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PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT

Table of contents

  • Page 1
    PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT

  • Page 2
    ... and services, including life insurance, annuities, mutual funds, pension and retirement-related services and administration, asset management, banking and trust services, real estate brokerage and relocation services, and, through a joint venture, retail securities brokerage services. Today, we...

  • Page 3
    ... traded company. And we continue to look for opportunities to reduce costs and increase our efficiency. • We have divested low-growth, low-return and volatile businesses. In 2003, we sold our property and casualty business and combined our retail securities brokerage operations with Wachovia...

  • Page 4
    ... component of our retirement and savings market presence is our annuities business. Today's variable annuities offer customers access to sophisticated investment and risk management capabilities, making them key to effective retirement strategies. Our acquisition of American Skandia in A balanced...

  • Page 5
    ... version of our popular Lifetime Five living benefit option, as well as Highest Daily Lifetime Five , adding new options to this suite of products, which are designed to help investors grow and protect their retirement savings. We now hold a leading position in the variable annuity market, and have...

  • Page 6
    ..., our International Insurance business had more than $1.12 billion in annualized new business premiums and more than 7 million total policies in force. The strength of our Life Planner business-which relies on a distribution force of welleducated, highly trained life insurance sales professionals...

  • Page 7
    ... the essence of the strong value proposition that Prudential Financial offers investors today: • High value-added business models that produce high returns with low risk; • Our highest-return businesses are also our fastestgrowing businesses; • A portfolio of businesses in which risks are well...

  • Page 8
    ..., extraordinary gain on acquisition and cumulative effect of accounting change Return on average equity (B) EARNINGS PER SHARE OF COMMON STOCK - diluted Adjusted operating income after income taxes Reconciling items: Realized investment gains (losses), net, and related charges and adjustments Other...

  • Page 9
    ... operations (after-tax) before extraordinary gain on acquisition and cumulative effect of accounting change by average total attributed equity for the Financial Services Businesses. Both income amounts above give effect to the direct equity adjustment for earnings per share calculation. $1,000...

  • Page 10
    ... by Prudential Investment Management Services, LLC, American Skandia Marketing, Incorporated, and Pruco Securities, LLC (all members SIPC). Insurance issued by The Prudential Insurance Company of America and American Skandia Life Assurance Corporation. All are Prudential Financial companies, and...

  • Page 11
    ... Private Securities Reform Act of 1995. Please see page 187 for a description of certain risks and uncertainties that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements. PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT...

  • Page 12
    ... Equity and Related Stockholder Matters ...Performance Graph ...Forward-Looking Statements ...SEC and NYSE Certifications ... 11 13 84 89 90 92 93 94 95 96 182 185 186 187 188 Throughout this Annual Report, "Prudential Financial" refers to Prudential Financial, Inc., the ultimate holding company...

  • Page 13
    ... markets activities of Prudential Securities. This business had pre-tax income of $287 million in 2003, including the gain from a $332 million settlement of an arbitration award and a pre-tax loss of $36 million in 2002. In 2000, we sold Gibraltar Casualty Company, a commercial property and casualty...

  • Page 14
    ... investments excluding policy loans ...Separate account assets ...Total assets ...Future policy benefits and policyholders' account balances ...Separate account liabilities ...Short-term debt ...Long-term debt ...Total liabilities ...Guaranteed beneficial interest in Trust holding solely debentures...

  • Page 15
    ... fund payments of all expenses, taxes, and policyholder benefits to be paid to, and the reasonable dividend expectations of, holders of the Closed Block policies. We also segregated for accounting purposes the assets that we need to hold outside the Closed Block to meet capital requirements related...

  • Page 16
    ... fees from the distribution, servicing and management of mutual funds, retirement products and other asset management products and services. Our operating expenses principally consist of insurance benefits provided, general business expenses, dividends to policyholders, commissions and other costs...

  • Page 17
    ... annuity business acquired from The Allstate Corporation on June 1, 2006. Results for both the current and prior years benefited from reductions in amortization of deferred policy acquisition costs and other costs, reflecting increased estimates of profitability based on an annual review. • Group...

  • Page 18
    ... comprehensive income (loss), net," a separate component of equity. For our investments classified as trading, the impact of changes in fair value is recorded within "Asset management fees and other income." In addition, investments classified as PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT 16

  • Page 19
    ... Closed Block Business and the non-participating whole life, term life, and life contingent structured settlement and group annuity products of our Financial Services Businesses. The future policy benefit reserves for the traditional participating life insurance products of our Closed Block Business...

  • Page 20
    ... products of our Closed Block Business is amortized over the expected lives of those contracts in proportion to gross margins. Gross margins consider premiums, investment returns, benefit claims, costs for policy administration, changes in reserves, and dividends to policyholders. We evaluate our...

  • Page 21
    ...in separate account investment options, and the shorter average life of the contracts. This rate of return influences the fees we earn, costs we incur associated with minimum death benefit and other contractual guarantees specific to our variable annuity contracts, as well as other sources of profit...

  • Page 22
    ... of our expected rate of return on plan assets and discount rate for our qualified pension plan in 2007 see "-Results of Operations for Financial Services Businesses by Segment-Corporate and Other." In addition to the effect of changes in our assumptions, the net periodic cost or benefit from our...

  • Page 23
    ... "Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts." The following provides additional discussion of certain accounting policies adopted. Share-Based Payments Effect of Adoption We issued employee stock options...

  • Page 24
    ... valuing employee stock options issued in 2006, 2005, and 2004. Excess Tax Benefits An excess tax benefit is generated whenever the tax deduction associated with share-based payment arrangements exceeds the related cumulative compensation cost recognized for financial reporting purposes. Excess tax...

  • Page 25
    ... International Insurance and Investments Division ...Corporate and Other ...Income from continuing operations before income taxes, equity in earnings of operating joint ventures, extraordinary gain on acquisition and cumulative effect of accounting change for Financial Services Businesses ...Income...

  • Page 26
    ... the Class B Stock for earnings per share purposes. The holders of the Common Stock will benefit from the direct equity adjustment as long as reported administrative expenses of the Closed Block Business are less than the cash flows for administrative expenses determined by the policy servicing fee...

