Prudential 2007 Annual Report Download - page 173

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
20. SEGMENT INFORMATION (continued)
Adjusted Operating Income
In managing the Financial Services Businesses, the Company analyzes the operating performance of each segment using “adjusted
operating income.” Adjusted operating income does not equate to “income from continuing operations before income taxes and equity in
earnings of operating joint ventures” or “net income” as determined in accordance with U.S. GAAP but is the measure of segment profit or
loss used by the Company to evaluate segment performance and allocate resources, and, consistent with SFAS No. 131, “Disclosures about
Segments of an Enterprise and Related Information,” is the measure of segment performance presented below.
Adjusted operating income is calculated by adjusting each segment’s “income from continuing operations before income taxes and
equity in earnings of operating joint ventures” for the following items, which are described in greater detail below:
• realized investment gains (losses), net, and related charges and adjustments;
• net investment gains and losses on trading account assets supporting insurance liabilities and changes in experience-rated
contractholder liabilities due to asset value changes;
• the contribution to income/loss of divested businesses that have been or will be sold or exited but that did not qualify for
“discontinued operations” accounting treatment under U.S. GAAP; and
• equity in earnings of operating joint ventures.
These items are important to an understanding of overall results of operations. Adjusted operating income is not a substitute for
income determined in accordance with U.S. GAAP, and the Company’s definition of adjusted operating income may differ from that used
by other companies. However, the Company believes that the presentation of adjusted operating income as measured for management
purposes enhances the understanding of results of operations by highlighting the results from ongoing operations and the underlying
profitability factors of the Financial Services Businesses.
Realized investment gains (losses), net, and related charges and adjustments. Adjusted operating income excludes realized
investment gains (losses), net, except as indicated below. A significant element of realized investment gains and losses are impairments and
credit-related and interest rate-related gains and losses. Impairments and losses from sales of credit-impaired securities, the timing of which
depends largely on market credit cycles, can vary considerably across periods. The timing of other sales that would result in gains or losses,
such as interest rate-related gains or losses, is largely subject to the Company’s discretion and influenced by market opportunities, as well
as the Company’s tax profile. Trends in the underlying profitability of the Company’s businesses can be more clearly identified without the
fluctuating effects of these transactions.
Charges that relate to realized investment gains (losses), net, are also excluded from adjusted operating income. The related charges
are associated with: policyholder dividends; amortization of deferred policy acquisition costs, VOBA, unearned revenue reserves and
deferred sales inducements; interest credited to policyholders’ account balances; reserves for future policy benefits; payments associated
with the market value adjustment features related to certain of the annuity products the Company sells; and minority interest in
consolidated operating subsidiaries. The related charges associated with policyholder dividends include a percentage of the net increase in
the fair value of specified assets included in Gibraltar Life’s reorganization plan that is required to be paid as a special dividend to Gibraltar
Life policyholders. Deferred policy acquisition costs, VOBA, unearned revenue reserves and deferred sales inducements for certain
products are amortized based on estimated gross profits, which include net realized investment gains and losses on the underlying invested
assets. The related charge for these items represent the portion of this amortization associated with net realized investment gains and losses.
The related charges for interest credited to policyholders’ account balances relate to certain group life policies that pass back certain
realized investment gains and losses to the policyholder. The reserves for certain policies are adjusted when cash flows related to these
policies are affected by net realized investment gains and losses, and the related charge for reserves for future policy benefits represents
that adjustment. Certain of the Company’s annuity products contain a market value adjustment feature that requires us to pay to the
contractholder or entitles us to receive from the contractholder, upon surrender, a market value adjustment based on the crediting rates on
the contract surrendered compared to crediting rates on newly issued contracts or based on an index rate at the time of purchase compared
to an index rate at time of surrender, as applicable. These payments mitigate the net realized investment gains or losses incurred upon the
disposition of the underlying invested assets. The related charge represents the payments or receipts associated with these market value
adjustment features. Minority interest expense is recorded for the earnings of consolidated subsidiaries owed to minority investors. The
related charge for minority interest in consolidated operating subsidiaries represents the portion of these earnings associated with net
realized investment gains and losses.
Adjustments to “Realized investment gains (losses), net,” for purposes of calculating adjusted operating income, include the
following:
Gains and losses pertaining to derivative contracts that do not qualify for hedge accounting treatment, other than derivatives used in
the Company’s capacity as a broker or dealer, are included in “Realized investment gains (losses), net.” This includes mark-to-market
adjustments of open contracts as well as periodic settlements. As discussed further below, adjusted operating income includes a portion of
realized gains and losses pertaining to certain derivative contracts.
Prudential Financial 2007 Annual Report 171