expected returns vary by duration in the U.S. in the fixed income instruments, we reduced our fixed income and returns for longer durations by about 100 basis points and on long-term equity returns by 125 basis points, and that's across the board in all reserves.

In the Annuities business, our annual review of experience and actuarial assumptions, giving effect to lower assumed long-term returns and other refinements, resulted in a charge related to guaranteed minimum debt and income benefits and DAC that was offset by the third quarter favorable equity market performance, resulting in a $0.07 per share charge.

In Retirement, a write-off of intangible assets related to a business we acquired in 2008, together with an unlocking based on the annual review of experience and assumptions, resulted in a $0.05 per share charge.

In our Individual Life and Group Insurance business, the annual -- review resulted in a $0.03 per share charge.

In International, results for our Life Planner business benefited $0.03 per share from our annual review. Also in International Insurance, Gibraltar Life benefited $0.08 per share from a partial sale of our indirect investment in China Pacific Life. This benefit was partially offset by integration cost of $0.05 per share relating to the Star and Edison acquisition.

And finally, Corporate and Other results included an $0.11 per share charge to strengthen reserves related to certain of our pre-demutualization policyholder obligations, driven by the annual actuarial assumption update, as well as an additional $0.02 per share charge to write off some bond issuance costs on debt we redeemed prior to maturity.

In total, the items I just mentioned had an unfavorable impact of about $0.22 per share on the third quarter results. Our results in the year-ago quarter included net charges of about $0.65 per share from a number of items, mainly driven by negative unlockings related to the 14% decline in the S&P 500.

Taking these items out of both the current and year-ago quarters, the EPS comparison would be $1.75 for the current quarter versus $1.49 a year ago, a 17% increase driven by organic business results and the realization of cost savings from the Star/Edison acquisition. And Mark will discuss our business results in more detail in a few moments.

Now moving onto the GAAP results of the Financial Services business. We reported a net loss of $661 million or $1.41 per share for the third quarter. This compares to net income of $1.6 billion or $3.18 per share a year ago. The GAAP net loss for the quarter includes amounts characterized as net realized investment losses of $1.3 billion pretax. This compares to $1.8 billion of pre-tax net realized investment gains in the year-ago quarter.

The $1.3 billion current quarter net realized loss can be broken down into 3 pieces: First, we recorded $684 million of net losses from product-related embedded derivatives and hedging activities, largely driven by changes in our assumptions for mortality behavior and -- for policyholder behavior and mortality that affected the annuity living benefit liability. Second, we recorded $521 million of losses from asset and liability value changes, driven largely by currency fluctuations. These currency-driven losses primarily represent changes in the value of non-yen liabilities related to products on the books of our Japanese companies, whose functional currency is yen, and that's what's important here.

As I've explained in the past, when the yen weakens in relation to currencies underlying these products, we'll record a loss in the income statement for the increase in these liabilities as measured in yen. That part is okay because it will take more yen to pay them off. However, we consider this noneconomic because the liabilities are appropriately matched with investments in the currencies, in which they will be settled, whose value went up in yen terms, as well and in equal amount to the decline or to -- excuse me, to the increase in the liability. The loss in the income statement is offset in AOCI where the revaluation of the asset sits, not through the P&L. With the end result that GAAP equity is essentially unaffected despite the volatility in reported net income. And third, we recorded $107 million of impairments and credit losses. The current quarter net loss also reflects a $685 million pretax loss from a divested business, a business that we divested during the quarter, driven almost entirely by our annual update of actuarial assumptions applicable to our long-term care business, including loan -- including lower long term interest rates.

Book value per share, on a GAAP basis, amounted to $79.51 at the end of the quarter, and this compares to $69.07 at year end. At the end of the quarter, gross unrealized losses of general account fixed income maturities stood at $2.4 billion, and we're in a net realized gain position of roughly $18 billion.

Excluding AOCI, book value per share amounted to $59.35 as of the end of the third quarter compared to $52 -- $58.02 at year end. For Prudential Insurance giving effect of statutory results and $600 million of dividends paid during the quarter for the 9 months of the year, we estimate the RBC remains above our 400% threshold as of the end of the third quarter.

I will discuss our capital position later on as part of our financial outlook. And now, I'll turn it over to Mark.

Mark B. Grier

Thanks, John and Rich, and good morning, good afternoon or good evening. I'll start with our U.S. businesses. Our Annuity business reported adjusted operating income of $207 million for the third quarter compared to a loss of $192 million a year ago. The reserve true-ups and DAC unlocking that Rich mentioned had a net unfavorable impact of $48 million on current quarter results. This net impact included a charge of $106 million, reflecting the annual update of our actuarial assumptions, mainly driven by reductions in the assumed long-term rates of return we apply in projecting growth of consumer account values. This charge was partly offset by a benefit of $58 million from favorable market performance in comparison to our assumptions, largely driven by the 6% increase in the S&P 500 for the current quarter.

Results for the year-ago quarter included a net charge of $421 million from an unfavorable DAC unlocking and reserve true-ups, largely driven by unfavorable equity market performance. Stripping out the unlockings and true-ups, annuity results were $255 million for the current quarter compared to $229 million a year ago for a $26 million increase. This increase, in what I would think of as baseline results, was driven by higher fees, reflecting growth in variable annuity account values, including the benefit of $13 billion of net flows over the past year.

Our gross variable annuity sales for the quarter were $5.9 billion, up from $4.5 billion a year ago. In August, we launched our new variable annuity product, HDI 2.0. We're starting to sound like Microsoft. This product increased our rider fee to 100 basis points on individual contracts and 110 basis points on spousal contracts from 95 basis points on our earlier HDI product. The new product also increased the minimum issue age by 5 years to age 50 and reduced the payout rate from 5% to 4% for the age 59.5 to 65 band. HDI 2.0 continues our successful highest daily value proposition, backed by auto-rebalancing tailored to the risk profile of each individual contract.

We also took other actions over the summer to improve the risk profile and enhance return prospects on new business and enforce contracts. These actions included the withdrawal in July of our X shares or bonus product and our suspension commencing in September of acceptance of subsequent premium payments on generations of highest daily products earlier than the HDA -- HDI product that we introduced early last year. We estimated about $500 million of current quarter gross sales came from acceleration of subsequent premium payments on in-force contracts in advance of that suspension. Adjusting for that and perhaps some uptick in sales in advance of our product change, sales in the current quarter were roughly in line with our average of about $5 billion per quarter since we introduced the HDI product.

The Retirement segment reported adjusted operating income of $110 million for the current quarter compared to $111 million a year ago. Current quarter results included $29 million charge to write off intangible assets relating to a business we acquired in 2008 and a charge of $13 million from updating of DAC and other amortization items based on our annual review. Results for the year-ago quarter included a charge of $24 million, reflecting a similar annual review.

Stripping these items out of the comparison, results for the Retirement business are up $17 million from a year ago. Current quarter results benefited from a greater contribution from net investment results. Crediting rate reductions we've implemented on our Full Service Stable Value business in January and July of this year, together with more favorable results from non-coupon asset classes, more than offset the impact of lower reinvestment yields over the course of the past year and the loss of spread income on bank deposits we transferred to third parties in connection with our decision to restructure our savings and loan to a trust-only organization.

