10-Q 1 d524014d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2013

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition Period from            to            

 

Commission File Number 001-16707

 

 

 

Prudential Financial, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

New Jersey   22-3703799

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

 

751 Broad Street

Newark, New Jersey 07102

(973) 802-6000

(Address and Telephone Number of Registrant’s Principal Executive Offices)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of the Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x   Accelerated filer  ¨   Non-accelerated filer  ¨       Smaller reporting company  ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 

As of April 30, 2013, 464 million shares of the registrant’s Common Stock (par value $0.01) were outstanding. In addition, 2 million shares of the registrant’s Class B Stock, for which there is no established public trading market, were outstanding.

 

 

 


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TABLE OF CONTENTS

 

               Page  

PART I FINANCIAL INFORMATION

  
   Item 1.   

Financial Statements:

  
     

Unaudited Interim Consolidated Statements of Financial Position as of March 31, 2013 and December 31, 2012

     1   
     

Unaudited Interim Consolidated Statements of Operations for the three months ended March 31, 2013 and 2012

     2   
     

Unaudited Interim Consolidated Statements of Comprehensive Income for the three months ended March 31, 2013 and 2012

     3   
     

Unaudited Interim Consolidated Statements of Equity for the three months ended March 31, 2013 and 2012

     4   
     

Unaudited Interim Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and 2012

     5   
     

Notes to Unaudited Interim Consolidated Financial Statements

     6   
     

Unaudited Interim Supplemental Combining Financial Information:

  
     

Unaudited Interim Supplemental Combining Statements of Financial Position as of March 31, 2013 and December 31, 2012

     102   
     

Unaudited Interim Supplemental Combining Statements of Operations for the three months ended March 31, 2013 and 2012

     103   
     

Notes to Unaudited Interim Supplemental Combining Financial Information

     104   
   Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     106   
   Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

     200   
   Item 4.   

Controls and Procedures

     200   

PART II OTHER INFORMATION

  
   Item 1.   

Legal Proceedings

     201   
   Item 1A.   

Risk Factors

     201   
   Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

     201   
   Item 6.   

Exhibits

     202   

SIGNATURES

     203   


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Forward-Looking Statements

 

Certain of the statements included in this Quarterly Report on Form 10-Q, including but not limited to those in Management’s Discussion and Analysis of Financial Condition and Results of Operations, constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Words such as “expects,” “believes,” “anticipates,” “includes,” “plans,” “assumes,” “estimates,” “projects,” “intends,” “should,” “will,” “shall” or variations of such words are generally part of forward-looking statements. Forward-looking statements are made based on management’s current expectations and beliefs concerning future developments and their potential effects upon Prudential Financial, Inc. and its subsidiaries. There can be no assurance that future developments affecting Prudential Financial, Inc. and its subsidiaries will be those anticipated by management. These forward-looking statements are not a guarantee of future performance and involve risks and uncertainties, and there are certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements, including, among others: (1) general economic, market and political conditions, including the performance and fluctuations of fixed income, equity, real estate and other financial markets; (2) the availability and cost of additional debt or equity capital or external financing for our operations; (3) interest rate fluctuations or prolonged periods of low interest rates; (4) the degree to which we choose not to hedge risks, or the potential ineffectiveness or insufficiency of hedging or risk management strategies we do implement, with regard to variable annuity or other product guarantees; (5) any inability to access our credit facilities; (6) reestimates of our reserves for future policy benefits and claims; (7) differences between actual experience regarding mortality, longevity, morbidity, persistency, surrender experience, interest rates or market returns and the assumptions we use in pricing our products, establishing liabilities and reserves or for other purposes; (8) changes in our assumptions related to deferred policy acquisition costs, value of business acquired or goodwill; (9) changes in assumptions for retirement expense; (10) changes in our financial strength or credit ratings; (11) statutory reserve requirements associated with term and universal life insurance policies under Regulation XXX and Guideline AXXX; (12) investment losses, defaults and counterparty non-performance; (13) competition in our product lines and for personnel; (14) difficulties in marketing and distributing products through current or future distribution channels; (15) changes in tax law; (16) economic, political, currency and other risks relating to our international operations; (17) fluctuations in foreign currency exchange rates and foreign securities markets; (18) regulatory or legislative changes, including the Dodd-Frank Wall Street Reform and Consumer Protection Act; (19) inability to protect our intellectual property rights or claims of infringement of the intellectual property rights of others; (20) adverse determinations in litigation or regulatory matters and our exposure to contingent liabilities, including in connection with our divestiture or winding down of businesses; (21) domestic or international military actions, natural or man-made disasters including terrorist activities or pandemic disease, or other events resulting in catastrophic loss of life; (22) ineffectiveness of risk management policies and procedures in identifying, monitoring and managing risks; (23) effects of acquisitions, divestitures and restructurings; (24) interruption in telecommunication, information technology or other operational systems or failure to maintain the security, confidentiality or privacy of sensitive data on such systems; (25) changes in statutory or U.S. GAAP accounting principles, practices or policies; (26) Prudential Financial, Inc.’s primary reliance, as a holding company, on dividends or distributions from its subsidiaries to meet debt payment obligations and the ability of the subsidiaries to pay such dividends or distributions in light of our ratings objectives and/or applicable regulatory restrictions; and (27) risks due to the lack of legal separation between our Financial Services Businesses and our Closed Block Business. Prudential Financial, Inc. does not intend, and is under no obligation, to update any particular forward-looking statement included in this document. See “Risk Factors” included in the Annual Report on Form 10-K for the year ended December 31, 2012 for discussion of certain risks relating to our businesses and investment in our securities.


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Throughout this Quarterly Report on Form 10-Q, “Prudential Financial” and the “Registrant” refer to Prudential Financial, Inc., the ultimate holding company for all of our companies. “Prudential Insurance” refers to The Prudential Insurance Company of America. “Prudential,” the “Company,” “we” and “our” refer to our consolidated operations.

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

 

PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Financial Position

March 31, 2013 and December 31, 2012 (in millions, except share amounts)

 

     March 31,
2013
    December 31,
2012
 

ASSETS

    

Fixed maturities, available-for-sale, at fair value (amortized cost: 2013-$273,678; 2012-$277,654)(1)

   $ 300,382     $ 301,336  

Fixed maturities, held-to-maturity, at amortized cost (fair value: 2013-$4,186; 2012-$4,511)(1)

     3,878       4,268  

Trading account assets supporting insurance liabilities, at fair value(1)

     20,890       20,590  

Other trading account assets, at fair value

     6,862       6,328  

Equity securities, available-for-sale, at fair value (cost: 2013-$6,613; 2012-$6,759)(1)

     8,918       8,277  

Commercial mortgage and other loans (includes $726 and $162 measured at fair value under the fair value option at March 31, 2013 and December 31, 2012, respectively)(1)

     38,458       36,733  

Policy loans

     11,938       11,575  

Other long-term investments (includes $487 and $465 measured at fair value under the fair value option at March 31, 2013 and December 31, 2012, respectively)(1)

     9,863       10,028  

Short-term investments(1)

     6,288       6,447  
  

 

 

   

 

 

 

Total investments

     407,477       405,582  

Cash and cash equivalents(1)

     14,477       18,100  

Accrued investment income(1)

     3,143       3,127  

Deferred policy acquisition costs

     14,374       14,100  

Value of business acquired

     4,167       3,248  

Other assets(1)

     14,151       11,887  

Separate account assets (1)

     266,308       253,254  
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 724,097     $ 709,298  
  

 

 

   

 

 

 

LIABILITIES AND EQUITY

    

LIABILITIES

    

Future policy benefits

   $ 210,918     $ 216,050  

Policyholders’ account balances

     138,316       134,413  

Policyholders’ dividends

     7,452       7,507  

Securities sold under agreements to repurchase

     6,702       5,818  

Cash collateral for loaned securities

     3,390       3,941  

Income taxes

     8,039       8,551  

Short-term debt

     2,228       2,484  

Long-term debt

     25,488       24,729  

Other liabilities

     12,694       11,683  

Notes issued by consolidated variable interest entities (includes $1,768 and $1,406 measured at fair value under the fair value option at March 31, 2013 and December 31, 2012, respectively)(1)

     1,896       1,577  

Separate account liabilities(1)

     266,308       253,254  
  

 

 

   

 

 

 

Total liabilities

     683,431       670,007  
  

 

 

   

 

 

 

COMMITMENTS AND CONTINGENT LIABILITIES (See Note 15)

    

EQUITY

    

Preferred Stock ($.01 par value; 10,000,000 shares authorized; none issued)

     0       0  

Common Stock ($.01 par value; 1,500,000,000 shares authorized; 660,111,307 and 660,111,307 shares issued at March 31, 2013 and December 31, 2012, respectively)

     6       6  

Class B Stock ($.01 par value; 10,000,000 shares authorized; 2,000,000 shares issued and outstanding at March 31, 2013 and December 31, 2012, respectively)

     0       0  

Additional paid-in capital

     24,354       24,380  

Common Stock held in treasury, at cost (194,777,322 and 197,077,940 shares at March 31, 2013 and December 31, 2012, respectively)

     (12,018     (12,163

Accumulated other comprehensive income (loss)

     12,418       10,214  

Retained earnings

     15,203       16,138  
  

 

 

   

 

 

 

Total Prudential Financial, Inc. equity

     39,963       38,575  
  

 

 

   

 

 

 

Noncontrolling interests

     703       716  
  

 

 

   

 

 

 

Total equity

     40,666       39,291  
  

 

 

   

 

 

 

TOTAL LIABILITIES AND EQUITY

   $ 724,097     $ 709,298  
  

 

 

   

 

 

 

 

(1) See Note 5 for details of balances associated with variable interest entities.