  • Page 27
    ... of deferred policy acquisition costs and other costs. The net reduction in amortization and other costs is due to an increased estimate of total gross profits used as a basis for amortizing deferred policy acquisition costs and unearned revenue reserves, based on an annual review, primarily...

  • Page 28
    ...higher asset based fees due to higher asset balances from market appreciation. 2005 to 2004 Annual Comparison. Revenues increased $189 million, from $2.073 billion in 2004 to $2.262 billion in 2005. Premiums increased $57 million, primarily due to increased premiums on term life insurance reflecting...

  • Page 29
    ...$236 155 $391 (1) Scheduled premiums from new sales on an annualized basis and first year excess premiums and deposits on a cash-received basis. 2006 to 2005 Annual Comparison. Sales of new life insurance, excluding corporate-owned life insurance, measured as described above, increased $11 million...

  • Page 30
    ... increase in distribution costs charged to expense associated with increased variable annuity sales and account values and increased general expenses related to expansion initiatives. In addition, results for 2005 benefited $6 million, net of related amortization of deferred policy acquisition costs...

  • Page 31
    ... associated with increased variable annuity sales. In addition, our asset based costs associated with trail commissions and sub-advisory expenses have increased due to growth in account values. Partially offsetting these items was a decrease of PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT 29

  • Page 32
    ...) Variable Annuities(1): Beginning total account value ...Sales ...Surrenders and withdrawals ...Net sales ...Benefit payments ...Net flows ...Change in market value, interest credited and other activity ...Policy charges ...Acquisition ...Ending total account value ...Fixed Annuities: Beginning...

  • Page 33
    ... in invested assets and higher interest rates on shorter-term investments. Less favorable claims experience in our group life business and higher expenses, including higher costs in 2006 related to legal and regulatory matters, largely offset these increases. 2005 to 2004 Annual Comparison. Adjusted...

  • Page 34
    ...161 $398 (1) Amounts exclude new premiums resulting from rate changes on existing policies, from additional coverage under our Servicemembers' Group Life Insurance contract and from excess premiums on group universal life insurance that build cash value but do not purchase face amounts, and include...

  • Page 35
    ... and retail customer assets as a result of increased asset values due to market appreciation and net asset inflows. Higher expenses, including performance-related compensation costs, partially offset the foregoing increases. 2005 to 2004 Annual Comparison. Adjusted operating income increased $198...

  • Page 36
    ... to provide essentially a fixed fee for managed account services and is now scheduled to expire on July 1, 2008. Also includes payments from Wachovia Corporation under an agreement dated as of July 30, 2004 implementing arrangements with respect to money market mutual funds in connection with the...

  • Page 37
    ... 2004 and 2005, including assets associated with the retirement business acquired from CIGNA, as well as net market appreciation. Additionally, revenues for 2005 include an increase of $79 million in performance based incentive and transaction fees primarily related to our real estate investment...

  • Page 38
    ... and related adjustments(1) ...Related charges(2) ...Investment gains (losses) on trading account assets supporting insurance liabilities, net(3) ...Change in experience-rated contractholder liabilities due to asset value changes(4) ...Income from continuing operations before income taxes, equity in...

  • Page 39
    ... an increase in sales of life-contingent structured settlements following the upgrade of Prudential Insurance's financial strength rating by A.M. Best during 2004. Net investment income increased $145 million reflecting a larger base of invested assets due to sales of guaranteed investment products...

  • Page 40
    ... $ (363) $ (1,468) $ (909) (1) Account values and activity related to the CIGNA retirement business include amounts acquired under reinsurance agreements. (2) Ending total account value for the full service business includes assets of Prudential's retirement plan of $5.6 billion, $5.3 billion and...

  • Page 41
    ...account values to our Asset Management segment. An increase in structured settlement sales during 2005 partially offset these transfers. In addition, the prior year reflects only the initial nine months of sales and withdrawal activity from the retirement business acquired from CIGNA. International...

  • Page 42
    ...gains (losses), net, on the amortization of deferred policy acquisition costs. (3) Revenues exclude net investment gains and losses on trading account assets supporting insurance liabilities. See "-Trading Account Assets Supporting Insurance Liabilities." (4) Benefits and expenses exclude changes in...

  • Page 43
    ... of $93 million in single premiums, as sales associated with retirement and savings objectives have transitioned from traditional products on which premiums are recorded to U.S. dollar denominated fixed annuities for which customer funds received are accounted for as deposits. The remainder of the...

  • Page 44
    ... the acquired Aoba Life business. Premiums and policy charges and fee income from our Korean operation increased $115 million, from $781 million in 2004 to $896 million in 2005. The increases in premiums and policy charges and fee income are associated with business growth and reflect new sales and...

  • Page 45
    ... premium fixed annuity product. Investment Margins and Other Profitability Factors Many of our insurance products sold in international markets provide for the buildup of cash values for the policyholder at mandated guaranteed interest rates. Japanese authorities regulate interest rates guaranteed...

  • Page 46
    ...2005 Annual Comparison. Adjusted operating income increased $37 million, from $106 million in 2005 to $143 million in 2006. This increase reflects income recognized in 2006 from market value changes on securities held, principally relating to trading PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT 44

  • Page 47
    ... fee revenue from the Korean government under an agreement entered into in connection with the acquisition in 2004 of PISC, related to the provision of asset management and brokerage services, which agreement extends until February 27, 2009. 2005 to 2004 Annual Comparison. Adjusted operating income...

  • Page 48
    ... demutualization. The Closed Block Business includes our in force traditional domestic participating life insurance and annuity products and assets that are used for the payment of benefits and policyholder dividends on these policies, as well as other assets and equity and related liabilities that...

  • Page 49
    ... well as changes in assets and related liabilities that support the policies. Additionally, net unrealized investment gains have arisen subsequent to the establishment of the Closed Block due to the impact of lower interest rates on the market value of fixed maturities available for sale. These net...

  • Page 50
    ... sold or held for sale ...Canadian intermediate weekly premium and individual health operations ...Philippine insurance operations ...Dryden Wealth Management ...International securities operations ...Healthcare operations ...Other ...Income (loss) from discontinued operations before income taxes...

