Prudential 2006 Annual Report Download - page 104

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
are generated from numerous sources, including the sale of fixed maturity securities, equity securities, investments in joint ventures
and limited partnerships and other types of investments, as well as adjustments to the cost basis of investments for other than
temporary impairments. Realized investment gains and losses are also generated from prepayment premiums received on private
fixed maturity securities, recoveries of principal on previously impaired securities, provisions for losses on commercial loans, fair
value changes on commercial mortgage operations’ loans, gains on commercial loans in connection with securitization transactions,
fair value changes on embedded derivatives and derivatives that do not qualify for hedge accounting treatment, except those
derivatives used in the Company’s capacity as a broker or dealer.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, money market instruments 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.”
Reinsurance Recoverables and Payables
Reinsurance recoverables and payables primarily include receivables and corresponding payables associated with the modified
coinsurance arrangements used to effect the Company’s acquisition of the retirement businesses of CIGNA. The reinsurance
recoverables and the reinsurance payables associated with this acquisition are each $1.3 billion and $2.9 billion at December 31,
2006 and 2005, respectively. See Note 3 for additional information about these arrangements. The remaining amounts relate to other
reinsurance arrangements entered into by 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 and
underwriting, and variable field office expenses. Deferred policy acquisition costs (“DAC”) are subject to recoverability testing at
the end of each accounting period. 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 “Accumulated other
comprehensive income (loss).”
For traditional participating life insurance included in the Closed Block, DAC is amortized over the expected life of the
contracts (up to 45 years) in proportion to gross margins based on historical and anticipated future experience, which is evaluated
regularly. The average rate per annum of assumed future investment yield used in estimating expected gross margins was 7.89% at
December 31, 2006 and gradually increases to 8.06% for periods after December 31, 2031. The effect of changes in estimated gross
margins on unamortized deferred acquisition costs is reflected in “General and administrative expenses” in the period such
estimated gross margins are revised. Policy acquisition costs related to interest-sensitive and variable life products and fixed and
variable annuity products are deferred and amortized over the expected life of the contracts (periods ranging from 7 to 99 years) in
proportion to gross profits arising principally from investment results, mortality and expense margins, and surrender charges based
on historical and anticipated future experience, which is updated periodically. The effect of changes to estimated gross profits on
unamortized deferred acquisition costs is reflected in “General and administrative expenses” in the period such estimated gross
profits are revised. DAC related to non-participating traditional individual life insurance is amortized in proportion to gross
premiums.
The Company has offered programs under which policyholders, for a selected product or group of products, can exchange an
existing policy or contract issued by the Company for another form of policy or 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 an estimate of the remaining unamortized DAC on the
surrendered policies. For other internal replacement transactions, the unamortized DAC on the surrendered policies 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 policies
have terms that 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. The Company expects to adopt Statement of Position (“SOP”) 05-1
“Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance
Contracts” on January 1, 2007. See “New Accounting Pronouncements.”
PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT
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