If one judges CEO pay solely on the basis of total compensation reported in SEC-filed proxy statements, then the pay package of Prudential Financial Chief Executive Officer John Strangfeld, the top earner in NU’s inaugural November 2013 feature on CEO compensation, clearly is a cut above the rest.
In 2012, Prudential recorded summary compensation table pay of $30.7 million for Strangfeld. Accounting for changes in the value of the equity portion of the package, actual or “realizable” pay was $29.9 million, a 46.2 percent increase over the $20.5 recorded in 2011.
The 2012 amounts are well above what CEOs of other U.S. publicly held life insurers enjoyed that year. A review of NU’s Top 25 list shows the summary compensation table pay of the next three highest paid CEOs within Prudential’s 21-company peer group — those of Ameriprise Financial, Allstate Corp. and AFLAC — at $17.8 million, $17.1 million and $13.8 million, respectively. Realizable pay of Ameriprise's Cracchiolo, the highest earner of the three, stood at $19.2 million last year.
Is Strangfeld worth what Prudential is awarding him? Opinions differ. Institutional Shareholder Services Inc., a proxy advisory firm, believes the executive’s pay is high relative to company performance, though in fact ISS expressed “cautionary support” for the CEO’s pay package in its proxy analysis for shareholders.
Others believe that ISS’s pay-for-performance assessment warranted disapproval.
“Strangfeld’s pay last year was 2.45 times the median compensation of his peers,” says Compensation Resources Managing Director Paul Dorf, citing the ISS report. “Considering that the company had lackluster performance, as ISS asserts, I would certainly question why Prudential paid him so much.”
Compensation consultant Steve Hall, a managing director of Steve Hall & Partners, disagrees.
“The Compensation Discussion & Analysis in Prudential’s 2013 Proxy Statement is much more valuable than an ISS report for assessing pay because you gain a better understanding there as to what the company was doing and why,” he says. “And a review of the CD&A doesn’t suggest to me there was a big performance drop-off last year.”
What the CD&A says
Indeed, Prudential’s CD&A points to a number of accomplishments that factored into Strangfeld’s compensation. Among them: gains in operating return on average equity (up two percent); after-tax adjusted operating income (up four percent); annual dividends per share of common stock (up 10 percent); book value per share (up 15 percent); and assets under management (up 18 percent).
In assessing Strangfeld’s performance, Prudential also factored in the attainment of certain objectives aimed at strengthening the company’s competitive position. Last year, for example, the insurer inked pension risk transfer transactions with General Motors and Verizon Communications, resulting in the acquisition of $33 billion of annuity account values.
The company also purchased Hartford Financial’s Individual Life Insurance business, which boosted Prudential’s Individual Life Insurance business by 700,000 policies with in-force face amounts of $135 billion. The company also cites in Strangfeld’s performance evaluation a 26 percent rise in retirement account values to a record high of $289.8 billion; a 28 percent gain in international insurance annualized new business premiums; plus Strangfeld’s participation in the “successful” leadership transition for Prudential’s Individual Life, Group Insurance and Annuities businesses.
“Prudential’s CD&A seems to indicate that 2012 was a strong year in terms of company performance and that Mr. Strangfeld did a great job,” says Hall. “Everything looks rosy in terms of the comparative charts.
“The question is, why are Prudential’s earnings off so badly?” he adds. “That's a key issue, in part because net income is a variable the CEO may not have real control over.
“Without knowing the reasons for the decline, I beg to differ with any compensation consultant who says Strangfeld shouldn't have received the pay package he did,” Hall adds.
An analysis of the income statement in Prudential’s 2013 annual report (10K) pegs the company’s net income in 2012 at $469 million or $0.94 diluted earnings per share of common stock attributable to Prudential’s financial services businesses. This is down 87 percent from the $3.6 billion or $6.99 per diluted share recorded for the year earlier period.
Prudential’s 10K attributes the decline in earnings to a host of factors. Among them: Lower pre-tax earnings of $2.4 billion resulting from foreign currency exchange rate movements; “unfavorable variance[s]” of $666 million and $639 million, respectively, caused by (1) changes to the value of embedded derivatives and related hedge positions associated with certain variable annuities; and (2) adjustments to deferred policy acquisition and other costs, plus the reserves for Prudential’s long-term care products.
Additionally, Prudential was unable to secure last year the same large pre-tax gains and benefits the company enjoyed in 2011. For example, a $237 million pre-tax benefit in 2011 dipped to $60 million in 2012, reflecting partial sales of the company’s indirect interest in China Pacific Insurance Group.