  • Page 51
    ... sales of investments pursuant to our credit risk and portfolio management objectives. Impairments, interest-rate related losses and credit losses are excluded from adjusted operating income. We require most issuers of private fixed maturity securities to pay us make-whole yield maintenance payments...

  • Page 52
    ...Life ...Individual Annuities ...Group Insurance ...Asset Management ...Financial Advisory ...Retirement ...International Insurance ...International Investments ...Corporate and Other Operations ...Total ...Realized investment gains (losses), net-Financial Services Businesses ...Closed Block Business...

  • Page 53
    ... Retirement, Individual Annuities and International Insurance segments, which were primarily interest-rate related. Interest-rate related losses on fixed maturities primarily reflect sales of lower yielding bonds in a higher rate environment in order to meet various cash flow needs, manage portfolio...

  • Page 54
    ... of fixed maturity securities of $349 million, which were primarily interest rate-related. Interest-rate related losses on fixed maturities primarily reflect losses from sales of lower yielding bonds in a higher rate environment in order to meet various cash flow needs, manage portfolio duration...

  • Page 55
    ... portfolio in our insurance companies to support our liabilities to customers in our Financial Services Businesses and the Closed Block Business, as well as our other general liabilities. Our general account does not include: (1) assets of our securities brokerage, securities trading, banking...

  • Page 56
    ... experience, such as fixed annuities and universal life insurance; • participating individual and experience rated group products in which customers participate in actual investment and business results through annual dividends, interest or return of premium; and • guaranteed products for which...

  • Page 57
    ... reinvestment of net investment income and changes in foreign exchange rates, partially offset by the net decline in market values attributable to higher interest rates. Also contributing to the increase was the addition of investments related to the acquisition of the variable annuity business of...

  • Page 58
    ...11,354 12,077 (1,064) Fixed maturities ...Trading account assets supporting insurance liabilities ...Equity securities ...Commercial loans ...Policy loans ...Short-term investments and cash equivalents ...Other investments ...Gross investment income before investment expenses ...Investment expenses...

  • Page 59
    ...301) 5,517 217 $5,734 Fixed maturities ...Trading account assets supporting insurance liabilities ...Equity securities ...Commercial loans ...Policy loans ...Short-term investments and cash equivalents ...Other investments ...Gross investment income before investment expenses ...Investment expenses...

  • Page 60
    ... directed or overseen by the Asset Liability and Risk Management Group and, in the case of our international insurance portfolios, to a profile that also reflects the local market environment. We seek to employ relative value analysis both in credit selection and in purchasing and selling securities...

  • Page 61
    ...of the mortgage-backed securities in the Financial Services Businesses were publicly traded agency pass-through securities related to residential mortgage loans. Collateralized mortgage obligations represented the remaining 2% of mortgage backed securities (and less than 1% of total fixed maturities...

  • Page 62
    ...insurance companies are based on ratings assigned by Moody's, Standard & Poor's, or rating equivalents based on ratings assigned by Japanese credit ratings agencies. The amortized cost of our public and private below investment grade fixed maturities attributable to the Financial Services Businesses...

  • Page 63
    ... as held to maturity that are not reflected in other comprehensive income. The following table sets forth our public fixed maturity portfolios by NAIC rating attributable to the Closed Block Business as of the dates indicated. (1) NAIC Designation 1 2 December 31, 2006 December 31, 2005 Gross Gross...

  • Page 64
    ...as held to maturity that are not reflected in other comprehensive income. The following table sets forth our private fixed maturity portfolios by NAIC rating attributable to the Closed Block Business as of the dates indicated. (1) NAIC Designation 1 2 December 31, 2006 December 31, 2005 Gross Gross...

  • Page 65
    ...where we have sold credit protection through credit derivatives in the Closed Block Business portfolios by NAIC rating of the underlying credits as of the dates indicated. (1) NAIC Designation 1 2 December 31, 2006 Rating Agency Equivalent Aaa, Aa, A ...Baa ...Subtotal Investment Grade ...3 4 5 6 Ba...

  • Page 66
    ... of Fixed Maturity Securities We maintain separate monitoring processes for public and private fixed maturities and create watch lists to highlight securities that require special scrutiny and management. Our public fixed maturity asset managers formally review all public fixed maturity holdings on...

  • Page 67
    ... ...Fixed Maturities: U.S. Government ...Foreign Government ...Corporate Securities ...Asset-Backed Securities ...Mortgage Backed ...Total Fixed Maturities ...Equity Securities ...Total trading account assets supporting insurance liabilities ... PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT 65

  • Page 68
    ... that are not rated by U.S. insurance regulatory authorities. (3) Amounts are reported in "Asset management fees and other income." The following table sets forth our private fixed maturities included in our trading account assets supporting insurance liabilities portfolio by NAIC rating as of the...

  • Page 69
    ... location. The following tables set forth the breakdown of the gross carrying values of our commercial loan portfolio by geographic region and property type as of the dates indicated. December 31, 2005 December 31, 2006 Financial Services Closed Block Financial Services Closed Block Businesses...

  • Page 70
    Commercial Loans by Contractual Maturity Date The following tables set forth the breakdown of our commercial loan portfolio by contractual maturity as of December 31, 2006. December 31, 2006 Financial Services Closed Block Businesses Business Gross Gross Carrying % of Carrying % of Value Total Value...

  • Page 71
    ...314 $3,426 Fair Value $3,721 130 $3,851 Public equity securities include common stock mutual fund shares representing our interest in the underlying assets of certain of our separate account investments. These mutual funds invest primarily in high yield bond funds. The cost, gross unrealized gains...

  • Page 72
    ... The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. Estimated fair values for publicly traded equity securities are based on quoted market prices or prices obtained from independent pricing services. Estimated fair values for privately traded...

  • Page 73
    ...Total divested business excluded from adjusted operating income ... In the fourth quarter of 2003, we sold our property and casualty insurance companies that operated nationally in 48 states outside of New Jersey, and the District of Columbia, to Liberty Mutual Group, and our New Jersey property and...