The benefits of current quarter results from higher fees, driven by account value growth in the Institutional Investment Products, was largely offset by a lower contribution of about $10 million from mortality-driven case experience on our traditional retirement products.

Total retirement gross deposits and sales were $6.4 billion for the quarter compared to $9.5 billion a year ago. The decrease is mainly a result of lower current quarter standalone sales of stable value wrap products to plan sponsors and fund managers, which contributed $2.5 billion in the current quarter and $5.1 billion in the year-ago quarter to sales of our Institutional Investment Products. These sales are mainly driven by large case business and tend to be lumpy from one quarter to another.

Full Service Retirement gross deposits and sales were $3.5 billion in the current quarter compared to $4 billion a year ago. We continue to see limited activity in the mid-to-large case market, which is our major focus. Overall, net additions for the Retirement business were about $800 million for the quarter, and the cap values passed the $250 billion milestone as of the end of the quarter, up 17% from a year ago.

Last week, we announced the closing of our pension risk transfer transaction with General Motors, which will bring us approximately $25 billion of group annuity account values, representing the transfer of benefit obligations for 110,000 salaried retirees from GM's pension plan to Prudential. This transaction and the approximately $7.5 billion Verizon pension risk transfer transaction, which is expected to close in December, are building our leadership position in a market where we see great potential and an excellent fit for our skills in managing group annuity, where we have a track record of more than 80 years.

The Asset Management business reported adjusted operating income of $187 million for the current quarter compared to $123 million a year ago. While the segment's basic earnings come from asset management fees, the increase in results in relation to the year-ago quarter was mainly driven by a $55 million greater contribution from what we call other related revenues. This bucket encompasses results from incentive, transaction, strategic investing and commercial mortgage activities, which are variable in nature and partly driven by changing valuations and the timing of the transactions. In total, these activities produced pre-tax income of $71 million in the current quarter compared to $16 million in the year-ago quarter. The greater contribution from these activities came mainly from more favorable performance of fixed income and real estate funds.

Stripping out our results from activities that come under the heading of other related revenues, the Asset Management business produced adjusted operating income of $116 million in the current quarter compared to $107 million a year ago. The increase reflects higher asset management fees driven by growth in assets under management, net of higher expenses in the current quarter. The segment's assets under management stood at $670 billion as of the end of the quarter, up $71 billion or 12% from a year earlier. Adjusted operating income for our Individual Life Insurance business was $112 million for the current quarter compared to $111 million a year ago.

Current quarter results included charge of $27 million from an unlocking of DAC and other items resulting from our annual actuarial review, driven mainly by our reductions in assumed long-term rates of return for fixed income investments and equities. Results for the year-ago quarter benefited by $27 million from a favorable unlocking based on the annual review.

Stripping these items from the comparison, results from Individual Life increased by $55 million from a year ago. The increase reflected more favorable mortality experience in the current quarter, as well as charges of about $15 million in the year-ago quarter to accelerate amortization of DAC due to unfavorable separate account performance linked to the decline in the S&P 500.

Individual Life sales, based on annualized new business premiums, amounted to $98 million for the current quarter, up from $70 million a year ago. The increase was driven by strong current quarter universal life sales through third-party distribution and reflects our improved competitive position as some key competitors have recently raised rates, bringing their pricing more in line with our premium rates, which we increased several years ago. We expect our universal life products to remain competitive following further price increases we implemented last month.

Our acquisition of Hartford's Individual Life Insurance business, expected to close early next year, represents a rare market opportunity to bring high-quality business onto the books with appropriate returns, accelerating growth that might have been achieved organically over a period of years, along with offering potential expense synergies that we believe are clearly achievable. We are also gaining distribution strength in the bank and wirehouse channels that will contribute to organic growth going forward.

The Group Insurance business reported adjusted operating income of $35 million in the current quarter compared to $45 million a year ago. Current quarter results benefited by $7 million from refinements in Group life and Disability reserves, reflecting our annual review, while results for the year-ago quarter benefited by $22 million from a similar review.

Stripping the reserve refinements out of the comparison, Group Insurance results are up $5 million from a year ago. [Audio Gap] Less favorable group life underwriting results.

Group Insurance sales for the quarter were $46 million compared to $40 million a year ago. Most of our Group Insurance sales are recorded in the first quarter based on the effective date of the business. We are taking significant actions to enhance our return prospects in Group Insurance. We announced our exit from the long-term care insurance market in July and are focusing on our core group life and disability coverages, where we are exercising pricing discipline on new business and as cases come up for renewal.

Turning to our International businesses. Gibraltar Life's adjusted operating income was $390 million in the current quarter compared to $329 million a year ago. As Rich mentioned, Gibraltar's current quarter results include income of $60 million from the partial sale of our investment in China Pacific Group by the Carlyle consortium. As of the end of the quarter, our remaining investment in China Pacific had market appreciation of about $50 million, which is included in the net unrealized gains on our balance sheet.

Going the other way, Gibraltar's results for the current quarter absorbed $34 million of integration costs for the Star and Edison acquisitions. With all major aspects of the business integration completed or nearing completion, we currently estimate that total integration cost will be below $450 million, with about $300 million incurred through the end of the third quarter and $10 million to $15 million expected for the remainder of the year.

Results for the year-ago quarter included income of $84 million from a partial sale of our investment in China Pacific and absorption of $43 million of integration costs. Excluding the China Pacific gains and integration costs, Gibraltar's adjusted operating income was $364 million for the current quarter, up $76 million from a year ago. The increase reflects business growth and cost savings from Star and Edison integration synergies.

Current quarter results reflect about $40 million of cost savings achieved thus far as a result of the business integration compared to about $500 million of early saves that benefited the year-ago quarter. We remain well on track to achieve our targeted annual cost savings of about $250 million after the business integration is completed. In addition, foreign currency exchange rates, including the impact of our hedging program, contributed $13 million to the increase in earnings from a year ago.

Our Life Planner business reported adjusted operating income of $393 million for the current quarter compared to $331 million a year ago. Current quarter results benefited by $20 million from refinements of reserves and other items reflecting our annual review. Excluding the impact of these refinements, Life Planner results are up $42 million from a year ago. The increase came mainly from continued business growth.

On a constant dollar basis, insurance revenues, including premiums, policy charges and fees, were up

8% from a year ago. In addition, foreign currency exchange rates contributed $14 million to the increase in earnings in the Life Planner business from a year ago.

International Insurance sales, on a constant dollar basis, amounted to $900 million for the third quarter compared to $810 million a year ago. Sales from Gibraltar Life were $636 million in the current quarter compared to $537 million a year ago. Current quarter sales reflect accelerated purchases of our Single Premium yen-based whole life bank channel product, which amounted to $311 million in the current quarter compared to $29 million a year ago. This sales surge reflected recent actions by competitors, which limited the alternatives available to bank customers with significant funds available for investment in life insurance products. In order to limit our concentration in this product and maintain appropriate returns, we have taken actions to limit monthly sales of the bank Single Premium yen product through December of this year to roughly the pace of the third quarter, and we will be implementing a crediting rate reduction thereafter.

Although our sales numbers count the Single Premiums we received at 10%, based on industry practice for recording annualized new business, they are reflected at 100% in our income statement, with an offset in reserves that we include in insurance and annuity benefits. These sales added about $3 billion to both premiums and the benefits line in the current quarter, distorting ratios that some of you may calculate.

