Prudential 2003 Annual Report Download - page 164

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
19. SEGMENT INFORMATION (continued)
The excluded items are important to an understanding of overall results of operations. Adjusted operating income
is not a substitute for net income determined in accordance with GAAP, and the Company’s definition of adjusted
operating income may differ from that used by other companies. However, the Company believes that the presentation
of adjusted operating income as measured for management purposes enhances the understanding of results of
operations by highlighting the results from ongoing operations and the underlying profitability factors of the Financial
Services Businesses.
Adjusted operating income excludes net realized investment gains and losses. A significant element of realized
losses is impairments and losses from sales of credit-impaired securities, the timing of which depends largely on
market credit cycles and can vary considerably across periods. The timing of other sales that would result in gains or
losses is largely subject to the Company’s discretion and influenced by market opportunities. Trends in the underlying
profitability of the Company’s businesses can be more clearly identified without the fluctuating effects of these
transactions. Adjusted operating income excludes life insurance sales practices remedies and costs relating to the
settlement of individual life insurance sales practices issues for the period from 1982 through 1995 because they relate
to a substantial and identifiable non-recurring event. Adjusted operating income excludes the results of divested
businesses, which are not indicative of the Company’s future operating results. Adjusted operating income also
excludes demutualization costs and expenses as they are directly related to demutualization and could distort the trends
associated with ongoing business operations.
The related charges, which offset against net realized investment gains and losses, relate to policyholder
dividends, amortization of deferred policy acquisition costs, and reserves for future policy benefits. The related charges
associated with policyholder dividends include a percentage of net realized investment gains on specified Gibraltar
Life assets that is required to be paid as dividends to Gibraltar Life policyholders. Deferred policy acquisition costs for
certain investment-type products are amortized based on estimated gross profits, which include net realized investment
gains and losses on the underlying invested assets, and the related charge for amortization of deferred policy
acquisition costs represents the portion of this amortization associated with net realized investment gains and losses.
The reserves for certain policies are adjusted when cash flows related to these policies are affected by net realized
investment gains and losses, and the related charge for reserves for future policy benefits represents that adjustment.
Gains and losses pertaining to derivatives contracts that do not qualify for hedge accounting treatment, other than
derivatives used for trading purposes, are included in “Realized investment gains (losses), net.” This includes mark-to-
market adjustments of open contracts as well as periodic settlements. As discussed further below, adjusted operating
income includes a portion of realized gains and losses pertaining to certain derivative contracts.
Adjusted operating income of the International Insurance segment reflects the impact of an intercompany
arrangement with Corporate and Other operations pursuant to which the segment’s results for a particular year,
including its interim reporting periods, are translated at fixed currency exchange rates. The fixed rates are determined
in connection with a currency hedging program designed to mitigate the risk that unfavorable rate changes will reduce
the segment’s U.S. dollar equivalent earnings. Pursuant to this program, the Company executes forward sale contracts
in the hedged currency in exchange for U.S. dollars at a specified exchange rate. The maturities of these contracts
correspond with the future periods in which the non-U.S. earnings are expected to be generated. These contracts do not
qualify for hedge accounting under GAAP and, as noted above, all resulting profits or losses from such contracts are
included in “Realized investment gains (losses), net.” When the contracts are terminated in the same period that the
expected earnings emerge, the resulting positive or negative cash flow effect is included in adjusted operating income
(losses of $51 million, and revenues of $42 million and $34 million for the years ended December 31, 2003, 2002 and
2001, respectively). As of December 31, 2003 and 2002, the fair value of open contracts used for this purpose was a net
liability of $152 million and $52 million, respectively.
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