Prudential Financial - Earnings Call - Q2 2020
August 5, 2020
Transcript
Operator (participant)
Ladies and gentlemen, thank you for standing by, and welcome to the Prudential Quarterly Earnings Conference Call. At this point, all the participant lines are in a listen-only mode. However, there will be an opportunity for your questions. Instructions will be given at that time. If you should require any assistance during the call, please press star then zero, and an operator will assist you offline. As a reminder, today's call is being recorded. I will turn the call now over to Darin Arita. Please go ahead, sir.
Darin Arita (Head of Investor Relations)
Good morning, and thank you for joining our call. Representing Prudential on today's call are Charlie Lowrey, Chairman and CEO, Bob Falzon, Vice Chairman, Andy Sullivan, Head of U.S. Businesses, Scott Sleyster, Head of International Businesses, Ken Tanji, Chief Financial Officer, and Rob Axel, Controller and Principal Accounting Officer. We will start with prepared comments by Charlie, Rob, and Ken, and then we will take your questions. Today's presentation may include forward-looking statements. It is possible that actual results may differ materially from the predictions we make today. In addition, this presentation may include references to non-GAAP measures.
For a reconciliation of such measures to the comparable GAAP measures and the discussion of factors that could cause actual results to differ materially from those in the forward-looking statements, please see the slide titled "Forward-looking Statements and Non-GAAP Measures" in the appendix to today's presentation, which can be found on our website at investor.prudential.com. With that, I'll hand it over to Charlie.
Charles Lowrey (Chairman and CEO)
Thank you, Darin. Good morning, everyone, and thank you for joining us today. I will start by saying we hope that you, your families, and colleagues remain safe and healthy during these extraordinary times. The events of the past several months have created unforeseen new difficulties for people around the world, while further exposing the deep-seated problem of inequity in our society. It's in times like these that we believe our company's purpose of solving the financial challenges of our changing world and standing by our employees, customers, and communities is most important. After transitioning over 95% of our U.S. employees and most of our international employees to remote work in March, we continue to seamlessly serve customers, while the vast majority of our employees around the world continue to work in that fashion.
This allows us to exercise utmost caution as we evaluate how and when to return to the workplace. In the meantime, I am so proud of our people and how they've continued to focus on meeting the evolving needs of our customers, many of whom face new challenges related to the COVID-19 pandemic and its economic impact. We will continue to innovate the ways we serve our customers during and after the pandemic. During the second quarter, we maintained a clear focus on executing against our 2020 initiative, despite the challenging macroeconomic backdrop, by delivering on progress on our cost savings targets, aggressively repricing and pivoting products to mitigate the impact of low rates on our performance, and rotating our international earnings mix. We are also focused on identifying opportunities for further action, particularly as we look to continue to reduce our sensitivity to markets.
We are exploring the potential to generate additional cost savings on top of our existing 2020 target. Throughout this period, we have benefited from the strength of our rock-solid balance sheet, which gives us the confidence and the flexibility to navigate changes to the economic environment. I will touch on each of these points in greater detail before turning it over to Rob and Ken for a look at our second quarter results. Turning now to our 2020 priorities on slide 3, we remain on track to achieve our $140 million cost savings target for the full year and have achieved $75 million in savings year-to-date, with $45 million in the second quarter. We also continue to make progress in shifting our international earnings mix to higher growth markets.
We remain on track to close on the sale of Prudential Korea in the second half of 2020 and are advancing our review of strategic options for Prudential Taiwan, which may include a sale. As I mentioned earlier, we are aggressively modifying our product mix while exercising a highly disciplined approach to pricing in this low-interest rate environment. Turning to slide 4, while we are encouraged by the progress we're making to position our businesses and operations for the future, we continue to look at ways to work smarter and more efficiently in order to achieve cost savings on top of our target of $500 million by 2022. This includes using technology and automation and leveraging the learnings from operating in a remote work environment to optimize how and where we work.
In addition, we are looking at other ways to build upon our repricing and product shift to further mitigate the impact of market sensitivity. On slide 5, we note how we're embarking on these initiatives with the foundational strength provided by our balance sheet and robust capital position, including highly liquid assets of $4.5 billion at the end of the second quarter. Prudential Financial and its subsidiaries continue to exceed a double-A financial strength rating. Our second quarter assumption update had a modest effect on our financial results, even as we reduced our U.S. long-term interest rate by 50 bps to 3.25%. Lastly, we anticipate receiving the $1.7 billion of proceeds from the sale of our Korea business by the end of the year. In terms of our capital deployment plan, we will continue to monitor developments in the credit markets and the economy to determine our strategy.