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

1


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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Operations

Three Months Ended March 31, 2013 and 2012 (in millions, except per share amounts)

 

     Three Months Ended
March 31,
 
        2013           2012     

REVENUES

    

Premiums

   $ 7,084     $ 6,773  

Policy charges and fee income

     1,356       1,049  

Net investment income

     3,638       3,320  

Asset management fees and other income

     (1,170     (135

Realized investment gains (losses), net:

    

Other-than-temporary impairments on fixed maturity securities

     (308     (573

Other-than-temporary impairments on fixed maturity securities transferred to Other Comprehensive Income

     238       461  

Other realized investment gains (losses), net

     (653     (1,272
  

 

 

   

 

 

 

Total realized investment gains (losses), net

     (723     (1,384
  

 

 

   

 

 

 

Total revenues

     10,185       9,623  
  

 

 

   

 

 

 

BENEFITS AND EXPENSES

    

Policyholders’ benefits

     7,219       6,443  

Interest credited to policyholders’ account balances

     1,050       966  

Dividends to policyholders

     560       442  

Amortization of deferred policy acquisition costs

     218       (225

General and administrative expenses

     2,683       2,760  
  

 

 

   

 

 

 

Total benefits and expenses

     11,730       10,386  
  

 

 

   

 

 

 

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND EQUITY IN EARNINGS OF OPERATING JOINT VENTURES

     (1,545     (763
  

 

 

   

 

 

 

Income tax expense (benefit)

     (831     179  
  

 

 

   

 

 

 

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE EQUITY IN EARNINGS OF OPERATING JOINT VENTURES

     (714     (942

Equity in earnings of operating joint ventures, net of taxes

     49       7  
  

 

 

   

 

 

 

INCOME (LOSS) FROM CONTINUING OPERATIONS

     (665     (935

Income from discontinued operations, net of taxes

     1       7  
  

 

 

   

 

 

 

NET INCOME (LOSS)

     (664     (928

Less: Income attributable to noncontrolling interests

     42       11  
  

 

 

   

 

 

 

NET INCOME (LOSS) ATTRIBUTABLE TO PRUDENTIAL FINANCIAL, INC

   $ (706   $ (939
  

 

 

   

 

 

 

EARNINGS PER SHARE (See Note 8)

    

Financial Services Businesses

    

Basic earnings per share-Common Stock:

    

Income (loss) from continuing operations attributable to Prudential Financial, Inc.

   $ (1.55   $ (2.04

Income from discontinued operations, net of taxes

     0.00       0.01  
  

 

 

   

 

 

 

Net income (loss) attributable to Prudential Financial, Inc.

   $ (1.55   $ (2.03
  

 

 

   

 

 

 

Diluted earnings per share-Common Stock:

    

Income (loss) from continuing operations attributable to Prudential Financial, Inc.

   $ (1.55   $ (2.04

Income from discontinued operations, net of taxes

     0.00       0.01  
  

 

 

   

 

 

 

Net income (loss) attributable to Prudential Financial, Inc.

   $ (1.55   $ (2.03
  

 

 

   

 

 

 

Dividends declared per share of Common Stock

   $ 0.40    
  

 

 

   

Closed Block Business

    

Basic and Diluted earnings per share-Class B Stock:

    

Income (loss) from continuing operations attributable to Prudential Financial, Inc.

   $ 5.50     $ 6.50  

Income from discontinued operations, net of taxes

     0.00       0.00  
  

 

 

   

 

 

 

Net income (loss) attributable to Prudential Financial, Inc.

   $ 5.50     $ 6.50  
  

 

 

   

 

 

 

Dividends declared per share of Class B Stock

   $ 2.41    
  

 

 

   

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

2


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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Comprehensive Income

Three Months Ended March 31, 2013 and 2012 (in millions)

 

     Three Months Ended
March 31,
 
        2013           2012     

NET INCOME (LOSS)

   $ (664   $ (928

Other comprehensive income (loss), before tax:

    

Foreign currency translation adjustments:

    

Foreign currency translation adjustments for the period

     (902     (179

Reclassification adjustment for amounts included in net income

     1       0  
  

 

 

   

 

 

 

Total

     (901     (179
  

 

 

   

 

 

 

Net unrealized investment gains:

    

Unrealized investment gains for the period

     4,452       2,891  

Reclassification adjustment for (gains) losses included in net income

     (174     93  
  

 

 

   

 

 

 

Total

     4,278       2,984  
  

 

 

   

 

 

 

Defined benefit pension and postretirement unrecognized net periodic benefit:

    

Impact of foreign currency changes and other

     19       15  

Amortization included in net income

     31       24  
  

 

 

   

 

 

 

Total

     50       39  
  

 

 

   

 

 

 

Other comprehensive income, before tax

     3,427       2,844  

Less: Income tax expense (benefit) related to:

    

Foreign currency translation adjustments

     (269     (34

Net unrealized investment gains

     1,474       1,083  

Defined benefit pension and postretirement unrecognized net periodic benefit

     18       1  
  

 

 

   

 

 

 

Total

     1,223       1,050  

Other comprehensive income, net of taxes

     2,204       1,794  
  

 

 

   

 

 

 

Comprehensive income

     1,540       866  

Less: Comprehensive income attributable to noncontrolling interests

     42       7  
  

 

 

   

 

 

 

Comprehensive income attributable to Prudential Financial, Inc.

   $ 1,498     $ 859  
  

 

 

   

 

 

 

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

3


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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Equity(1)

Three Months Ended March 31, 2013 and 2012 (in millions)

 

    Prudential Financial, Inc. Equity              
    Common
Stock
    Additional
Paid-in
Capital
    Retained
Earnings
    Common
Stock
Held In
Treasury
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Prudential
Financial, Inc.
Equity
    Noncontrolling
Interests
    Total
Equity
 

Balance December 31, 2012

  $ 6     $ 24,380     $ 16,138     $ (12,163   $ 10,214     $ 38,575     $ 716     $ 39,291  

Contributions from noncontrolling interests

              0       1       1  

Distributions to noncontrolling interests

              0       (56     (56

Consolidations/deconsolidations

               

Stock-based compensation programs

      (26     (36     145         83         83  

Dividends declared on Common Stock

        (188         (188       (188

Dividends declared on Class B Stock

        (5         (5       (5

Comprehensive income:

               

Net income

        (706         (706     42       (664

Other comprehensive income (loss), net of tax

            2,204       2,204       0       2,204  
           

 

 

   

 

 

   

 

 

 

Total comprehensive income (loss)

              1,498       42       1,540  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, March 31, 2013

  $ 6     $ 24,354     $ 15,203     $ (12,018   $ 12,418     $ 39,963     $ 703     $ 40,666  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    Prudential Financial, Inc. Equity              
    Common
Stock
    Additional
Paid-in
Capital
    Retained
Earnings
    Common
Stock
Held In
Treasury
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Prudential
Financial, Inc.
Equity
    Noncontrolling
Interests
    Total
Equity
 

Balance, December 31, 2011

  $ 6     $ 24,293     $ 16,629     $ (11,920   $ 5,245     $ 34,253     $ 588     $ 34,841  

Common Stock acquired

          (250       (250       (250

Contributions from noncontrolling interests

              0       1       1  

Stock-based compensation programs

      (5     (150     253         98         98  

Comprehensive income:

               

Net income

        (939         (939     11       (928

Other comprehensive income (loss), net of tax

            1,798       1,798       (4     1,794  
           

 

 

   

 

 

   

 

 

 

Total comprehensive income (loss)

              859       7       866  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, March 31, 2012

  $ 6     $ 24,288     $ 15,540     $ (11,917   $ 7,043     $ 34,960     $ 596     $ 35,556  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Class B Stock is not presented as the amounts are immaterial.

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

4


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PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Cash Flows

Three Months Ended March 31, 2013 and 2012 (in millions)

 

     2013     2012  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income (loss)

   $ (664   $ (928

Adjustments to reconcile net income to net cash provided by operating activities:

    

Realized investment (gains) losses, net

     723       1,384  

Policy charges and fee income

     (514     (326

Interest credited to policyholders’ account balances

     1,050       966  

Depreciation and amortization

     109       105  

Gains on trading account assets supporting insurance liabilities, net

     (93     (234

Change in:

    

Deferred policy acquisition costs

     (645     (1,047

Future policy benefits and other insurance liabilities

     2,545       2,689  

Other trading account assets

     (10     (48

Income taxes

     (1,653     281  

Other, net

     (661     (2,075
  

 

 

   

 

 

 

Cash flows from operating activities

     187       767  
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Proceeds from the sale/maturity/prepayment of:

    

Fixed maturities, available-for-sale

     11,805       10,967  

Fixed maturities, held-to-maturity

     125       123  

Trading account assets supporting insurance liabilities and other trading account assets

     5,658       4,512  

Equity securities, available-for-sale

     1,003       1,088  

Commercial mortgage and other loans

     1,287       784  

Policy loans

     572       577  

Other long-term investments

     499       554  

Short-term investments

     9,311       7,399  

Payments for the purchase/origination of:

    

Fixed maturities, available-for-sale

     (13,564     (13,573

Fixed maturities, held-to-maturity

     (14     0  

Trading account assets supporting insurance liabilities and other trading account assets

     (6,498     (4,360

Equity securities, available-for-sale

     (985     (941

Commercial mortgage and other loans

     (2,008     (1,380

Policy loans

     (441     (451

Other long-term investments

     (633     (277

Short-term investments

     (9,053     (7,262

Acquisition of business, net of cash acquired

     (488     0  

Other, net

     (228     16  
  

 

 

   

 

 

 

Cash flows used in investing activities

     (3,652     (2,224
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Policyholders’ account deposits

     5,881       5,404  

Policyholders’ account withdrawals

     (6,438     (6,074

Net change in securities sold under agreements to repurchase and cash collateral for loaned securities

     344       970  

Cash dividends paid on Common Stock

     (206     (44

Cash dividends paid on Class B Stock

     (5     0  

Net change in financing arrangements (maturities 90 days or less)

     591       145  

Common Stock acquired

     0       (225

Common Stock reissued for exercise of stock options

     46       63  

Proceeds from the issuance of debt (maturities longer than 90 days)

     1,233       1,130  

Repayments of debt (maturities longer than 90 days)

     (1,240     (191

Excess tax benefits from share-based payment arrangements

     8       44  

Change in bank deposits

     0       (49

Other, net

     135       346  
  

 

 

   

 

 

 

Cash flows from financing activities

     349       1,519  
  

 

 

   

 

 

 

Effect of foreign exchange rate changes on cash balances

     (507     (112

NET DECREASE IN CASH AND CASH EQUIVALENTS

     (3,623     (50

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

     18,100       14,251  
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 14,477     $ 14,201  
  

 

 

   

 

 

 

NON-CASH TRANSACTIONS DURING THE PERIOD

    

Treasury Stock shares issued for stock-based compensation programs

   $ 101     $ 205  

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements

 

1. BUSINESS AND BASIS OF PRESENTATION

 

Prudential Financial, Inc. (“Prudential Financial”) and its subsidiaries (collectively, “Prudential” or the “Company”) provide a wide range of insurance, investment management, and other financial products and services to both individual and institutional customers throughout the United States and in many other countries. Principal products and services provided include life insurance, annuities, retirement-related services, mutual funds, and investment management. The Company has organized its principal operations into the Financial Services Businesses and the Closed Block Business. The Financial Services Businesses operate through three operating divisions: U.S. Retirement Solutions and Investment Management, U.S. Individual Life and Group Insurance, and International Insurance. The Company’s businesses that are not sufficiently material to warrant separate disclosure and divested businesses, are included in Corporate and Other operations within the Financial Services Businesses. The Closed Block Business, which includes the Closed Block (see Note 6), is managed separately from the Financial Services Businesses. The Closed Block Business was established on the date of demutualization and includes the Company’s in force participating insurance and annuity products and assets that are used for the payment of benefits and policyholders’ dividends on these products, as well as other assets and equity that support these products and related liabilities. In connection with the demutualization, the Company ceased offering these participating products.

