Prudential 2012 Annual Report Download - page 148

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
5. VARIABLE INTEREST ENTITIES (continued)
In addition, not reflected in the table above, the Company has created a trust that is a VIE, to facilitate Prudential Insurance’s Funding
Agreement Notes Issuance Program (“FANIP”). The trust issues medium-term notes secured by funding agreements issued to the trust by
Prudential Insurance with the proceeds of such notes. The trust is the beneficiary of an indemnity agreement with the Company that
provides that the Company is responsible for costs related to the notes issued with limited exception. As a result, the Company has
determined that it is the primary beneficiary of the trust, which is therefore consolidated.
The funding agreements represent an intercompany transaction that is eliminated upon consolidation. However, in recognition of the
security interest in such funding agreements, the trust’s medium-term note liability of $1,780 million and $3,197 million at December 31,
2012 and 2011, respectively, is classified within “Policyholders’ account balances.” Creditors of the trust have recourse to Prudential
Insurance if the trust fails to make contractual payments on the medium-term notes. The Company has not provided material financial or
other support that was not contractually required to the trust.
Unconsolidated Variable Interest Entities
The Company has determined that it is not the primary beneficiary of certain VIEs for which it is the investment manager, including
certain CDOs and other investment structures, as it does not have both (1) the power to direct the activities of the VIE that most
significantly impact the economic performance of the entity and (2) the obligation to absorb losses of the entity that could be potentially
significant to the VIE or the right to receive benefits from the entity that could be potentially significant. The Company’s maximum
exposure to loss resulting from its relationship with unconsolidated VIEs for which it is the investment manager is limited to its investment
in the VIEs, which was $602 million and $622 million at December 31, 2012 and 2011, respectively. These investments are reflected in
“Fixed maturities, available-for-sale,” “Other trading account assets, at fair value” and “Other long-term investments.” The fair value of
assets held within these unconsolidated VIEs was $9,240 million and $9,819 million as of December 31, 2012 and 2011, respectively. The
Company has provided a guarantee to an unconsolidated VIE under which the Company is exposed to potential losses in the amount of $64
million and $97 million as of December 31, 2012 and 2011, respectively. There are no liabilities associated with these unconsolidated VIEs
on the Company’s balance sheet.
In the normal course of its activities, the Company will invest in joint ventures and limited partnerships. These ventures include hedge
funds, private equity funds and real estate-related funds and may or may not be VIEs. The Company’s maximum exposure to loss on these
investments, both VIEs and non-VIEs, is limited to the amount of its investment. The Company has determined that it is not required to
consolidate these entities because either (1) it does not control them or (2) it does not have the obligation to absorb losses of the entities that
could be potentially significant to the entities or the right to receive benefits from the entities that could be potentially significant. The
Company classifies these investments as “Other long-term investments” and its maximum exposure to loss associated with these entities
was $6,873 million and $4,486 million as of December 31, 2012 and 2011, respectively.
In addition, in the normal course of its activities, the Company will invest in structured investments including VIEs for which it is not
the investment manager. These structured investments typically invest in fixed income investments and are managed by third parties and
include asset-backed securities, commercial mortgage-backed securities and residential mortgage-backed securities. The Company’s
maximum exposure to loss on these structured investments, both VIEs and non-VIEs, is limited to the amount of its investment. See Note 4
for details regarding the carrying amounts and classification of these assets. The Company has not provided material financial or other
support that was not contractually required to these structures. The Company has determined that it is not the primary beneficiary of these
structures due to the fact that it does not control these entities.
Included among these structured investments are asset-backed securities issued by VIEs that manage investments in the European
market. In addition to a stated coupon, each investment provides a return based on the VIE’s portfolio of assets and related investment
activity. The market value of these VIEs was approximately $2.1 billion and $2.6 billion as of December 31, 2012 and 2011, respectively,
and these VIEs were financed primarily through the issuance of notes similar to those purchased by the Company. The Company generally
accounts for these investments as available-for-sale fixed maturities containing embedded derivatives that are bifurcated and marked-to-
market through “Realized investment gains (losses), net,” based upon the change in value of the underlying portfolio. The Company’s
variable interest in each of these VIEs represents less than 50% of the only class of variable interests issued by the VIE. The Company’s
maximum exposure to loss from these interests was $314 million and $664 million at December 31, 2012 and 2011, respectively, which
includes the fair value of the embedded derivatives.
6. DEFERRED POLICY ACQUISITION COSTS
The balances of and changes in deferred policy acquisition costs as of and for the years ended December 31, are as follows:
2012 2011 2010
(in millions)
Balance, beginning of year ............................................................... $12,517 $12,328 $14,578
Impact from adoption of new accounting pronouncement ................................... 0 0 (3,754)
Capitalization of commissions, sales and issue expenses .................................... 3,565 3,070 2,460
Amortization—Impact of assumption and experience unlocking and true-ups ................... 328 (52) 225
Amortization—All other ............................................................. (1,832) (2,643) (1,310)
Change in unrealized investment gains and losses ......................................... (168) (346) (233)
Foreign currency translation and other .................................................. (310) 160 362
Balance, end of year .................................................................... $14,100 $12,517 $12,328
146 Prudential Financial, Inc. 2012 Annual Report