Prudential 2011 Annual Report Download - page 154

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (continued)
including, but not limited to the following: (1) the extent and the duration of the decline; (2) the reasons for the decline in value (credit
event, currency or interest-rate related, including general credit spread widening); and (3) the financial condition of and near-term prospects
of the issuer. With regard to available-for-sale equity securities, the Company also considers the ability and intent to hold the investment
for a period of time to allow for a recovery of value. When it is determined that a decline in value of an equity security is other-than-
temporary, the carrying value of the equity security is reduced to its fair value, with a corresponding charge to earnings.
Under the authoritative guidance for the recognition and presentation of other-than-temporary impairments for debt securities, an
other-than-temporary impairment must be recognized in earnings for a debt security in an unrealized loss position when an entity either
(a) has the intent to sell the debt security or (b) more likely than not will be required to sell the debt security before its anticipated recovery.
For all debt securities in unrealized loss positions that do not meet either of these two criteria, the guidance requires that the Company
analyze its ability to recover the amortized cost by comparing the net present value of projected future cash flows with the amortized cost
of the security. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows at the
effective interest rate implicit in the debt security prior to impairment. The Company may use the estimated fair value of collateral as a
proxy for the net present value if it believes that the security is dependent on the liquidation of collateral for recovery of its investment. If
the net present value is less than the amortized cost of the investment, an other-than-temporary impairment is recognized. In addition to the
above mentioned circumstances, the Company also recognizes an other-than-temporary impairment in earnings when a non-functional
currency denominated security in an unrealized loss position due to currency exchange rates approaches maturity.
Under the authoritative guidance for the recognition and presentation of other-than-temporary impairments, when an other-than-
temporary impairment of a debt security has occurred, the amount of the other-than-temporary impairment recognized in earnings depends
on whether the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its
amortized cost basis. If the debt security meets either of these two criteria or the foreign currency translation loss is not expected to be
recovered before maturity, the other-than-temporary impairment recognized in earnings is equal to the entire difference between the
security’s amortized cost basis and its fair value at the impairment measurement date. For other-than-temporary impairments of debt
securities that do not meet these criteria, the net amount recognized in earnings is equal to the difference between the amortized cost of the
debt security and its net present value calculated as described above. Any difference between the fair value and the net present value of the
debt security at the impairment measurement date is recorded in “Other comprehensive income (loss).” Unrealized gains or losses on
securities for which an other-than-temporary impairment has been recognized in earnings is tracked as a separate component of
“Accumulated other comprehensive income (loss).”
For debt securities, the split between the amount of an other-than-temporary impairment recognized in other comprehensive income
and the net amount recognized in earnings is driven principally by assumptions regarding the amount and timing of projected cash flows.
For mortgage-backed and asset-backed securities, cash flow estimates consider the payment terms of the underlying assets backing a
particular security, including prepayment assumptions, and are based on data from widely accepted third-party data sources or internal
estimates. In addition to prepayment assumptions, cash flow estimates include assumptions regarding the underlying collateral including
default rates and recoveries, which vary based on the asset type and geographic location, as well as the vintage year of the security. For
structured securities, the payment priority within the tranche structure is also considered. For all other debt securities, cash flow estimates
are driven by assumptions regarding probability of default and estimates regarding timing and amount of recoveries associated with a
default. The Company has developed these estimates using information based on its historical experience as well as using market
observable data, such as industry analyst reports and forecasts, sector credit ratings and other data relevant to the collectability of a security,
such as the general payment terms of the security and the security’s position within the capital structure of the issuer.
The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. In periods subsequent to
the recognition of an other-than-temporary impairment, the impaired security is accounted for as if it had been purchased on the
measurement date of the impairment. For debt securities, the discount (or reduced premium) based on the new cost basis may be accreted
into net investment income in future periods, including increases in cash flow on a prospective basis. In certain cases where there are
decreased cash flow expectations, the security is reviewed for further cash flow impairments.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, certain money market investments and other debt
instruments with maturities of three months or less when purchased, other than cash equivalents that are included in “Trading account
assets supporting insurance liabilities, at fair value.”
Deferred Policy Acquisition Costs
Costs that vary with and that are related primarily to the production of new insurance and annuity business are deferred to the extent
such costs are deemed recoverable from future profits. Such deferred policy acquisition costs (“DAC”) include commissions, costs of
policy issuance and underwriting, and variable field office expenses that are incurred in producing new business. See below under “Future
Adoption of New Accounting Pronouncements” for a discussion of the new authoritative guidance adopted effective January 1, 2012,
regarding which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. In each reporting period,
capitalized DAC is amortized to “Amortization of deferred policy acquisition costs,” net of the accrual of imputed interest on DAC
balances. DAC is subject to recoverability testing at the end of each reporting period to ensure that the balance does not exceed the present
152 Prudential Financial, Inc. 2011 Annual Report