Prudential 2006 Annual Report Download - page 51

Realized Investment Gains and General Account Investments
Realized Investment Gains
Realized investment gains and losses 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 our capacity as a broker or dealer.
We perform impairment reviews on an ongoing basis to determine when a decline in value is other than temporary. In evaluating
whether a decline in value is other than temporary, we consider several factors including, but not limited to, the following: the extent
(generally if greater than 20%) and duration (generally if greater than six months) of the decline in value; the reasons for the decline (credit
event, currency or interest-rate related); our ability and intent to hold our investment for a period of time to allow for a recovery of value;
and the financial condition of and near-term prospects of the issuer. When we determine that there is an other than temporary impairment,
we write down the value of the security to its fair value, with a corresponding charge recorded in “Realized investment gains (losses), net.”
The causes of the impairments discussed below were specific to each individual issuer and did not directly result in impairments to other
securities within the same industry or geographic region.
For a further discussion of our policies regarding other than temporary declines in investment value and the related methodology for
recording fixed maturity impairments, see “—General Account Investments—Fixed Maturity Securities—Impairments of Fixed Maturity
Securities” below. For a further discussion of our policies regarding other than temporary declines in investment value and the related
methodology for recording equity impairments, see “—General Account Investments—Equity Securities—Impairments of Equity
Securities” below.
The level of impairments generally reflects economic conditions and is expected to increase when economic conditions worsen and to
decrease when economic conditions improve. We may realize additional credit- and interest-rate related losses through 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 when they prepay the
securities. Prepayments are driven by factors specific to the activities of our borrowers as well as the interest rate environment.
We use interest and currency swaps and other derivatives to manage interest and currency exchange rate exposures arising from
mismatches between assets and liabilities, including duration mismatches. We also use derivative contracts to mitigate the risk that
unfavorable changes in currency exchange rates will reduce U.S. dollar equivalent earnings generated by certain of our non-U.S.
businesses. Derivative contracts also include forward purchases and sales of to-be-announced mortgage-backed securities primarily related
to our mortgage dollar roll program. Many of these derivative contracts do not qualify for hedge accounting, and, consequently, we
recognize the changes in fair value of such contracts from period to period in current earnings, although we do not necessarily account for
the related assets or liabilities the same way. Accordingly, realized investment gains and losses from our derivative activities can contribute
significantly to fluctuations in net income.
Adjusted operating income excludes “Realized investment gains (losses), net,” (other than those representing profit or loss of certain
of our businesses which primarily originate investments for sale or syndication to unrelated investors, and those associated with terminating
hedges of foreign currency earnings, current period yield adjustments, or product derivatives and the effect of any related economic
hedging program) and related charges and adjustments.
PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT
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