During his company’s August earnings call, Robert Falzon, the CFO of Prudential Financial, demonstrated his longstanding ability to develop a positive outcome from a negative event.
Falzon and other executives of the life insurance and financial services giant had some bad news to explain to the market: a 22.88% negative earnings surprise versus the consensus of analysts’ estimates. Perhaps to soften the blow, the finance chief portrayed the surprise in terms of a bigger corporate picture.
Yes, Falzon acknowledged, the Pru’s reported second-quarter profits had been hurt by the cost of making significant enhancements in the actuarial systems it uses in setting its insurance reserves. Changes the company also made in the accounting for insurance policies still on its books but no longer actively sold also had a negative effect.
In the longer term, however, changes like the ones in the company’s actuarial assumptions could take the wrinkles out of volatility, he contended.
Falzon says he tries to clarify for analysts the difference between the immediate, often negative, “noise” produced by one-time actions and the positive long-term effects of those actions. In a previous example, a 2015 Pru divisional restructuring in Japan aimed at curbing long-term volatility in the company’s foreign exchange results may have played a part in some temporary financial reporting dips in 2016, he adds, also mentioning the elimination of the company’s interest-rate hedge as an instance of such a tradeoff.
Describing such changes as “non-economic” — not reflective of the Prudential’s underlying business — Falzon granted that they may create financial disruptions that can affect share price. “And if it has an impact on our share price, it is, by definition, economic, and so we care about it,” Falzon added.
Those changes would produce “a more sophisticated and granular capability for modeling. Over time, that enhanced capability would lead to better modeling and less reliance on estimates and approximations,” he assured the analysts.
In a later interview with CFO, Falzon said that the first thing he tries to do in explaining negative company news is “to put it into a broader context.” In that way, he can make use of an ability to perceive how negatives can be turned to positives.
That ability seems to have been at least partly spawned by an occurrence at the end of the first decade of his nearly 34-year career with Prudential. The event? He was fired from his managing director slot at the private-placement arm of Pru’s global investment management group.
“After an initial period of anxiety, dejection, and self doubt about being fired, I decided that I had no interest in being a victim,” he told graduates of the Rutgers University business school during a commencement address last year.
“Instead, I decided to look at my dislocation not as an obstacle, but rather as an opportunity. I doubled down and completely changed my career track,” he said.
That track ultimately led to his being named CFO of the company, which took in about $23 billion in gross profit on $59 billion in revenue last year. Adept as he appears in corporate finance, Falzon said in the August 31 interview that the aspect of his job he’s most passionate about is developing Prudential’s talent. Today, he’s encouraging newer employees to work in a variety of functions within the company just as he did — but maybe without the pain. An edited and excerpted version of the interview follows.
I’m intrigued by what you did in Japan to curb financial reporting volatility caused by foreign exchange fluctuation. How did that work?
We undertook a number of large initiatives in order to stamp out that volatility, some of which has been non-economic, some of which has been economic. The biggest thing that we did from a non-economic standpoint is that in 2015 we completed something we called the division project, which eliminated a lot of completely non-economic noise we were getting from our international operations.
It was a really modest restructuring. We spent a couple of million bucks to do it, and it it was 100% non-economic. We have a different program for managing foreign currency risk. This was an undertaking to manage foreign currency reporting, which was not reflective of underlying risk.
[Analysts] who followed us understood that this was completely non-economic. But when you start talking about investors who don’t follow us closely, all they’re seeing is a billion-dollar charge related to FX. They don’t know what that means, so they think it means something bad.
Our stock value suffered by virtue of that. So while I describe it as non-economic accounting, it was having an economic repercussion in terms of valuation. Hence we thought it important to identify and isolate it and fix it.
What we had to do was to create three functional currencies within our Japan business. We sell products in Japan in yen, in Aussie dollars, and in U.S. dollars. If you have a functional currency of yen under our Japan GAAP reporting there, it all works out fine. But when you translate that from Japan GAAP over into U.S. GAAP you get a mismatching of the Aussie dollar and the U.S. dollar because of the designation of yen as your functional currency.
So we created three functional currencies within our Japan business, a U.S. dollar, an Aussie dollar, and yen. To do that, we had to create three divisions in order to match up with each of those functional currencies, hence the name “division project.”
The project allowed us to re-assign functional currencies to eliminate purely non-economic GAAP noise, so that both U.S and Aussie dollars wound up in the same place and neutralized each other out.
