Prudential 2011 Annual Report Download - page 47

acquisition costs and unearned revenue reserves, as well as the reserve for the guaranteed minimum death benefit feature in certain
contracts. Results in 2011 included a $75 million benefit from the annual reviews, primarily reflecting updates to our persistency
assumptions as a result of more favorable lapse experience on variable life policies, and improved mortality based on experience. Adjusted
operating income for 2010 included a $52 million benefit from the annual reviews, primarily reflecting methodology refinements to the
treatment of certain investment income in our assumptions, as well as improved mortality based on experience.
Absent the effect of these items, adjusted operating income for 2011 decreased $6 million from 2010 including a $23 million increase
in amortization of deferred policy acquisition costs net of related amortization of unearned revenue reserves, resulting from changes in our
estimates of total gross profits arising from separate account fund performance, which is described in more detail below. This increase in
amortization largely reflects the impact of equity markets on separate account fund performance in the respective periods. The decrease in
adjusted operating income also reflects the decline in earnings from our variable products primarily due to the runoff of variable policies in
force. These decreases to adjusted operating income were partially offset by higher net investment spread income driven by higher asset
balances supporting growth in our universal life insurance products, as well as the impact from mortality experience, net of reinsurance,
which was $12 million less unfavorable relative to expected levels, compared to 2010.
The changes in our estimates of total gross profits arising from separate account fund performance, as discussed above, reflects the
impact on our estimates of total gross profits of the difference between our actual quarterly rate of return on separate accounts compared to
our previously expected quarterly rate of return. The following table shows the actual quarterly rate of return on separate accounts for the
four quarters of 2011 and 2010 compared to our previously expected quarterly rate of return used in our estimates of total gross profits.
2011 2010
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
Actual rate of return ................................. 4.4% 0.4% (11.6)% 7.0% 3.8% (7.4)% 8.3% 7.3%
Expected rate of return ............................... 2.2% 2.0% 2.1% 2.5% 2.6% 2.6% 2.6% 2.5%
The overall lower than expected market returns in 2011 resulted in a decrease in total future gross profits by establishing a lower
starting point for the fund balances used in estimating those profits in future periods. The decrease in our estimates of total gross profits
resulted in a $9 million net expense in 2011 reflecting a higher required rate of amortization of deferred policy acquisition costs, partially
offset by a higher required rate of amortization of unearned revenue reserves. The overall actual rate of return on separate account funds for
2010 was higher than our expected rate of return which resulted in an increase in total future gross profits by establishing a higher starting
point for the fund balances used in estimating those profits in future periods. The increase in our estimates of total gross profits resulted in a
$14 million net benefit in 2010 reflecting a lower required rate of amortization of deferred policy acquisition costs, partially offset by a
lower required rate of amortization of unearned revenue reserves. 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 deferred policy
acquisition costs and unearned revenue reserves, see “—Accounting Policies & Pronouncements—Application of Critical Accounting
Estimates.”
2010 to 2009 Annual Comparison. Adjusted operating income decreased $62 million, from $562 million in 2009 to $500 million in
2010. Results in 2010 included a $52 million benefit from lower amortization of net deferred policy acquisition costs and unearned revenue
reserves, as well as a decrease in reserves for the guaranteed minimum death benefit feature in certain contracts, reflecting updates of our
actuarial assumptions based on an annual review, compared to a $55 million benefit from the annual review in 2009. The annual reviews
cover assumptions used in our estimates of total gross profits which form the basis for amortizing deferred policy acquisition costs and
unearned revenue reserves, as well as the reserve for the guaranteed minimum death benefit feature in certain contracts. Results in 2009
also included a $30 million benefit from compensation received based on multi-year profitability of third-party products we distribute.
These compensation arrangements are subject to renegotiations periodically which will affect the amount of additional compensation we
are eligible to receive. The largest of these arrangements was renegotiated in 2008 and the profit opportunities were reduced significantly in
2010 and beyond resulting in a benefit of less than $1 million in 2010.
Absent the effect of these items, adjusted operating income in 2010 decreased $29 million, including $33 million from mortality
experience, net of reinsurance, which was slightly unfavorable relative to expected levels in 2010, compared to favorable mortality
experience in 2009. The decrease in adjusted operating income also reflects a $17 million increase in amortization of deferred policy
acquisition costs net of related amortization of unearned revenue reserves, reflecting a net expense of $1 million in 2010 compared to a net
benefit of $16 million in 2009, resulting from changes in our estimates of total gross profits primarily from variable products arising from
separate account fund performance and policyholder experience. This increase in amortization largely reflects the impact of equity markets
on separate account fund performance in the respective periods, partially offset by the impact of policyholder persistency which in 2010
returned to levels that are more consistent with expectations. The decline in our in force block of variable life business also contributed to
the decrease in adjusted operating income. Partially offsetting the decrease in adjusted operating income was higher net investment income
from an increase in assets supporting our term and universal life products, growth in universal life policyholder account balances and the
impact of gains in 2010 on investments in real property separate account funds compared to losses in 2009.
Revenues
2011 to 2010 Annual Comparison. Revenues, as shown in the table above under “—Operating Results,” increased $85 million, from
$2,815 million in 2010 to $2,900 million in 2011. Net investment income increased $75 million reflecting higher asset balances supporting
growth in our universal life insurance products including higher account balances resulting from increased policyholder deposits and higher
regulatory capital requirements. Policy charges and fees and asset management fees and other income increased $8 million. This increase
included a $24 million reduction in amortization of unearned revenue reserves due to annual reviews of assumptions. Absent this item,
policy charges and fees and asset management fees and other income increased $32 million driven by an increase in current period
amortization of unearned revenue reserves due to changes in our estimates of total gross profits primarily reflecting the impact of less
Prudential Financial, Inc. 2011 Annual Report 45