  • Page 74
    ...(8) ...Shareholder dividends ...Purchase of funding agreements from Prudential Insurance, net of maturities(2) ...Net payments under intercompany loan agreements(9) ...Distribution to subsidiaries of tax settlement(5) ...Other, net ...Total uses ...Net increase in cash and short-term investments...

  • Page 75
    ..., LLC, or Prudential Holdings. Prudential Holdings then distributed $1.597 billion of those dividends to Prudential Financial, which excludes the portion of the dividends allocated to the Closed Block Business. Also in the second quarter of 2006, American Skandia Life Assurance Corporation paid an...

  • Page 76
    ... maturities and sales associated with our insurance and annuity operations. The principal uses of that liquidity include benefits, claims, dividends paid to policyholders, and payments to policyholders and contractholders in connection with surrenders, withdrawals and net policy loan activity. Other...

  • Page 77
    ... annuity reserves and deposit liabilities because policyholders may incur surrender charges and be subject to a new underwriting process in order to obtain a new insurance policy. Annuity benefits under group annuity contracts are generally not subject to early withdrawal. Gross account withdrawals...

  • Page 78
    ...form of either additional policy values or cash. Gibraltar Life's investment portfolio is structured to provide adequate liquidity for the special dividend. Prudential of Japan had $16.8 billion and $15.5 billion of general account insurance related liabilities, other than dividends to policyholders...

  • Page 79
    ... Our asset management businesses, which include real estate, public and private fixed income and public equity asset management, as well as commercial mortgage origination, servicing and securitization, proprietary investing and retail investment products, such as mutual funds and wrap-fee products...

  • Page 80
    ... to adjustment upon certain corporate events. The conversion feature requires net settlement in shares; therefore, upon conversion, a holder would receive cash equal to the par amount of the convertible notes surrendered for conversion and shares of Prudential Financial Common Stock only for the...

  • Page 81
    ... grade fixed income investment portfolio. Current capital markets activities for the Company on a consolidated basis principally consist of unsecured short-term and long-term debt borrowings issued by Prudential Funding and Prudential Financial, unsecured third party bank borrowing, and asset...

  • Page 82
    ... in "Policyholders' account balances" and not included in the foregoing table) secured by funding agreements issued to the trust by Prudential Insurance and included in our Retirement segment. The funding agreements provide cash flow sufficient for the debt service on the related medium-term notes...

  • Page 83
    ...the settlement of these obligations are reflected in estimated payments due in less than one year. Commitments to purchase or fund investments include $5.823 billion that we anticipate will be funded from the assets of our separate accounts. (4) Loan commitments of our commercial mortgage operations...

  • Page 84
    ...contracts in force carried a total guaranteed value of $2.400 billion. We arrange for credit enhancements of certain debt instruments that provide financing for commercial real estate assets, including certain tax-exempt bond financings. The credit enhancements provide assurances to the debt holders...

  • Page 85
    ... Annuities segment, and 9% related to our Closed Block Business. If we were to experience a significant decrease in asset values or increase in lapse or surrender rates on policies for which we amortize DAC based on gross margins or gross profits, such as participating and variable life insurance...

  • Page 86
    ... additional information about the guaranteed minimum death benefits associated with our variable life and variable annuity contracts, and the guaranteed minimum income, withdrawal, and accumulation benefits associated with the variable annuity contracts we issue. For a discussion of asset based fees...

  • Page 87
    ... to increase statutory reserves or adjust portfolio management strategies. Market Risk Related to Interest Rates Our "other than trading" assets that subject us to interest rate risk include primarily fixed maturity securities, commercial loans and policy loans. In the aggregate, the carrying value...

  • Page 88
    ... assets with interest rate risk: Fixed maturities ...Commercial loans ...Mortgage broker-loan inventory ...Policy loans ...Derivatives: Swaps ...Futures ...Options ...Forwards ...Financial liabilities with interest rate risk: Short-term and long-term debt ...Investment contracts ...Bank customer...

  • Page 89
    ...mismatches between assets and liabilities. In addition, we use derivative financial instruments to mitigate risk associated with some of our benefit features of our variable annuity contracts. Trading Activities We engage in trading activities primarily in connection with our equity and derivatives...

  • Page 90
    ... 31, 2006 and 2005 was related to commodities price risk. The total average daily VaR for our trading activities considering our exposure to interest rate risk, equity risk, foreign currency exchange rate risk, and commodities price risk, expressed in terms of adverse changes to fair value with a 95...

  • Page 91
    ... Statements of the Company included in this Annual Report, which expresses unqualified opinions on management's assessment and on the effectiveness of the Company's internal control over financial reporting as of December 31, 2006. February 28, 2007 PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT 89

  • Page 92
    ..., the Company changed its method of accounting for defined benefit pension and other postretirement plans on December 31, 2006 and for certain nontraditional long-duration contracts and separate accounts on January 1, 2004. Internal control over financial reporting Also, in our opinion, management...

  • Page 93
    ... of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. New York, New York February 28, 2007 PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT 91

  • Page 94
    ...-$3,228) ...Trading account assets supporting insurance liabilities, at fair value ...Other trading account assets, at fair value ...Equity securities, available for sale, at fair value (cost: 2006-$6,824; 2005-$6,176) ...Commercial loans ...Policy loans ...Securities purchased under agreements to...

  • Page 95
    ... acquisition, net of taxes ...Cumulative effect of accounting change, net of taxes ...Net income per share of Common Stock ...Dividends declared per share of Common Stock ...Closed Block Business Net income per share of Class B Stock-basic and diluted ...Dividends declared per share of Class B Stock...

  • Page 96
    ... Common Accumulated Additional Stock Other Total Common Class B Paid-in Retained Held in Comprehensive Stockholders' Stock Stock Capital Earnings Treasury Income (Loss) Equity Balance, December 31, 2003 ...Common Stock issued ...Common Stock acquired ...Stock-based compensation programs ...Dividends...

  • Page 97
    ... premiums and discounts ...Change in: Deferred policy acquisition costs ...Future policy benefits and other insurance liabilities ...Trading account assets supporting insurance liabilities and other trading account assets ...Income taxes ...Securities sold but not yet purchased ...Other, net ...Cash...

