Prudential 2012 Annual Report Download - page 209

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
22. SEGMENT INFORMATION (continued)
These items are important to an understanding of overall results of operations. Adjusted operating income is not a substitute for
income determined in accordance with U.S. GAAP, and the Company’s definition of adjusted operating income may differ from that used
by other companies. However, the Company believes that the presentation of adjusted operating income as measured for management
purposes enhances the understanding of results of operations by highlighting the results from ongoing operations and the underlying
profitability factors of the Financial Services Businesses.
Realized investment gains (losses), net, and related charges and adjustments
Realized investment gains (losses), net
Adjusted operating income excludes “Realized investment gains (losses), net,” except for certain items described below. Significant
activity excluded from adjusted operating income includes impairments and credit-related gains and losses from sales of securities, the
timing of which depends largely on market credit cycles and can vary considerably across periods, and interest rate-related gains and losses
from sales of securities, which are largely subject to the Company’s discretion and influenced by market opportunities, as well as the
Company’s tax and capital profile. Additionally, certain gains and losses pertaining to derivative contracts that do not qualify for hedge
accounting treatment are also excluded from adjusted operating income. Trends in the underlying profitability of the Company’s businesses
can be more clearly identified without the fluctuating effects of these transactions.
The following table sets forth the components of “Realized investment gains (losses), net” that are included in adjusted operating
income and, as a result, are reflected as adjustments to “Realized investment gains (losses), net” for purposes of calculating adjusted
operating income:
Years Ended December 31,
2012 2011 2010
(in millions)
Net gains (losses) from:
Terminated hedges of foreign currency earnings .......................................... $(75) $(136) $ (93)
Current period yield adjustments ....................................................... $338 $ 257 $243
Principal source of earnings .......................................................... $ 97 $156 $ 18
Terminated Hedges of Foreign Currency Earnings. The amounts shown in the table above primarily reflect the impact of an
intercompany arrangement between Corporate and Other operations and the International Insurance segment, pursuant to which the non-
U.S. dollar-denominated earnings in all countries for a particular year, including its interim reporting periods, are translated at fixed
currency exchange rates. The fixed rates are determined in connection with a currency hedging program designed to mitigate the risk that
unfavorable rate changes will reduce the segment’s U.S. dollar equivalent earnings. Pursuant to this program, the Company’s Corporate
and Other operations may execute forward currency contracts with third parties to sell the net exposure of projected earnings from the
hedged currency in exchange for U.S. dollars at a specified exchange rate. The maturities of these contracts correspond with the future
periods in which the identified non-U.S. dollar-denominated earnings are expected to be generated. These contracts do not qualify for
hedge accounting under U.S. GAAP, so the resulting profits or losses are recorded in “Realized investment gains (losses), net.” When the
contracts are terminated in the same period that the expected earnings emerge, the resulting positive or negative cash flow effect is included
in adjusted operating income.
Current Period Yield Adjustments. The Company uses interest rate and currency swaps and other derivatives to manage interest and
currency exchange rate exposures arising from mismatches between assets and liabilities, including duration mismatches. For derivative
contracts that do not qualify for hedge accounting treatment, the periodic swap settlements, as well as certain other derivative related yield
adjustments are recorded in “Realized investment gains (losses), net”, and are included in adjusted operating income to reflect the after-
hedge yield of the underlying instruments. In certain instances, when these derivative contracts are terminated or offset before their final
maturity, the resulting realized gains or losses are recognized in adjusted operating income over periods that generally approximate the
expected terms of the derivatives or underlying instruments in order for adjusted operating income to reflect the after-hedge yield of the
underlying instruments. Included in the amounts shown in the table above are gains on certain derivatives contracts that were terminated or
offset in prior periods of $64 million, $50 million and $35 million for the years ended 2012, 2011 and 2010, respectively. Additionally, as
of December 31, 2012, there was a $575 million deferred net gain related to certain derivative contracts that were terminated or offset in
prior periods, primarily in the International Insurance segment.
Principal Source of Earnings. The Company conducts certain activities for which realized investment gains and losses are a
principal source of earnings for its businesses and therefore included in adjusted operating income, particularly within the Company’s
Asset Management segment. For example, Asset Management’s strategic investing business makes investments for sale or syndication to
other investors or for placement or co-investment in the Company’s managed funds and structured products. The realized investment gains
and losses associated with the sale of these strategic investments, as well as related derivative results, are a principal activity for this
business and included in adjusted operating income. In addition, the realized investment gains and losses associated with loans originated
by the Company’s commercial mortgage operations, as well as related derivative results and retained mortgage servicing rights, are a
principal activity for this business and included in adjusted operating income.
Prudential Financial, Inc. 2012 Annual Report 207