Prudential 2006 Annual Report Download - page 19

available for sale, as well as those classified as held to maturity, are subject to impairment reviews to identify when a decline in value is
other than temporary. Factors we consider in determining whether a decline in value is other than temporary include: the extent (generally
if greater than 20%) and duration (generally if greater than six months) of the decline; the reasons for the decline in value (credit event,
currency or interest rate related); our ability and intent to hold the investment for a period of time to allow for a recovery of value; and the
financial condition and near-term prospects of the issuer. When it is determined that a decline in value is other than temporary, the carrying
value of the security is reduced to its fair value, with a corresponding charge to earnings. This corresponding charge is referred to as an
impairment. Impairments are reflected in “Realized investment gains (losses), net” in the statements of operations and are excluded from
adjusted operating income. The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. In
periods subsequent to the recognition of an other-than-temporary impairment, the impaired security is accounted for as if it had been
purchased on the measurement date of the impairment. Accordingly, the discount (or reduced premium) based on the new cost basis is
accreted into net investment income over the remaining life of the security based upon the amount and timing of expected future cash flows
and is included in adjusted operating income. The level of impairment losses can be expected to increase when economic conditions
worsen and decrease when economic conditions improve. See “—Realized Investment Gains and General Account Investments—Realized
Investment Gains” for a discussion of the effects of impairments on our operating results for the years ended December 31, 2006, 2005 and
2004.
Commercial loans, which comprise 11% of our investments as of December 31, 2006, are carried primarily at unpaid principal
balances, net of unamortized premiums or discounts and a valuation allowance for losses. This valuation allowance includes a loan specific
portion as well as a portfolio reserve for probable incurred but not specifically identified losses. The loan specific portion is based on the
Company’s assessment as to ultimate collectibility of loan principal. Valuation allowances for non-performing loans are recorded based on
the present value of expected future cash flows discounted at the loan’s effective interest rate or based on the fair value of the collateral if
the loan is collateral dependent. A non-performing loan is defined as a loan for which it is probable that amounts due according to the
contractual terms of the loan agreement will not be collected. The portfolio reserve is based on a number of factors, such as historical
experience and portfolio diversification. We record subsequent adjustments to our valuation allowances when appropriate. Adjustments to
the allowance are reflected in “Realized investment gains (losses), net,” in our statements of operations. Similar to impairment losses
discussed above, the allowance for losses can be expected to increase when economic conditions worsen and decrease when economic
conditions improve. See “—Realized Investment Gains and General Account Investments—General Account Investments—Commercial
Loans—Commercial Loan Quality” for a discussion of the effects of the valuation allowance on our operating results for the years ended
December 31, 2006 and 2005.
See “—Realized Investment Gains and General Account Investments—General Account Investments” for a discussion of our
investment portfolio, including the gross unrealized gains and losses as of December 31, 2006, related to the fixed maturity and equity
securities of our general account, our policies and procedures regarding the identification of other than temporary declines in investment
value, and the carrying value, credit quality, and allowance for losses related to the commercial loans of our general account.
Policyholder Liabilities
Future Policy Benefit Reserves, other than Unpaid Claims and Claim Adjustment Expenses
We establish reserves for future policy benefits to or on behalf of policyholders in the same period in which the policy is issued. These
reserves relate primarily to the traditional participating whole life policies of our 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, which as of
December 31, 2006, represented 48% of our total future policy benefit reserves are determined using the net level premium method as
prescribed by U.S. GAAP. Under this method, the future policy benefit reserves are accrued as a level proportion of the premium paid by
the policyholder. In applying this method, we use mortality assumptions to determine our expected future benefits and expected future
premiums, and apply an interest rate to determine the present value of both the expected future benefit payments and the expected future
premiums. The mortality assumptions used are based on data from the standard industry mortality tables that were used to determine the
cash surrender value of the policies, and the interest rates used are the contractually guaranteed interest rates used to calculate the cash
surrender value of the policy. Gains or losses in our results of operations resulting from deviations in actual experience compared to the
experience assumed in establishing our reserves for this business are recognized in the determination of our annual dividends to these
policyholders. Given our current level of policy dividends, we do not anticipate significant volatility in our results of operations in future
periods as a result of these deviations.
The future policy benefit reserves for our International Insurance segment and Individual Life segment, which as of December 31,
2006, represented 34% of our total future policy benefit reserves combined, relate primarily to non-participating whole life and term life
products and are determined in accordance with U.S. GAAP as the present value of expected future benefits to or on behalf of
policyholders plus the present value of future maintenance expenses less the present value of future net premiums. The expected future
benefits and expenses are determined using assumptions as to mortality, lapse, and maintenance expense. Reserve assumptions are based
on best estimate assumptions as of the date the policy is issued with provisions for the risk of adverse deviation. After our reserves are
initially established, we perform premium deficiency tests using best estimate assumptions as of the testing date without provisions for
adverse deviation. If reserves determined based on these best estimate assumptions are greater than the net U.S. GAAP liabilities (i.e.,
reserves net of any DAC asset), the existing net U.S. GAAP liabilities are adjusted to the greater amount. Our best estimate assumptions are
determined by product group. Mortality assumptions are generally based on the Company’s historical experience or standard industry
tables, as applicable; our expense assumptions are based on current levels of maintenance costs, adjusted for the effects of inflation; and
PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT
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