  • Page 98
    ... other countries. Principal products and services provided include life insurance, annuities, mutual funds, pension and retirement-related services and administration, and asset management. In addition, the Company provides retail securities brokerage services indirectly through a minority ownership...

  • Page 99
    ...tax effected at the statutory tax rate as of the adoption of SFAS No. 123(R). Subsequent to the date of adoption, the Company's policy is to account for this additional paid-in capital as a single "pool" available to all share-based compensation awards. PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT...

  • Page 100
    ... 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) In accordance with SFAS No. 123(R), the Company does not recognize excess tax benefits in additional paid-in capital until the benefits result in a reduction in taxes payable. The Company has elected the "tax-law ordering methodology" and...

  • Page 101
    ... for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services" and related interpretations in accounting for its non-employee stock options. Earnings Per Share As discussed in Note 1, the Company has outstanding two separate classes...

  • Page 102
    ... trading account assets are reported in "Asset management fees and other income." Equity securities are comprised of common stock and non-redeemable preferred stock and are carried at fair value. The associated unrealized gains and losses, net of tax and the effect on deferred policy acquisition...

  • Page 103
    ...borrow funds, the associated borrowing cost is reported as interest expense (included in "General and administrative expenses"). Income and expenses related to these transactions executed within the Company's commercial mortgage and derivative dealer operations are reported in "Asset management fees...

  • Page 104
    ... the Company. Deferred Policy Acquisition Costs The costs that vary with and that are related primarily to the production of new insurance and annuity business are deferred to the extent such costs are deemed recoverable from future profits. Such costs include commissions, costs of policy issuance...

  • Page 105
    ... interest method. For other group life and disability insurance contracts and guaranteed investment contracts, acquisition costs are expensed as incurred. Separate Account Assets and Liabilities Separate account assets and liabilities are reported at fair value and represent segregated funds that...

  • Page 106
    ...certain group insurance policies. The extraordinary dividends payable to the policyholders of Gibraltar Life are based on 70% of net realized investment gains, if any, over the value of certain real estate and loans included in Gibraltar Life's reorganization plan, net of transaction costs and taxes...

  • Page 107
    ... individual life contracts, deferred fixed annuities, structured settlements and other contracts without life contingencies, and participating group annuities are reported as deposits to "Policyholders' account balances." Revenues from these contracts are reflected in "Policy charges and fee income...

  • Page 108
    ... fair value are recorded in "Accumulated other comprehensive income (loss)" until earnings are affected by the variability of cash flows being hedged (e.g., when periodic settlements on a variable-rate asset or liability are recorded in earnings). At that time, the related portion of deferred gains...

  • Page 109
    ... Deferred income taxes are recognized, based on enacted rates, when assets and liabilities have different values for financial statement and tax reporting purposes. A valuation allowance is recorded to reduce a deferred tax asset to the amount expected to be realized. New Accounting Pronouncements...

  • Page 110
    ... with subsequent changes in value reported based on either a fair value or amortized cost approach. Under the previous guidance, such servicing assets or liabilities were initially measured at historical cost and the amortized cost method was required for subsequent reporting. The Company expects to...

  • Page 111
    ... 2005, the Accounting Standards Executive Committee ("AcSEC") of the American Institute of Certified Public Accountants ("AICPA") issued SOP 05-1, "Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts." SOP 05...

  • Page 112
    ...from separate account accounting treatment to general account accounting treatment, including carrying the related liabilities at accreted value, and the effect of establishing reserves for guaranteed minimum death benefit provisions of the Company's variable annuity and variable life contracts. The...

  • Page 113
    ... benefit guaranteed-cost contracts acquired. Under the modified coinsurance arrangement associated with the separate account contracts, CIGNA retained the separate account and other assets as well as the related separate account and other liabilities until the agreed upon dates of asset transfer...

  • Page 114
    ...at fair value(1) ...Cash and cash equivalents ...Accrued investment income ...Valuation of business acquired ("VOBA") ...Goodwill ...Reinsurance recoverable(2) ...Deferred tax asset ...Other assets ...Separate account assets ...Total assets acquired ...Future policy benefits-assumed ...Policyholders...

  • Page 115
    ... from the date of acquisition. In connection with the acquisition, PISC entered into an agreement with the Korean government related to the provision of asset management and brokerage services, which agreement extends until February 27, 2009. Fees from the Korean government under the terms of this...

  • Page 116
    ..., the Company completed the sale of its Philippine insurance operations. (4) On October 4, 2005, the Company completed the sale of its Dryden Wealth Management business ("Dryden"), which offered financial advisory, private banking and portfolio management services primarily to retail investors in...

  • Page 117
    ... tables provide information relating to fixed maturities and equity securities (excluding investments classified as trading) at December 31: 2006 Amortized Cost Fixed maturities, available for sale U.S. Treasury securities and obligations of U.S. government corporations and agencies ...Obligations...

  • Page 118
    ... and cash equivalents ...Fixed maturities: U.S. government corporations and agencies and obligations of U.S. states ...Foreign government bonds ...Corporate securities ...Mortgage-backed securities ...Total fixed maturities ...Equity securities ...Total trading account assets supporting insurance...

  • Page 119
    ... 8 17 (28) (102) $ 15 $ 49 Non-performing commercial loans with allowance for losses ...Non-performing commercial loans with no allowance for losses ...Allowance for losses, end of year ...Net carrying value of non-performing commercial loans ... PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT 117

  • Page 120
    ... investment income recognized on these loans totaled $3 million, $4 million and $18 million for the years ended December 31, 2006, 2005 and 2004, respectively. The Company's loans held for sale are primarily commercial mortgage loans to be sold in securitization transactions. The net carrying value...

  • Page 121
    ... ...Borrowed funds-Prudential ...Payables ...Other liabilities(2) ...Total liabilities ...Partners' capital ...Total liabilities and partners' capital ...Equity in partners' capital included above ...Equity in limited partnership interests not included above ...Carrying value ...(1) Other assets...

  • Page 122
    ... for sale ...Fixed maturities, held to maturity ...Equity securities, available for sale ...Trading account assets ...Commercial loans ...Policy loans ...Broker-dealer related receivables ...Short-term investments and cash equivalents ...Other investment income ...Gross investment income ...Less...