Excluding the bank channel Single Premium product, Gibraltar's current quarter sales were $325 million compared to $508 million a year ago. The decrease reflected acceleration of sales in the first half of the year, as we anticipated, due to a tax law change in April that affected our cancer whole life product and due to crediting rate reductions we implemented in the second quarter for our U.S. dollar retirement and whole life products.

Life planner sales were $264 million in the current quarter compared to $273 million a year ago. Sales by Life Planners in Japan amounted to $171 million, down $27 million from a year ago. This reflected decreases of $23 million from U.S. dollar retirement income and whole life products and $16 million from our cancer whole life product, reflecting the acceleration of sales into the earlier part of this year due to the tax law change and our crediting rate reductions.

Life Planner sales outside of Japan were up by $18 million or 24% from a year ago, reflecting higher sales in Korea and several other markets. Corporate and Other operations reported a loss of $452 million for the current quarter compared to a $349 million loss a year ago. As Rich mentioned, the current quarter loss includes a $78 million charge to strengthen reserves based on our annual actuarial review for obligations we retained to pre-demutualization policyholders and a $16 million charge to write off bond issue cost for debt that we redeemed prior to maturity.

In the year-ago quarter, we absorbed charges of $99 million to increase reserves for estimated death claims based on applying new matching criteria to the Social Security Death File and charges of $20 million for a contribution to be made to an insurance industry insolvency fund. Excluding these items, the Corporate and Other loss was $358 million in the current quarter compared to $230 million a year ago. The greater loss in the current quarter was mainly a result of higher expenses, including some non-linear items such as employee benefit costs and advertising and higher interest costs, mainly reflecting our deployment of capital debt in our businesses.

To sum up, I would say that our current quarter results reflect strong business performance virtually across the board and that we are in a solid position to achieve the goals that Rich will talk about shortly. Our U.S. Retirement Solutions and Asset Management businesses are continuing to benefit from growth of our base of fee generating businesses. Current quarter results also benefited from more favorable investment results in the Retirement business and a greater contribution from activities that complement our main focus on recurring fees and asset management. Our prospects in Retirement are enhanced by our leading position in the pension risk transfer market, where we recently announced 2 major groundbreaking transactions that will contribute to our future results.

Underlying results for our U.S. Protection businesses benefited from more favorable mortality in Individual Life and a greater contribution from investment results in Group Insurance. We will strengthen our Individual Life business with our acquisition of Hartford's business expected to close early next year. This acquisition will bring us a high-quality bloc of business, market-leading distribution in key channels and a strong pool of talent. In Group Insurance, we're taking actions to enhance return prospects through a focus on our core Group Life and Disability businesses and pricing discipline.

Our International businesses continue to perform well, benefiting from sustained growth, driven by multiple distribution channels and cost savings from business integration synergies on track with our targets.

Now, I'll turn it back over to Rich. Rich?

Richard J. Carbone

Okay. Let me give everybody a minute to get out their decks. So get on that line. Get their iPads warmed up. And we'll take you through the 2013 guidance. All right.

On Slide 4, you'll see the items that should help you understand how 2013 may unfold. First, we need to develop a starting point, a baseline 2012, which includes an accounting change in the fourth quarter of this year for pensions. And I'll discuss that in detail in a moment.

We are assuming the S&P ends 2012 with 1,425 and appreciates at 6% in '13, and that's a change from our traditional 8% assumption, resulting in an average S&P of 1,470 for 2013 that will drive our fee income.

In 2013, the yen is hedged at 80 versus 85 in 2012, and the won is hedged at 1,160 versus 1,180 in 2012. So they're going in opposite directions. We have assumed that interest rates will follow the forward curve with a 10-year treasury beginning 2013 at 1.73% and rising to 1.94% by 12/31/13. Obviously, we invest in spreads above that, mainly in the A and AAA space or around the board there. We're doing a little better in our private placements.

We expect a higher tax rate as the result of higher earnings as the relative portion -- proportion of tax preference items to taxable income declines. Leverage will remain at around 25% debt-to-capital. And lastly, the major transactions in pension risk transfer, Hartford and Star/Edison contribute substantially to 2013 earnings.

Slide 5. That summarizes the impact of the items I just mentioned in somewhat of a graphic form, so let's walk through it. We'll start with our reported AOI EPS for the first 9 months, and that should total $4.41. Adding back to our reported AOI, the onetimers or unusual items, that Eric and I and Mark have called out throughout the year, gets us to a normalized 9-months EPS of $4.74. We then add the impact of a pension accounting change.

Now here goes with the explanation of that. Every year, we update our pension assumptions, such as the discount rate and the expected return on the plan assets, and that's the discount rate on the liability. This year, we also plan on making a change to our pension accounting to remove the smoothing of the return on fixed income assets. This change is to a preferable method of accounting under GAAP that better aligns the interest rate sensitivities of the fixed income assets with the pension liability, thereby mitigating a revenue and expense disconnect. That has about a $0.22 per share impact on 2012 results. Though that will be spread amongst the whole year, we will restate the first 3 quarters for that, and the fourth quarter will contain 1 quarter of that impact.

Adding an estimate for the fourth quarter results including that 1 quarter's impact of pension gets us to EPS for 2012. This baseline estimate, on a normalized basis and including the pension accounting change, is the starting point to build to, to get to 2013. As you can see, without providing numbers for the fourth quarter estimate or the baseline 2012, we simply are not comfortable in providing a single quarter's estimate.

Okay. Starting from there, we'd add the U.S. and international growth, income from the risk transfer -- the pension risk transfer transactions in the Hartford acquisition, then adjust the denominator for capital activities that I will discuss later on, we expect 2013 normalized AOI EPS to range from $7.70 to $8.10. Reported EPS, on an AOI basis, puts in Hartford or takes out Hartford integration costs and Star/Edison integration costs and is estimated at $7.50 to $7.90.

Slide 6. Slide 6 shows our capital view at year end. While not on the slide, capital capacity at 9/30/12 was $4 billion to $4.5 billion, about the same as 6/30/12. Approximately $2 billion of which was readily deployable. The 2 pension risk transfer transactions, the statutory impact of the LPC [ph] third quarter reserve, which will be reflected in our year-end asset adequacy testing reserves and our annual shareholder dividend take capacity down to around $2 billion to 2.5 billion at 12/31. Over 1/2 of which, however, is readily deployable. So readily deployable was not depleted as much as the total capital on a proportional basis. You'll also see these impacts in our year-end PICA RBC, which is estimated to be above 400%.

Now moving onto ROE. Slide 7 notes the items impacting both the numerator and the denominator, and that little fuzzy line in between is trying to delineate which is which, but we all know that these things leak into both the numerator and the denominator. Income is obviously dependent on meeting the organic growth plans. Interest rates rising modestly to the forward rates I just mentioned. The 6% appreciation in the S&P, and the integration of Hartford Life. The denominator we used in our estimate, which can cause some mischief, as we all know -- but the denominator we used in the estimates for average equity simply took our 9/30/12 FSB equity of $27.7 billion and rolls forward earnings and plan capital actions from 9/30/12 to 12/31/13. As a result of the Hartford acquisition and the pension transactions and our desire to reduce overall leverage below 25%, of the $1 billion of share repurchases authorized under the current plan, we assume repurchases of $400 million. This would be $250 million more than the $150 million we purchased in the third quarter.

