Prudential 2007 Annual Report Download - page 110

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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.
Adjustments to the costs of fixed maturities and equity securities for other-than-temporary impairments are also included in “Realized
investment gains (losses), net.” In evaluating whether a decline in value is other-than-temporary, the Company considers several factors
including, but not limited to the following: (1) the extent (generally if greater than 20%) and the duration (generally if greater than six
months) of the decline; (2) the reasons for the decline in value (credit event, currency or interest rate); (3) the Company’s ability and intent
to hold the investment for a period of time to allow for a recovery of value; and (4) the financial condition of and near-term prospects of the
issuer. In addition, for its impairment review of asset-backed fixed maturity securities with a credit rating below AA, the Company
forecasts the prospective future cash flows of the security and determines if the present value of those cash flows, discounted using the
effective yield of the most recent interest accrual rate, has decreased from the previous reporting period. When a decrease from the prior
reporting period has occurred and the security’s market value is less than its carrying value, the carrying value of the security is reduced to
its fair value, with a corresponding charge to earnings. 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 in future periods based upon the amount and timing of expected future cash flows of
the security, if the recoverable value of the investment based upon those cash flows is greater than the carrying value of the investment
after the impairment.
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 reinsurance
arrangements used to effect the Company’s acquisition of the retirement businesses of CIGNA. The remaining amounts relate to other
reinsurance arrangements entered into by the Company. For each of its reinsurance contracts, the Company determines if the contract
provides indemnification against loss or liability relating to insurance risk in accordance with applicable accounting standards. The
Company reviews all contractual features, particularly those that may limit the amount of insurance risk to which the reinsurer is subject or
features that delay the timely reimbursement of claims. See Note 11 for additional information about the Company’s reinsurance
arrangements.
Deferred Policy Acquisition Costs
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).” DAC amortization is
reflected in “General and administrative expenses.”
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 7.90% at December 31, 2007 and
gradually increases to 8.06% for periods after December 31, 2031, consistent with the assumptions used in funding the Closed Block. 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 deferred annuity products are deferred and amortized over the expected life of the contracts (periods
ranging from 25 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.
108 Prudential Financial 2007 Annual Report