In written responses to questions posed by NU, Prudential did not specifically address decisions Strangfeld made that may account for the reduced year-over-year earnings. But the company made clear that the less favorable 2012 financial results are indeed reflected in his direct compensation: Total compensation less his pension and deferred compensation.
Last year, Strangfeld received an annual incentive award (bonus) of $5.6 million, about 1.005 times his target award amount. The payout compares to a bonus of $6.3 million for 2011, representing an 11 percent decrease. Of the $5.6 million, $1.7 million (30 percent of the award) was mandatorily deferred into Prudential’s Book Value Performance Program; the balance was paid in cash.
“The 30 percent mandatory deferral is a very good thing,” says Dorf. “If Prudential found that something about Strangfeld’s compensation wasn’t kosher, they potentially could recover the money through a provision of the 2010 Dodd-Frank Act known as clawback.
“However, considering that the 30 percent supplements a $3.9 million cash bonus, I believe the annual incentive awards are exorbitant given the company’s performance,” Dorf noted.
Delving into the metrics
Ascertaining whether pay is indeed in alignment (or not) with performance requires an understanding of the performance metrics the company employs to fix compensation. Prudential uses earnings per share (on an adjusted operating earnings basis) to determine pay awarded through the insurer’s short-term incentive plan. Prudential also considers performance in terms of absolute return on equity (ROE), growth in book value per share, plus EPS relative to the North American life insurer subset of its compensation peer group.
Prudential’s long-term incentive program likewise ties executive pay to the achievement and maintenance of key performance metrics. Thus, performance shares are awarded for sustaining a 13 to 14 percent ROE and increases in the value of Prudential’s stock. Book value units reward increases in book value per share. And stock options reward increases in the market value of company stock.
Prudential, however, qualifies another performance metric that factored into ISS’ analysis of Strangfeld’s compensation: Relative total shareholder return or TSR, which the company describes as a volatile point-in-time snapshot.
“Our relative TSR in 2012 was low in part due to the life insurance sector losing favor with investors in a sustained environment of low interest rates,” Prudential states. “In addition, several peer companies that historically were poor performers experienced partial recoveries from low bases in 2012.
“We believe that our solid fundamental performance (growth in sales and assets under management) last year is being reflected in our 50 percent share price gain as of July 31, 2013,” Prudential adds. “Our relative TSR was at the 91st percentile of our compensation peer group as of that date.”
Kevin McManus, editor and president of ProxyTell LLC, a proxy advisory firm, adds that short-term metrics like TSR aren’t always well-suited to gauging executive performance and pay from year to year.
“The fundamental problem here is you are looking at a variety of metrics for measuring company performance, with differing time periods to boot,” he says. “For example, if I bonus my CEO on stock price appreciation for the seven-year period he has been CEO and someone else looks at three-year total shareholder return, it shouldn't be shocking when the two don't always match.
“I would rather look at 10-year TSR but few CEOs last that long,” he adds. “I hate the idea of using one-year TSR, but to the degree CEOs are paid on prior year performance that may be the better measure.”
These perspectives aside, Strangfeld’s compensation stands out for two reasons: (1) He was only one of three CEOs among NU’s Top 25 list — and alone among Prudential’s peers within the list —to have received a discretionary cash bonus; and (2) his pension value and deferred compensation earnings account for half of his total compensation.
Respecting the first, Prudential’s inferior 2012 EPS result relative to most of the North American life subgroup of its peers was evidently outweighed by other metrics Prudential uses to determine annual incentive awards. An analysis of the 7 companies within the subgroup shows that, excepting Hartford Financial, basic (as opposed to diluted) earnings per share for every company within the subgroup surpassed Prudential’s $0.91 EPS. Similarly, all but one company (MetLife) within the subgroup outperformed Prudential’s total shareholder return (9.7 percent), the group’s results ranging between 19.3 percent (Principal Financial) and Hartford Financial (41 percent).
However, over a three-year period (2010-2012), which analysts view as a more accurate gauge of performance because the longer time-frame compensates for one-time events (such as acquisitions), Prudential moves up in the rankings. The insurer’s three-year annualized TSR of 5.1 percent beat the results of all but three companies: Ameriprise Financial (19.6 percent), Principal Financial (8.6 percent) and AFLAC (7.5 percent).
These same companies surpassed Prudential’s three-year overall return to shareholders (16.2 percent): Aflac (24.3 percent), Ameriprise (71.1 percent), and Principal (28.1 percent). And not one of these companies, it bears repeating, awarded its CEO a discretionary, non-performance-based cash bonus.