  • Page 123
    ... Acquisition Income (Loss) Net Costs and Deferred Related To Net Unrealized Income Tax Unrealized Gains (Losses) Valuation Future of Business Policy Policyholders' (Liability) Investment On Dividends Benefit Gains (Losses) Investments(1) Acquired Benefits (in millions) Balance, December 31, 2003...

  • Page 124
    ... $46,290 3 53 712 134 $909 (1) Includes $2,045 million of fair value and $51 million of gross unrealized losses at December 31, 2005 on securities classified as held to maturity, which are not reflected in accumulated other comprehensive income. PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT 122

  • Page 125
    ... been in that position for less than six months. In accordance with its policy described in Note 2, the Company concluded that an adjustment for other than temporary impairments for these securities was not warranted at December 31, 2006 or 2005. PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT 123

  • Page 126
    ... Unrealized Fair Value Losses $53 $6 The aggregate cost of the Company's cost method investments included in "Other long-term investments" totaled $214 million and $148 million at December 31, 2006 and 2005, respectively. In accordance with its policy described in Note 2, the Company concluded that...

  • Page 127
    ... income ...Other assets ...Total assets of consolidated VIEs ...Total liabilities of consolidated VIEs ... In addition, the Company has created a trust that is a VIE, to facilitate Prudential Insurance's Funding Agreement Notes Issuance Program ("FANIP"). The trust issues medium-term notes secured...

  • Page 128
    ... or trustees. Additionally, assets carried at $697 million and $706 million at December 31, 2006 and 2005, respectively, were held in voluntary trusts established primarily to fund guaranteed dividends to certain policyholders and to fund certain employee benefits. Restricted cash and securities of...

  • Page 129
    ... to the Company's share of the then appraised value of the common equity of the organization, determined as if it were a public company and including a control premium such as would apply in the case of a sale of 100% of its common equity. The agreement between Prudential Financial and Wachovia also...

  • Page 130
    ...the VOBA related to Allstate, CIGNA, American Skandia, Aoba Life and Gibraltar Life, respectively. Certain contracts acquired by the Company include a market value adjustment ("MVA") feature that requires the Company to pay to the contractholder upon surrender the accreted value of the fund as well...

  • Page 131
    ... and $77 million, respectively. The fair values of net mortgage servicing rights were $176 million and $163 million at December 31, 2006 and 2005, respectively. At December 31, 2006, the gross carrying amount and accumulated amortization for customer relationships amounted to $181 million and $122...

  • Page 132
    ...group annuities. Other contract liabilities include unearned revenue and certain other reserves for group and individual life and health products. Future policy benefits for individual participating traditional life insurance are based on the net level premium method, calculated using the guaranteed...

  • Page 133
    ... ...Group annuities ...Guaranteed investment contracts and guaranteed interest accounts ...Funding agreements ...Interest-sensitive life contracts ...Dividend accumulations and other ...Policyholders' account balances ... Policyholders' account balances represent an accumulation of account deposits...

  • Page 134
    ... or at specified dates during the accumulation period and withdrawal and income benefits payable during specified periods. The Company also issues annuity contracts with market value adjusted investment options ("MVAs"), which provide for a return of principal plus a fixed rate of return if held to...

  • Page 135
    ... ...Bond funds ...Balanced funds ...Money market funds ...Other ...Total ... In addition to the amounts invested in separate account investment options above, $4,312 million at December 31, 2006 and $3,755 million at December 31, 2005 of account balances of variable annuity contracts with guarantees...

  • Page 136
    ...any "step-up" and every anniversary date thereafter. All guaranteed amounts include any additional purchase payments and credits less withdrawals. Significant or prolonged declines in the value of any variable investment options a customer may choose as part of their GRO benefit may result in all or...

  • Page 137
    ... of: (1) the account value on the date of first withdrawal; (2) cumulative premiums when withdrawals commence, less cumulative withdrawals plus a minimum return; or (3) the highest contract value on a specified date minus any withdrawals. The income option guarantees that a contract holder can, upon...

  • Page 138
    ...2004, Prudential Insurance's Board of Directors acted to reduce dividends, effective January 1, 2005 on Closed Block policies to reflect changes in the economic environment, primarily the persistent low levels of fixed income interest rates experienced in recent years, as well as poor equity returns...

  • Page 139
    ... ...Policyholder dividend obligation ...Policyholders' account balances ...Other Closed Block liabilities ...Total Closed Block Liabilities ...Closed Block Assets Fixed maturities, available for sale, at fair value ...Equity securities, available for sale, at fair value ...Commercial loans ...Policy...

  • Page 140
    ...the transfer of the retirement business included in the transaction. These reinsurance arrangements are more fully described in Note 3. Also, in the fourth quarter of 2003, the Company sold its property and casualty insurance companies that operated nationally in 48 states outside of New Jersey, and...

  • Page 141
    ... and group annuities(1) ...Life insurance ...Other reinsurance ...Total reinsurance recoverable ... (1) Primarily represents reinsurance recoverables established under the reinsurance arrangements associated with the acquisition of the retirement business of CIGNA. The Company has recorded related...

  • Page 142
    ... agreements. Long-term Debt Long-term debt at December 31, is as follows: Maturity Dates Prudential Holdings, LLC notes (the "IHC debt") Series A ...Series B ...Series C ...Fixed rate notes: Fixed rate note subject to set-off arrangements ...Surplus notes ...Other fixed rate notes ...Floating rate...

  • Page 143
    ... related to the total amount of debt, net tangible assets and other matters. At December 31, 2006 and 2005, the Company was in compliance with all debt covenants. The fixed rate surplus notes issued by Prudential Insurance are subordinated to other Prudential Insurance borrowings and policyholder...

  • Page 144
    ... the Closed Block Business and the ability of Prudential Insurance, the sole direct subsidiary of PHLLC, to dividend such funds to PHLLC. The payment of scheduled principal and interest on the Series A notes and the Series B notes is insured by a financial guarantee insurance policy. The payment of...