 

Basis of Presentation

 

The Unaudited Interim Consolidated Financial Statements include the accounts of Prudential Financial, entities over which the Company exercises control, including majority-owned subsidiaries and minority-owned entities such as limited partnerships in which the Company is the general partner, and variable interest entities in which the Company is considered the primary beneficiary. See Note 5 for more information on the Company’s consolidated variable interest entities. The Unaudited Interim Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) on a basis consistent with reporting interim financial information in accordance with instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (“SEC”). Intercompany balances and transactions have been eliminated.

 

In the opinion of management, all adjustments necessary for a fair statement of the financial position and results of operations have been made. All such adjustments are of a normal, recurring nature. Interim results are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with the Company’s Audited Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

 

The Company’s Gibraltar Life Insurance Company, Ltd. (“Gibraltar Life”) consolidated operations, use a November 30 fiscal year end for purposes of inclusion in the Company’s Consolidated Financial Statements. Therefore, the Unaudited Interim Consolidated Financial Statements as of March 31, 2013, include the assets and liabilities of Gibraltar Life as of February 28, 2013 and the results of operations for Gibraltar Life for the three months ended February 28, 2013.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The most significant estimates include those used in determining deferred policy acquisition costs and related amortization; value of business acquired and its amortization; amortization of sales inducements; measurement of goodwill and any related impairment; valuation of investments including derivatives and the recognition of other-than-temporary impairments; future policy benefits including guarantees; pension and other postretirement benefits; provision for income taxes and valuation of deferred tax assets; and reserves for contingent liabilities, including reserves for losses in connection with unresolved legal matters.

 

Reclassifications

 

Certain amounts in prior periods have been reclassified to conform to the current period presentation.

 

2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS

 

Investments in Debt and Equity Securities and Commercial Mortgage and Other Loans

 

The Company’s investments in debt and equity securities include fixed maturities; equity securities; and short-term investments. The accounting policies related to these, as well as commercial mortgage and other loans, are as follows:

 

Fixed maturities are comprised of bonds, notes and redeemable preferred stock. Fixed maturities classified as “available-for-sale” are carried at fair value. See Note 13 for additional information regarding the determination of fair value. Fixed maturities that the Company has both the positive intent and ability to hold to maturity are carried at amortized cost and classified as “held-to-maturity.” The amortized cost of fixed maturities is adjusted for amortization of premiums and accretion of discounts to maturity. Interest income, as well as the related amortization of premium and accretion of discount, is included in “Net investment income” under the effective yield method. For mortgage-backed and asset-backed securities, the effective yield is based on estimated cash flows, including interest rate and prepayment assumptions based on data from widely accepted third-party data sources or internal estimates. In addition to interest rate and prepayment assumptions, cash flow estimates also vary based on other assumptions regarding the underlying collateral, including default rates and changes in value. These assumptions can significantly impact income recognition and the amount of other-than-temporary impairments recognized in earnings and other comprehensive income. For high credit quality mortgage-backed and asset-backed securities (those rated AA or above), cash flows are provided quarterly, and the amortized cost and effective yield of the security are adjusted as necessary to reflect historical prepayment experience and changes in estimated future prepayments. The adjustments to amortized cost are recorded as a charge or credit to net investment income in accordance with the retrospective method. For mortgage-backed and asset-backed securities rated below AA or those for which an other than temporary impairment has been recorded, the effective yield is adjusted prospectively for any changes in estimated cash flows. See the discussion below on realized investment gains and losses for a description of the accounting for impairments. Unrealized gains and losses on fixed maturities classified as “available-for-sale,” net of tax, and the effect on deferred policy acquisition costs, value of business acquired, deferred sales inducements, future policy benefits and policyholders’ dividends that would result from the realization of unrealized gains and losses, are included in “Accumulated other comprehensive income (loss)” (“AOCI”).

 

“Trading account assets supporting insurance liabilities, at fair value” includes invested assets that support certain products included in the Retirement segment, as well as certain products included in the International Insurance segment, which are experience rated, meaning that the investment results associated with these products are expected to ultimately accrue to contractholders. Realized and unrealized gains and losses for these investments are reported in “Asset management fees and other income.” Interest and dividend income from these investments is reported in “Net investment income.”

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

“Other trading account assets, at fair value” consist primarily of fixed maturities, equity securities, including certain perpetual preferred stock, and certain derivatives, including those used by the Company in its capacity as a broker-dealer and derivative hedging positions, used in a non-broker-dealer capacity primarily to hedge the risks related to certain products. These instruments are carried at fair value. Realized and unrealized gains and losses on these investments and on derivatives used by the Company in its capacity as a broker-dealer are reported in “Asset management fees and other income” and, for those related to the Company’s global commodities group, in “Income from discontinued operations, net of taxes.” Interest and dividend income from these investments is reported in “Net investment income” and, for those related to the Company’s global commodities group, in “Income from discontinued operations, net of taxes.”

 

Equity securities available-for-sale are comprised of common stock, mutual fund shares, non-redeemable preferred stock, and certain perpetual preferred stock, and are carried at fair value. The associated unrealized gains and losses, net of tax, and the effect on deferred policy acquisition costs, value of business acquired, deferred sales inducements, future policy benefits and policyholders’ dividends that would result from the realization of unrealized gains and losses, are included in AOCI. The cost of equity securities is written down to fair value when a decline in value is considered to be other-than-temporary. See the discussion below on realized investment gains and losses for a description of the accounting for impairments. Dividends from these investments are recognized in “Net investment income” when earned.

 

Commercial mortgage and other loans consist of commercial mortgage loans, agricultural loans, loans backed by residential properties, as well as certain other collateralized and uncollateralized loans. Loans backed by residential properties primarily include recourse loans held by the Company’s international insurance businesses. Other collateralized loans primarily include senior loans made by the Company’s international insurance businesses and loans made to the Company’s former real estate franchisees. Uncollateralized loans primarily represent reverse dual currency loans and corporate loans held by the Company’s international insurance businesses.

 

Commercial mortgage and other loans originated and held for investment are generally carried at unpaid principal balance, net of unamortized deferred loan origination fees and expenses and net of an allowance for losses. Commercial mortgage loans originated within the Company’s commercial mortgage operations include loans held for sale which are reported at the lower of cost or fair value; loans held for investment which are reported at amortized cost net of unamortized deferred loan origination fees and expenses and net of an allowance for losses; and loans reported at fair value under the fair value option. Commercial mortgage and other loans acquired, including those related to the acquisition of a business, are recorded at fair value when purchased, reflecting any premiums or discounts to unpaid principal balances.

 

Interest income, as well as prepayment fees and the amortization of the related premiums or discounts, related to commercial mortgage and other loans, are included in “Net investment income.”

 

Impaired loans include those loans for which it is probable that amounts due will not all be collected according to the contractual terms of the loan agreement. The Company defines “past due” as principal or interest not collected at least 30 days past the scheduled contractual due date. Interest received on loans that are past due, including impaired and non-impaired loans as well as loans that were previously modified in a troubled debt restructuring, is either applied against the principal or reported as net investment income based on the Company’s assessment as to the collectability of the principal. See Note 4 for additional information about the Company’s past due loans.

 

The Company discontinues accruing interest on loans after the loans become 90 days delinquent as to principal or interest payments, or earlier when the Company has doubts about collectability. When the Company

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

discontinues accruing interest on a loan, any accrued but uncollectible interest on the loan and other loans backed by the same collateral, if any, is charged to interest income in the same period. Generally, a loan is restored to accrual status only after all delinquent interest and principal are brought current and, in the case of loans where the payment of interest has been interrupted for a substantial period, or the loan has been modified, a regular payment performance has been established.

 

The Company reviews the performance and credit quality of the commercial mortgage and other loan portfolio on an on-going basis. Loans are placed on watch list status based on a predefined set of criteria and are assigned one of three categories. Loans are placed on “early warning” status in cases where, based on the Company’s analysis of the loan’s collateral, the financial situation of the borrower or tenants or other market factors, it is believed a loss of principal or interest could occur. Loans are classified as “closely monitored” when it is determined that there is a collateral deficiency or other credit events that may lead to a potential loss of principal or interest. Loans “not in good standing” are those loans where the Company has concluded that there is a high probability of loss of principal, such as when the loan is delinquent or in the process of foreclosure. As described below, in determining the allowance for losses, the Company evaluates each loan on the watch list to determine if it is probable that amounts due will not be collected according to the contractual terms of the loan agreement.

