Operational and financial debt
An insurance company may raise debt capital for two requirements—operational and financial. While the former is raised by an insurance company for operational activities, financial debt is raised to implement activities like capital allocation to various subsidiaries and maintaining solvency ratios. Financial debt is generally issued by the holding company.
As shown in the above chart, the proportion of capital debt in Prudential’s (PRU) capital structure increased from 14% at the end of 2013 to 20% at the end of 2014. As noted by Prudential’s management team, this increase was due to additional capital required to cover assumption changes such as interest rates.
After meeting its minimum requirements, known as capital capacity, Prudential Financial intends to use its excess capital to grow its business further. The company’s growth occurs both organically and through acquisitions, along with returning capital to shareholders.
Prudential reported a capital capacity of ~$2 billion at the end of 2014. This figure is net of another ~$2 billion capital that the company earmarked for debt reduction.
Prudential’s capital capacity dropped from ~$3.5 billion at the end of 2013 to the current ~$2 billion. The company returned $2 billion capital to shareholders in the form of dividends and buybacks, offset to some extent by capital generation from operations.
Prudential’s dividend payments have remained consistent over the last two years, which we will discuss later. Several insurance companies, including MetLife (MET) and AIG (AIG), are returning capital to their shareholders through share repurchases.