Slide 6 shows our second quarter financial results. This quarter exemplified the benefits of our thoughtful approach to risk management and our complementary business mix. We aim to balance mortality and longevity risk, so we do not have a one-sided exposure. In the quarter, we had net favorable underwriting experience. Our adjusted operating income was $931 million in the quarter, while we recorded a net GAAP loss driven primarily by the non-cash effect of non-economic market impacts, which have no effect on our regulatory capital position. Our U.S. businesses reported adjusted operating income of $455 million due to more favorable underwriting, offset by the unfavorable impact of the assumption update and lower fee and spread income. PGIM reported record adjusted operating income of $324 million, as well as record assets under management of $1.4 trillion, a 9% increase from the year-earlier period.
This growth reflected strong flows into fixed income, as well as market appreciation. Our international businesses reported adjusted operating income of $693 million, as more favorable underwriting, higher earnings from joint ventures, and business growth were offset by the unfavorable impact of the assumption update and lower spread income and higher expenses. Before turning it over to Rob, I would like to address the recent disturbing incident of racial injustice and how we, as an organization, are responding to the deep-seated and persistent problem of racism and inequity in society. Last month, we announced commitments to advance racial equity, as highlighted on slide 7. These commitments were born out of the courageous candor of our employees, who have shared their experiences and their expectations, and the listening that has taken place all across Prudential.
Taking a bottom-up approach, we develop concrete and measurable actions spanning our talent practices to how we design and deliver products, to the investments we make, and to how we foster social and racial equity in the communities where we work and do business. We already had a substantive set of programs underway and a body of work that reflects our long-standing commitment to racial equity, including investing over $1 billion in our hometown of Newark. We recognize that this moment calls for us to amplify what Prudential has already been doing to drive change within our company and within society. It is immoral, and it is a business imperative that aligns directly with our company's purpose to solve the financial challenges of our changing world, as well as our multi-stakeholder commitment to employees, customers, shareholders, and society.
We stand by the promises we make, and we are prepared to be judged for our actions to support our colleagues, customers, and communities today and over the long term. With that, I will turn it over to Rob.
Robert Falzon (Vice Chairman)
Thank you, Charlie. I want to re-emphasize your comment about our commitment as a management team to supporting racial equity. This is an issue that is aligned to our purpose. It is part of the fabric of our culture and critical to our success as an organization. I'll now provide an update on how we are executing on our strategy within our U.S., PGIM, and international businesses, as well as on the outlook for these businesses. We will also provide an update on our investment portfolio. Turning to slide 8, U.S. businesses produce a diversified source of earnings from fees, net investment spread, and underwriting income. We continue to execute on three key priorities. First, we have implemented pricing and product actions to simplify and de-risk our business mix while protecting profitability.
For example, we took aggressive pricing actions aligned with our intention to significantly reduce sales of HDI, our legacy flagship VA product, and launched FlexGuard, our buffered annuity product, which has been well received by the market, supporting our product mix shift to less interest-rate-sensitive solutions. In our individual life business, we suspended sales of our single-life guaranteed universal life product in July. This will result in the continued shift to variable life and other less interest-rate-sensitive products. We will continue to take product and pricing actions, including steps to diversify our mix of business to maintain profitability in this interest-rate environment. As a result, we expect individual annuities and individual life sales to continue to move lower in the near term.
Second, as the needs of our customers rapidly evolve, including in response to COVID-19 and its economic impact, we are increasingly leveraging technology to enhance customer engagement and efficiency. For example, we have expanded our process to electronically deliver policies from application submission to policy issuance and have increased the use of our FastTrack automated underwriting process. We have expanded the use of electronic signatures and self-service customer capabilities across our businesses. Third, we remain committed to expanding our addressable market. The pandemic has amplified the financial wellness challenges that many U.S. households face and has highlighted the importance of our financial wellness platform and our life insurance, retirement, and financial planning solutions. We also continue to see increasing interest in our Assurance IQ platform from customers in the healthcare, life, and P&C lines of business.