Slide 8. Slide 8 rolls 2012's ROE into '13. AOI increases for both organic growth and capital deployment, the acquisition of Hartford and the execution of the 2 historic pension risk transfer transactions. Additional capital management activities will adjust the denominator. And ignoring the accounting noise from FX and whatever else goes on in accounting, ROE for 2013 will range from 12.5% to 13.1% from normalized results. Put in the effects, positive and the negative, of the known onetime items -- and I guess these are both negatives like the -- unlike the known unknowns from Rumsfeld's day, like Hartford and Star/Edison, integration costs resulted in a reported ROE of 12.2% to 12.8%.

And finally, and unfortunately, we can't predict the outcome on the regulatory front, particularly around the non-bank SIFI impact. We've disclosed that we are in a stage 3 evaluation and continues to have really constructed dialogue with our regulators around the significant differences between insurance and banks. And I want to make one other point. It is a judicious process. Everybody is listening on both sides.

And now, I'll turn the question over to Mark -- to everybody, I'd like to turn it.

John Robert Strangfeld

So we'll open to questions.

Mark B. Grier

This is Mark. Just one quick correction. I'm advised by my colleagues that I misspoke with respect to year-ago Star/Edison synergies. It wasn't $500 million, it was 5. Maybe a little wishful thinking in there.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from the line of Ryan Krueger with Dowling & Partners.

Ryan Krueger - Dowling & Partners Securities, LLC

First, I just wanted to make a couple of clarifications. Can you just repeat the share repurchase assumption? I think I didn't fully understand the assumption that you guys were using.

Richard J. Carbone

Okay. We had a $1 billion authorization. We purchased the $150 million in the third quarter, and we are going to purchase another $250 million over the next several months through June 30, 2013 for a total of $400 million.

Ryan Krueger - Dowling & Partners Securities, LLC

Okay. And then does the plan -- and then presumably, there could be something in additional, post mid-year in 2013?

Richard J. Carbone

That will have to go to the Board at that time, and it depends on their approval.

Ryan Krueger - Dowling & Partners Securities, LLC

Okay. And then, turning to the Hartford Life deal, we know that you're paying a $600 million seeding commission. Can you talk about how much additional capital will be required to support that business? And how do you expect your expense synergies to merge over the next couple of years?

Mark B. Grier

John, you want to take the expense? And I'll take...

John Robert Strangfeld

I'll take the capital base. Let me do that first. Let me do the capital piece first. That capital is going to -- the capital that we're going to get to pay for Hartford is coming from the reduction in the buybacks. So the capital capacity we're paying is relatively unchanged as a result.

Mark B. Grier

But I think Ryan was asking a different question. He was asking how much over and above the 615 [ph] we intended to put in, in support of the acquisition. That's the number that we're not prepared to give you today nor are we prepared to give you the expense synergies today.

Ryan Krueger - Dowling & Partners Securities, LLC

Okay. And -- all right. Maybe just one more quick one. That pension accounting change -- so I should think about the accounting change as adding $0.22 to your operating EPS definition for 2012 versus what was previously recorded?

Richard J. Carbone

That is correct.

Operator

Our next question comes from the line of Steven Schwartz with Raymond James.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

I just -- okay. I totally got it in a different way. The pension accounting change adds to earnings, adds to the baseline for 2012?

Richard J. Carbone

That's correct. Yes.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

And is it expected to have a similar effect for 2013?

Richard J. Carbone

Yes.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. And then -- I wanted to move away from this. I just want to talk about Gibraltar. Numbers have kind of been all over the place because of various different items having gone through the quarter. Do you guys -- when you back out everything, are you guys thinking now that this is probably a decent run rate on Gibraltar? Or is there some over earning may be going on or under earning that wasn't really pointed out?

Edward P. Baird

Are you speaking about earnings or sales?

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Earnings, Ed.

Edward P. Baird

On the earnings side, I think what you're starting to see here is what we had forecasted, which is you're starting to see the improvements taking place in terms of the expense savings coming into play here. You're also getting improvement coming from the growth of the business. So aside from onetimers, of which the third quarter does have some because of annual adjustments, you do have a steady improvement taking place as this business grows and gets the expense savings.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. And then one more, if I may. I know you're not really ready to talk about SIFI stuff. But, John, I think you made the assumption in the -- at the Investor Day that you didn't expect anything SIFI-wise really to come down and affect you until 2014. I'm wondering if -- what your thoughts are on that right now?

Mark B. Grier

Well, as you know, we're in the midst of the process right now, reviewing the designation question. We're in stage 3 of that process, which is interactive, involving the company and a variety of regulators and FSOC staff. I guess relative to what we thought at the beginning of the summer, the process is moving more quickly. They have set more ambitious deadlines and targets and objectives for addressing the designation process. However, the loose end there relates to the question of capital standards and solvency and risk regime if we are designated as a SIFI. And that process is more uncertain. It's possible that we could go through the designation process without having a resolution of the capital and solvency regime question. And so, I would still, I guess, convey some uncertainty around the timing of knowing, understanding and implementing whatever capital insolvency rules might arise if we are designated a SIFI. So while designation is -- may be moving more quickly, although that's a process that, as Rich said, is an earnest and hard-working process with good quality, give-and-take, the issue of standards is still highly uncertain.

Operator

Our next question comes from the line of Eric Berg with RBC.

Eric N. Berg - RBC Capital Markets, LLC, Research Division

Just one question. So in your discussion of the DAC unlockings, you indicated that -- I think you said that you have lowered your expectation for long-term equity returns. Two-part question, what do we mean by the long term over each of the next 10 years, 20 years, 30 years? And why do you think that the common stocks will permanently produce -- and that's a pretty heavy thing to say that common stocks will permanently produce a lower rate of return than you had anticipated, why do you think that's the case?

Mark B. Grier

Eric, it's Mark. With respect to the time horizon for the assumptions, it reflects the duration of the products. So where we need a 30-year assumption, we have a 30-year assumption that reflects the decrease in expected returns that we just talked about. So that long-term assumption is over the life of the underlying products. And by the way, it is stable over the lifetime. We extrapolate the returns from 4 years to 10 years to 26 years or whatever we need. With respect to the question about why lower returns, I think, at 40,000 feet, maintaining a reasonable relationship between fixed income returns and equity returns is appropriate. The risk premium in the market tends to be, over a long period of time, fairly durable and we're reflecting in our assumptions now interest rates lower by 100 basis points. And so, coincident with the broader return picture and relative return relationships, it seems appropriate to reconsider the equity return as well, otherwise we'd be widening the gap and probably distorting some of our reserve entries, where we're more heavily dependent on equity assumptions. It may be viewed as conservative, but we would certainly view it as appropriate.

Eric N. Berg - RBC Capital Markets, LLC, Research Division

No, I got it. That's very clear. Actually, one quick related follow-up. When you talk about your expected return to fixed income, do you mean the coupon income or do you mean the total return to the investor from investing in a bond?

Mark B. Grier

It's generally total return to investor because, ultimately, what matters here is the accumulation of assets either in our general account where we support a product or in a separate account where the client owns the asset.

Operator

Our next question comes from the line of Suneet Kamath with UBS.

