Prudential 2015 Annual Report Download - page 118

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. In periods subsequent to
the recognition of an OTTI, the impaired security is accounted for as if it had been purchased on the measurement date of the impairment.
For debt securities, the discount (or reduced premium) based on the new cost basis may be accreted into net investment income in future
periods, including increases in cash flow on a prospective basis. In certain cases where there are decreased cash flow expectations, the
security is reviewed for further cash flow impairments.
Unrealized investment gains and losses are also considered in determining certain other balances, including DAC, VOBA, DSI,
certain future policy benefits, policyholders’ account balances, policyholders’ dividends and deferred tax assets or liabilities. These
balances are adjusted, as applicable, for the impact of unrealized gains or losses on investments as if these gains or losses had been realized,
with corresponding credits or charges included in AOCI. Each of these balances is discussed in greater detail below.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, certain money market investments and other debt
instruments with maturities of three months or less when purchased, other than cash equivalents that are included in “Trading account
assets supporting insurance liabilities, at fair value.”
DAC
Costs that are related directly to the successful acquisition of new and renewal insurance and annuity business are deferred to the extent
such costs are deemed recoverable from future profits. Such DAC primarily includes commissions, costs of policy issuance and underwriting,
and certain other expenses that are directly related to successfully negotiated contracts. In each reporting period, capitalized DAC is
amortized to “Amortization of DAC,” net of the accrual of imputed interest on DAC balances. DAC is subject to periodic recoverability
testing. DAC, for applicable products, is adjusted for the impact of unrealized gains or losses on investments as if these gains or losses had
been realized, with corresponding credits or charges included in AOCI.
For traditional participating life insurance included in the Closed Block, DAC is amortized over the expected life of the contracts in
proportion to gross margins based on historical and anticipated future experience, which is evaluated regularly. The effect of changes in
estimated gross margins on unamortized DAC is reflected in the period such estimated gross margins are revised. DAC related to universal
and variable life products and fixed and variable deferred annuity products are generally deferred and amortized over the expected life of
the contracts in proportion to gross profits arising principally from investment margins, mortality and expense margins, and surrender
charges, based on historical and anticipated future experience, which is updated periodically. The Company uses a reversion to the mean
approach for equities to derive future equity return assumptions. However, if the projected equity return calculated using this approach is
greater than the maximum equity return assumption, the maximum equity return is utilized. Gross profits also include impacts from the
embedded derivatives associated with certain of the optional living benefit features of the Company’s variable annuity contracts and related
hedging activities. The effect of changes to total gross profits on unamortized DAC is reflected in the period such total gross profits are
revised. DAC related to non-participating traditional individual life insurance and longevity reinsurance contracts is amortized in
proportion to gross premiums.
For group annuity contracts (other than single premium group annuities), acquisition costs are generally deferred and amortized over
the expected life of the contracts in proportion to gross profits. For group corporate-, bank- and trust-owned life insurance contracts,
acquisition costs are generally deferred and amortized in proportion to lives insured. For single premium immediate annuities with life
contingencies, single premium group annuities, including non-participating group annuity contracts, and single premium structured
settlements with life contingencies, all acquisition costs are charged to expense immediately because generally all premiums are received at
the inception of the contract. For funding agreement notes contracts, single premium structured settlement contracts without life
contingencies, and single premium immediate annuities without life contingencies, acquisition expenses are deferred and amortized over
the expected life of the contracts using the interest method. For other group life and disability insurance contracts and guaranteed
investment contracts, acquisition costs are expensed as incurred.
For some products, policyholders can elect to modify product benefits, features, rights or coverages by exchanging a contract for a
new contract or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. These
transactions are known as internal replacements. If policyholders surrender traditional life insurance policies in exchange for life insurance
policies that do not have fixed and guaranteed terms, the Company immediately charges to expense the remaining unamortized DAC on the
surrendered policies. For other internal replacement transactions, except those that involve the addition of a nonintegrated contract feature
that does not change the existing base contract, the unamortized DAC is immediately charged to expense if the terms of the new policies
are not substantially similar to those of the former policies. If the new terms are substantially similar to those of the earlier policies, the
DAC is retained with respect to the new policies and amortized over the expected life of the new policies.
VOBA
As a result of certain acquisitions and the application of purchase accounting, the Company reports a financial asset representing
VOBA. VOBA represents an adjustment to the stated value of inforce insurance contract liabilities to present them at fair value, determined
as of the acquisition date. VOBA balances are subject to recoverability testing, in the manner in which they were acquired. The Company
has established a VOBA asset primarily for its acquired life insurance products, accident and health products with fixed benefits, deferred
116 Prudential Financial, Inc. 2015 Annual Report