In preparation for the Medicare annual enrollment period in the fourth quarter, we've been progressing well with our agent onboarding and training process. Now, turning to slide 9, PGIM is a top 10 global investment manager that continues to demonstrate the strength and resilience of its multi-manager business model. Our assets under management reached a record level of $1.4 trillion, up 9% from the year-ago quarter, driven by net flows as well as the positive impact from equity and credit markets. PGIM's long-term investment performance remains strong and has rebounded from the temporary downturn in the first quarter. More than 85% of assets under management have outperformed their benchmarks over the last 3, 5, and 10-year periods. This strong investment performance, coupled with diversified investment capabilities across asset classes, regions, and client segments, has led to continued growth.
We generated nearly $4 billion of net third-party flows during the second quarter, driven by record retail flows of $9 billion. Institutional outflows were driven by a single passive equity client redemption. Our public fixed income platform generated flows of $10 billion as it continues to benefit from our broad suite of strategies and the leading position of our franchise. PGIM Investments was the No. 1 ranked U.S. mutual fund franchise across active and passive asset managers based on net year-to-date sales. PGIM's asset management fees were up 3% compared to the year-ago quarter, driven by the growth in average assets under management. In addition, other related revenues increased, primarily due to higher strategic investment earnings as a result of strong investment performance and the effect of credit spreads tightening, reversing the widening that had occurred in the first quarter.
We also continue to focus on cost discipline to fund growth and further increase our operating leverage. Turning to slide 10, our international businesses, including our Japanese life insurance operation, where we have a differentiated multi-channel distribution model, as well as other operations focused on high-growth markets. As expected, LifePlanner sales decreased 30% compared to the year-ago quarter, primarily reflecting lower sales in Japan due to COVID-19-related restrictions on sales activities. LifePlanner headcount, however, increased 5% compared to a year ago. Similar to LifePlanner, sales for Gibraltar were 34% lower, but the number of life consultants has declined as we continue to focus on quality distribution. In Chile, market returns in the quarter were higher than average, and that contributed to an operating income benefit of approximately $25 million, reversing the impact we experienced in the first quarter.
With respect to expenses across international, we provided appropriate sales support to protect and care for our captive distribution, as we noted last quarter. This contributed $55 million to expenses, which we expect to trend lower in the second half of the year. We have seen some recovery in Japan sales beginning in June as the state of emergency was lifted, and over time, we expect sales to normalize. In addition, to mitigate the impacts of reduced face-to-face sales, our agents have adapted to increased usage of virtual tools to connect with customers, and we have seen early signs of success. We believe that our needs-based selling approach and death protection product focus continue to provide important value to our customers. With respect to interest rates, we've successfully managed through decades of low interest rates and other market challenges in Japan.
As you have seen us do in the past, we adjust our product offering quickly to meet the needs and preferences of our customers while also achieving our return expectations. We have already taken actions and will continue to do so as needed as we move forward. Now, turning to slide 11, we have a conservative, quality-focused investment portfolio that reflects our robust asset liability management practices, commitment to broad diversification, and a disciplined interest rate risk management framework. We also leverage PGIM's expertise across multiple asset classes, including its deep and long-standing experience in private placements and real estate. Year-to-date credit migration and losses have trended below our expectations. Second quarter, credit losses were $139 million, driven by energy and consumer cyclical sectors.
While we expect credit losses to be a multiple quarter story, we feel comfortable that our exposure is manageable and that we are well capitalized to weather whatever emerges. With that, I will hand it over to Ken.
Kenneth Tanji (CFO)
Thanks, Rob. I will begin on slide 12, which provides insight into earnings for the third quarter relative to our second quarter results. The key point is that our underlying earnings power increased slightly from last quarter, primarily reflecting higher equity markets. To help you see this, I will start with pre-tax adjusted operating income in the second quarter, which was $931 million and resulted in earnings per share of $1.85 on an after-tax basis. We adjust for the following items. First, the annual review of assumptions and other refinements resulted in a net charge of $334 million in the second quarter, primarily driven by a reduction of our long-term interest rate assumption by 50 bps in the U.S. Next, we adjust variable investment income to a normalized level, which is worth $130 million.
Please note that while we have not included an adjustment for variable investment income for the third quarter, the potential exists for continued revaluation of private equity and real estate investments due to the current adverse economic conditions. While returns of our alternative investment portfolio are currently lower than our target returns and will vary period to period, over time, this portfolio has generated income above our targeted returns. Third, we adjusted underwriting experience by $155 million. This reflects $100 million of favorable experience in the second quarter, primarily driven by reserve gains in retirement. We estimate claims experience in the third quarter will include $55 million for COVID-19. Next, there are other items that combined may be $75 million more favorable in the third quarter, primarily related to expenses and markets. We expect expenses, including implementation costs, to be $130 million lower in the third quarter.