Suneet L. Kamath - UBS Investment Bank, Research Division

A question about Slide 6, the 12/31/2012 projected numbers. Given HIG Hartford Life is closing in the first quarter, I'm assuming it's not in these numbers, is that correct?

Richard J. Carbone

That's correct.

Suneet L. Kamath - UBS Investment Bank, Research Division

Okay. So in terms of the capital that you plan to use to back that -- I know you're not going to give us the amount, but which bucket should we take it out of? I mean, is it coming out of the readily deployable capital or the on balance sheet capital?

Richard J. Carbone

Well, what's going to happen is it's going to go in the required equity, required capital up at the top. And then, it's going to -- what's going to happen is we're going to have attributed equity go up through -- due to earnings, and then we're going to go serve on the buybacks, so the buybacks will not deplete the attributed equity. And at the end of it all, I think it'll even out.

Suneet L. Kamath - UBS Investment Bank, Research Division

Okay. And then, similar question in terms of the RBC ratio. You're saying above 400% for year-end 2012, but if we put Hartford Life in here, I mean, is that number going to be still be above 400% as your -- is that your expectation?

Richard J. Carbone

Yes, because the capital that was going to be used to buyback stocks will remain in a FICA or be sent down to FICA.

Suneet L. Kamath - UBS Investment Bank, Research Division

Okay. And I guess my second question is on the non-bank SIFI. Maybe just asking it in a slightly different way, I get everything you're saying in terms of the uncertainty and things are constantly moving. But with that as a given, meaning things are uncertain, how did you get comfortable adding what looks to be $39 billion of general account assets? If I take the GM pension, the Verizon and then the Hartford Life, it seems like that's a pretty big amount of assets coming on, where there might be some uncertainty around the capital required to back that. So how did you get comfortable with that?

Mark B. Grier

We got comfortable, I guess -- or maybe the way you're asking it, in 2 -- sort of in 2 worlds. One is, with respect to where we are today, we apply a pretty sharp-penciled analysis to the economics of these transactions, and we're very careful about understanding the risk dynamics and concept of economic capital that we believe is consistent with what you guys as investors would expect and demand on these products. From there, in terms of the current picture, we also look very closely at the statutory impact then we look very closely at the GAAP impact. So there are 3 prongs, 3 different levels to the static question about the way that fits our books and where we have to be comfortable, and the answer is we have to be comfortable with all 3. Then looking at the question of SIFI-ness and the possibility of operating in a different capital regime and what this may mean, we have had a view that we're well run and well capitalized and doing the right things with respect to both risk and balance sheet, and that we'll address SIFI standards and issues around whatever insolvency and capital regime we face at the time that, that's actually settled. And as we pointed out, we generate a lot of capital. If we have to do something different in order to satisfy a new requirement, we believe that we have the capacity and flexibility to address those issues.

John Robert Strangfeld

And this is John. Suneet, I'd like to add on to that. Actually, not the question you asked but I think providing a better context around how we think about pension risk transfer as an important thing to do because I don't think we've really done that in a setting like this other than focusing on individual transactions. So let me just take a moment. And then, if there's a second part of your question, we'll come back to it. But let me just take a moment to talk about this a little because innovation of a scale of this magnitude is rare. And from our point of view, this is a wonderful complement to organic growth in M&A, and some context around it is, I think, is useful. This did not arise because of some sort of opportunistic flash in the pan that came in over the transom and nor is this is a kind of business that's simply driven by the sleight of hand and structuring or pricing. In our case, what we did is we established a dedicated PRT, pension risk transfer team as an R&D project in 2007. We saw some interesting macro forces. We thought we were well positioned for a whole variety of reasons. And frankly, we continue to invest in [ph] it and right through the financial crisis. And the reason for that is we thought that there are a lot of good reasons why we would have the opportunity to be well positioned to take advantage of this. And in a sense, this type of opportunity is just the opposite of a commodity. It's complex, it's big, it's multidimensional and high-value added. And while it may be less obvious to the outsider -- to the client, it's just best done by those who have businesses and cultures that do a really good job of interweaving different disciplines. And what I'm talking about there are things like actuarial investment business, legal, administration and asset management skills. It's not easy for people to do this or to replicate it. And furthermore, it's not only about the pricing. It's about the confidence a client has in a high-quality close and execution and doing it on a timely basis as GM has been quite focused upon and Verizon will be as well. I think you'll find -- for those who are thinking about this area and trying to put in some context, I think you'd find that we have very good marks for this in the industry. And I actually doubt that anyone else -- any other insurer, at least, has started in early -- as early or invested as heavily as we have in this era. So I think this is what explains both our interest in this area and I think what explains our early successes and market-leading position. Now when you back, back to the financials of this, just to complete the picture, what this produces is a stable earnings stream with moderate market sensitivity. It's consistent with our 13%-plus ROE goal. It involves risks that we know and manage well, and it doesn't have onetime costs or synergy phase-ins that are normally associated with a large outsized activity. And when we look at this from a multi-year context, when you think about what we've done post crisis, whether it's a strong organic growth, whether it's the well-executed M&A like Star/Edison and, prospectively, Hartford, and then the addition of the outsized organic growth on PRT, we really think this is probably the best business portfolio we've ever had in terms of an attractive balance of growth, stability and sustainability. So that's how we're thinking in the broadest terms about PRT, the role it plays and our thinking perspectively. And I understand that wasn't exactly to your question, but it felt like there's an opportunity here for me to speak to that.

Suneet L. Kamath - UBS Investment Bank, Research Division

No, that's helpful.

Richard J. Carbone

I would just like to add one other point because I know there's a lot of folklore running around in the street. The capital that we hold against this product is significantly in excess of capital that we hold against similar products, such as Stable Value, GICs and Group Annuities. So the -- we went back and we lost just a proportion of capital we have traditionally held against these products, these 2 transactions hold per capital at a higher level.

Suneet L. Kamath - UBS Investment Bank, Research Division

I'm sorry, did you say the capital is higher or lower?

Richard J. Carbone

Higher.

Suneet L. Kamath - UBS Investment Bank, Research Division

Okay. And then, just as you think about the returns on this business, I know you've said it's accretive to your ROE objectives. I'm not sure what that means if the capital is currently earning very little. So can you put some parameters around what, sort of, return you'd expect?

Mark B. Grier

Yes. When I was talking about the first answer I gave, the idea of a pretty sharp pencil and a careful look at risk adjustment returns and the performance of these products is very much true. We work hard to make sure that we understand the right capital and the right risk return picture here. And while we've talked about this in the context of our stated objectives and made the observation that these transactions are accretive to our objective relative to where we are without them and consistent with the goals that we've set, they are also consistent with what we believe to be the real economics of the transactions. These are sophisticated counterparties. Everybody is doing their homework and looking carefully from both sides at how these happens. And we recognize the discipline of the market to make sure that our economics are fully justified, and we believe they are, but I think what that also means is that if this were a stand-alone company starting up, doing these deals, you would invest in it.

Operator

Our next question comes from the line of Jimmy Bhullar with JPMorgan.