Finance led the entire initiative, and we executed it from start to finish. And we think we added real value to the organization, because [the Japan currency issue] was a distraction for investors.
Besides non-economic exposures, what’s your role in managing underlying foreign currency risk?
The finance organization is charged with managing our foreign currency exposure. We do that primarily through two mechanisms. One, we have a rolling, three-year income hedge that creates a high degree of predictability as to what the influence of foreign exchange rates will be on our earnings over the next couple of quarters and years.
We roll into our hedges over time, so we’re actually able to say to analysts, “Don’t worry about FX, the exchange rate for purposes of your modeling is going to look like this.” That reduces the noise and distraction that can occur by virtue of changes in foreign exchange for our company, which has 45% of its operations outside of the United States.
An equal, if not greater, component of how we manage FX exposures is our equity hedge. In the case of Japan, for example, which comprises 80% or 90% of our international operations, we immunize our shareholders’ return on equity from changes in exchange rates between the yen and the U.S. dollar.
The equity hedge effectively ensures that, regardless of the direction of the yen, the return on equity that we get from our Japan business, which is quite high, is sustained.
How does Prudential’s finance function connect to the structure of the rest of the company?
The more finance is connected to both the functions and the businesses throughout the enterprise the better we are as a function. So we embed our finance teams within the businesses. While they have a direct reporting line to me, they also report on a dual basis to the CEOs of their businesses. They become part of the leadership team of those businesses. We have regular engagement with the other functional areas as well, and many of the projects that we lead require cross-business and cross-functional collaboration.
Which of all your tasks are you most passionate about?
I have a lot of passion around talent. How we train that talent is absolutely what drives success in the organization. The experiences that we give them through our mobility and rotation programs, the way in which they then are able to engage with the various functions and businesses and connect dots across the entire enterprise, enable us to do things like the division project, and the half-dozen other things that we’ve done in the last few years.
Our belief is that our single sustainable competitive advantage is talent and culture. That everything else that we do — the products, strategy, all of that — can be matched by competitors. What we don’t think our competitors can match is the quality of our people and the culture that we’ve created that enables those people to work together in a way that facilitates the kind of successes we have.
How do your views on employee mobility and the need to rotate people into various functions flow from your career experience?
My own personal experience has been one where I had a lot of mobility. And the first stage of that mobility [that of being fired], wasn’t something I sought. It was imposed on me, but I learned from that and then sought mobility afterwards.
So if you’ve been in a controller’s role with our individual life business, then maybe a planning and analysis role with our group [insurance] business or our annuities business would be a good next experience for you.
That creates optionality for our employees to become better, more well-rounded professionals. The win for us is that they’re more likely to stay. People don’t have to leave Pru and our finance area to try something different. They can stay and try something different within the organization, much like my experience has been through the organization.
What career insights did your firing and its aftermath provide you with?
I like to call it dislocation instead of a firing. But yeah, I was fired. I started in our our private placement group [in 1983], spent about a decade doing that, grew to a leadership position, and got fired. There was a reorganization. I was just one of those individuals who didn’t turn out on the right side of that reorganization.
I did have offers to leave Pru. But I also had an offer at another part of Prudential. We had an investment bank, and I had been looking at investment banking, and that’s where my other offers were coming from. But I decided to stay with Pru, only because, despite that event, I actually still liked the quality of the people and the culture. Up until that one disruption, I’d actually had quite a good experience with Prudential and had strong relationships.
Then I worked for a for a little less than a decade in the investment banking area. I got tremendous education and training from that and ultimately was very successful at it.
I also had a much greater opportunity to engage internationally and ran our European business for a bit of time as well. The investment banking experience gave me capital market skills, and I learned how to manage a different set of team dynamics and personalities than I would have in other parts of the organization.
But investment banking required a very high level of engagement on the work front and less engagement on the personal front, and I got to a point where that equation needed to change for me. I had done real estate investment banking during the latter part of my career [in the investment banking unit], which created an opportunity for me to go over to Prudential’s real estate investment management operations.
All those experiences ultimately gave that made me a legitimate candidate to become a treasurer of a company, and I became Prudential’s. From there I was ultimately appointed to be CFO. Those were great experiences that built skills, and, reflecting on that, I see why I have such a passion for having other individuals do that programmatically, as well as leaving them on their own to do it. In my particular case there was no program for that to happen.