This is primarily due to legal expenses in the second quarter. In addition, due to favorable markets in the second quarter, other related revenues in PGIM benefited by $45 million. In Kai income in our Gibraltar segment also benefited by $25 million. Fifth, we expect operating costs due to COVID-19 to be $25 million lower in the third quarter. Last, we anticipate net investment income will be reduced by $15 million, reflecting the difference between new money rates and disposition yields of our investment portfolio. These items combined get us to a baseline of $2.63 per share for the third quarter. Please note that this baseline includes items specific to the third quarter that reduce EPS by approximately $0.19 per share. While we have provided these items to consider, there may be other factors that affect earnings per share in the third quarter.
On slide 13, we provided an update on the potential impact of the pandemic. We have included a sensitivity for operating income based on the U.S. population experiencing 100,000 incremental deaths due to the pandemic. We estimate that this may lower operating income by $70 million. This is less than the sensitivity we provided on our last earnings call, as we have seen a lower fatality rate due to COVID-19 in our U.S. insurance businesses than previously estimated. Our third quarter baseline includes a net impact for mortality due to COVID-19 of approximately $55 million. The actual impact will depend on a variety of factors such as infection and fatality rates, geographic considerations, and progress in testing and medical treatments. We have also reduced our estimate for incremental operating costs due to COVID-19 and have estimated the potential reduction in other operating costs such as for travel and entertainment.
In the second half of 2020, we expect to incur incremental operating costs of $60 million due to COVID-19, with $40 million in the third quarter and $20 million in the fourth quarter. The estimate of these costs is lower than what we provided on our last call, primarily due to lower health benefit costs of our U.S. employees and lower costs to support our sales professionals in Japan as their productivity is improving faster than previously estimated. We also expect to have $30 million of lower travel and entertainment expenses in the second half of 2020. Turning to slide 14, we continue to maintain a robust capital position and adequate sources of funding. Our capital position exceeds our AA financial strength targets, and we maintain liquid assets at the parent company that are greater than three times annual fixed charges. We have substantial sources of funding.
Our cash and liquid assets at the parent company were $4.5 billion at the end of the quarter. We expect to receive net proceeds of $1.7 billion from the sale of our Prudential Korea business following the close of the transaction, which is expected in the second half of this year. Another source of funding is free cash flow from our businesses. In May, we added a new $1.5 billion contingent capital facility that, combined with our previous facility, brings our total available contingent capital funding resources to $3 billion. Turning to slide 15, and in summary, we remain on track with our objectives for the year as we accelerate the execution of our initiatives. We are exploring the potential to increase our cost savings initiative and looking at additional ways to build upon our repricing and product shift to further mitigate market impacts.
We maintain a rock-solid balance sheet with a robust capital and liquidity position. Now, I wil turn it over to the operator for your questions.
Operator (participant)
Ladies and gentlemen, if you wish to ask a question, please press 1 then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1-0 command. We ask if you're using a speakerphone, please pick up the handset before pressing the numbers. Once again, if you have a question, you may press 1 then 0 at this time. We do ask in the interest of time if you could please try and limit yourself to one question and one follow-up. First, we will go to Elise Greenspan with Wells Fargo. Please go ahead.
Elyse Greenspan (Analyst)
Hi, thanks. Good morning. My first question was just on the mortality assumption you laid out for the third quarter. If I look at your disclosures, longevity did benefit your results in both the Q1 and the Q2 this year. I am just trying to understand why that would not at least continue to some degree in the third quarter.
Kenneth Tanji (CFO)
Hi, Elise. This is Ken. I will take a question about the COVID mortality into the third quarter. In our second quarter, we benefited from our longevity business in the U.K. Mortality in the U.K. came in a little bit higher than we had previously estimated, and that resulted in a gain from our U.K. longevity reinsurance business. While there were fatalities in the U.K. in the second quarter, right now that seems to be more contained, and we wouldn't expect that to continue given the current fatality rates. We also, in our new estimate, have incorporated into that sensitivity what we learned from the second quarter, which is also in our life insurance and group insurance businesses, the fatality rates were lower than we previously estimated. We have incorporated that into our new estimate.