 

Loan-to-value and debt service coverage ratios are measures commonly used to assess the quality of commercial mortgage loans. The loan-to-value ratio compares the amount of the loan to the fair value of the underlying property collateralizing the loan, and is commonly expressed as a percentage. Loan-to-value ratios greater than 100% indicate that the loan amount exceeds the collateral value. A smaller loan-to-value ratio indicates a greater excess of collateral value over the loan amount. The debt service coverage ratio compares a property’s net operating income to its debt service payments. Debt service coverage ratios less than 1.0 times indicate that property operations do not generate enough income to cover the loan’s current debt payments. A larger debt service coverage ratio indicates a greater excess of net operating income over the debt service payments. The values utilized in calculating these ratios are developed as part of the Company’s periodic review of the commercial mortgage loan and agricultural loan portfolio, which includes an internal appraisal of the underlying collateral value. The Company’s periodic review also includes a quality re-rating process, whereby the internal quality rating originally assigned at underwriting is updated based on current loan, property and market information using a proprietary quality rating system. The loan-to-value ratio is the most significant of several inputs used to establish the internal credit rating of a loan which in turn drives the allowance for losses. Other key factors considered in determining the internal credit rating include debt service coverage ratios, amortization, loan term, estimated market value growth rate and volatility for the property type and region. See Note 4 for additional information related to the loan-to-value ratios and debt service coverage ratios related to the Company’s commercial mortgage and agricultural loan portfolios.

 

Loans backed by residential properties, other collateralized loans, and uncollateralized loans are also reviewed periodically. Each loan is assigned an internal or external credit rating. Internal credit ratings take into consideration various factors including financial ratios and qualitative assessments based on non-financial information. In cases where there are personal or third party guarantors, the credit quality of the guarantor is also reviewed. These factors are used in developing the allowance for losses. Based on the diversity of the loans in these categories and their immateriality, the Company has not disclosed the credit quality indicators related to these loans in Note 4.

 

For those loans not reported at fair value, the allowance for losses includes a loan specific reserve for each impaired loan that has a specifically identified loss and a portfolio reserve for probable incurred but not specifically identified losses. For impaired commercial mortgage and other loans the allowances for losses are

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

determined based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or based upon the fair value of the collateral if the loan is collateral dependent. The portfolio reserves for probable incurred but not specifically identified losses in the commercial mortgage and agricultural loan portfolio segments considers the current credit composition of the portfolio based on an internal quality rating (as described above). The portfolio reserves are determined using past loan experience, including historical credit migration, loss probability and loss severity factors by property type. These factors are reviewed each quarter and updated as appropriate.

 

The allowance for losses on commercial mortgage and other loans can increase or decrease from period to period based on the factors noted above. “Realized investment gains (losses), net” includes changes in the allowance for losses and changes in value for loans accounted for under the fair value option. “Realized investment gains (losses), net” also includes gains and losses on sales, certain restructurings, and foreclosures.

 

When a commercial mortgage or other loan is deemed to be uncollectible, any specific valuation allowance associated with the loan is reversed and a direct write down to the carrying amount of the loan is made. The carrying amount of the loan is not adjusted for subsequent recoveries in value.

 

Commercial mortgage and other loans are occasionally restructured in a troubled debt restructuring. These restructurings generally include one or more of the following: full or partial payoffs outside of the original contract terms; changes to interest rates; extensions of maturity; or additions or modifications to covenants. Additionally, the Company may accept assets in full or partial satisfaction of the debt as part of a troubled debt restructuring. When restructurings occur, they are evaluated individually to determine whether the restructuring or modification constitutes a “troubled debt restructuring” as defined by authoritative accounting guidance. If the borrower is experiencing financial difficulty and the Company has granted a concession, the restructuring, including those that involve a partial payoff or the receipt of assets in full satisfaction of the debt is deemed to be a troubled debt restructuring. Based on the Company’s credit review process described above, these loans generally would have been deemed impaired prior to the troubled debt restructuring, and specific allowances for losses would have been established prior to the determination that a troubled debt restructuring has occurred.

 

In a troubled debt restructuring where the Company receives assets in full satisfaction of the debt, any specific valuation allowance is reversed and a direct write down of the loan is recorded for the amount of the allowance, and any additional loss, net of recoveries, or any gain is recorded for the difference between the fair value of the assets received and the recorded investment in the loan. When assets are received in partial settlement, the same process is followed, and the remaining loan is evaluated prospectively for impairment based on the credit review process noted above. When a loan is restructured in a troubled debt restructuring, the impairment of the loan is remeasured using the modified terms and the loan’s original effective yield, and the allowance for loss is adjusted accordingly. Subsequent to the modification, income is recognized prospectively based on the modified terms of the loans in accordance with the income recognition policy noted above. Additionally, the loan continues to be subject to the credit review process noted above.

 

In situations where a loan has been restructured in a troubled debt restructuring and the loan has subsequently defaulted, this factor is considered when evaluating the loan for a specific allowance for losses in accordance with the credit review process noted above.

 

See Note 4 for additional information about commercial mortgage and other loans that have been restructured in a troubled debt restructuring.

 

“Short-term investments” primarily consist of highly liquid debt instruments with a maturity of twelve months or less and greater than three months when purchased, other than those debt instruments meeting this

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

definition that are included in “Trading account assets supporting insurance liabilities, at fair value.” These investments are generally carried at fair value and include certain money market investments, short-term debt securities issued by government sponsored entities and other highly liquid debt instruments. Short-term investments held in the Company’s former broker-dealer operations were marked-to-market through “Income from discontinued operations, net of taxes.”

 

Realized investment gains (losses) are computed using the specific identification method with the exception of some of the Company’s International Insurance businesses’ portfolios, where the average cost method is used. 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 net other-than-temporary impairments recognized in earnings. Realized investment gains and losses are also generated from prepayment premiums received on private fixed maturity securities, allowance for losses on commercial mortgage and other loans, fair value changes on commercial mortgage loans carried at fair value, and fair value changes on embedded derivatives and free-standing derivatives that do not qualify for hedge accounting treatment, except those derivatives used in the Company’s capacity as a broker or dealer.

 

The Company’s available-for-sale and held-to-maturity securities with unrealized losses are reviewed quarterly to identify other-than-temporary impairments in value. 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 and the duration of the decline; (2) the reasons for the decline in value (credit event, currency or interest-rate related, including general credit spread widening); and (3) the financial condition of and near-term prospects of the issuer. With regard to available-for-sale equity securities, the Company also considers the ability and intent to hold the investment for a period of time to allow for a recovery of value. When it is determined that a decline in value of an equity security is other-than-temporary, the carrying value of the equity security is reduced to its fair value, with a corresponding charge to earnings.

 

An other-than-temporary impairment is recognized in earnings for a debt security in an unrealized loss position when the Company either (a) has the intent to sell the debt security or (b) more likely than not will be required to sell the debt security before its anticipated recovery. For all debt securities in unrealized loss positions that do not meet either of these two criteria, the Company analyzes its ability to recover the amortized cost by comparing the net present value of projected future cash flows with the amortized cost of the security. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows at the effective interest rate implicit in the debt security prior to impairment. The Company may use the estimated fair value of collateral as a proxy for the net present value if it believes that the security is dependent on the liquidation of collateral for recovery of its investment. If the net present value is less than the amortized cost of the investment, an other-than-temporary impairment is recognized. In addition to the above mentioned circumstances, the Company also recognizes an other-than-temporary impairment in earnings when a non-functional currency denominated security in an unrealized loss position due to currency exchange rates approaches maturity.

 

When an other-than-temporary impairment of a debt security has occurred, the amount of the other-than-temporary impairment recognized in earnings depends on whether the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the debt security meets either of these two criteria or the foreign currency translation loss is not expected to be recovered before maturity, the other-than-temporary impairment recognized in earnings is equal to the entire difference between the security’s amortized cost basis and its fair value at the impairment measurement date. For other-than-temporary impairments of debt securities that do not meet these criteria, the net amount recognized in

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

earnings is equal to the difference between the amortized cost of the debt security and its net present value calculated as described above. Any difference between the fair value and the net present value of the debt security at the impairment measurement date is recorded in “Other comprehensive income (loss).” Unrealized gains or losses on securities for which an other-than-temporary impairment has been recognized in earnings is tracked as a separate component of AOCI.

 

For debt securities, the split between the amount of an other-than-temporary impairment recognized in other comprehensive income and the net amount recognized in earnings is driven principally by assumptions regarding the amount and timing of projected cash flows. For mortgage-backed and asset-backed securities, cash flow estimates consider the payment terms of the underlying assets backing a particular security, including interest rate and prepayment assumptions, based on data from widely accepted third-party data sources or internal estimates. In addition to interest rate and prepayment assumptions, cash flow estimates also include other assumptions regarding the underlying collateral including default rates and recoveries, which vary based on the asset type and geographic location, as well as the vintage year of the security. For structured securities, the payment priority within the tranche structure is also considered. For all other debt securities, cash flow estimates are driven by assumptions regarding probability of default and estimates regarding timing and amount of recoveries associated with a default. The Company has developed these estimates using information based on its historical experience as well as using market observable data, such as industry analyst reports and forecasts, sector credit ratings and other data relevant to the collectability of a security, such as the general payment terms of the security and the security’s position within the capital structure of the issuer.

 

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. For debt securities, the discount (or reduced premium) based on the new cost basis may be accreted into net investment income in future periods, including increases in cash flow on a prospective basis. In certain cases where there are decreased cash flow expectations, the security is reviewed for further cash flow impairments.

 

Derivative Financial Instruments

 

Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices, values of securities or commodities, credit spreads, market volatility, expected returns, and liquidity. Values can also be affected by changes in estimates and assumptions, including those related to counterparty behavior and non-performance risk used in valuation models. Derivative financial instruments generally used by the Company include swaps, futures, forwards and options and may be exchange-traded or contracted in the over-the-counter market. Derivative positions are carried at fair value, generally by obtaining quoted market prices or through the use of valuation models.

 

Derivatives are used in a non-broker-dealer capacity to manage the interest rate and currency characteristics of assets or liabilities and to mitigate volatility of expected non-U.S. earnings and net investments in foreign operations resulting from changes in currency exchange rates. Additionally, derivatives may be used to seek to reduce exposure to interest rate, credit, foreign currency and equity risks associated with assets held or expected to be purchased or sold, and liabilities incurred or expected to be incurred. As discussed in detail below and in Note 14, all realized and unrealized changes in fair value of derivatives are recorded in current earnings, with the exception of the effective portion of cash flow hedges and effective hedges of net investments in foreign operations. Cash flows from derivatives are reported in the operating, investing, or financing activities sections in the Unaudited Interim Consolidated Statements of Cash Flows based on the nature and purpose of the derivative.

