Prudential 2011 Annual Report Download - page 126

Individual life insurance policies are less susceptible to withdrawal than our annuity reserves and deposit liabilities because
policyholders may incur surrender charges and be subject to a new underwriting process in order to obtain a new insurance policy. Our
annuity reserves with guarantee features may be less susceptible to withdrawal than historical experience indicates, due to the perceived
value of these guarantee features to policyholders as a result of market declines in recent years. Annuity benefits and guaranteed investment
withdrawals under group annuity contracts are generally not subject to early withdrawal. Gross account withdrawals for our domestic
insurance operations’ products were consistent with our assumptions in asset/liability management, and the associated cash outflows did
not have a material adverse impact on our overall liquidity.
Liquid Assets
Liquid assets include cash, cash equivalents, short-term investments, fixed maturities that are not designated as held-to-maturity and
public equity securities. As of December 31, 2011 and 2010, our domestic insurance operations had liquid assets of $144.8 billion and
$138.5 billion, respectively, which includes a portion financed with asset-based financing. The portion of liquid assets comprised of cash
and cash equivalents and short-term investments was $6.6 billion and $5.8 billion as of December 31, 2011 and 2010, respectively. As of
December 31, 2011, $124.6 billion, or 92.4%, of the fixed maturity investments that are not designated as held-to-maturity within our
domestic insurance company general account portfolios were considered high or highest quality based on NAIC or equivalent rating. The
remaining $10.3 billion, or 7.6%, of these fixed maturity investments were considered other than high or highest quality based on NAIC or
equivalent rating. We consider attributes of the various categories of liquid assets (for example, type of asset and credit quality) in
calculating internal liquidity measures to evaluate the adequacy of our domestic insurance operations’ liquidity under a variety of stress
scenarios. We believe that the liquidity profile of our assets is sufficient to satisfy current liquidity requirements, including under
reasonably foreseeable stress scenarios.
Given the size and liquidity profile of our investment portfolios, we believe that claim experience varying from our projections does
not constitute a significant liquidity risk. Our asset/liability management process takes into account the expected maturity of investments
and expected claim payments as well as the specific nature and risk profile of the liabilities. Historically, there has been no significant
variation between the expected maturities of our investments and the payment of claims.
Our domestic insurance companies’ liquidity is managed through access to substantial investment portfolios as well as a variety of
instruments available for funding and/or managing cash flow mismatches, including from time to time those arising from claim levels in
excess of projections. To the extent we need to pay claims in excess of projections, we may borrow temporarily or sell investments sooner
than anticipated to pay these claims, which may result in increased borrowing costs or realized investment gains or losses affecting results
of operations. For a further discussion of realized investment gains and losses, see “—Realized Investment Gains and Losses and General
Account Investments—Realized Investment Gains and Losses.” We believe that borrowing temporarily or selling investments earlier than
anticipated will not have a material impact on the liquidity of our domestic insurance companies. Payment of claims and sale of
investments earlier than anticipated would have an impact on the reported level of cash flow from operating, investing, and financing
activities, respectively, in our financial statements. Instead of selling investments at depressed market prices externally, in order to preserve
economic value (including tax attributes), we may also sell investments from one subsidiary to another at fair market value or transfer
investments internally between businesses within the same subsidiary, subject to applicable regulatory constraints.
Capital
The Risk Based Capital, or RBC, ratio is a primary measure by which we evaluate the capital adequacy of Prudential Insurance and
our other domestic life insurance subsidiaries, which includes businesses in both the Financial Services Businesses and the Closed Block
Business. We manage Prudential Insurance’s and our other domestic life insurance subsidiaries’ RBC ratios to a level consistent with their
ratings targets. RBC is determined by statutory guidelines and formulas that consider, among other things, risks related to the type and
quality of the invested assets, insurance-related risks associated with an insurer’s products and liabilities, interest rate risks and general
business risks. The RBC ratio calculations are intended to assist insurance regulators in measuring the adequacy of an insurer’s statutory
capitalization. As of December 31, 2011, the RBC ratio for Prudential Insurance was approximately 490%, which exceeded the minimum
levels required by applicable insurance regulations. In addition, all of our other domestic life insurance subsidiaries have RBC ratios that
exceed the minimum level required by applicable insurance regulations. The reporting of RBC measures is not intended for the purpose of
ranking any insurance company or for use in connection with any marketing, advertising or promotional activities.
The level of statutory capital of our domestic life insurance subsidiaries can be materially impacted by interest rate and equity market
fluctuations, changes in the values of derivatives, the level of impairments recorded and credit quality migration of the investment
portfolio, among other items. Further, the recapture of business subject to reinsurance arrangements due to defaults by, or credit quality
migration affecting, the reinsurers could result in higher required statutory capital levels. The level of statutory capital of our domestic life
insurance subsidiaries is also affected by statutory accounting rules, which are subject to change by insurance regulators.
During 2010, as part of our Capital Protection Framework, we developed a broad view of the impact of market distress on the
statutory capital of the Company. Beginning in the second quarter of 2010, we have entered into equity index-linked derivative transactions
that are designed to mitigate the impact of a severe equity market stress event on statutory capital. The program focuses on tail risk to
protect our capital in a cost-effective manner under stress scenarios. We assess the composition of our hedging program on an ongoing
basis, and we may change it from time to time based on our evaluation of the Company’s risk position or other factors.
In addition to hedging equity market exposure, we also manage certain risks associated with our variable annuity products through our
hedging programs. In our living benefits hedging program, we purchase interest rate derivatives and equity options and futures to hedge
certain optional living benefit features accounted for as embedded derivatives against changes in certain capital market assumptions such as
interest rates, equity markets and market volatility. Prior to the third quarter of 2010, our hedging strategy sought to generally match certain
capital market sensitivities of the embedded derivative liability as defined by U.S. GAAP, excluding the impact of the market-perceived
risk of our own non-performance, with capital market derivatives. In the third quarter of 2010, we revised our hedging strategy as, in a low
124 Prudential Financial, Inc. 2011 Annual Report