One could argue that Prudential should revise its annual pay formula to better reflect these relative performance metrics. It’s important to note, however, that several of the companies are not true peers of Prudential. Excepting Aflac and MetLife, the subgroup companies do not match the Newark, N.J.-based behemoth in terms of financial muscle.
Prudential’s critics note as much. A more appropriate peer group comparison, they point out, encompasses other financial giants, among them U.S. Bancorp, American Express Company and Bank of America Corp. These financial services firms are included among the peers in the ISS proxy analysis that recommended — albeit not without qualification — that Prudential shareholders approve Strangfeld’s compensation in their “say-on-pay” vote.
Downsize the nest egg?
Turning to the other anomaly of Strangfeld’s 2012 compensation, the change in pension value and deferred compensation, Prudential Chief Communications Officer Bob DeFillippo attributes Strangfeld’s extraordinarily large retirement fund to several factors, including his age, his average earnings, historically low interest rates and, not least, his long tenure at the company.
“John Strangfeld has been with Prudential for 35 years,” says DeFillippo. “None of his peers in the industry has served with their companies for anywhere near this length of time.
“Regardless, it’s important to note that potential pension values may fluctuate significantly from year to year in tandem with the underlying securities,” he adds. “And it’s possible the change in his pension value in subsequent years could be a negative amount.”
True. The point is equally applicable to other components of Strangfeld’s compensation that face equity market exposure — stock awards and option awards.
Also, if one counts only direct compensation, which Prudential views as a fairer measure of pay relative to that of his CEO counterparts, then Strangfeld cannot be considered the highest paid. Three other chief executives in NU’s Top 25 list (not all industry peers) surpass his $15.5 million in direct compensation: Wellpoint CEO Angela Braly ($20.6 million) GE CEO Jeffrey Immelt ($20.5 million); and Ameriprise Financial CEO James Cracchiolo ($16.1 million).
Strangfeld’s pension and deferred compensation are, nonetheless, part of his overall package. And some observers believe this component of his compensation should be revamped. To that end, Proxytell’s McManus advises “slimming down” the CEO’s pension by replacing it with a long-term stock price tracking plan that doesn’t pay out until he retires.
Hitting once more on Strangfeld’s short-term incentive opportunities, Compensation Resources’ Dorf insists that the non-equity component, which Prudential pegs at 400 percent of base salary (target) and 800 percent of base salary (maximum) are too high. Multiples of 100 percent and 200 percent, respectively, would be more in line with industry norms.
Hall disagrees, observing that many large financial services companies, notably those engaged in investment banking, don’t even have caps on non-equity compensation. And among life insurers, Prudential doesn’t have the largest cap: MetLife pegs CEO Kandarian’s maximum short-term non-equity incentive opportunity at 937 percent of base salary.
Brushing off the critics
It remains to be seen whether Prudential would be amenable to changing how it fixes pay for its CEO or other top executives in its C-suite. What’s clear now is that the insurer is unapologetic about Strangfeld’s compensation. The company’s recent performance, and the metrics and objectives by which his pay is determined are, in Prudential’s telling, fully justified.
“There’s no way you can look at John’s total compensation and say that it’s unreasonably high or that it went up amid lackluster performance,” says DeFillippo. “When you examine the variable components of his pay — the annual incentive awards — they actually went down this past year.”
And they could decline further still. In the wake of the Financial Stability Oversight Council's designation of Prudential as a systematically important financial institution (SIFI) — a decision that will subject the insurer to not only enhanced standards imposed by the Federal Reserve Board, but also BASEL III's strict minimum capital requirements — speculation among market analysts is rife that the labeling will hobble Prudential financially, placing it at a competitive disadvantage.
A less business-friendly regulatory environment could negatively impact not only Strangfeld's compensation but, ultimately, his legacy at Prudential.
But whatever the future holds, there's no denying what Prudential's chief has accomplished to date. Since becoming president and CEO in 2008, he has presided over a near-tripling of the company's revenue, gross income rising to $84.8 billion in 2012 from $28.7 billion in 2008. In the process, he has created a financial service powerhouse whose business divisions — Retirement Solutions and Investment Management, Individual Life and Group Insurance, plus International Insurance — now have global reach.
That Prudential now stands at the pinnacle of the industry, while many of the insurer's competitors remain second- or third-tier companies in terms of capitalization and market penetration, may be a testament to Strangfeld's superior managerial skills, ability to think strategically and long-term vision.
In the final analysis, these intangible attributes, rather than point-in-time snapshots of financial results, may prove a more reliable determinant of CEO compensation. And it may be the CEOs of Prudential's peers, rather than Strangfeld, who must be called to account.