A time to reap rewards.

Prudential's 10-year turnaround came in three phases: damage control stemming from life agent sales misconduct, divestiture of businesses from its 1980s' financial supermarket strategy, and what happened during and after demutualization. That third phase, from the initial public offering to mergers and acquisitions to stock buybacks, set the stage for tangible improvements that the company reported in December during its "Investor Day" presentation.

For the nine-month period ending Sept. 30, Prudential reported a 22% rise in pre-tax adjusted operating income to $1.8 billion, a 38% increase in earnings per share of common stock based on that income to $2.63, and a return on equity of 10%, up from 7.6% a year earlier. Prudential's ROE goal in 2005 is 12%. Andrew Kligerman, a UBS equity analyst, said in a recent report he expects Prudential to achieve that goal and that the company is "improving towards the peer-group average."

"Certainly one of the headlines would have to be the focus that we now have on the grow-and-protect strategy, and the changes we've made in the mix of businesses," said Mark Grier, vice chairman, Financial Management Division, earlier in the year. "But we've also significantly strengthened our operating platform; the corporate functions have gotten themselves to the point we're at market standards in the things we do in finance and HR, compliance and law. We have a common business system within Prudential as opposed to a totally decentralized and fragmented operating environment. So all those combine to make it easier today than it was 10 years ago"

Leading the way in growth and ROE is the International Insurance and Investments Division, headed by Vice Chairman Rodger Lawson. Despite representing less than 18% of operating businesses in attributed equity, a measure of stockholder value, the division contributes about 40% of operating revenue and a 27% ROE. The Life Planning part of the division, nearly 20 years old, grew agent by agent in country by country, and Chairman Art Ryan retained the business model. The professional field force made up of life planners receive training from Prudential in needs-based selling of life insurance for purposes of family protection. "When we start in a new country, like Brazil, it takes about two years to get the business off the ground," said Lawson. "We recruit extremely carefully. In most countries, being a life planner is a very good job. Normally we take only three or four out of every 100 applicants, and they go through a rigorous vetting program." The company also provides a high level of service to individual clients, who are typically building their incomes but may not have a lot of wealth. As a result of this model, policy persistency is the highest in each country in which Prudential competes, Lawson said.

Building on Acquisitions

Major acquisitions under Ryan, primarily of Hyundai Investments in Korea and Kyoei Life Insurance Co. in Japan, provided the basis for the traditional life insurance business and the foreign asset-management business.

Over the past three years, Prudential has imparted the skills and qualities of its life planners business to agents in the traditional life model of Kyoei, which Prudential renamed Gibraltar Life. Some left, but retention was better than expected. In November, for the first time, the number of Gibraltar Life advisers grew. "We couldn't fire all the insurance agents and start over again," said Lawson. "We've put a lot of money into training and recruiting, and we've changed to a compensation system based on performance." The result has been greater productivity, policy persistency and agent retention. As of Sept. 30, its ROE was an amazing 34%.

Domestically, Prudential expects the greatest growth to come from the retirement market, with its Investment Division leading the way. From year end 2002 to Sept. 30, 2004, the company's retirement and annuity businesses grew in attributed equity from 11% of its financial services businesses to 28%. This sudden growth relates to Prudential's acquisitions of American Skandia Life Insurance Co. and Cigna's retirement business for a combined $3.4 billion. Individual life insurance during that same period declined as a percentage of the total. "This shows that our capital is following the growth prospects, and the growth prospects are in retirement," said John Strangfeld, vice chairman, Investment Division. The other business growing on a percentage basis is investment management, which runs money for institutions and other third-party investors, he said.

While the merger of Prudential Securities and Wachovia Securities had no impact on the amount of money run by Prudential Securities, and thus represented a slightly smaller percentage of Pru's overall financial services businesses, Strangfeld said the company should see better performance because the business is no longer disadvantaged by a lack of scale. "Our expectation is that this should produce handsome financial outcomes, and sustainable ones over time" he said.

Except for the American Skandia purchase, changes in the Insurance Division have been in both product and distribution. "Our life business is a significant turnaround story," said Vice Chairman Vivian Banta earlier last year. "The improvement in returns in this business have been nothing short of spectacular." She added that changes in distribution, product development and service quality delivered have been "very dramatic."

Banta said the number of career agents dropped from a high of about 6,100 to about 3,700 last year. The company also has upgraded recruiting standards and reduced annual recruits from 3,000 to 750 while providing a transitional salary, bonus and better training to improve the probability they will succeed. Agents now serve under one sales channel instead of three, and Prudential also continues to "raise the bar" in productivity requirements.

Prudential's third-party distributors are mainly in the wirehouse, bank and independent-financial-adviser channels. The company services them through nearly 200 wholesalers. About 70% of life insurance revenues come from career agents vs. 30% from third-party distributors. That was also true of annuity revenues before the American Skandia purchase, but since then third-parties generate more annuity revenues than the captive agents, said Banta.