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

So first, I just had a question on your ROE. As I think about the 13% to 14% target, you're getting there if you use the top end of the range, but there are items in there in your guidance that we wouldn't have, like, really expected previously. There is the pension accounting change, the book value hasn't grown as much as you would have thought, given the charges, and I don't think all of the charges would -- were expected at the beginning of the year. So if I adjust for these, the is ROE still getting better but not as much as you would have assumed previously. So my question was just on, what do you believe are the key drivers of that? Is the performance in some of the businesses falling short? Or is it the macro environment, or is it something else? And then secondly, on your -- in the Gibraltar business, you had pretty strong sales of single-premium, whole life policies. And that -- obviously, your capping production levels in the fourth quarter lowering crediting rates next year, I mean, just how comfortable are you with the margins and returns on the business that you've sold over the past few months?

Mark B. Grier

Jimmy, it's Mark. Let me start off on your first one. We set this goal several years ago. And almost everything is different. And we knew when we set it that we were putting a stake in the ground around the earnings power of the company, but we were not putting a stake in the ground around every line item that was going to get us there. And over a period of several years, we know that almost everything is going to turn out to be different. In fact, we faced substantial headwinds with respect to the level of interest rates, and the cumulative impact of that, by the way, is larger than the impact of either of the items that you mentioned. And so our view is not to parse line items and try to reconstruct the -- either each assumption and the way in which that has come through or individual line items on our income statement and balance sheet and the way in which they have evolved in the context of what's come true relative to assumptions. I think the idea at a time was a reflection of our earnings power in a variety of circumstances. And we believe that, as you correctly point out, we made substantial progress, we are differentiated from the pack with respect to our level of returns and we're certainly within an eyelash of being totally consistent, at least in the aggregate, with the objectives that we've set. So I think you can look at the headwinds and look at the negatives and look at the positives, but our view is that we're doing what we said we were going to do under pretty difficult conditions. And you mentioned the macro environment, that would be the biggest one.

Richard J. Carbone

And Jimmy, the guide in volatility and returns on Gibraltar. Just a quick reminder: In terms of the volatility issue, we have 3 different distribution systems going on inside Gibraltar now. We have the traditional life consultant, we have the bank channel and we have the independent agent. Those last 2 are very spreadsheet-oriented, third-party kinds of supplemental businesses. So you're going to see a lot of volatility, as we've discussed in Investor Day, in those 2, less so on the life consultant one. Although for, frankly, even there for the next couple of years, you'll see more volatility than you have historically or that you will when we finish Prudential-izing the Star and Edison sales organizations. So just to the first point, unlike POJ and Life Planner, inside Gibraltar, for the next couple of years, we will see more volatility in results permanently in the third party but, in the short term, also in the life consultants. And specifically on the Single Premium product, which as you point out, was a primary driver of the bank channel, which is really what it's limited to it, it's not much of a factor outside of that, but inside the bank channel, it really dominated the quarter primarily because, as Mark pointed out in his opening comments, a lot of the competitors have been pulling back for more aggressive either plan designs, product designs or the rate setting. So there, it's gone up a fair bit. The challenge with that part, because it's Single Premium, it's much more sensitive to the interest rate market, so we applied a few techniques there that we don't apply anywhere else. One is we do adjust the crediting rates, but those, obviously, you can't move every time the interest rate market moves. So we will moderate as time goes on with that, as was pointed out. But secondly, we also, in this product can manage the sales volume by channel, so we will limit some of the sales. And the third is we also look at commissions, so we can lower commissions over time both to dampen the sales if we think it's disproportionate and also to improve the profitability. So all 3 of those will be active factors. In general, we're pretty comfortable that, while it's at the lower end of our target range at the moment, as interest rates move up, it will be better. But then on average, it's -- we're comfortable with it as part of the portfolio. For example, while it's high in this quarter, year-to-date, it's less than 20% of our sales, which I think is a key fact to keep in mind unlike some of the competitors who concentrate or are even limited to third party. For us, this is simply part of a supplemental distribution.

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

Okay, that's helpful. And maybe if I could ask just one more of Charlie. In the disability business, margins are still pretty depressed but you've seen a couple of quarters of improvement now, so just what's your expectations for that business? And as you are raising prices, what do you see in the market in terms of competitor behavior? Is the pricing environment overall getting better or is it not?

Charles Frederick Lowrey

I think it's still, on the disability side, relatively competitive, but we do see pricing going up. We are certainly raising pricing consistent with what we've said before. So while we're not pleased with the overall number yet in disability, we're pleased that our efforts are beginning to have some tractions. We've had 4 quarters of declining benefit ratio. It's not back to the 88% to 92% that we're -- that is the -- is where we wanted to be. But what we said on Investor Day is that we're taking aggressive action and that we have been, for over a year now, to grind down that ratio back to where it should be. And we've made some progress this quarter, particularly in claims management. Cases that are terminated were ones with relatively high severity, meaning the average reserve amount released had increased. On the other hand, new claims incidents and severity continue to remain high consistent with where the economy is today. So while we can't predict accurately the rate of improvement in our disability ratio, we have been and we'll continue to do whatever it takes to get the ratio back to where it should be. But said differently, this will not be a linear process. It has been for the past 4 quarters, but it won't necessarily be. We're in 1 year into our multiyear process and the economy isn't helping, so while the trends lane -- the trend line down will continue, you can expect there to be variation quarter-to-quarter, but over the long term, we'll get the ratio back to where it needs to be.

Mark B. Grier

Jimmy, it's Mark. I want to come back to one thing. And I know I promised I wasn't going to parse line items, but I want to make sure this pension accounting change doesn't devolve into something that it's not. This pension accounting change mitigates a drag that would not be here under our original assumptions. It doesn't represent an unanticipated benefit or a windfall. It's offsetting something that wouldn't have been part of the negatives as we set the original objective. So you shouldn't be thinking of this as a nice healthy surprise on the upside, you should be thinking of it as something that helps out a little on some of the other stuff that's gone on, on the downside.

Operator

Our next question comes from the line of Randy Binner with FBR.

Randy Binner - FBR Capital Markets & Co., Research Division

Just one more kind of around capital and FSOC. Assuming there's a designation -- whether or not there's a designation sometime next year for Prudential and other folks that are non-bank SIFIs, what's your expectation about how the stress test process would move forward kind of before designation and after designation, based on what you know now?

Mark B. Grier

I would say, highly uncertain. The discussion of the capital insolvency and risk regime is very much ongoing. And I think there have been lessons in the market about the challenges related to applying the bank stress test to an insurance company, and I believe that those challenges have been noted. So I'd say, very much work in process. I wouldn't want to speculate, and really don't know. That's got to be sorted out.

Randy Binner - FBR Capital Markets & Co., Research Division

Could you -- is it -- but if you were designated but there were no Prudential standards, could you even take a stress test?

Mark B. Grier

Well, we need a framework in which to conduct the stress test. We do our own around here. We've talked about our capital protection plan. And the way in which we stress our system for our internal test is actually extremely harsh and probably, all in, in terms of the direct impact on us, harsher than the bank framework. Although, I don't want to comment on a lot of specific details there because we don't do it that way. But we would need a framework in which to conduct the stress test. And right now, I don't think we have that.

John Robert Strangfeld

But just taking from Mark's point: We conduct our own internal stress test, and we put in a plan in place to remediate the impacts of that stress.