Elyse Greenspan (Analyst)
Okay, thanks. Then second, on the capital side, you guys said in your remarks that you would continue to monitor credit markets and the economy in determining your strategy. I guess, as we have one additional quarter under your belt, how are you thinking about capital return? Is it dependent upon getting the capital, the $1.7 billion from the Korea sales towards the end of this year, or is it more just dependent upon kind of more time going on and seeing how credit markets develop?
Charles Lowrey (Chairman and CEO)
Elise, it's Charlie. I will take that one. As you know, we paused our share repurchases in the second quarter in line with the risk framework that we had in place. As you said, until we get better visibility into the depth and the duration of the pandemic, the possible recession, and the credit cycle, we will maintain our financial flexibility and resiliency. When we get the clarity into those issues I just mentioned, we'll then share the timing of our plan to resume share buybacks and by how much. That would also include the proceeds from the sale, the potential sale of the Korean business. We are going to focus on maintaining our financial strength, but when we get clarity into the issues going forward, we will certainly let you know and we will be transparent about it.
Elyse Greenspan (Analyst)
Thank you. I appreciate the color.
Operator (participant)
Our next question is from the line of Ryan Krueger with KBW. Please go ahead.
Ryan Krueger (Analyst)
Hi, good morning. Could you elaborate on, I guess, the things you're considering that would cause a reduction in your market in interest rate sensitivity? I guess, in particular, I guess I would assume to meaningfully change that, that would require some sort of enforced reinsurance transaction. If you could elaborate some on what you are thinking about.
Robert Falzon (Vice Chairman)
Ryan, it's Rob. I will take a shot at that. First, let me just bring it up a level and say, as we sort of think about our strategy on a go-forward basis, we think about the elements of that as, in the first instance, simplifying and de-risking the business, as we articulated in our opening remarks. The other components of that are about improving near-term earnings through the efficiency initiatives that we have talked about and which we think have some expansion opportunity associated with them. Obviously, continue to expand our addressable market in order to support longer-term growth. Specifically, with regard to the de-risking, I would characterize the repricing and product shifts that we've done as sort of the first steps in transitioning to lower volatility, less interest rate, and general market sensitivity across our businesses.
For those products that we've either stepped back from or actually explicitly discontinued, so think about that as being HDI in the variable annuities business and guaranteed universal life in the life business, we will look actively at opportunities to optimize the economics of the legacy blocks that are associated with those products. Those options range anywhere from simply sort of just running off the blocks to reinsuring and/or looking at selling the blocks. A couple of other things outside of that, across our products, we are actually looking actively at product design as well as individual and aggregate limits that could reduce the amount of potential volatility that we get from any individual product or grouping of products. You saw us significantly reduce the retention limits that we have within our individual life business by way of example. Charlie hit on financial flexibility and resiliency.
We are going to retain our capital in order to make sure that we have that in place. We think that that is an element of the de-risking, at least in the near term. We are also looking at the investment portfolio and looking at strategic asset allocation, re-optimizing sort of the risk, return, and volatility trade-offs that are associated with our equity, our credit, and our interest rate exposures in light of where we are in the cycle and the opportunities that are in front of us. I guess the last thing I would mention is that as we look at the growth of the business on a go-forward basis, our strategic emphasis is really on growing the elements of our business that are less rate-sensitive and more predictable and more capital-like, like, for instance, PGIM, our asset management business.
Those would be the primary things that we're thinking about from a de-risking standpoint. Charlie, I don't know if there's any further color you would want to add on to that.
Charles Lowrey (Chairman and CEO)
Thanks, Rob. Ryan, let me just try and connect some dots because over the past 18 months, as Rob said, we have taken actions to begin to accomplish many of the objectives that Rob articulated, namely, lower market sensitivity, lower capital intensity of our business mix, becoming more competitive in terms of serving our customers with better processes and lower costs. Finally, as Rob said, increasing growth, right? Let me just tick through a number of things that we have done in order to achieve those objectives. We are sold or selling out of lower-growth businesses: Italy, Poland, Korea, and exploring options for Taiwan. We acquired Assurance IQ, around which we have high conviction about growth in a business that is not as market-sensitive, so lower risk. We've significantly reduced or stopped selling certain highly interest-rate-sensitive products in annuities and ILI.
We introduced less market-sensitive products such as the buffered annuity. We repriced almost our entire product line. We announced and are executing on our future work initiative, which will produce $500 million in cost savings with the potential to do more. As Rob said, we are currently exploring other options on books of business that are market-sensitive. We are executing on a series of incremental changes that we believe will lead to fundamental change in our business mix and ultimately the trajectory of the firm as we go forward. That's a foundation off of which we are going to grow going forward.