 

Derivatives are recorded either as assets, within “Other trading account assets, at fair value” or “Other long-term investments,” or as liabilities, within “Other liabilities,” except for embedded derivatives which are

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

recorded with the associated host contract. The Company nets the fair value of all derivative financial instruments with counterparties for which a master netting arrangement has been executed.

 

The Company designates derivatives as either (1) a hedge of the fair value of a recognized asset or liability or unrecognized firm commitment (“fair value” hedge); (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge); (3) a foreign-currency fair value or cash flow hedge (“foreign currency” hedge); (4) a hedge of a net investment in a foreign operation; or (5) a derivative that does not qualify for hedge accounting.

 

To qualify for hedge accounting treatment, a derivative must be highly effective in mitigating the designated risk of the hedged item. Effectiveness of the hedge is formally assessed at inception and throughout the life of the hedging relationship. Even if a derivative qualifies for hedge accounting treatment, there may be an element of ineffectiveness of the hedge. Under such circumstances, the ineffective portion is recorded in “Realized investment gains (losses), net.”

 

The Company formally documents at inception all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives designated as fair value, cash flow, or foreign currency hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. Hedges of a net investment in a foreign operation are linked to the specific foreign operation.

 

When a derivative is designated as a fair value hedge and is determined to be highly effective, changes in its fair value, along with changes in the fair value of the hedged asset or liability (including losses or gains on firm commitments), are reported on a net basis in the income statement, generally in “Realized investment gains (losses), net.” When swaps are used in hedge accounting relationships, periodic settlements are recorded in the same income statement line as the related settlements of the hedged items.

 

When a derivative is designated as a cash flow hedge and is determined to be highly effective, changes in its fair value are recorded in AOCI until earnings are affected by the variability of cash flows being hedged (e.g., when periodic settlements on a variable-rate asset or liability are recorded in earnings). At that time, the related portion of deferred gains or losses on the derivative instrument is reclassified and reported in the income statement line item associated with the hedged item.

 

When a derivative is designated as a foreign currency hedge and is determined to be highly effective, changes in its fair value are recorded either in current period earnings if the hedge transaction is a fair value hedge (e.g., a hedge of a recognized foreign currency asset or liability) or in AOCI if the hedge transaction is a cash flow hedge (e.g., a foreign currency denominated forecasted transaction). When a derivative is used as a hedge of a net investment in a foreign operation, its change in fair value, to the extent effective as a hedge, is recorded in the cumulative translation adjustment account within “Accumulated other comprehensive income (loss).”

 

If it is determined that a derivative no longer qualifies as an effective fair value or cash flow hedge or management removes the hedge designation, the derivative will continue to be carried on the balance sheet at its fair value, with changes in fair value recognized currently in “Realized investment gains (losses), net.” In this scenario, the hedged asset or liability under a fair value hedge will no longer be adjusted for changes in fair value and the existing basis adjustment is amortized to the income statement line associated with the asset or liability. The component of AOCI related to discontinued cash flow hedges is reclassified to the income statement line associated with the hedged cash flows consistent with the earnings impact of the original hedged cash flows.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, or because it is probable that the forecasted transaction will not occur by the end of the specified time period, the derivative will continue to be carried on the balance sheet at its fair value, with changes in fair value recognized currently in “Realized investment gains (losses), net.” Any asset or liability that was recorded pursuant to recognition of the firm commitment is removed from the balance sheet and recognized currently in “Realized investment gains (losses), net.” Gains and losses that were in AOCI pursuant to the hedge of a forecasted transaction are recognized immediately in “Realized investment gains (losses), net.”

 

If a derivative does not qualify for hedge accounting, all changes in its fair value, including net receipts and payments, are included in “Realized investment gains (losses), net” without considering changes in the fair value of the economically associated assets or liabilities.

 

The Company is a party to financial instruments that contain derivative instruments that are “embedded” in the financial instruments. At inception, the Company assesses whether the economic characteristics of the embedded instrument are clearly and closely related to the economic characteristics of the remaining component of the financial instrument (i.e., the host contract) and whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When it is determined that (1) the embedded instrument possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded instrument qualifies as an embedded derivative that is separated from the host contract, carried at fair value, and changes in its fair value are included in “Realized investment gains (losses), net.” For certain financial instruments that contain an embedded derivative that otherwise would need to be bifurcated and reported at fair value, the Company may elect to classify the entire instrument as a trading account asset and report it within “Other trading account assets, at fair value.”

 

Adoption of New Accounting Pronouncements

 

In December 2011 and January 2013, the FASB issued updated guidance regarding the disclosure of recognized derivative instruments (including bifurcated embedded derivatives), repurchase agreements and securities borrowing/lending transactions that are offset in the statement of financial position or are subject to an enforceable master netting arrangement or similar agreement (irrespective of whether they are offset in the statement of financial position). This new guidance requires an entity to disclose information on both a gross and net basis about instruments and transactions within the scope of this guidance. This new guidance is effective for interim or annual reporting periods beginning on or after January 1, 2013, and should be applied retrospectively for all comparative periods presented. The disclosures required by this guidance are included in Note 14.

 

In February 2013, the FASB issued updated guidance regarding the presentation of comprehensive income. Under the guidance, an entity is required to separately present information about significant items reclassified out of accumulated other comprehensive income by component as well as changes in accumulated other comprehensive income balances by component in either the financial statements or the notes to the financial statements. The guidance does not change the items that are reported in other comprehensive income, does not change when an item of other comprehensive income must be reclassified to net income, and does not amend any existing requirements for reporting net income or other comprehensive income. The guidance is effective for the first interim or annual reporting period beginning after December 15, 2012 and should be applied prospectively. The disclosures required by this guidance are included in Note 7.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Future Adoption of New Accounting Pronouncements

 

In March 2013, the FASB issued updated guidance regarding the recognition in net income of the cumulative translation adjustment upon the sale or loss of control of a business or group of assets residing in a foreign subsidiary, or a loss of control of a foreign investment. Under this guidance, the reporting entity is required to recognize in net income the proportionate share of the cumulative translation adjustment attributable to the respective investment upon the loss of control or sale. The guidance is effective for the first interim or annual reporting period beginning after December 15, 2013 and should be applied prospectively. This guidance is not expected to have a significant effect on the Company’s consolidated financial position, results of operations, and financial statement disclosures.

 

3. ACQUISITIONS AND DISPOSITIONS

 

Acquisition of The Hartford’s Individual Life Insurance Business

 

On January 2, 2013, the Company acquired The Hartford’s individual life insurance business through a reinsurance transaction. Under the agreement, the Company paid The Hartford cash consideration of $615 million, primarily in the form of a ceding commission to provide reinsurance for approximately 700,000 life insurance policies with a net retained face amount in force of approximately $141 billion. This acquisition increases the Company’s scale in the U.S. individual life insurance market, particularly universal life products, and provides complementary distribution opportunities through expanded wirehouse and bank distribution channels.

 

The assets and liabilities assumed have been included in the Company’s Consolidated Financial Statements as of the acquisition date. Total assets assumed were $11.3 billion, which includes $1.3 billion of value of business acquired and $0.1 billion of cash, and total liabilities assumed were $10.7 billion. There is no goodwill, including tax deductible goodwill, associated with the acquisition.

 

Acquisition of AIG Star Life Insurance Co., Ltd., AIG Edison Life Insurance Company and Related Entities from AIG

 

On February 1, 2011, Prudential Financial completed the acquisition from American International Group, Inc. (“AIG”) of AIG Star Life Insurance Co., Ltd. (“Star”), AIG Edison Life Insurance Company (“Edison”), AIG Financial Assurance Japan K.K., and AIG Edison Service Co., Ltd. (collectively, the “Star and Edison Businesses”) pursuant to the stock purchase agreement dated September 30, 2010 between Prudential Financial and AIG. The total purchase price was $4,709 million, comprised of $4,213 million in cash and $496 million in assumed third party debt, substantially all of which is expected to be repaid, over time, with excess capital of the acquired entities. The acquisition of these businesses included the purchase by the Company of all of the shares of these entities, which became indirect wholly-owned subsidiaries of the Company. All acquired entities were Japanese corporations and their businesses were in Japan, increasing the Company’s scale in the Japanese insurance market. On January 1, 2012, Star and Edison were merged into Gibraltar Life.

 

Sale of Wealth Management Services

 

In April 2013, the Company signed a definitive agreement to sell its wealth management services unit to Envestnet Inc. The transaction, which will not have a material impact to the Company’s financial results, is expected to close in 2013, subject to customary closing conditions.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Discontinued Operations

 

Income from discontinued businesses, including charges upon disposition, are as follows:

 

     Three Months Ended
March 31,
 
     2013      2012  
     (in millions)  

Real estate investments sold or held for sale(1)

   $ 0      $ 10  

Global commodities business

     2        0  
  

 

 

    

 

 

 

Income from discontinued operations before income taxes

     2        10  

Income tax expense

     1        3  
  

 

 

    

 

 

 

Income from discontinued operations, net of taxes

   $ 1      $ 7  
  

 

 

    

 

 

 

 

(1) Reflects the income from discontinued real estate investments.

 

Charges recorded in connection with the disposals of businesses include estimates that are subject to subsequent adjustment.

