Prudential 2011 Annual Report Download - page 231

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
19. INCOME TAXES (continued)
For tax years 2007 through 2011, the Company is participating in the IRS’s Compliance Assurance Program (“CAP”). Under CAP,
the IRS assigns an examination team to review completed transactions contemporaneously during these tax years in order to reach
agreement with the Company on how they should be reported in the tax returns. If disagreements arise, accelerated resolutions programs
are available to resolve the disagreements in a timely manner before the tax returns are filed. It is management’s expectation this program
will shorten the time period between the filing of the Company’s federal income tax returns and the IRS’s completion of its examination of
the returns.
The Company’s affiliates in Japan file separate tax returns and are subject to audits by the local taxing authority. The general statute of
limitations is five years from when the return is filed. During 2009, the Tokyo Regional Taxation Bureau (“TRTB”) concluded a routine
tax audit of the tax returns of Prudential Life Insurance Company Ltd. for its tax years ended March 31, 2004 to March 31, 2008. During
2011 the TRTB concluded a routine tax audit of the tax returns of Edison Life Insurance Company Ltd. for its tax years ended March 31,
2009 to March 31, 2010. These activities had no material impact on the Company’s 2009, 2010 or 2011 results.
The Company’s affiliates in South Korea file separate tax returns and are subject to audits by the local taxing authority. The general
statute of limitations is five years from when the return is filed. During 2009, a local district office in the South Korean tax authority
concluded a routine tax audit of the local taxes for tax years ended March 31, 2004 through March 31, 2007 of Prudential Life Insurance
Company of Korea, Ltd. (“POK”). During 2010, South Korea’s National Tax Service concluded a general tax audit of POK’s tax years
ended March 31, 2006 to March 31, 2010. These activities had no material impact on the Company’s 2009, 2010 or 2011 results.
On March 23, 2010, President Obama signed into law the Patient Protection and Affordable Care Act, which was modified by the
Health Care and Education Reconciliation Act of 2010 signed into law on March 30, 2010, (together, the “Healthcare Act”). The federal
government provides a subsidy to companies that provide certain retiree prescription drug benefits (the “Medicare Part D subsidy”),
including the Company. The Medicare Part D subsidy was previously provided tax-free. However, as currently adopted, the Healthcare Act
includes a provision that would reduce the tax deductibility of retiree health care costs to the extent of any Medicare Part D subsidy
received. In effect, this provision of the Healthcare Act makes the Medicare Part D subsidy taxable beginning in 2013. Therefore, the
Company incurred a charge in 2010 for the reduction of deferred tax assets of $94 million, which reduces net income and is reflected in
“Income tax expense (benefit).”
20. FAIR VALUE OF ASSETS AND LIABILITIES
Fair Value Measurement—Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. The authoritative guidance around fair value established a
framework for measuring fair value that includes a hierarchy used to classify the inputs used in measuring fair value. The hierarchy
prioritizes the inputs to valuation techniques into three levels. The level in the fair value hierarchy within which the fair value measurement
falls is determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy
are as follows:
Level 1—Fair value is based on unadjusted quoted prices in active markets that are accessible to the Company for identical assets or
liabilities. These generally provide the most reliable evidence and are used to measure fair value whenever available. Active markets are
defined as having the following characteristics for the measured asset/liability: (i) many transactions, (ii) current prices, (iii) price quotes
not varying substantially among market makers, (iv) narrow bid/ask spreads and (v) most information publicly available. The Company’s
Level 1 assets and liabilities primarily include certain cash equivalents and short-term investments, equity securities and derivative
contracts that are traded in an active exchange market. Prices are obtained from readily available sources for market transactions involving
identical assets or liabilities.
Level 2—Fair value is based on significant inputs, other than Level 1 inputs, that are observable for the asset or liability, either
directly or indirectly, for substantially the full term of the asset or liability through corroboration with observable market data. Level 2
inputs include quoted market prices in active markets for similar assets and liabilities, quoted market prices in markets that are not active
for identical or similar assets or liabilities and other market observable inputs. The Company’s Level 2 assets and liabilities include: fixed
maturities (corporate public and private bonds, most government securities, certain asset-backed and mortgage-backed securities, etc.),
certain equity securities (mutual funds, which do not actively trade and are priced based on a net asset value) and commercial mortgage
loans, short-term investments and certain cash equivalents (primarily commercial paper), and certain over-the-counter derivatives.
Valuations are generally obtained from third party pricing services for identical or comparable assets or liabilities or through the use of
valuation methodologies using observable market inputs. Prices from services are validated through comparison to trade data and internal
estimates of current fair value, generally developed using market observable inputs and economic indicators.
Level 3—Fair value is based on at least one or more significant unobservable inputs for the asset or liability. These inputs reflect the
Company’s assumptions about the inputs market participants would use in pricing the asset or liability. The Company’s Level 3 assets and
liabilities primarily include: certain private fixed maturities and equity securities, certain manually priced public equity securities and fixed
maturities, certain highly structured over-the-counter derivative contracts, certain commercial mortgage loans, certain consolidated real
estate funds for which the Company is the general partner, and embedded derivatives resulting from certain products with guaranteed
Prudential Financial, Inc. 2011 Annual Report 229