Ryan Krueger (Analyst)
Thank you. Appreciate it.
Operator (participant)
Ladies and gentlemen, just a quick reminder, if you do have a question, please press 1 then 0. Next, we will go to the line of Humphrey Lee with Dowling & Partners. Please go ahead.
Humphrey Lee (Analyst)
Good morning and thank you for taking my questions. Regarding the kind of potential, hello?
Charles Lowrey (Chairman and CEO)
Humphrey, we can hear you.
Humphrey Lee (Analyst)
I know it is still probably in the early stage of planning, but is there any way to have us to think about the potential size and scope of that impact? Should it be kind of comparable to what you have been targeting so far or just more of an incremental to what you've just a modest incremental to what you have been targeting?
Robert Falzon (Vice Chairman)
Humphrey, it's Rob. I will take a shot at that. You cut out a little bit, but I think I understood your question. As we have been in the course of executing on the efficiency initiatives that we had articulated earlier in the year, earlier last year, we have actually accelerated those actions. In the course of doing so, we have actually institutionalized continuous transformation capability. As a result of that, we are generating new ideas and strategies for further efficiencies that enhance customer experiences. Remember, that is sort of the first priority of that, is they enable our businesses, putting us in more competitive positions, and it increases our operating profits, particularly in light of the impact of earnings of a low-rate environment. The levers we're using, Humphrey, are pretty much the things that we have done to date.
Kenneth Tanji (CFO)
Increased use of technology and automation, process improvements, sourcing, org design, all the things that are classic. We just think there is, as a result of this continuous process, much further that we can go than what we have articulated to date. We are also contemplating learnings from the crisis and some of the implications of the pandemic and our experience in that on things like remote work, changes in communications and travel, and use of technology on a go-forward basis. All of that leads us to be optimistic that we can expand materially from where we are today, but we are not ready to quantify that. We will provide more guidance on that when we get further into the year. Once we've finished our work, as Charlie indicated, we'll be transparent.
Humphrey Lee (Analyst)
Appreciate the color. Shifting gear, looking at PGIM, as you mentioned, flows were very good in the quarter, especially on the retail side. On the institutional side, even after that $4.5 billion of passive equity mandates redemption, flows were still kind of negative. I was just wondering, can you comment on what you saw in the quarter and then also how is your pipeline looking out for, especially on the institutional side?
Andy Sullivan (Head of U.S. Businesses)
Sure, Humphrey. Andy, I will take your question. You were cutting in a little bit. I am not sure if it was you or me. Retail flows are really a result of three things: very strong investment management performance, a broad and wide product portfolio, and strong distribution. We are performing well on all of those fronts. Our investment performance in the second quarter was very strong. All of our PGIM fixed income strategies outperformed benchmark. 96% of our Geneson equities outperformed benchmark. Very, very strong fundamental performance. As you know, we have been building out our global distribution over time. We were actually quite pleased with our flows in the quarter. We were the No. 1 mutual fund family year-to-date and had $9.5 billion in positive retail flows. We did have the $4.5 billion index passive flow related to QMA.
That was a very low fee rate mandate, so think in the neighborhood of 1 to 2 bps. Literally, it was less than $1 million in fees. It also was the last of our, what I would call, size index mandate. As you look forward, quarter-to-quarter, there will be variability. Over the long run, our fundamental investment performance, the strength of our distribution, we have had strong organic flows over the last 5 years, and we would expect that to continue as we look forward over the next several years.
Robert Falzon (Vice Chairman)
Hey, Andy, you cut out for one second. Do you want to repeat the point you were making about I do not know that it was well heard on the number of large mandate passive funds? That one was a little blurry.
Andy Sullivan (Head of U.S. Businesses)
Sure. Sorry about that. All I mentioned was the $4.5 billion outflow was the last large passive mandate that we have in our portfolio.
Humphrey Lee (Analyst)
Got it. Appreciate the color.
Operator (participant)
Next, we will go to the line of Tom Gallagher with Evercore. Please go ahead.
