Prudential 2012 Annual Report Download - page 23

For our investments classified as available-for-sale, the impact of changes in fair value is recorded as an unrealized gain or loss in
“Accumulated other comprehensive income (loss),” or “AOCI,” a separate component of equity. For our investments classified as trading,
the impact of changes in fair value is recorded within “Asset management fees and other income.” In addition, investments classified as
available-for-sale, as well as those classified as held-to-maturity, are subject to impairment reviews to identify when a decline in value is
other-than-temporary. For a discussion of our policies regarding other-than-temporary declines in investment value and the related
methodology for recording other-than-temporary impairments of fixed maturity and equity securities, see Note 2 to the Consolidated
Financial Statements, “—Realized Investment Gains and Losses—Other-than-Temporary Impairments —Fixed Maturity Securities” and
“—Realized Investment Gains and Losses—Other-than-Temporary Impairments—Equity Securities.”
Commercial mortgage and other loans are carried primarily at unpaid principal balances, net of unamortized deferred loan origination
fees and expenses and unamortized premiums or discounts and a valuation allowance for losses. For a discussion of our policies regarding
the valuation allowance for commercial mortgage and other loans see “—General Account Investments—Commercial Mortgage and Other
Loans—Commercial Mortgage and Other Loan Quality.”
Policyholder Liabilities
Future Policy Benefit Reserves, other than Unpaid Claims and Claim Adjustment Expenses
We establish reserves for future policy benefits to, or on behalf of, policyholders in the same period in which the policy is issued,
using methodologies prescribed by U.S. GAAP. In applying these methodologies, we are required to make certain reserve assumptions. For
most contracts, we utilize best estimate assumptions as of the date the policy is issued or acquired with provisions for the risk of adverse
deviation. After these reserves are initially established, we perform premium deficiency tests using best estimate assumptions as of the
testing date without provisions for adverse deviation. If reserves determined based on these best estimate assumptions are greater than the
net liabilities (i.e., reserves net of any DAC asset), the existing net liabilities are adjusted by first reducing the DAC asset by the amount of
the deficiency or to zero through a charge to current period earnings. If the deficiency is more than the DAC balance, we then increase the
reserve by the excess, again through a charge to current period earnings. We typically update our actuarial assumptions, such as mortality,
morbidity, retirement and policyholder behavior assumptions, annually in the third quarter of each year, unless a material change is
observed in an interim period that we feel is indicative of a long term trend. Generally, we do not expect trends to change significantly in
the short-term and, to the extent these trends may change, we expect such changes to be gradual over the long-term. In a sustained low
interest rate environment, there is an increased likelihood that the reserves determined based on best estimate assumptions may be greater
than the net liabilities. The following paragraphs provide additional details about our reserves for our Closed Block Business and Financial
Services Businesses.
The future policy benefit reserves for the traditional participating life insurance products of our Closed Block Business, which as of
December 31, 2012, represented 24% of our total future policy benefit reserves are determined using the net level premium method. Under
this method, the future policy benefit reserves are accrued as a level proportion of the premium paid by the policyholder. In applying this
method, we use mortality assumptions to determine our expected future benefits and expected future premiums, and apply an interest rate
to determine the present value of both the expected future benefit payments and the expected future premiums. The mortality assumptions
are based on data from the standard industry mortality tables that were used to determine the cash surrender value of the policies, and the
interest rates used are the contractually guaranteed interest rates used to calculate the cash surrender value of the policies. Gains or losses in
our results of operations resulting from deviations in actual experience compared to the experience assumed in establishing our reserves for
this business are recognized in the determination of our annual dividends to these policyholders. These gains or losses generally have not
created significant volatility in our results of operations since, during most years, the Closed Block has recognized a cumulative
policyholder dividend obligation expense in “Policyholders’ dividends,” for the excess of actual cumulative earnings over expected
cumulative earnings as determined at the time of demutualization. However, if actual cumulative earnings fall below expected cumulative
earnings in future periods, thereby eliminating the cumulative policyholder dividend obligation expense, these gains or losses could result
in greater volatility in the Closed Block Business results of operations.
The future policy benefit reserves for our International Insurance segment and Individual Life segment, which as of December 31,
2012, represented 47% of our total future policy benefit reserves combined, relate primarily to non-participating whole life and term life
products and endowment contracts, and are determined as the present value of expected future benefits to, or on behalf of, policyholders
plus the present value of future maintenance expenses less the present value of future net premiums. The expected future benefits and
expenses are determined using assumptions about mortality, lapse, and maintenance expense. These assumptions are determined by product
group. Mortality assumptions are generally based on the Company’s historical experience or standard industry tables, as applicable; our
expense assumptions are based on current levels of maintenance costs, adjusted for the effects of inflation; and our interest rate
assumptions are based on current and expected net investment returns.
The reserves for future policy benefits of our Retirement segment, which as of December 31, 2012 represented 23% of our total future
policy benefit reserves, primarily relate to our non-participating life contingent group annuity and structured settlement products. These
reserves are generally determined as the present value of expected future benefits and expenses based on assumptions about mortality,
retirement, maintenance expense, and interest rates. These assumptions are determined by product group. Our mortality and retirement
assumptions are based on Company or industry experience; our expense assumptions are based on current levels of maintenance costs,
adjusted for the effects of inflation; and our interest rate assumptions are based on current and expected net investment returns.
The reserves for future policy benefits of our Corporate & Other operations, which as of December 31, 2012 represented 2% of our
total future policy benefit reserves, primarily relate to our long-term care products. These reserves are generally determined as the present
value of expected future benefits and expenses less future premiums, based on assumptions about interest rates, morbidity, mortality,
lapses, premium rate increases, and maintenance expenses. Our morbidity and mortality assumptions are based on industry experience, and
may include certain adjustments for Company experience. Our lapse assumptions are based upon Company experience, our expense
assumptions are based on current levels of maintenance costs, adjusted for the effects of inflation, and our interest rate assumptions are
based on current and expected net investment returns. Our premium rate increase assumptions are based on our projected experience, which
considers state regulatory standards for inforce rate increases, as well as our historical experience with filing for such increases.
Prudential Financial, Inc. 2012 Annual Report 21