Mark B. Grier

In a way, there's something inconsistent because our core business is loss absorption, whereas the approach that's taken to the banking world is to think of loss absorption as an add-on. And for us, it's built into everything about the way in which we reserve and the way in which we manage assets and liabilities and the way in which we capitalized. So -- and there's kind of an anomaly there around the imposition of a loss absorption picture on a company whose core business is loss absorption.

Randy Binner - FBR Capital Markets & Co., Research Division

Right, understood. And I'm just trying to think about it more from a procedural perspective, but I appreciate your commentary. And if I could, real quick, just on the long-term care charge. I wanted to try and understand, and I apologize if I missed this, how much of that $685 million is ultimately reflected in stat? And would that all come through AAT [ph]? Or is that going to be spread across different areas in stat?

Richard J. Carbone

Well, it's going to -- it's not going to be spread across a whole bunch of areas. The first step is the charge will reduce surplus, but at year end -- and I don't want to get into this now, at year end, we will have to run the AAT testing against the cash flows and establish an AAT reserve at year end.

Randy Binner - FBR Capital Markets & Co., Research Division

So when you've adjusted AAT in the past, has long-term care been the big driver? And what -- because that reserve's built actually over time, right, over the last few years as rates have gone lower. Has that been the big kind of thing in the background for long-term care?

Richard J. Carbone

Right. As you know, AAT is sensitive to interest rate. So as interest rates have graded down over the years, we have been building in AAT reserves for our long-term care. I can give you the math. At year-end 12/31/11, that AAT reserve for long-term care was $400 million.

Randy Binner - FBR Capital Markets & Co., Research Division

Okay. And when you tested -- when you did discharge for long-term care, I assume you updated your outlook for lower interest rates. Was that by the -- so was it larger than the overall change of around 100 basis points?

Richard J. Carbone

No, no, no. You apply the same, we applied the same rules in long-term care, as we did across the portfolio.

Mark B. Grier

Yes, randy, you know that the AAT reserve will reflect the low rate scenario in the New York 7, so it won't exactly match the assumption that we're using in GAAP. But as Rich pointed out, we had $400 million at the end of last year. It will be rerun this year. Actually, the way AAT works is you start from scratch every year and post a new reserve, and that work has yet to be done.

Operator

Our next question comes from the line of John Nadel with Sterne Agee.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Just a real quick follow-up on Randy's question on the long-term care charge, though. There's no corresponding statutory charge in 3Q from this GAAP charge, is there, or do I have that wrong?

Richard J. Carbone

Yes, there is. There's a -- there's not a corresponding charge. There's an independent calculation in statutory for this event in the 3Q, but that will be refreshed in the 4Q when the final number is cast.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Okay, so we'll get that next quarter. So then just real quick one on the pension adjustment. So this benefits 2012, does it -- in your guidance for 2013, is there any expectation that, that benefit grows?

Richard J. Carbone

It does not decline, but it continues.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Okay, got it. Okay. And then I just -- I know you guys don't want to talk about capital deployed or earnings expected from any of these one-off transactions individually, the GM, the Verizon or the Hartford, but I'm hoping you'd be at least somewhat willing to give us some help in understanding the capital deployed and the earnings contribution from maybe the 3 of them in aggregate. I mean, there's an awful lot of -- it appears, anyway, that there's an awful lot of capital and there's an awful lot of earnings that ought to come that's being deployed and should be generated from these transactions. At least in part, it's being funded by what was otherwise expected to be buybacks. So is there any help you can provide on that? Because I think it's an important one.

Mark B. Grier

The help that we provided has been to acknowledge that the range of capital requirements that's been discussed in the marketplace is reasonable in terms of how we think about these businesses and to add that the return is consistent with the objectives that we've set for this kind of a transaction but also consistent with the overall corporate ROE objectives. So we've acknowledged those points and believe that the people who have thought this through and put numbers out there have not been very far off.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Okay. Well, I -- and that's fair. I think that's been probably a little bit more -- a little bit easier to do, though, with the pension risk transfer deals. I'd -- I'm still sort of curious as to, beyond a reinsurance ceding commission that you'll be paying for the Hartford life deal, how much more capital you'll be putting behind that once it's on your books, but...

Richard J. Carbone

Randy, in a way, it doesn't matter because, whatever that capital is, it's going to return the hurdle rates that we need to support our 13% objective.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Okay. Then last quick question for you is, on the S&P 500 assumption, they -- over a long period of time, you have assumed 8%. You're assuming 6% now. I -- it's probably certainly more conservative relative to 8%. I'm just wondering if you can give us some kind of an estimate on how much that difference in assumption impacts your overall earnings outlook or ROE expectation for 2013. Can you help us with an estimate on that impact of 8% versus 6%?

Richard J. Carbone

It's not. It...

Mark B. Grier

Everybody is shaking their head. But it's all in our forecast, but I'm not sure we have it broken out the way you're asking it.

Richard J. Carbone

Cumulative over time, it may amount to something, but one year, I wouldn't sweat over it. I guess the other thing I'd say, John, this is John, is that what is important to keep in mind here is that some of these moves we've made recently that, start at the 2 risk transfer transactions, Hartford and Star/Edison, had all made us less market sensitive, less appreciation sensitive, and we clearly were going into the financial crisis. And we've got a lot more balance. They've got more stability, kind of like International, and Star/Edison. It's got both stability, scale and growth but it's a materially enhanced business mix from the one we had at that time. And less dependent on appreciation, frankly, more driven off of business fundamentals on flows and sales than as that time too. So we think we're in a much better place.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Well, I -- and John, I appreciate that. Where I was trying to go with the question was I -- your business mix versus many of your larger peers has been less rate sensitive, more capital markets sensitive. And in an environment certainly post the election where it appears, long-term rates, lower for even longer, I would have thought there'd be even that much more interest in Prudential on a relative basis. That's why I was trying to go there.

Mark B. Grier

We appreciate that sentiment.

Operator

We'll go to the line of Chris Giovanni with Goldman Sachs.

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

I guess, following up on John's question in terms of the aggregate of capital management, I think most of us have kind of thought about the pension risk transfer business from capital absorption as roughly 5% to maybe 6% of the liability. And I think, Rich, you alluded to a number maybe above that because that's typically what we thought about in terms of GICs and other products. So I guess if we take -- I guess the math I was going to try and do is, if we take the 5% to 6%, say we take 6%, for the liabilities. We add in Hartford, we add in the dividend and we add in the buybacks, we're getting in around $3.7 billion of capital management. So I guess that would be along the lines that, John, you talked about in terms of being well in excess of the $3 billion. I mean, is that the math? Or are we missing something on the pension side of things?

John Robert Strangfeld

You got the math right. I just want to correct one thing, well not correct one thing, modify one thing you said. What I was saying was that the -- and Mark -- to embellish on Mark's point. Mark said that you guys are out there calculating what you think the capital we need to hold against these transactions are. And I'm talking about risk transfer. You're in the ballpark, okay? And that is the ballpark, those ratios, the 5% to 6% that you just quoted, exceed the historical capital that we keep against GICs and stable value and group annuities, and yet we are getting our hurdle rates on those higher capitals as we do on those other products.

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

Okay. And then I guess, just a few follow-up. The buyback, I mean, I guess, what gives you kind of the comfort that you can and you should be buying back stock given the murky kind of regulatory outlook?