Remarkably, Prudential considered divesting its annuities business before the Skandia acquisition. "We knew we were a subscale business and that having scale was very important in order to compete," she said. "We also knew that our primary distribution channel was through our captive agency, and yet the fastest-growing channels were the independent channels. This did not bode well for us." The Skandia deal gave Prudential the channel diversification it needed, and it met and exceeded the company's targeted hurdle returns. "That made it doubly attractive" Banta said. "It was a great move for us."

Product Diversity

On the product side, Prudential had been primarily a variable life shop, but the 2000-2003 bear market exposed the vulnerability in that strategy. Since then, Prudential has diversified its product lineup with more universal life and term life products. Overall, both the insurance and annuities businesses are much more market-focused since the company's demutualization in December 2001, including products that are updated and freshened, she said.

Kligerman reported that variable annuity sales declined 18% sequentially during last year's third quarter, more than the industry's decline of 11%. He said converting 550,000 American Skandia contracts onto Pru's systems resulted in delays in new-product introductions, but said new products are on the way.

With the company's reconstruction in place, Prudential was focused on execution last year and will be again this year, said Grier. "We haven't printed a 12% ROE in '05 yet," he said. "Beyond that, we will be trying to enhance our positioning in grow and protect, investments in our own businesses or to look outside for other opportunities. But I don't see us drastically changing course. We'll continue to be opportunistic in the deals we do and the way we use our capital."

Leaps to 5th Among
Variable Annuity Writers.

By adviser-sold assets under
management on Sept. 30, 2004,
Prudential's purchase of American
Skandia propelled it past five
top-10 writers into fifth place.

($ Millions)

Hartford        $87,298
Equitable        51,271
MetLife          45,106
Lincoln          43,568 [left arrow] #5
Prudential       42,644
Nationwide       37,500
AIG Sun/VALIC    31,376
Manulife         29,989
ING              28,795

Adviser-sold market (excludes Group/retirement
plan contracts); Source: VARDS

Note: Table made from bar graph.

And to 8th in New Sales

Among adviser-sold variable
annuity products.

                        3Q '04
3Q '04                   Sales    3Q '04
Rank     Company          ($B)    Share %

1        Hartford         $3.4      13.7
2        Equitable         2.2       9.0
3        MetLife           2.0       7.9
4        Lincoln           1.7       6.9
5        ING Group         1.6       6.3
6        Pacific Life      1.4       5.7
7        Manulife          1.4       5.6
8        Prudential        1.3       5.0
9        IDS               1.0       4.2
10       Allianz           1.0       4.1

         Industry        $24.8

Source: VARDS

Creating Scale.

With the acquisitions of American
Skandia Life Insurance Co. in May
2003 and Cigna Life Insurance Co.
in April 2004, Prudential increased
account values enough in variable
annuities and defined-benefit and
defined-contribution retirement to
become a major player.

Account Values

                 Dec 31, 2002     Sept 30, 2004

                 $80.7 billion    $172.6 billion
Retirement       $62.0            $124.3
Annuities        $18.7             $48.3

Source: Prudential

Note: Table made from bar graph.

Earnings Generators

The American Skandia and Cigna acquisitions helped fuel nearly a
fivefold increase in annuities' and retirement accounts' contribution
to operating income as a ratio of the income of all of Prudential's
financial services businesses.

Adjusted operating income of the Financial Services Business (1)

Year ended Dec. 31 2002       Year ended Sept. 30, 2004 (2)
      $1.7 billion                  $1.8 billion

6% Retirement & Annuities     29% Retirement & Annuities

(1) Pre-tax

(2) Includes results of retirement business acquired from Cigna
commencing on acquisition date April 1, 2004

Source: Prudential

Note: Table made from pie chart.

International's Growing Role

With a presence in Mexico, South America, Europe and Pacific Asia,
Prudential's international insurance business now produces the
greatest share of corporate earnings. Major businesses are in Japan,
Korea and Taiwan.

Adjusted operating income (1) $1,825 million

International's Growing Role             39%
* Life Planner model
* Gibraltar Life

Retirement & Savings                     29%
* Retirement
* Individual Annuities

Investment Business & Corporate          10%
* Financial Advisory
* Asset Management

Domestic Insurance                       22%
* Individual Life
* Group Insurance

(1) Before-tax; for the financial services businesses; nine months
ended Sept. 30, 2004

Source: Prudential

Note: Table made from pie chart.

Positioned for Growing Sales

Third-party distribution channels drive most of variable annuity sales,
particularly the independent broker-dealer channel, which is where
Prudential has nearly two-thirds of its distribution alignment.

VA Channel Sales
Share: 3Q '04
                   Annuity Industry   Prudential Annuities

Independent            37%                 64%
Banks                  16%                  5%
Direct                  1%
Agency                 22%                 24%
Regional               11%                  2%
Wirehouse              13%                  5%

Source: VARDS

Note: Table made from pie chart.