Tom Gallagher (Analyst)
Morning, Charlie. Just to follow up on Ryan's question on, I guess, the range of things you're considering with risk transfer. I hear what you guys are saying on limiting new sales, considering some reinsurance of back books, it sounds like maybe on life insurance. Have you considered anything more transformational? The reason I ask that is kind of a more moderate, we will say, limited approach to this strategy, probably from a shareholder standpoint, is going to result in very limited growth as you have some of these businesses that you still own that are shrinking every year. It becomes kind of a challenge from an annual earnings growth standpoint. Have you considered that, and would you consider something more extreme like an IPO of some of your capital market-sensitive businesses or a bigger reinsurance transaction, or are you thinking in a more limited scale?
Charles Lowrey (Chairman and CEO)
Tom, thanks for the question. I appreciate it. Let me just take a step back, and then I will answer your question directly and make a comment about how we think about capital allocation and particular optimization. Because when we look across our businesses, what we try and do both domestically and internationally is ensure we're optimizing that capital deployment. We have mentioned in the past that we're looking at or continue to look at businesses such as ILI, annuities, and some of our international operations, as well as LTC. You have seen us take some bold action in terms of Italy, Poland, Korea, potentially Taiwan, etc. What we are going to do is, and what we can assure you is that we will continue to look to ways to optimize capital and capital deployment to maximize outcomes for shareholders, right?
Be that through significant dispositions, whatever flavor that may take, through potential share repurchases, or through acquisitions. Right now, we have acknowledged and will continue to acknowledge that there's a high hurdle for any major acquisition given where our stock price is trading. We get that. We are looking, as you've seen in the actions we have taken to date over the last 18 months, and I think what you will see us do going forward is look at all our businesses in order to optimize the capital we deploy and how we do that. That is our commitment to shareholders, and that is what we are doing.
Tom Gallagher (Analyst)
Gotcha. Appreciate it. I guess my follow-up is just it looks like you have reduced pretty substantially the expense drag for the subsidies you were planning on or you've been paying to the life planners in Japan. Is that because you see greater visibility on a sales recovery emerging, or have you just lowered the level of subsidy?
Charles Lowrey (Chairman and CEO)
Why do not I go ahead and take that, Tom, Mr. Scott? I think the answer is multifaceted, but maybe I will speak first to the question on have we seen a sales recovery. We actually started to see a pretty good bounce back in June to the point where we were starting to get close to even to 2019 sales in both Japan and in Brazil. That has continued and actually modestly strengthened in the month of July. We are seeing a pretty good sales recovery, and we're encouraged. Of course, that has to be tempered by any kind of resurgence that could occur.
In the case of the Life Planners, we were actually able to take what was an initial subsidy that was sort of an uncharacteristic payment that we have, and we were able to roll it into their bonusable plan. A portion of the amount that we have for Prudentisl of Japan (POJ) is actually being deferred into their sales comp. You are not seeing it as directly, but it is still there.
Tom Gallagher (Analyst)
Okay. Thanks.
Operator (participant)
Next, we will go to Jimmy Bhullar with JPMorgan. Please go ahead.
Jimmy Bhullar (Analyst)
Hi. Good morning. First, just on your annual assumption review and the interest rate assumption. Obviously, it is more conservative than it was before, but still fairly optimistic versus market level. Just if you could talk about what went into your thoughts on how much to reduce the rate assumption by and why did you not make a bigger adjustment given where market rates are.
Kenneth Tanji (CFO)
Hey, Jimmy. It is Ken. In terms of our long-term rate assumption, we followed a very established process that we have had for a number of years, and it considers multiple perspectives. We look at, again, long-term interest rate forecasts of economists, banks, and managers, and we look to be at the median of all those. For this year, when we looked at that, that meant a 10-year U.S. Treasury rate in the long term of 3.25% and 1% for the JGB in Japan. We followed the same process we have had for a number of years. It is also important to know how we grade into that long-term assumption. We do that over 10 years, and the first 2 years follows the forward curve. As a result, it is not just the long-term assumption, but the path of which we get there.
Over the next 5 years, our average rate would be 1.25%, and over 10 years, it is about 1.9%. We have a pretty established process. We look at third-party inputs and look to be at the median, and that was the result for this year.
Jimmy Bhullar (Analyst)
Okay. Any color on how your long-term care block has held up recently and whether you have seen any benefit on your claims or reserves from the pandemic?
Kenneth Tanji (CFO)
We saw a little bit elevated mortality in our policies that are already on claim, but it was fairly modest, and I would not call it significant.
Jimmy Bhullar (Analyst)
Okay. Thanks.
Operator (participant)
Ladies and gentlemen, once again, if you do have a question, please press 1 then 0 at any time. Next, we will go to John Barnidge with Piper Sandler. Please come in.