 

The Company’s Unaudited Interim Consolidated Statements of Financial Position include total assets and total liabilities related to discontinued businesses as follows:

 

     March 31,
2013
     December 31,
2012
 
     (in millions)  

Total assets

   $ 33      $ 13  

Total liabilities

   $ 0      $ 0  

 

4. INVESTMENTS

 

Fixed Maturities and Equity Securities

 

The following tables provide information relating to fixed maturities and equity securities (excluding investments classified as trading) as of the dates indicated:

 

     March 31, 2013  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
     Other-than-
temporary
Impairments
in AOCI(3)
 
     (in millions)  

Fixed maturities, available-for-sale

              

U.S. Treasury securities and obligations of U.S. government authorities and agencies

   $ 13,102      $ 3,296      $ 44      $ 16,354      $ 0  

Obligations of U.S. states and their political subdivisions

     3,381        533        9        3,905        0  

Foreign government bonds

     76,284        8,611        62        84,833        1  

Corporate securities

     149,825        15,252        1,744        163,333        (5

Asset-backed securities(1)

     11,263        257        479        11,041        (880

Commercial mortgage-backed securities

     11,659        651        24        12,286        5  

Residential mortgage-backed securities(2)

     8,164        489        23        8,630        (11
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities, available-for-sale

   $ 273,678      $ 29,089      $ 2,385      $ 300,382      $ (890
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities, available-for-sale

   $ 6,613      $ 2,321      $ 16      $ 8,918     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

     March 31, 2013  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
     Other-than-
temporary
Impairments
in AOCI(3)
 
     (in millions)  

Fixed maturities, held-to-maturity

              

Foreign government bonds

   $ 1,050      $ 172      $ 0      $ 1,222      $ 0  

Corporate securities(4)

     987        39        46        980        0  

Asset-backed securities(1)

     864        59        0        923        0  

Commercial mortgage-backed securities

     278        38        0        316        0  

Residential mortgage-backed securities(2)

     699        46        0        745        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities, held-to-maturity(4)

   $ 3,878      $ 354      $ 46      $ 4,186      $ 0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes credit-tranched securities collateralized by sub-prime mortgages, auto loans, credit cards, education loans and other asset types.
(2) Includes publicly-traded agency pass-through securities and collateralized mortgage obligations.
(3) Represents the amount of other-than-temporary impairment losses in “Accumulated other comprehensive income (loss),” or “AOCI,” which were not included in earnings. Amount excludes $913 million of net unrealized gains on impaired available-for-sale securities and less than $1 million of net unrealized gains on impaired held-to-maturity securities relating to changes in the value of such securities subsequent to the impairment measurement date.
(4) Excludes notes with amortized cost of $1,500 million (fair value, $1,644 million) which have been offset with the associated payables under a netting agreement.

 

     December 31, 2012  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
     Other-than-
temporary
Impairments
in AOCI(3)
 
     (in millions)  

Fixed maturities, available-for-sale

  

U.S. Treasury securities and obligations of U.S. government authorities and agencies

   $ 13,973      $ 3,448      $ 35      $ 17,386      $ 0  

Obligations of U.S. states and their political subdivisions

     2,952        505        5        3,452        0  

Foreign government bonds

     81,578        6,778        66        88,290        1  

Corporate securities

     146,924        13,996        1,589        159,331        (2

Asset-backed securities(1)

     11,846        221        731        11,336        (964

Commercial mortgage-backed securities

     11,228        726        17        11,937        5  

Residential mortgage-backed securities(2)

     9,153        484        33        9,604        (11
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities, available-for-sale

   $ 277,654      $ 26,158      $ 2,476      $ 301,336      $ (971
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities, available-for-sale

   $ 6,759      $ 1,573      $ 55      $ 8,277     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

     December 31, 2012  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
     Other-than-
temporary
Impairments
in AOCI(3)
 
     (in millions)  

Fixed maturities, held-to-maturity

              

Foreign government bonds

   $ 1,142      $ 108      $ 0      $ 1,250      $ 0  

Corporate securities(4)

     1,065        37        67        1,035        0  

Asset-backed securities(1)

     1,001        66        0        1,067        0  

Commercial mortgage-backed securities

     302        49        0        351        0  

Residential mortgage-backed securities(2)

     758        50        0        808        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities, held-to-maturity(4)

   $ 4,268      $ 310      $ 67      $ 4,511      $ 0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes credit-tranched securities collateralized by sub-prime mortgages, auto loans, credit cards, education loans, and other asset types.
(2) Includes publicly-traded agency pass-through securities and collateralized mortgage obligations.
(3) Represents the amount of other-than-temporary impairment losses in AOCI, which were not included in earnings. Amount excludes $778 million of net unrealized gains on impaired available-for-sale securities and $1 million of net unrealized gains on impaired held-to-maturity securities relating to changes in the value of such securities subsequent to the impairment measurement date.
(4) Excludes notes with amortized cost of $1,500 million (fair value, $1,660 million) which have been offset with the associated payables under a netting agreement.

 

The amortized cost and fair value of fixed maturities by contractual maturities at March 31, 2013, are as follows:

 

     Available-for-Sale      Held-to-Maturity  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Due in one year or less

   $ 15,725      $ 16,341      $ 0      $ 0  

Due after one year through five years

     48,878        53,141        90        91  

Due after five years through ten years

     56,682        63,286        329        343  

Due after ten years(1)

     121,307        135,657        1,618        1,768  

Asset-backed securities

     11,263        11,041        864        923  

Commercial mortgage-backed securities

     11,659        12,286        278        316  

Residential mortgage-backed securities

     8,164        8,630        699        745  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 273,678      $ 300,382      $ 3,878      $ 4,186  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes notes with amortized cost of $1,500 million (fair value, $1,644 million) which have been offset with the associated payables under a netting agreement.

 

Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Asset-backed, commercial mortgage-backed, and residential mortgage-backed securities are shown separately in the table above, as they are not due at a single maturity date.

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The following table depicts the sources of fixed maturity proceeds and related investment gains (losses), as well as losses on impairments of both fixed maturities and equity securities:

 

     Three Months Ended
March 31,
 
         2013             2012      
     (in millions)  

Fixed maturities, available-for-sale

    

Proceeds from sales

   $ 6,495     $ 5,663  

Proceeds from maturities/repayments

     5,739       4,989  

Gross investment gains from sales, prepayments, and maturities

     229       127  

Gross investment losses from sales and maturities

     (106     (78

Fixed maturities, held-to-maturity

    

Gross investment gains from prepayments

   $ 0     $ 0  

Proceeds from maturities/repayments

     125       123  

Equity securities, available-for-sale

    

Proceeds from sales

   $ 1,048     $ 1,082  

Gross investment gains from sales

     107       122  

Gross investment losses from sales

     (23     (86

Fixed maturity and equity security impairments

    

Net writedowns for other-than-temporary impairment losses on fixed maturities recognized in earnings(1)

   $ (70   $ (112

Writedowns for impairments on equity securities

     (7     (49

 

 

(1) Excludes the portion of other-than-temporary impairments recorded in “Other comprehensive income (loss),” representing any difference between the fair value of the impaired debt security and the net present value of its projected future cash flows at the time of impairment.

 

As discussed in Note 2, a portion of certain other-than-temporary impairment (“OTTI”) losses on fixed maturity securities are recognized in “Other comprehensive income (loss)” (“OCI”). For these securities, the net amount recognized in earnings (“credit loss impairments”) represents the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in OCI. The following table sets forth the amount of pre-tax credit loss impairments on fixed maturity securities held by the Company as of the dates indicated, for which a portion of the OTTI loss was recognized in OCI, and the corresponding changes in such amounts.

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Credit losses recognized in earnings on fixed maturity securities held by the Company for which a portion of the OTTI loss was recognized in OCI

 

     Three Months Ended
March 31,
 
        2013           2012     
     (in millions)  

Balance, beginning of period

   $ 1,166     $ 1,475  

Credit loss impairments previously recognized on securities which matured, paid down, prepaid or were sold during the period

     (97     (18

Credit loss impairments previously recognized on securities impaired to fair value during the period(1)

     0       (59

Credit loss impairment recognized in the current period on securities not previously impaired

     1       24  

Additional credit loss impairments recognized in the current period on securities previously impaired

     12       37  

Increases due to the passage of time on previously recorded credit losses

     12       13  

Accretion of credit loss impairments previously recognized due to an increase in cash flows expected to be collected

     (5     (7
  

 

 

   

 

 

 

Balance, end of period

   $ 1,089     $ 1,465  
  

 

 

   

 

 

 

 

(1) Represents circumstances where the Company determined in the current period that it intends to sell the security or it is more likely than not that it will be required to sell the security before recovery of the security’s amortized cost.

 

Trading Account Assets Supporting Insurance Liabilities

 

The following table sets forth the composition of “Trading account assets supporting insurance liabilities” as of the dates indicated:

 

     March 31, 2013      December 31, 2012  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Short-term investments and cash equivalents

   $ 1,126      $ 1,126      $ 938      $ 938  

Fixed maturities:

           

Corporate securities

     11,222        12,168        11,076        12,107  

Commercial mortgage-backed securities

     2,331        2,441        2,096        2,229  

Residential mortgage-backed securities(1)

     1,884        1,932        1,965        2,026  

Asset-backed securities(2)

     1,048        1,047        1,179        1,116  

Foreign government bonds

     631        668        683        708  

U.S. government authorities and agencies and obligations of U.S. states

     346        410        369        426  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

     17,462        18,666        17,368        18,612  

Equity securities

     857        1,098        943        1,040  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total trading account assets supporting insurance liabilities

   $ 19,445      $ 20,890      $ 19,249      $ 20,590  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes publicly-traded agency pass-through securities and collateralized mortgage obligations.
(2) Includes credit tranched securities collateralized by sub-prime mortgages, auto loans, credit cards, education loans and other asset types.

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The net change in unrealized gains (losses) from trading account assets supporting insurance liabilities still held at period end, recorded within “Asset management fees and other income”, was $104 million and $263 million during the three months ended March 31, 2013 and 2012, respectively.

 

Other Trading Account Assets

 

The following table sets forth the composition of the “Other trading account assets” as of the dates indicated:

 

     March 31, 2013      December 31, 2012  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Short-term investments and cash equivalents

   $ 58      $ 59      $ 42      $ 42  

Fixed maturities

     2,614        2,595        2,196        2,132  

Equity securities

     1,236        1,338        1,363        1,437  

Other

     3        6        3        6  
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     3,911        3,998        3,604        3,617  
  

 

 

    

 

 

    

 

 

    

 

 

 

Derivative instruments

        2,864           2,711  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other trading account assets

   $ 3,911      $ 6,862      $ 3,604      $ 6,328  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

The net change in unrealized gains (losses) from other trading account assets, excluding derivatives instruments, still held at period end, recorded within “Asset management fees and other income”, was $74 million and $137 million during the three months ended March 31, 2013 and 2012, respectively.

 

Concentrations of Financial Instruments

 

The Company monitors its concentrations of financial instruments on an on-going basis, and mitigates credit risk by maintaining a diversified investment portfolio which limits exposure to any one issuer.

