Prudential 2002 Annual Report Download - page 28
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Please find page 28 of the 2002 Prudential annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.and expected investment returns. Although mortality and interest rate assumptions are “locked-in” upon the
issuance of new insurance or annuity business with fixed and guaranteed terms, significant changes in experience
or assumptions may require us to provide for expected future losses on a product by establishing premium
deficiency reserves. For example, in 2000 we restructured the portfolio that supports the structured settlement
products within our Retirement segment to reduce the emphasis on equity investments, which in turn lowered our
expected future investment returns. As a result, we recorded a charge to establish a premium deficiency reserve
for these products.
Our liability for “Unpaid claims and claim adjustment expenses,” which is 1% of total liabilities as of
December 31, 2002, includes estimates of claims that we believe have been incurred, but have not yet been
reported (“IBNR”) as of the balance sheet date, primarily attributable to our Property and Casualty Insurance
segment and our Group Insurance segment. Consistent with industry accounting practice, we do not establish loss
reserves until a loss, including a loss from catastrophe, has occurred. These IBNR estimates, and estimates of the
amounts of loss we will ultimately incur on reported claims, which are based in part on our historical experience,
are regularly adjusted to reflect actual claims experience. When actual experience differs from our previous
estimate, the resulting difference will be included in our reported results for the period of the change in estimate
in the “Policyholders’ benefits” caption in our statements of operations. On an ongoing basis, trends in actual
experience are a significant factor in the determination of claim reserve levels. In recent years, actual claims
experience with respect to our automobile insurance business within our Property and Casualty Insurance segment
has been more favorable than the assumptions we used in originally establishing the reserves for these claims,
which resulted in a benefit to earnings for these years due to reserve releases. Actual claims experience can also
be less favorable than that assumed in establishing reserves, which can require a charge to earnings to increase
reserves.
For most life insurance and annuity products that we sell, we defer costs that vary with and are related
primarily to the production of new business to the extent these costs are deemed recoverable from future profits,
and we record these costs as an asset known as “Deferred policy acquisition costs” or “DAC” in the statements of
financial position. We amortize this DAC asset over the expected lives of the contracts, based on the level and
timing of either estimated profits or premiums, depending on the type of contract. For products with amortization
based on estimated profits, the amortization rate is periodically updated to reflect current period experience or
changes in assumptions that affect future profitability, such as lapse rates, investment returns, mortality
experience, expense margins and surrender charges. However, for products with amortization based on future
premiums, the amortization rate is locked-in when the product is sold.
For example, expected profitability is a significant estimate in evaluating deferred acquisition costs related to
annuity products. Expected profitability considers, among other assumptions, our best estimate of future asset
returns to estimate the future fees we expect to earn, the costs associated with minimum death benefit guarantees
we expect to incur and other profitability factors. For the average remaining life of our variable annuity contracts
in force as of December 31, 2002, our evaluation of deferred policy acquisition costs is based on a 9.25% annual
blended rate of return that reflects an assumed rate of return of 11.5% for equity type assets. Continuation of
current market conditions or further deterioration in market conditions may result in increases in the amortization
of deferred policy acquisition costs, while a significant improvement in market conditions may result in a
decrease in the amortization of deferred policy acquisition costs. These changes in DAC balances are included as
a component of “General and administrative expenses” in our statements of operations.
See “—Insurance Division—Individual Life and Annuities” for discussion of the impact of DAC
amortization on our results of our annuities businesses, including increased amortization recorded in 2002 and
2001 reflecting lower estimates of future gross profits as well as a discussion of the proposed AICPA Statement
of Position, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts.”
Reserves For Contingencies
A contingency is an existing condition that involves a degree of uncertainty that will ultimately be resolved
upon the occurrence of future events. Under GAAP, reserves for contingencies are required to be established
when the future event is probable and its impact can be reasonably estimated. An example is the establishment of
Prudential Financial 2002 Annual Report 27