John Barnidge (Analyst)
Great. Thanks. Most of my questions have been answered. Can you talk about commercial mortgage loan forbearance in the quarter, directionality of that as well? Thank you.
Robert Falzon (Vice Chairman)
Hey, John. It's Rob. To date, we've received forbearance requests that are about 8% or so of the portfolio. We have provided forbearance in 6% of those instances, and the remaining 2% are under review. That excludes a little bit that we've gotten requests on that were declined. In that, only about 1% of the requests have resulted in a deferral of interest. In all other instances, we remain current on interest, and they have been deferrals of principal. Recall that across our portfolio, our loan-to-values (LTV) are actually quite low. As a result of that, when we defer principal, we're actually not particularly concerned about that because we know that the principal amount is actually quite safe. The average loan-to-value across our entire portfolio, based on our internal appraisals, is 56-ish percent.
Using external appraisals, it would be about 10 percentage points lower than that, so less than 50%. Given that low LTV, accommodations on amortization of principal or repayment of principal, we believe, is a prudent thing to be doing. If we can remain current on interest, that keeps the loans performing, and that's been sort of our experience to date.
John Barnidge (Analyst)
Great. Thanks for the answer.
Operator (participant)
Next, we will go to Sunit Kamath with Citi. Please go ahead.
Sunit Kamath (Analyst)
Thanks. Just a question, first off, on variable annuities. One of the things that folks are talking about now is that the NAIC is reviewing the mean-to-reversion assumption that they include in VA capital reform. Just curious if that was changed, would you expect to see either a big impact on your hedging program or your capital requirements for VA?
Kenneth Tanji (CFO)
Hi. This is Ken. Just a little bit of backdrop on this for us. We have managed our VA business with a very robust economic view and active hedging for many years. We're very supportive of a statutory framework that also is based on robust economic scenarios, both in terms of the long-term assumptions but also the dispersion around those assumptions. Our internal scenarios that we use to manage the business are actually more conservative than those being considered by the NAIC. We continue to advocate for appropriate economic scenarios within the VM-21 framework, and we believe that we will be well-positioned due to the internal framework that we have used to manage the business for many years.
Sunit Kamath (Analyst)
Got it. Okay. Just to shift over to international, if I could. Obviously, a lot of moving parts in terms of COVID, face-to-face sales, low interest rates, expenses. As you think about the longer-term outlook for the Japan businesses, when do you see those businesses sort of back to earnings growth as opposed to earnings declines or flattish earnings? Again, just conceptually, how are you thinking about the outlook for that business?
Scott Sleyster (Head of International Businesses)
Hi, Sunit. This is Scott again. I will go ahead and take that. I guess I would talk a little bit about capital rotation mixed in with that question. We were seeing low growth in the developed markets in Korea, Taiwan, and Japan. You saw that we took actions in Korea and were considering those in Taiwan. The reason that you see a difference between those businesses and Japan is that we have really strong market share in Japan, and we have a really high-performing LP model there. The business generates attractive returns over our cost of capital, and it generates a lot of free cash flow to the parent. We really like our Japan operation, and we continue to invest in it. That being said, overall premium growth in Japan has been negative for the last several years, and the country continues to face demographic challenges.
The fact that we have been able to continue to grow in POJ has been a significant outperformance in the country. I guess what I would say is we expect kind of low-single-digit growth in Japan. If we're achieving that, that's actually very strong relative performance and then in the context of a business system that's creating a lot of value and cash to the parent. In the meantime, we will look for redeployment in higher growth markets, but those are going to have to be opportunistic.
Humphrey Lee (Analyst)
Okay. Thanks, Scott.
Operator (participant)
Again, ladies and gentlemen, if you have a question, please press 1 then 0 at this time. Seeing no further questions coming in, Mr. Lowrey, I will turn it over to you.
Charles Lowrey (Chairman and CEO)
Okay. Thanks very much. As we come to the end of the call today, I would just like to thank you for listening and for your continued interest in Prudential. I also want to take a moment to thank all our employees for the steps they continue to take to support our business, our customers, and our community, including our collective efforts to address racial equity at Prudential and in society at large. We continue to make progress on executing our initiatives for the year and, frankly, are working to do more even as the global health pandemic continues. Backed by our financial strength and guided by our purpose, we'll continue to focus on delivering meaningful outcomes and value to all our stakeholders. Thanks again for joining us today. We appreciate it.
Operator (participant)
Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.