  • Page 145
    ...The Class B Stock is a separate class of common stock which is not publicly traded. The Common Stock reflects the performance of the Financial Services Businesses and the Class B Stock reflects the performance of the Closed Block Business. Holders of Common Stock have no interest in a separate legal...

  • Page 146
    ...that (a) the Class B Stock will no longer be treated as equity of Prudential Financial for federal income tax purposes or (b) the New Jersey Department of Banking and Insurance amends, alters, changes or modifies the regulation of the Closed Block, the Closed Block Business, the Class B Stock or the...

  • Page 147
    ... of the net cash flows of the Closed Block Business. Notwithstanding this formula, as with any common stock, Prudential Financial retains the flexibility to suspend dividends on the Class B Stock; however, if CB Distributable Cash Flow exists and Prudential Financial chooses not to pay dividends on...

  • Page 148
    ... to the Financial Services Businesses available to holders of Common Stock after direct equity adjustment ...$3,147 Effect of dilutive securities and compensation programs Stock options ...Deferred and long-term compensation programs ...Equity security units ...Diluted earnings per share Income from...

  • Page 149
    ... method, were antidilutive. Class B Stock Net income per share of Class B Stock was $108.00, $119.50 and $249.00 for the years ended December 31, 2006, 2005 and 2004, respectively. The net income attributable to the Closed Block Business available to holders of Class B Stock after direct equity...

  • Page 150
    ... the fair market value of the Company's Common Stock on the date of grant and has a maximum term of 10 years. Generally, one third of the option grant vests in each of the first three years. Participants are employees and non-employees (i.e., statutory agents who perform services for the Company and...

  • Page 151
    ... 15. SHARE-BASED PAYMENTS (continued) A summary of the status of the Company's employee and non-employee stock option grants is as follows: Employee Stock Options Weighted Average Shares Exercise Price Outstanding at December 31, 2003 ...Granted ...Exercised ...Forfeited ...Expired ...Transferred...

  • Page 152
    ... measure of the reported performance for the Company's Financial Services Businesses relative to stated goals. (2) Represents additional shares issued based upon the attainment of performance goals for the Company's Financial Services Businesses. The fair value of employee share awards released for...

  • Page 153
    ... stock options as well as for the release of restricted stock shares, restricted stock units, and performance shares. As of December 31, 2006, the company has not settled any equity instruments granted under share-based payment arrangements in cash. PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT...

  • Page 154
    ... on an account balance that takes into consideration age, service and earnings during their career. The Company provides certain health care and life insurance benefits for its retired employees, their beneficiaries and covered dependents ("other postretirement benefits"). The health care plan is...

  • Page 155
    ...Disbursement for settlements ...Benefits paid ...Foreign currency changes ...Divestiture ...Fair value of plan assets at end of period ...Funded status Funded status at end of period ...Unrecognized transition obligation(1) ...Unrecognized prior service costs(1) ...Unrecognized actuarial losses, net...

  • Page 156
    ... Prudential Insurance for $4 million and zero million, respectively. The approximate future annual benefit payment for all annuity contracts was $24 million and $23 million in 2006 and 2005, respectively. The benefit obligation for pension benefits increased by $83 million in 2006 related to plan...

  • Page 157
    ... results in the present value for each respective benefit obligation. A single discount rate is calculated that results in the same present value. The rate is then rounded to the nearest 25 basis points. The pension and postretirement expected long-term rates of return on plan assets for 2006 were...

  • Page 158
    ... long-term rate of return for 2007 is 8.00% and 9.25%, respectively, for the pension and postretirement plans. The Company, with respect to pension benefits, uses market related value to determine the components of net periodic benefit cost. Market related value is a measure of asset value that...

  • Page 159
    ... and short-term investments, while meeting the cash requirements for the postretirement obligations that includes a medical benefit including prescription drugs, a dental benefit and a life benefit. Stocks are used to provide expected growth in assets deposited into the plan assets. Bonds provide...

  • Page 160
    ... costs ...Employee benefits ...Other ...Deferred tax liabilities ...Net deferred tax liability ...$ 873 1,127 863 1,139 4,002 (592) 3,410 1,825 2,778 94 936 5,633 $ 1,045 1,044 831 1,627 4,547 (676) 3,871 2,450 2,418 389 767 6,024 $(2,223) $(2,153) PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT...

  • Page 161
    ...income tax returns for tax years 2002-2003. The Company anticipates the final report to be submitted to the Joint Committee on Taxation for their review during the first quarter of 2007. The statute of limitations for the 2002-2003 tax years expires in 2008. In addition, in January 2007, the Service...

  • Page 162
    ... demand, savings and money market accounts) approximates or equals their fair values. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates being offered on certificates at the reporting dates to a schedule of aggregated...

  • Page 163
    ... separate account assets and liabilities, trading account assets supporting insurance liabilities, other trading account assets, broker-dealer related receivables and payables, securities purchased under agreements to resell, securities sold under agreements to repurchase, cash collateral for loaned...

  • Page 164
    ... the change in value of the underlying contractual guarantees which are determined using pricing models. The Company invests in fixed maturities that, in addition to a stated coupon, provide a return based upon the results of an underlying portfolio of fixed income investments and related investment...

  • Page 165
    ... rate swaps, currency swaps and currency forwards. As noted above, these instruments are only designated for hedge accounting in instances where the appropriate criteria are met. The Company does not use futures, options, credit or equity derivatives in any of its fair value, cash flow or net...

  • Page 166
    ... anticipated date or within the additional time period permitted by SFAS No. 133. Presented below is a roll forward of current period cash flow hedges in "Accumulated other comprehensive income (loss)" before taxes: (in millions) Balance, December 31, 2003 ...Net deferred losses on cash flow hedges...

  • Page 167
    ... manufactures and distributes a full range of group life, long-term and short-term group disability, long-term care and corporate-owned and trust-owned life insurance products in the U.S. primarily to institutional clients for use in connection with employee and membership benefit plans. Investment...

  • Page 168
    ... and individual health insurance. The divested businesses consist primarily of property and casualty insurance businesses and Prudential Securities capital markets business. Closed Block Business. The Closed Block Business, which is managed separately from the Financial Services Businesses, was...

