Prudential 2015 Annual Report Download - page 117

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
The Company’s wholly-owned investment real estate consists of real estate which the Company has the intent to hold for the
production of income as well as real estate held for sale. Real estate which the Company has the intent to hold for the production of income
is carried at depreciated cost less any writedowns to fair value for impairment losses and is reviewed for impairment whenever events or
circumstances indicate that the carrying value may not be recoverable. Real estate held for sale is carried at the lower of depreciated cost or
fair value less estimated selling costs and is not further depreciated once classified as such. An impairment loss is recognized when the
carrying value of the investment real estate exceeds the estimated undiscounted future cash flows (excluding interest charges) from the
investment. At that time, the carrying value of the investment real estate is written down to fair value. Decreases in the carrying value of
investment real estate held for the production of income due to OTTI are recorded in “Realized investment gains (losses), net.”
Depreciation on real estate held for the production of income is computed using the straight-line method over the estimated lives of the
properties, and is included in “Net investment income.” In the period a real estate investment is deemed held for sale and meets all of the
discontinued operation criteria, the Company reports all related net investment income and any resulting investment gains and losses as
discontinued operations for all periods presented.
“Short-term investments” primarily consist of highly liquid debt instruments with a maturity of twelve months or less and greater than
three months when purchased, other than those debt instruments meeting this definition that are included in “Trading account assets
supporting insurance liabilities, at fair value.” These investments are generally carried at fair value and include certain money market
investments, short-term debt securities issued by government-sponsored entities and other highly liquid debt instruments.
Realized investment gains (losses) are computed using the specific identification method with the exception of some of the
Company’s International Insurance businesses’ portfolios, where the average cost method is used. Realized investment gains and losses are
generated from numerous sources, including the sale of fixed maturity securities, equity securities, investments in joint ventures and limited
partnerships and other types of investments, as well as adjustments to the cost basis of investments for net OTTI recognized in earnings.
Realized investment gains and losses are also generated from prepayment premiums received on private fixed maturity securities,
allowance for losses on commercial mortgage and other loans, fair value changes on commercial mortgage loans carried at fair value, and
fair value changes on embedded derivatives and free-standing derivatives that do not qualify for hedge accounting treatment. See
“Derivative Financial Instruments” below for additional information regarding the accounting for derivatives.
The Company’s available-for-sale and held-to-maturity securities with unrealized losses are reviewed quarterly to identify OTTI in
value. In evaluating whether a decline in value is other-than-temporary, the Company considers several factors including, but not limited to
the following: (1) the extent and the duration of the decline; (2) the reasons for the decline in value (credit event, currency or interest-rate
related, including general credit spread widening); and (3) the financial condition of and near-term prospects of the issuer. With regard to
available-for-sale equity securities, the Company also considers the ability and intent to hold the investment for a period of time to allow
for a recovery of value. When it is determined that a decline in value of an equity security is other-than-temporary, the carrying value of the
equity security is reduced to its fair value, with a corresponding charge to earnings.
An OTTI is recognized in earnings for a debt security in an unrealized loss position when either (a) the Company has the intent to sell
the debt security or (b) it is more likely than not the Company will be required to sell the debt security before its anticipated recovery. For
all debt securities in unrealized loss positions that do not meet either of these two criteria, the Company analyzes its ability to recover the
amortized cost by comparing the net present value of projected future cash flows with the amortized cost of the security. The net present
value is calculated by discounting the Company’s best estimate of projected future cash flows at the effective interest rate implicit in the
debt security prior to impairment. The Company may use the estimated fair value of collateral as a proxy for the net present value if it
believes that the security is dependent on the liquidation of collateral for recovery of its investment. If the net present value is less than the
amortized cost of the investment, an OTTI is recognized. In addition to the above mentioned circumstances, the Company also recognizes
an OTTI in earnings when a non-functional currency denominated security in an unrealized loss position due to currency exchange rates
approaches maturity.
When an OTTI of a debt security has occurred, the amount of the OTTI recognized in earnings depends on whether the Company
intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the debt
security meets either of these two criteria or the unrealized losses due to changes in foreign currency exchange rates are not expected to be
recovered before maturity, the OTTI recognized in earnings is equal to the entire difference between the security’s amortized cost basis and
its fair value at the impairment measurement date. For OTTI of debt securities that do not meet these criteria, the net amount recognized in
earnings is equal to the difference between the amortized cost of the debt security and its net present value calculated as described above.
Any difference between the fair value and the net present value of the debt security at the impairment measurement date is recorded in
“Other comprehensive income (loss).” Unrealized gains or losses on securities for which an OTTI has been recognized in earnings is
tracked as a separate component of AOCI.
For debt securities, the split between the amount of an OTTI recognized in other comprehensive income and the net amount
recognized in earnings is driven principally by assumptions regarding the amount and timing of projected cash flows. For mortgage-backed
and asset-backed securities, cash flow estimates consider the payment terms of the underlying assets backing a particular security,
including interest rate and prepayment assumptions based on data from widely accepted third-party data sources or internal estimates. In
addition to interest rate and prepayment assumptions, cash flow estimates also include other assumptions regarding the underlying
collateral including default rates and recoveries, which vary based on the asset type and geographic location, as well as the vintage year of
the security. For structured securities, the payment priority within the tranche structure is also considered. For all other debt securities, cash
flow estimates are driven by assumptions regarding probability of default and estimates regarding timing and amount of recoveries
associated with a default. The Company has developed these estimates using information based on its historical experience as well as using
market observable data, such as industry analyst reports and forecasts, sector credit ratings and other data relevant to the collectability of a
security, such as the general payment terms of the security and the security’s position within the capital structure of the issuer.
Prudential Financial, Inc. 2015 Annual Report 115