Prudential 2006 Annual Report Download - page 20

our interest rate assumptions are based on current and expected net investment returns. We review our mortality assumptions annually.
Generally, we do not expect our mortality trends to change significantly in the short-term and to the extent these trends may change we
expect such changes to be gradual over the long-term.
The reserves for future policy benefits of our Retirement segment, which as of December 31, 2006 represented 14% of our total future
policy benefit reserves, relate to our non-participating life contingent group annuity and structured settlement products. These reserves are
generally determined as the present value of expected future benefits and expenses based on assumptions as to mortality, retirement,
maintenance expense, and interest rates. Reserves are based on best estimate assumptions as of the date the contract is issued with
provisions for the risk of adverse deviation. After our reserves are initially established, we perform premium deficiency testing by product
group using best estimate assumptions as of the testing date without provisions for adverse deviation. If reserves determined based on these
assumptions are greater than the existing reserves, the existing reserves are adjusted to the greater amount. Our best estimate assumptions
are determined by product group. Our mortality and retirement assumptions are based on Company or industry experience; our expense
assumptions are based on current levels of maintenance costs, adjusted for the effects of inflation; and our interest rate assumptions are
based on current and expected net investment returns. We generally review our mortality assumptions and conduct a full actuarial study of
these assumptions annually. We conduct a full actuarial study of our retirement assumptions every three to five years. Generally, we do not
expect our actual mortality or retirement trends to change significantly in the short-term and to the extent these trends may change we
expect such changes to be gradual over the long-term.
Unpaid claims and claim adjustment expenses
Our liability for unpaid claims and claim adjustment expenses of $2.1 billion is reported as a component of “Future policy benefits”
and relates primarily to the group long-term disability products of our Group Insurance segment. This liability represents our estimate of
future disability claim payments and expenses as well as estimates of claims that we believe have been incurred, but have not yet been
reported as of the balance sheet date. We do not establish loss liabilities until a loss has occurred. As prescribed by U.S. GAAP, our
liability is determined as the present value of expected future claim payments and expenses. Expected future claims payments are estimated
using assumed mortality and claim termination factors and an assumed interest rate. The mortality and claim termination factors are based
on standard industry tables and the Company’s historical experience. Our interest rate assumptions are based on factors such as market
conditions and expected investment returns. Of these assumptions, our claim termination assumptions have historically had the most
significant effects on our level of liability. We regularly review our claim termination assumptions compared to actual terminations and
conduct full actuarial studies every two years. These studies review actual claim termination experience over a number of years with more
weight placed on the actual experience in the more recent years. If actual experience results in a materially different assumption, we adjust
our liability for unpaid claims and claims adjustment expenses accordingly with a charge or credit to current period earnings.
Deferred Policy Acquisition Costs
We capitalize costs that vary with and are related primarily to the acquisition of new and renewal insurance and annuity contracts.
These costs include primarily commissions, costs of policy issuance and underwriting, and variable field office expenses. We amortize
these deferred policy acquisition costs, or DAC, over the expected lives of the contracts, based on the level and timing of either gross
margins, gross profits, or gross premiums, depending on the type of contract. As of December 31, 2006, DAC in our Financial Services
Businesses was $9.9 billion and DAC in our Closed Block Business was $1.0 billion.
DAC associated with the traditional participating 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 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. Since many of the factors that affect gross margins are included in the determination of our dividends to
these policyholders, we do not anticipate significant volatility in our results of operations as a result of DAC adjustments, given our current
level of dividends.
DAC associated with the non-participating whole life and term life policies of our Individual Life segment and the non-participating
whole life, term life and health policies of our International Insurance segment is amortized in proportion to gross premiums. We evaluate
the recoverability of our DAC related to these policies as part of our premium deficiency testing. If a premium deficiency exists, we reduce
DAC by the amount of the deficiency or to zero through a charge to current period earnings. If the deficiency is more than the DAC
balance, we then increase the reserve for future policy benefits by the excess, by means of a charge to current period earnings. Generally,
we do not expect significant short-term deterioration in experience, and therefore do not expect significant writedowns to the related DAC.
DAC associated with the variable and universal life policies of our Individual Life segment and the variable and fixed annuity
contracts of our Individual Annuities segment is amortized over the expected life of these policies in proportion to gross profits. In
calculating gross profits, we consider mortality, persistency, and other elements as well as rates of return on investments associated with
these contracts. We regularly evaluate and adjust the related DAC balance with a corresponding charge or credit to current period earnings
for the effects of our actual gross profits and changes in our assumptions regarding estimated future gross profits.
For the variable and universal life policies of our Individual Life segment, a significant portion of our gross profits is derived from
mortality margins. As a result, our estimates of future gross profits are significantly influenced by our mortality assumptions. Our mortality
assumptions represent our expected claims experience over the life of these policies and are developed based on Company experience. We
review and update our mortality assumptions annually. Updates to our mortality assumptions in future periods could have a significant
PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT
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