  • Page 169
    ... schedules below, relate to policyholder dividends; amortization of deferred policy acquisition costs, VOBA, unearned revenue reserves and deferred sales inducements; interest credited to policyholders' account balances; reserves for future policy benefits; payments associated with the market value...

  • Page 170
    ... from adjusted operating income. The related change in value due to changes in foreign currency exchange rates of the U.S. dollar denominated policyholder liabilities and deferred acquisitions costs associated with these products is recorded in "Asset management fees and other income," and excluded...

  • Page 171
    ... of CIGNA's retirement business, the Company entered into reinsurance agreements with CIGNA, including a modified-coinsurance-with-assumption arrangement that applied to the defined benefit guaranteed-cost contracts acquired. The net results of these contracts were recorded in "Asset management fees...

  • Page 172
    ... income taxes, equity in earnings of operating joint ventures, extraordinary gain on acquisition and cumulative effect of accounting change ...$4,403 $4,288 $3,285 The Insurance division results reflect deferred policy acquisition costs as if the individual annuity business and group insurance...

  • Page 173
    ... of Deferred Net Policyholders' Policy Investment Policyholders' Account Dividends to Interest Acquisition Revenues Income Benefits Balances Policyholders Expense Costs (in millions) Financial Services Businesses: Individual Life ...Individual Annuities ...Group Insurance ...Total Insurance Division...

  • Page 174
    ... of Deferred Net Policyholders' Policy Investment Policyholders' Account Dividends to Interest Acquisition Revenues Income Benefits Balances Policyholders Expense Costs (in millions) Financial Services Businesses: Individual Life ...Individual Annuities ...Group Insurance ...Total Insurance Division...

  • Page 175
    ... of Deferred Net Policyholders' Policy Investment Policyholders' Account Dividends to Interest Acquisition Revenues Income Benefits Balances Policyholders Expense Costs (in millions) Financial Services Businesses: Individual Life ...Individual Annuities ...Group Insurance ...Total Insurance Division...

  • Page 176
    ... of asset-based management and administration fees. Management has determined the intersegment revenues with reference to market rates. Intersegment revenues are eliminated in consolidation in Corporate and Other. The summary below presents total assets for the Company's reportable segments...

  • Page 177
    ... be funded from the assets of its separate accounts. In the course of the Company's business, it provides certain guarantees and indemnities to third parties pursuant to which it may be contingently required to make payments now or in the future. A number of guarantees provided by the Company relate...

  • Page 178
    ... to adequately disclose the increased costs associated with payment of life insurance premiums on a "modal" basis, i.e., more frequently than once a year. Similar actions have been filed in New Mexico against over a dozen other insurance companies. The complaint asserts claims for breach of the...

  • Page 179
    ... proceedings. Prudential Insurance also settled the litigation brought by the California Department of Insurance and agreed to business reforms and disclosures as to group insurance contracts insuring customers or residents in California and to pay certain costs of investigation. These matters are...

  • Page 180
    ...the Prudential Securities control structure with responsibilities that related to the market timing activities, including certain former members of Prudential Securities senior management. The Prudential Securities operations were contributed to a joint venture with Wachovia Corporation in July 2003...

  • Page 181
    ... other actions are pending. Commencing in 2003, the Company received formal requests for information from the SEC and NYAG relating to market timing in variable annuities by certain American Skandia entities. In connection with these investigations, with the approval of Skandia Insurance Company Ltd...

  • Page 182
    ... Capitol Life Insurance Company v. Prudential Insurance, et al., in connection with the sale of certain subordinated mortgage securities sold by a subsidiary of Prudential Home Mortgage. In May 2000, plaintiffs filed a second amended complaint that alleges violations of the New Jersey securities and...

  • Page 183
    ... with Wachovia, including an increase in the reserve for estimated settlement costs related to market timing issues involving Prudential Equity Group, LLC's former Prudential Securities operations, with respect to which the Company announced that Prudential Equity Group, LLC had reached a settlement...

  • Page 184
    ...maturity, at amortized cost ...Trading account assets supporting insurance liabilities, at fair value ...Other trading account assets, at fair value ...Equity securities, available for sale, at fair value ...Commercial loans ...Policy loans ...Securities purchased under agreements to resell ...Other...

  • Page 185
    ... Businesses REVENUES Premiums ...Policy charges and fee income ...Net investment income ...Realized investment gains, net ...Asset management fees and other income ...Total revenues ...BENEFITS AND EXPENSES Policyholders' benefits ...Interest credited to policyholders' account balances ...Dividends...

  • Page 186
    ...may not change the allocation methodology or accounting policies for the allocation of earnings between the Financial Services Businesses and Closed Block Business without the prior consent of the Class B Stock holders or IHC debt bond insurer. General corporate overhead not directly attributable to...

  • Page 187
    ...holders of record for the Common Stock and 469 million shares outstanding. The Class B Stock was issued to institutional investors (two subsidiaries of American International Group, Inc. and Pacific Life Corp.) in a private placement pursuant to Section 4(2) of the Securities Act of 1933 on the date...

  • Page 188
    ... of the S&P 500 Life & Health Insurance and S&P 500 Diversified Financials indices. The figures presented below assume the reinvestment of all dividends into shares of common stock and an initial investment of $100 at the closing prices on December 31, 2001. ANNUAL RETURN PERCENTAGE Years Ending...

  • Page 189
    ...; (5) changes in our assumptions related to deferred policy acquisition costs, valuation of business acquired or goodwill; (6) changes in our claims-paying or credit ratings; (7) investment losses and defaults; (8) competition in our product lines and for personnel; (9) changes in tax law; (10...

  • Page 190
    ... to Prudential Financial's 2006 Annual Report on Form 10-K. In addition, the Chief Executive Officer of Prudential Financial made an unqualified certification to the New York Stock Exchange (NYSE) regarding Prudential Financial's compliance with the NYSE corporate governance listing standards...

  • Page 191
    ... Services at Computershare Computershare Trust Company, N.A., the transfer agent for Prudential Financial, Inc., can assist registered shareholders with a variety of services, including: • Change of address • Transfer of stock • Direct deposit of dividends • Online delivery of annual reports...

  • Page 192