 

As of both March 31, 2013 and December 31, 2012, the Company’s exposure to concentrations of credit risk of single issuers greater than 10% of the Company’s stockholders’ equity included securities of the U.S. government, certain U.S. government agencies and certain securities guaranteed by the U.S. government, as well as the securities disclosed below.

 

     March 31, 2013      December 31, 2012  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Investments in Japanese government and government agency securities:

           

Fixed maturities, available-for-sale

   $ 61,948      $ 67,907      $ 66,590      $ 70,997  

Fixed maturities, held-to-maturity

     1,026        1,196        1,118        1,223  

Trading account assets supporting insurance liabilities

     488        510        513        524  

Other trading account assets

     35        35        39        40  

Short-term investments

     0        0        0        0  

Cash equivalents

     574        574        1,637        1,637  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 64,071      $ 70,222      $ 69,897      $ 74,421  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

     March 31, 2013      December 31, 2012  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Investments in South Korean government and government agency securities:

           

Fixed maturities, available-for-sale

   $ 5,754      $ 6,963      $ 5,837      $ 6,883  

Fixed maturities, held-to-maturity

     0        0        0        0  

Trading account assets supporting insurance liabilities

     62        63        62        63  

Other trading account assets

     3        3        2        2  

Short-term investments

     0        0        0        0  

Cash equivalents

     0        0        0        0  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 5,819      $ 7,029      $ 5,901      $ 6,948  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Commercial Mortgage and Other Loans

 

The Company’s commercial mortgage and other loans are comprised as follows, as of the dates indicated:

 

     March 31, 2013     December 31, 2012  
     Amount
(in millions)
    % of
Total
    Amount
(in millions)
    % of
Total
 

Commercial and agricultural mortgage loans by property type:

        

Office

   $ 7,456       20.6   $ 6,890       20.1

Retail

     8,067       22.3       8,190       23.9  

Apartments/Multi-Family

     6,332       17.5       5,235       15.3  

Industrial

     7,754       21.4       7,636       22.3  

Hospitality

     1,496       4.2       1,322       3.9  

Other

     2,933       8.1       2,841       8.3  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial mortgage loans

     34,038       94.1       32,114       93.8  

Agricultural property loans

     2,147       5.9       2,122       6.2  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial and agricultural mortgage loans by property type

     36,185       100.0     34,236       100.0
    

 

 

     

 

 

 

Valuation allowance

     (226       (229  
  

 

 

     

 

 

   

Total net commercial and agricultural mortgage loans by property type

     35,959         34,007    
  

 

 

     

 

 

   

Other loans

        

Uncollateralized loans

     1,717         1,836    

Residential property loans

     690         790    

Other collateralized loans

     121         140    
  

 

 

     

 

 

   

Total other loans

     2,528         2,766    

Valuation allowance

     (29       (40  
  

 

 

     

 

 

   

Total net other loans

     2,499         2,726    
  

 

 

     

 

 

   

Total commercial mortgage and other loans(1)

   $ 38,458       $ 36,733    
  

 

 

     

 

 

   

 

(1) Includes loans held at fair value.

 

22


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The commercial mortgage and agricultural property loans are geographically dispersed throughout the United States, Canada and Asia with the largest concentrations in California (28%), New York (10%), and Texas (8%) at March 31, 2013.

 

Activity in the allowance for losses for all commercial mortgage and other loans, as of the dates indicated, is as follows:

 

    March 31, 2013  
    Commercial
Mortgage
Loans
    Agricultural
Property
Loans
    Residential
Property
Loans
    Other
Collateralized
Loans
    Uncollateralized
Loans
    Total  
    (in millions)  

Allowance for losses, beginning of year

  $ 209     $ 20     $ 11     $ 12     $ 17     $ 269  

Addition to / (release of) allowance of losses

    12       0       (1     (8     1       4  

Charge-offs, net of recoveries

    (15     0       0       0       0       (15

Change in foreign exchange

    0       0       (1     0       (2     (3
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending balance

  $ 206     $ 20     $ 9     $ 4     $ 16     $ 255  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    December 31, 2012  
    Commercial
Mortgage
Loans
    Agricultural
Property
Loans
    Residential
Property
Loans
    Other
Collateralized
Loans
    Uncollateralized
Loans
    Total  
    (in millions)  

Allowance for losses, beginning of year

  $ 294     $ 19     $ 16     $ 18     $ 20     $ 367  

Addition to / (release of) allowance of losses

    (20     1       (4     (6     (2     (31

Charge-offs, net of recoveries

    (65     0       0       0       0       (65

Change in foreign exchange

    0       0       (1     0       (1     (2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending balance

  $ 209     $ 20     $ 11     $ 12     $ 17     $ 269  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

23


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The following tables set forth the allowance for credit losses and the recorded investment in commercial mortgage and other loans as of the dates indicated:

 

    March 31, 2013  
    Commercial
Mortgage
Loans
    Agricultural
Property
Loans
    Residential
Property
Loans
    Other
Collateralized
Loans
    Uncollateralized
Loans
    Total  
    (in millions)  

Allowance for Credit Losses:

 

Ending balance: individually evaluated for impairment

  $ 39     $ 12     $ 0     $ 4     $ 0     $ 55  

Ending balance: collectively evaluated for impairment

    167       7       9       0       17       200  

Ending balance: loans acquired with deteriorated credit quality

    0       0       0       0       0       0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending balance

  $ 206     $ 19     $ 9     $ 4     $ 17     $ 255  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recorded Investment:(1)

           

Ending balance gross of reserves: individually evaluated for impairment

  $ 1,454     $ 52     $ 0     $ 82     $ 3     $ 1,591  

Ending balance gross of reserves: collectively evaluated for impairment

    32,584       2,095       690       39       1,714       37,122  

Ending balance gross of reserves: loans acquired with deteriorated credit quality

    0       0       0       0       0       0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending balance, gross of reserves

  $ 34,038     $ 2,147     $ 690     $ 121     $ 1,717     $ 38,713  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Recorded investment reflects the balance sheet carrying value gross of related allowance.

 

24


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

    December 31, 2012  
    Commercial
Mortgage
Loans
    Agricultural
Property
Loans
    Residential
Property
Loans
    Other
Collateralized
Loans
    Uncollateralized
Loans
    Total  
    (in millions)  

Allowance for Credit Losses:

 

Ending balance: individually evaluated for impairment

  $ 49     $ 12     $ 0     $ 12     $ 0     $ 73  

Ending balance: collectively evaluated for impairment

    160       8       11       0       17       196  

Ending balance: loans acquired with deteriorated credit quality

    0       0       0       0       0       0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending balance

  $ 209     $ 20     $ 11     $ 12     $ 17     $ 269  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recorded Investment:(1)

 

Ending balance gross of reserves: individually evaluated for impairment

  $ 1,011     $ 49     $ 0     $ 93     $ 3     $ 1,156  

Ending balance gross of reserves: collectively evaluated for impairment

    31,103       2,073       790       47       1,833       35,846  

Ending balance gross of reserves: loans acquired with deteriorated credit quality

    0       0       0       0       0       0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending balance, gross of reserves

  $ 32,114     $ 2,122     $ 790     $ 140     $ 1,836     $ 37,002  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

(1) Recorded investment reflects the balance sheet carrying value gross of related allowance.

 

25


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Impaired loans include those loans for which it is probable that all amounts due will not be collected according to the contractual terms of the loan agreement. Impaired commercial mortgage and other loans identified in management’s specific review of probable loan losses and the related allowance for losses, as of the dates indicated, are as follows:

 

     March 31, 2013  
     Recorded
Investment(1)
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
Before
Allowance(2)
     Interest
Income
Recognized(3)
 
     (in millions)  

With no related allowance recorded:

              

Commercial mortgage loans

   $ 1      $ 1      $ 0      $ 14      $ 1  

Agricultural property loans

     0        0        0        0        0  

Residential property loans

     0        0        0        0        0  

Other collateralized loans

     0        0        0        0        0  

Uncollateralized loans

     0        2        0        0        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total with no related allowance

   $ 1      $ 3      $ 0      $ 14      $ 1  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

              

Commercial mortgage loans

   $ 152      $ 153      $ 39      $ 169      $ 2  

Agricultural property loans

     18        17        12        17        0  

Residential property loans

     0        0        0        0        0  

Other collateralized loans

     7        7        4        12        3  

Uncollateralized loans

     0        0        0        0        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total with related allowance

   $ 177      $ 177      $ 55      $ 198      $ 5  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total:

              

Commercial mortgage loans

   $ 153      $ 154      $ 39      $ 183      $ 3  

Agricultural property loans

     18        17        12        17        0  

Residential property loans

     0        0        0        0        0  

Other collateralized loans

     7        7        4        12        3  

Uncollateralized loans

     0        2        0        0        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 178      $ 180      $ 55      $ 212      $ 6  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Recorded investment reflects the balance sheet carrying value gross of related allowance.
(2) Average recorded investment represents the average of the beginning-of-period and end-of-period balances.
(3) The interest income recognized is for the year-to-date of income regardless of when the impairments occurred.

 

26


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

     December 31, 2012  
     Recorded
Investment(1)
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
Before
Allowance(2)
     Interest
Income
Recognized(3)
 
     (in millions)  

With no related allowance recorded:

              

Commercial mortgage loans(4)

   $ 27      $ 166      $ 0      $ 54      $ 4  

Agricultural property loans

     0        0        0        0        0  

Residential property loans

     0        0        0        0        0  

Other collateralized loans

     0        0        0        0        0  

Uncollateralized loans

     0        2        0        4        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total with no related allowance

   $ 27      $ 168      $ 0      $ 58      $ 4  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

              

Commercial mortgage loans

   $ 185      $ 185      $ 50      $ 351      $ 8  

Agricultural property loans

     17        17        12        16        0  

Residential property loans

     0        0        0        0        0  

Other collateralized loans

     17        17        11        19        0  

Uncollateralized loans

     0        0        0        0        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total with related allowance

   $ 219      $ 219      $ 73      $ 386      $ 8  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total:

              

Commercial mortgage loans(4)

   $ 212      $ 351      $ 50      $ 405      $ 12  

Agricultural property loans

     17        17        12        16        0  

Residential property loans

     0        0        0        0        0  

Other collateralized loans

     17        17        11        19        0  

Uncollateralized loans

     0        2        0        4        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 246      $ 387      $ 73      $ 444      $ 12  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Recorded investment reflects the balance sheet carrying value gross of related allowance.
(2) Average recorded investment represents the average of the beginning-of-period and all subsequent quarterly end-of-period balances.
(3) The interest income recognized is for the year-to-date of income regardless of when the impairments occurred.
(4) Includes the impact of loans acquired from the Star Business for which the balance sheet carrying value had been previously written down.

