Prudential 2015 Annual Report Download - page 21

Account Values. In managing our Individual Annuity and Retirement businesses, we analyze account values, which do not
correspond to U.S. GAAP assets. Net sales (redemptions) in our Individual Annuity business and net additions (withdrawals) in our
Retirement business do not correspond to revenues under U.S. GAAP, but are used as a relevant measure of business activity.
Accounting Policies & Pronouncements
Application of Critical Accounting Estimates
The preparation of financial statements in conformity with U.S. GAAP requires the application of accounting policies that often
involve a significant degree of judgment. Management, on an ongoing basis, reviews estimates and assumptions used in the preparation of
financial statements. If management determines that modifications in assumptions and estimates are appropriate given current facts and
circumstances, the Company’s results of operations and financial position as reported in the Consolidated Financial Statements could
change significantly.
The following sections discuss the accounting policies applied in preparing our financial statements that management believes are
most dependent on the application of estimates and assumptions and require management’s most difficult, subjective, or complex
judgments.
Deferred Policy Acquisition and Other Costs
We capitalize costs that are directly related to the acquisition or renewal of insurance and annuity contracts. These costs primarily
include commissions, as well as costs of policy issuance and underwriting and certain other expenses that are directly related to
successfully negotiated contracts. We have also deferred costs associated with sales inducements related to our variable and fixed annuity
contracts primarily within our Individual Annuities segment. Sales inducements are amounts that are credited to the policyholder’s account
balance as an inducement to purchase the contract. For additional information about sales inducements, see Note 11 to the Consolidated
Financial Statements. We generally amortize these deferred policy acquisition costs (“DAC”) and deferred sales inducements (“DSI”) over
the expected lives of the contracts, based on our estimates of the level and timing of gross margins, gross profits, or gross premiums,
depending on the type of contract. As described in more detail below, in calculating DAC and DSI amortization, we are required to make
assumptions about investment returns, mortality, persistency, and other items that impact our estimates of the level and timing of gross
margins, gross profits, or gross premiums. We also periodically evaluate the recoverability of our DAC and DSI. For certain contracts, this
evaluation is performed as part of our premium deficiency testing, as discussed further below in “—Policyholder Liabilities.” As of
December 31, 2015, DAC and DSI for PFI excluding the Closed Block division were $16.3 billion and $1.2 billion, respectively, and DAC
in our Closed Block division was $373 million.
Amortization methodologies
DAC associated with the non-participating whole life and term life policies of our Individual Life segment and the whole life, term
life, endowment and health policies of our International Insurance segment is amortized in proportion to gross premiums.
DAC and DSI associated with the variable and universal life policies of our Individual Life and International Insurance segments and
the variable and fixed annuity contracts of our Individual Annuities and International Insurance segments are generally amortized over the
expected life of these policies in proportion to total gross profits. Total gross profits include both actual gross profits and estimates of gross
profits for future periods. In calculating gross profits, we consider mortality, persistency, and other elements as well as rates of return on
investments associated with these contracts and the costs related to our guaranteed minimum death and guaranteed minimum income
benefits. For variable annuities in our Individual Annuities segment, U.S. GAAP gross profits and amortization rates also include the
impacts of the embedded derivatives associated with certain of the living benefit features of our variable annuity contracts and related
hedging activities. In calculating amortization expense, we estimate the amounts of gross profits that will be included in our U.S. GAAP
results and in adjusted operating income, and utilize these estimates to calculate distinct amortization rates and expense amounts. We also
regularly evaluate and adjust the related DAC and DSI balances with a corresponding charge or credit to current period earnings for the
impact of actual gross profits and changes in our projections of estimated future gross profits on our DAC and DSI amortization rates.
Adjustments to the DAC and DSI balances include the impact to our estimate of total gross profits of the annual review of assumptions, our
quarterly adjustments for current period experience, and our quarterly adjustments for market performance. Each of these adjustments is
further discussed below in “—Annual assumptions review and quarterly adjustments.” For additional information on our internally-defined
hedge target, see “—Results of Operations by Segment—U.S. Retirement Solutions and Investment Management Division—Individual
Annuities—Variable Annuity Hedging Program Results.”
DAC associated with the traditional participating products of our Closed Block is amortized over the expected lives of those contracts
in proportion to estimated gross margins. Gross margins consider premiums, investment returns, benefit claims, costs for policy
administration, changes in reserves, and dividends to policyholders. We evaluate our estimates of future gross margins and adjust the
related DAC balance with a corresponding charge or credit to current period earnings for the effects of actual gross margins and changes in
our expected future gross margins. DAC adjustments for these participating products generally have not created significant volatility in our
results of operations since many of the factors that affect gross margins are also included in the determination of our dividends to these
policyholders and, 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, changes in gross margins and DAC amortization would result in a net impact to the
Closed Block results of operations. As of December 31, 2015, the excess of actual cumulative earnings over the expected cumulative
earnings was $1,694 million.
Prudential Financial, Inc. 2015 Annual Report 19