Prudential 2012 Annual Report Download - page 201

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
20. FAIR VALUE OF ASSETS AND LIABILITIES (continued)
Cash Collateral for Loaned Securities
Cash collateral for loaned securities represents the collateral received or paid in connection with loaning or borrowing securities,
similar to the securities sold under agreement to repurchase above. For these transactions, the carrying value of the related asset or liability
approximates fair value, as they equal the amount of cash collateral received/paid.
Debt
The fair value of short-term and long-term debt, as well as notes issued by consolidated VIEs, is generally determined by either prices
obtained from independent pricing services, which are validated by the Company, or discounted cash flow models. With the exception of
the notes issued by consolidated VIEs for which recourse is limited to the assets of the respective VIE and does not extend to the general
credit of the Company, the fair values of these instruments consider the Company’s own non-performance risk. Discounted cash flow
models predominately use market observable inputs such as the borrowing rates currently available to the Company for debt and financial
instruments with similar terms and remaining maturities. For commercial paper issuances and other debt with a maturity of less than 90
days, the carrying value approximates fair value.
A portion of the senior secured notes issued by Prudential Holdings, LLC (the “IHC debt”) is insured by a third-party financial
guarantee insurance policy. The effect of the third-party credit enhancement is not included in the fair value measurement of the IHC debt
and the methodologies used to determine fair value consider the Company’s own non-performance risk.
Bank Customer Liabilities
The carrying amount for certain deposits (interest and non-interest demand, savings and money market accounts) approximates or
equals their fair values. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies
interest rates being offered on certificates at the reporting dates to a schedule of aggregated expected monthly maturities. Bank customer
liabilities are reflected within “Other liabilities.” During 2012, the Company divested bank customer liabilities as part of a previously
announced decision to limit banking operations to trust services.
Other Liabilities
Other liabilities are primarily payables, such as reinsurance payables, unsettled trades, drafts and accrued expense payables. Due to the
short term until settlement of most of these liabilities, the Company believes that carrying value approximates fair value.
Separate Account Liabilities—Investment Contracts
Only the portion of separate account liabilities related to products that are investments contracts are reflected in the table above.
Separate account liabilities are recorded at the amount credited to the contractholder, which reflects the change in fair value of the
corresponding separate account assets including contractholder deposits less withdrawals and fees. Therefore, carrying value approximates
fair value.
21. DERIVATIVE INSTRUMENTS
Types of Derivative Instruments and Derivative Strategies used in a non-dealer or broker capacity
Interest Rate Contracts
Interest rate swaps and exchange-traded futures and options are used by the Company to reduce risks from changes in interest rates,
manage interest rate exposures arising from mismatches between assets and liabilities (including duration mismatches) and to hedge against
changes in the value of assets it owns or anticipates acquiring or selling. Swaps may be attributed to specific assets or liabilities or may be
used on a portfolio basis. Under interest rate swaps, the Company agrees with other parties to exchange, at specified intervals, the
difference between fixed-rate and floating-rate interest amounts calculated by reference to an agreed upon notional principal amount.
Generally, no cash is exchanged at the outset of the contract and no principal payments are made by either party. These transactions are
entered into pursuant to master agreements that provide for a single net payment to be made by one counterparty at each due date.
In exchange-traded futures transactions, the Company agrees to purchase or sell a specified number of contracts, the values of which
are determined by the values of underlying referenced investments, and to post variation margin on a daily basis in an amount equal to the
difference in the daily market values of those contracts. The Company enters into exchange-traded futures and options with regulated
futures commission’s merchants who are members of a trading exchange.
Equity Contracts
Equity index options are contracts which will settle in cash based on differentials in the underlying indices at the time of exercise and
the strike price. The Company uses combinations of purchases and sales of equity index options to hedge the effects of adverse changes in
equity indices within a predetermined range. These hedges do not qualify for hedge accounting.
Prudential Financial, Inc. 2012 Annual Report 199