Prudential 2012 Annual Report Download - page 122

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (continued)
Certain individual annuity contracts provide the holder a guarantee that the benefit received upon death or annuitization will be no less
than a minimum prescribed amount. These benefits are accounted for as insurance contracts and are discussed in further detail in Note 11.
The Company also provides contracts with certain living benefits which are considered embedded derivatives. These contracts are
discussed in further detail in Note 11.
Amounts received as payment for interest-sensitive group and individual life contracts, deferred fixed annuities, structured settlements
and other contracts without life contingencies, and participating group annuities are reported as deposits to “Policyholders’ account
balances.” Revenues from these contracts are reflected in “Policy charges and fee income” consisting primarily of fees assessed during the
period against the policyholders’ account balances for mortality charges, policy administration charges and surrender charges. In addition
to fees, the Company earns investment income from the investment of policyholders’ deposits in the Company’s general account portfolio.
Fees assessed that represent compensation to the Company for services to be provided in future periods and certain other fees are deferred
and amortized into revenue over the life of the related contracts in proportion to estimated gross profits. Benefits and expenses for these
products include claims in excess of related account balances, expenses of contract administration, interest credited to policyholders’
account balances and amortization of DAC.
For group life, other than interest-sensitive group life contracts, and disability insurance, premiums are recognized over the period to
which the premiums relate in proportion to the amount of insurance protection provided. Claim and claim adjustment expenses are
recognized when incurred.
Premiums, benefits and expenses are stated net of reinsurance ceded to other companies, except for amounts associated with certain
modified coinsurance contracts which are reflected in the Company’s financial statements based on the application of the deposit method of
accounting. Estimated reinsurance recoverables and the cost of reinsurance are recognized over the life of the reinsured policies using
assumptions consistent with those used to account for the underlying policies.
Asset Management Fees and Other Income
“Asset management fees and other income” principally include asset management fees and securities and commodities commission
revenues, which are recognized in the period in which the services are performed. Realized and unrealized gains or losses from investments
classified as “trading” such as “Trading account assets supporting insurance liabilities” and “Other trading account assets,” short-term
investments that are marked-to-market through other income, and from consolidated entities that follow specialized investment company
fair value accounting are also included in “Asset management fees and other income.” In certain asset management fee arrangements, the
Company is entitled to receive performance based incentive fees when the return on assets under management exceeds certain benchmark
returns or other performance targets. Performance based incentive fee revenue is accrued quarterly based on measuring fund performance
to date versus the performance benchmark stated in the investment management agreement. Certain performance based incentive fees are
also subject to future adjustment based on cumulative fund performance in relation to these specified benchmarks.
Foreign Currency
Assets and liabilities of foreign operations and subsidiaries reported in currencies other than U.S. dollars are translated at the exchange
rate in effect at the end of the period. Revenues, benefits and other expenses are translated at the average rate prevailing during the period.
The effects of translating the statements of operations and financial position of non-U.S. entities with functional currencies other than the
U.S. dollar are included, net of related qualifying hedge gains and losses and income taxes, in AOCI. Gains and losses resulting from the
remeasurement of foreign currency transactions are reported in either AOCI or current earnings in “Asset management fees and other
income” depending on the nature of the related foreign currency denominated asset or liability.
Derivative Financial Instruments
Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices, values of
securities or commodities, credit spreads, market volatility, expected returns, and liquidity. Values can also be affected by changes in
estimates and assumptions, including those related to counterparty behavior and non-performance risk used in valuation models. Derivative
financial instruments generally used by the Company include swaps, futures, forwards and options and may be exchange-traded or
contracted in the over-the-counter market. Derivative positions are carried at fair value, generally by obtaining quoted market prices or
through the use of valuation models.
Derivatives are used in a non-broker-dealer capacity to manage the interest rate and currency characteristics of assets or liabilities and
to mitigate volatility of expected non-U.S. earnings and net investments in foreign operations resulting from changes in currency exchange
rates. Additionally, derivatives may be used to seek to reduce exposure to interest rate, credit, foreign currency and equity risks associated
with assets held or expected to be purchased or sold, and liabilities incurred or expected to be incurred. As discussed in detail below and in
Note 21, all realized and unrealized changes in fair value of non-broker-dealer related derivatives are recorded in current earnings, with the
exception of the effective portion of cash flow hedges and effective hedges of net investments in foreign operations. Cash flows from
derivatives are reported in the operating, investing, or financing activities sections in the Consolidated Statements of Cash Flows based on
the nature and purpose of the derivative.
Derivatives were also used in a derivative broker-dealer capacity in the Company’s global commodities group to meet the needs of
clients by structuring transactions that allow clients to manage their exposure to interest rates, foreign exchange rates, indices and prices of
120 Prudential Financial, Inc. 2012 Annual Report