Mark B. Grier

Remember, we've been under the over-side of the Fed since summer of last year when the thrift holding company supervision kicked in at the Fed level, so we have worked with the Fed and discussed our capital actioned with the Fed as we've gone through the past 12 months. In terms of the current status of things, we have de-thrifted, so we're no longer under that umbrella. And as a forward-looking question about the potential impact of SIFI, as I've said, we believe that we're very well capitalized and I think, if you took a proper economic look at the GAAP balance sheet, you would see capital ratios that are multiples of typical bank standards. And we believe that, right now, the emphasize on doing the right thing, and supporting the business and managing capital as, we believe, is appropriate should still be our course.

Christopher Giovanni - Goldman Sachs Group Inc., Research Division

Okay. And then, I guess, just lastly, you guys did a pretty interesting hybrid offering back in August where you qualified for Tier 2 capital, 100% equity treatment from S&P. And I guess we view this as a positive given some of the unknowns around non-bank SIFI and stress testing. So just curious why you limited it -- limited this to just $1 billion? And could you do more to kind of bolster capital for stress tests? Or are there limitations on how much you can do?

Richard J. Carbone

That was a very economic transaction we did back in August. We took out some senior debt, higher-costing senior debt, replaced it with lower-costing junior capital, okay, got the equity credit. And as we conditions like that present ourselves -- themselves in the future where we can call expensive debt and restructure our capital structure to make it more efficient, we will do it.

Operator

Our next question comes from the line of Tom Gallagher with Crédit Suisse.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

First question I had was on the Hartford deal. Rich, if I understand it correctly -- and I guess you haven't given out explicit guidance, so I'll talk more in general terms. But my understanding was the Hartford deal was not expected to be highly earnings accretive in the first year. And if that's true, and I understood your other comment correctly that, that deal is taking directly away from buyback, is that actually earnings dilutive in the short term when we consider the opportunity cost? That's my first question.

John Robert Strangfeld

It's hard to tell. Maybe slightly dilutive to being a push. Meaning, that started up [ph] between a buyback and making an acquisition. In the long run, it will be accretive. In the short run, it's likely a push to be accretive [ph].

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Okay, so that implies actually Hartford will be contributing something in the 2013 time frame?

John Robert Strangfeld

Oh, sure. Sure. The normalized basis, x onetime charges, it will be accretive to EPS, absolutely.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Okay, I just wanted to clarify that. The next question I had, I guess it's a little higher level so for either Mark or John. So when we think about what you guys are doing from a buyback standpoint, $250 million buyback over the next 3 quarters, which is obviously a lighter number than you've done for a while now. Is it safe to say directionality that, just given the uncertainty, that your view as a firm is it's safer to deploy money into block deals or pension deals or organically than it is for capital management activity that might come to an abrupt halt at some point depending on new regulations. So how are you thinking about that from a high-level standpoint?

Mark B. Grier

No -- this is Mark. We look at these deals, as I've used the phrase a couple of times, with a very sharp pencil, and it really is a better deployment of capital that we're looking for. So I know there's been off and on questions about whether or not the potential regulatory environment would nudge us, one way or the other, vis-à-vis acquisitions or business investments versus dividends or share repurchases. And right now, the answer to that is no, we're making these decisions based on the best deployment of capital. These are attractive transactions for us that will allow us in the future to pay more dividends and buy back more stock. And so, I understand the question but that has not been part of our analytic at this point.

John Robert Strangfeld

I guess I would say that -- Tom, that generally speaking, the organic growth is cheaper and less intrusive way to develop business than M&A. And outsized organic growth, like the PRT activity is particularly attractive, for the reasons we talked about. Everything from skill sets and absence of onetime costs that are -- or the execution risks and synergy realization. This sort of thing.

So we still feel very, very positive about the role that they have and the opportunity that presents itself to put the capital to work.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Got it. And Mark, you had mentioned you guys have officially de-thrifted. When did that happen? And I assume that means it's totally done, there's no further hurdles.

Mark B. Grier

The answer is yes. It's totally done, there no further hurdles and that happened right at the end of October

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Okay. And then the other question I had -- and Rich, correct me if I'm wrong, but I -- it sounded like a change on -- maybe just a subtle change when you commented on reducing financial leverage. Is that a change at all? And maybe that's just been ongoing. Because one thing that certainly comes to mind for me, if you look at what AIG announced, and obviously they are regulated by the fed now officially and they had a very abrupt change with capital management plans where they said essentially they're going to start deleveraging from a share buyback program that they had previously indicated. So just curious, are you guys hearing anything similar in your preliminary discussions in terms of where you think eventually your financial leverage is? Is that going to be a real hot button item with where things are going here?

Richard J. Carbone

This decision to reduce leverage below the 25% level is ours. And what -- it's not that big a change. We have always had a target of 25%. Over the past couple of years, that's bumped up above that, and our objective is to get it below 25% so if we want to do something and we push it back to 25% or we push a bit over 25%, it's okay because everybody is confident. Then we're going to push it back down below it. So yes, 25% is our target. We'd like to run a little bit, borrow that, but we're not going to not push it back there if there's the right deal, it's got a lot of economics and it can support the leverage.

Thomas G. Gallagher - Crédit Suisse AG, Research Division

Got it. And then last question, the -- what you guys have done in terms of lowering your futures and returns in both fixed income and equities, how does that apply to pricing products? I assume, when you were using 8% return on equities and a somewhat lower-return for fixed income, in the old way, that's how you were pricing. But -- or have you changed pricing to reflect that yet? Or is that on the come? How should we think about that?

John Robert Strangfeld

I think we are -- we look at pricing relative to the markets and relative to our assumptions. So as Mark said, we just changed pricing on some of our life product. We changed pricing recently on annuities. We're changing pricing in our Group products. So we look at this continually and we'll change pricing accordingly. And these assumptions feed into those decisions. So it's a continuous thing we do and we'll continue to do it going forward.

Operator

And we have time for one final question. That'll be from the line of Sean Dargan with Macquarie.

Sean Dargan - Macquarie Research

I just have one point of clarification. On Slide 5, as we get to the guidance on an AOI basis, in the footnote, for unusual and non-recurring items, you've got business integration costs and DAC unlockings. Are we to take that to mean that there are going to be further unfavorable DAC unlockings on the legacy PRU business for which you just did the actuarial assumption review?

Richard J. Carbone

This is -- I want to get the right spot here. This is the -- this is that little box just to the left of the last gray column which says 2013 AOI basis?

Sean Dargan - Macquarie Research

Yes.

Richard J. Carbone

Okay. What's going in there, there is some mean reversion. It's not wholesale unlockings that we're expecting on anywhere along the magnitude that we talked about this year. That bucket is 90% Hartford and Star/Edison integration costs. Then maybe a little in there is we use the mean reversion technique. If the equity markets don't perform the way we plan for them to perform, we have a mean reversion formula. We may have to unlock a bit of DAC in there. But that column now does not -- plans for a modest amount of that. It's mostly Star/Edison and -- or at Hartford.

Operator

Thank you. And ladies and gentlemen, today's conference call will be available for replay after 2 p.m. today until midnight November 15. You may access the AT&T teleconference replay systems by dialing (800) 475-6701 and entering the access code of 225939. International participants dial (320) 365-3844.

That does conclude your conference call for today. Thank you for your participation and for using the AT&T Executive Teleconference Service. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Prudential Financial Management Discusses Q3 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts