Prudential 2011 Annual Report Download - page 32

(2) Amounts reflect (charges) or benefits for reserve (increases) or decreases, respectively, related to the GMDB / GMIB features of our variable annuity
products.
(3) Represents the impact of differences between actual gross profits for the period and the previously estimated expected gross profits for the period, as
well as updates for current and future expected claims costs associated with the GMDB / GMIB features of our variable annuity products.
The $288 million of charges and $103 million of benefits in 2011 and 2010, respectively, relating to the quarterly market performance
adjustments shown in the table above are attributable to changes to our estimate of total gross profits to reflect actual fund performance.
The following table shows the actual quarterly rates of return on variable annuity account values compared to our previously expected
quarterly rates of return used in our estimate of total gross profits for the periods indicated.
2011 2010
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
Actual rate of return .............................. 3.7% 0.8% (9.8)% 4.9% 3.4% (5.2)% 8.1% 6.0%
Expected rate of return ............................ 1.7% 1.7% 1.7% 2.2% 2.0% 1.9% 2.1% 1.9%
Overall lower than expected returns in 2011 decreased our estimate of total gross profits used as a basis for amortizing DAC and other
costs and increased our estimate of future expected claims costs associated with the GMDB and GMIB features of our variable annuity
products, by establishing a new, lower starting point for the variable annuity account values used in estimating those items for future
periods. This change results in a higher required rate of amortization and higher required reserve provisions, which are applied to all prior
periods. The resulting cumulative adjustment to prior amortization and reserve provisions are recognized in the current period. Overall
higher than expected returns in 2010 had opposite impacts, resulting in an increase to our estimate of total gross profits used as a basis for
amortizing DAC and other costs and a decrease to our estimate of future expected claims costs associated with the GMDB and GMIB
features of our variable annuity products. This change resulted in a lower required rate of amortization and lower required reserve
provisions, which were applied to all prior periods.
As discussed and shown in the table above, results for both years include the impact of the annual reviews performed in the third
quarter of the assumptions used in the reserves for the GMDB and GMIB features of our variable annuity products and in our estimate of
total gross profits used as a basis for amortizing DAC and other costs. The third quarter of 2011 included $20 million of net benefits from
these annual reviews, primarily related to a reduction of the assumption of the percentage of contracts with a GMIB feature that will
annuitize based on the guaranteed value, partially offset by a reduction of the weighted average future return assumption to 4.3% on fixed
rate portfolios. The reduction in the weighted average future return assumption on fixed rate portfolios was driven by a refinement to our
rate-setting methodology to reflect a lower interest rate assumption for the next five years to reflect current market conditions, and use the
long-term assumed rate thereafter in determining the blended future return on fixed rate investments of 4.3%. The third quarter of 2010
included $177 million of benefits from these annual reviews, primarily related to reductions in lapse rate assumptions and more favorable
assumptions relating to fee income.
For a further discussion of the assumptions, including our current near-term and long-term projected rates of return, used in estimating
total gross profits used as the basis for amortizing DAC and other costs, and for estimating future expected claims costs associated with the
GMDB and GMIB features of our variable annuity products, see “—Accounting Policies and Pronouncements—Application of Critical
Accounting Estimates.”
The $36 million and $68 million of benefits in 2011 and 2010, respectively, shown in the table above, reflect the quarterly adjustments
for current period experience and other updates, also referred to as experience true-up adjustments. The experience true-up adjustments for
2011 include reductions to both the amortization of DAC and other costs and the reserves related to the GMDB and GMIB features of our
variable annuity products. The reduction to the amortization of DAC and other costs was driven by higher than expected gross profits
primarily from lower than expected lapses, higher than expected fee income and higher than expected general account spreads. The
reduction to the reserves related to the GMDB and GMIB features of our variable annuity products was driven by lower than expected
actual contract guarantee claim costs, higher than expected fee income and higher than expected general account spreads, partially offset by
lower than expected lapses. The experience true-up adjustments for 2010 included a reduction in the amortization of DAC and other costs
driven by higher than expected gross profits primarily from higher than expected fee income, and a reduction to the reserves related to the
GMDB and GMIB features of our variable annuity products driven by lower than expected actual contract guarantee claim costs, more
favorable lapse experience and higher than expected fee income.
As noted previously, the quarterly adjustments to reflect current period market performance and experience and other updates, and the
annual reviews and updates of assumptions impact the estimated profitability of our business. Therefore, in addition to the current period
impacts discussed above, these items will also drive changes in our GMDB and GMIB reserves and the amortization of DAC and other
costs in future periods. Additionally, in the third and fourth quarters of 2011, we evaluated the results of our living benefits hedging
program and determined the difference between the change in the value of the hedge target liability and the change in the fair value of the
hedge assets to be other-than-temporary. As a result, we included these amounts in our best estimate of total gross profits used for setting
amortization rates, which will also drive changes in the amortization of DAC and other costs in future periods. The table above excludes
the impacts of resetting the amortization rates for this item, as both the hedge results and related amortization of DAC and other costs are
excluded from adjusted operating income. However, adjusted operating income in the fourth quarter of 2011 includes the subsequent
impact to base amortization from resetting the amortization rates at the end of the third quarter. Base amortization is calculated by applying
the new rates to actual gross profits for the quarter. See “—Net impact of embedded derivatives related to our living benefit features and
related hedge positions” for additional details on the impact of our hedge results that are excluded from adjusted operating income.
2010 to 2009 Annual Comparison. Adjusted operating income increased $289 million, from $757 million in 2009 to $1,046 million
in 2010. The increase in adjusted operating income was primarily due to an increase in fee income, net of higher distribution costs, driven
by higher average variable annuity account values invested in separate accounts due to positive net flows and net market appreciation.
30 Prudential Financial, Inc. 2011 Annual Report