Prudential 2015 Annual Report Download - page 186

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
validated quotes from pricing services are generally reflected within Level 2, as they are primarily based on observable pricing for similar
assets and/or other market observable inputs. Typical inputs used by these pricing services include but are not limited to, reported trades,
benchmark yields, issuer spreads, bids, offers, and/or estimated cash flow, prepayment speeds and default rates. If the pricing information
received from third-party pricing services is deemed not reflective of market activity or other inputs observable in the market, the Company
may challenge the price through a formal process with the pricing service or classify the securities as Level 3. If the pricing service updates
the price to be more consistent with the presented market observations, the security remains within Level 2.
Internally-developed valuations or indicative broker quotes are also used to determine fair value in circumstances where vendor
pricing is not available, or where the Company ultimately concludes that pricing information received from the independent pricing
services is not reflective of market activity. If the Company concludes the values from both pricing services and brokers are not reflective
of market activity, it may override the information with an internally-developed valuation. As of December 31, 2015 and 2014, overrides
on a net basis were not material. Pricing service overrides, internally-developed valuations and indicative broker quotes are generally
included in Level 3 in the fair value hierarchy.
The Company conducts several specific price monitoring activities. Daily analyses identify price changes over predetermined
thresholds defined at the financial instrument level. Various pricing integrity reports are reviewed on a daily and monthly basis to
determine if pricing is reflective of market activity or if it would warrant any adjustments. Other procedures performed include, but are not
limited to, reviews of third-party pricing services methodologies, reviews of pricing trends and back testing.
The fair value of private fixed maturities, which are comprised of investments in private placement securities, originated by internal private
asset managers, are primarily determined using discounted cash flow models. These models primarily use observable inputs that include Treasury
or similar base rates plus estimated credit spreads to value each security. The credit spreads are obtained through a survey of private market
intermediaries who are active in both primary and secondary transactions, and consider, among other factors, the credit quality and industry
sector of the issuer and the reduced liquidity associated with private placements. Since most private placements are valued using standard market
observable inputs and inputs derived from, or corroborated by, market observable data including observed prices and spreads for similar publicly-
traded or privately-traded issues, they have been reflected within Level 2. For certain private fixed maturities, the discounted cash flow model
may incorporate significant unobservable inputs, which reflect the Company’s own assumptions about the inputs that market participants would
use in pricing the asset. To the extent management determines that such unobservable inputs are significant to the price of a security, a Level 3
classification is made.
Trading Account Assets—Trading account assets consist primarily of fixed maturity securities, equity securities and derivatives
whose fair values are determined consistent with similar instruments described above under “Fixed Maturity Securities” and below under
“Equity Securities” and “Derivative Instruments.”
Equity Securities—Equity securities consist principally of investments in common and preferred stock of publicly-traded companies,
perpetual preferred stock, privately-traded securities, as well as mutual fund shares. The fair values of most publicly-traded equity
securities are based on quoted market prices in active markets for identical assets and are classified within Level 1 in the fair value
hierarchy. Estimated fair values for most privately traded equity securities are determined using discounted cash flow, earnings multiple
and other valuation models that require a substantial level of judgment around inputs and therefore are classified within Level 3. The fair
values of mutual fund shares that transact regularly (but do not trade in active markets because they are not publicly available) are based on
transaction prices of identical fund shares and are classified within Level 2 in the fair value hierarchy. The fair values of perpetual preferred
stock are based on inputs obtained from independent pricing services that are primarily based on indicative broker quotes. As a result, the
fair values of perpetual preferred stock are classified as Level 3.
Commercial Mortgage and Other Loans—The fair value of loans held and accounted for using the fair value option is determined
utilizing pricing indicators from the whole loan market, where investors are committed to purchase these loans at a predetermined price,
which is considered the principal exit market for these loans. The Company has evaluated the valuation inputs used for these assets,
including the existence of predetermined exit prices, the terms of the loans, prevailing interest rates and credit risk, and deemed that the
primary pricing inputs are Level 2 inputs in the fair value hierarchy.
Other Long-Term Investments—Other long-term investments include limited partnerships which are consolidated because the
Company is either deemed to exercise control or considered the primary beneficiary of a variable interest entity. These entities are
considered investment companies and follow specialized industry accounting whereby their assets are carried at fair value. The investments
held by these entities include various feeder fund investments in underlying master funds (whose underlying holdings generally include
public fixed maturities, equity securities and mutual funds), as well as wholly-owned real estate held within other investment funds. The
fair value is determined by reference to the underlying direct investments, with publicly-traded equity securities based on quoted prices in
active markets reflected in Level 1, and public fixed maturities and mutual funds priced via quotes from pricing services or observable data
reflected in Level 2. The fair value of investments in funds that are subject to significant liquidity restrictions are reflected in Level 3.
The fair value of real estate held in consolidated investment funds is determined through an independent appraisal process. The
appraisals generally utilize a discounted cash flow model, supplemented with replacement cost estimates and comparable recent sales data
when available. These appraisals and the related assumptions are updated at least annually. Since many of the assumptions utilized are
unobservable and are considered to be significant inputs to the valuation, the real estate investments within other long-term investments
have been reflected within Level 3 in the fair value hierarchy.
184 Prudential Financial, Inc. 2015 Annual Report