 

The net carrying value of commercial and other loans held for sale by the Company as of March 31, 2013 and December 31, 2012, was $678 million and $114 million, respectively. In all these transactions, the Company pre-arranges that it will sell the loan to an investor. As of both March 31, 2013 and December 31, 2012, all of the Company’s commercial and other loans held for sale were collateralized, with collateral primarily consisting of office buildings, retail properties, apartment complexes and industrial buildings.

 

27


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The following tables set forth the credit quality indicators as of March 31, 2013, based upon the recorded investment gross of allowance for credit losses.

 

Commercial mortgage loans

 

     Debt Service Coverage Ratio—March 31, 2013  
     Greater than
1.2X
     1.0X to <1.2X      Less than
1.0X
     Total  
     (in millions)  

Loan-to-Value Ratio

           

0%-59.99%

   $ 15,804      $ 670      $ 148      $ 16,622  

60%-69.99%

     9,919        666        230        10,815  

70%-79.99%

     4,463        694        181        5,338  

Greater than 80%

     323        455        485        1,263  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial mortgage loans

   $ 30,509      $ 2,485      $ 1,044      $ 34,038  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Agricultural property loans

 

     Debt Service Coverage Ratio—March 31, 2013  
     Greater than
1.2X
     1.0X to <1.2X      Less than
1.0X
     Total  
     (in millions)  

Loan-to-Value Ratio

           

0%-59.99%

   $ 1,687      $ 159      $ 44      $ 1,890  

60%-69.99%

     210        0        0        210  

70%-79.99%

     0        0        0        0  

Greater than 80%

     0        0        47        47  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total agricultural property loans

   $ 1,897      $ 159      $ 91      $ 2,147  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Total commercial and agricultural mortgage loans

 

     Debt Service Coverage Ratio—March 31, 2013  
     Greater than
1.2X
     1.0X to <1.2X      Less than
1.0X
     Total  
     (in millions)  

Loan-to-Value Ratio

           

0%-59.99%

   $ 17,491      $ 829      $ 192      $ 18,512  

60%-69.99%

     10,129        666        230        11,025  

70%-79.99%

     4,463        694        181        5,338  

Greater than 80%

     323        455        532        1,310  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial and agricultural mortgage loans

   $ 32,406      $ 2,644      $ 1,135      $ 36,185  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

28


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The following tables set forth the credit quality indicators as of December 31, 2012, based upon the recorded investment gross of allowance for credit losses.

 

Commercial mortgage loans

 

     Debt Service Coverage Ratio—December 31, 2012  
     Greater than
1.2X
     1.0X to <1.2X      Less than
1.0X
     Total  
     (in millions)  

Loan-to-Value Ratio

           

0%-59.99%

   $ 15,089      $ 487      $ 188      $ 15,764  

60%-69.99%

     9,263        801        36        10,100  

70%-79.99%

     3,689        776        217        4,682  

Greater than 80%

     219        770        579        1,568  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial mortgage loans

   $ 28,260      $ 2,834      $ 1,020      $ 32,114  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Agricultural property loans

 

     Debt Service Coverage Ratio—December 31, 2012  
     Greater than
1.2X
     1.0X to <1.2X      Less than
1.0X
     Total  
     (in millions)  

Loan-to-Value Ratio

           

0%-59.99%

   $ 1,635      $ 186      $ 44      $ 1,865  

60%-69.99%

     213        0        0        213  

70%-79.99%

     0        0        0        0  

Greater than 80%

     0        0        44        44  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total agricultural property loans

   $ 1,848      $ 186      $ 88      $ 2,122  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Total commercial and agricultural mortgage loans

 

     Debt Service Coverage Ratio—December 31, 2012  
     Greater than
1.2X
     1.0X to <1.2X      Less than
1.0X
     Total  
     (in millions)  

Loan-to-Value Ratio

           

0%-59.99%

   $ 16,724      $ 673      $ 232      $ 17,629  

60%-69.99%

     9,476        801        36        10,313  

70%-79.99%

     3,689        776        217        4,682  

Greater than 80%

     219        770        623        1,612  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial and agricultural mortgage loans

   $ 30,108      $ 3,020      $ 1,108      $ 34,236  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

29


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The following tables provide an aging of past due commercial mortgage and other loans as of the dates indicated, based upon the recorded investment gross of allowance for credit losses, as well as the amount of commercial mortgage loans on nonaccrual status as of the dates indicated.

 

    March 31, 2013  
    Current     30-59 Days
Past Due
    60-89 Days
Past Due
    Greater
Than 90
Days -
Accruing
    Greater
Than 90
Days - Not
Accruing
    Total Past
Due
    Total
Commercial
Mortgage
and Other
Loans
    Non
Accrual
Status
 
    (in millions)  

Commercial mortgage loans

  $ 33,909     $ 13     $ 0     $ 0     $ 116     $ 129     $ 34,038     $ 240  

Agricultural property loans

    2,099       0       0       0       48       48       2,147       49  

Residential property loans

    662       11       5       0       12       28       690       12  

Other collateralized loans

    120       0       0       0       1       1       121       7  

Uncollateralized loans

    1,717       0       0       0       0       0       1,717       3  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 38,507     $ 24     $ 5     $ 0     $ 177     $ 206     $ 38,713     $ 311  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    December 31, 2012  
    Current     30-59 Days
Past Due
    60-89 Days
Past Due
    Greater
Than 90
Days -
Accruing
    Greater
Than 90
Days - Not
Accruing
    Total Past
Due
    Total
Commercial
Mortgage
and Other
Loans
    Non
Accrual
Status
 
    (in millions)  

Commercial mortgage loans

  $ 31,943     $ 43     $ 91     $ 0     $ 37     $ 171     $ 32,114     $ 190  

Agricultural property loans

    2,077       0       0       0       45       45       2,122       49  

Residential property loans

    759       12       5       0       14       31       790       14  

Other collateralized loans

    139       0       0       0       1       1       140       17  

Uncollateralized loans

    1,836       0       0       0       0       0       1,836       3  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 36,754     $ 55     $ 96     $ 0     $ 97     $ 248     $ 37,002     $ 273  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

See Note 2 for further discussion regarding nonaccrual status loans.

 

For the three months ended March 31, 2013, there were $718 million of commercial mortgage and other loans acquired, other than those through direct origination. Additionally, there were no commercial mortgage and other loans sold, other than those classified as held-for-sale. For the three months ended March 31, 2012, there were no new commercial mortgage and other loans acquired, other than those through direct origination.

 

The Company’s commercial mortgage and other loans may occasionally be involved in a troubled debt restructuring. As of March 31, 2013 and December 31, 2012, the Company had committed to fund $10 million and $6 million, respectively, to borrowers that have been involved in a troubled debt restructuring. During the three months ended March 31, 2013 and 2012, respectively, there were no new troubled debt restructurings related to commercial mortgage loans, and no payment defaults on commercial mortgage and other loans that

 

30


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

were modified as a troubled debt restructuring within the 12 months preceding each respective period. See Note 2 for additional information relating to the accounting for troubled debt restructurings.

 

Net Investment Income

 

Net investment income for the three months ended March 31, 2013 and 2012, was from the following sources:

 

     Three Months Ended
March 31,
 
         2013             2012      
     (in millions)  

Fixed maturities, available-for-sale

   $ 2,651     $ 2,401  

Fixed maturities, held-to-maturity

     31       34  

Equity securities, available-for-sale

     78       76  

Trading account assets

     238       231  

Commercial mortgage and other loans

     490       487  

Policy loans

     148       148  

Short-term investments and cash equivalents

     10       12  

Other long-term investments

     133       40  
  

 

 

   

 

 

 

Gross investment income

     3,779       3,429  

Less: investment expenses

     (141     (109
  

 

 

   

 

 

 

Net investment income

   $ 3,638     $ 3,320  
  

 

 

   

 

 

 

 

Realized Investment Gains (Losses), Net

 

Realized investment gains (losses), net, for the three months ended March 31, 2013 and 2012, were from the following sources:

 

     Three Months Ended
March 31,
 
         2013             2012      
     (in millions)  

Fixed maturities

   $ 53     $ (63

Equity securities

     77       (13

Commercial mortgage and other loans

     13       11  

Investment real estate

     0       3  

Joint ventures and limited partnerships

     (1     (4

Derivatives(1)

     (870     (1,319

Other

     5       1  
  

 

 

   

 

 

 

Realized investment gains (losses), net

   $ (723   $ (1,384
  

 

 

   

 

 

 

 

(1) Includes the offset of hedged items in qualifying effective hedge relationships prior to maturity or termination.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Net Unrealized Gains (Losses) on Investments by Asset Class

 

The table below presents net unrealized gains (losses) on investments by asset class as of the dates indicated:

 

     March 31,     December 31,  
         2013             2012      
     (in millions)  

Fixed maturity securities on which an OTTI loss has been recognized

   $ 23     $ (194

Fixed maturity securities, available-for-sale—all other

     26,681       23,876  

Equity securities, available-for-sale

     2,305       1,518  

Derivatives designated as cash flow hedges(1)

     (79     (257

Other investments(2)

     (36     14  
  

 

 

   

 

 

 

Net unrealized gains (losses) on investments

   $ 28,894     $ 24,957  
  

 

 

   

 

 

 

 

(1) See Note 14 for more information on cash flow hedges.
(2) As of March 31, 2013, includes $44 million of net unrealized losses on held-to-maturity securities that were previously transferred from available-for-sale. Also includes net unrealized gains on certain joint ventures that are strategic in nature and are included in “Other assets.”

 

Duration of Gross Unrealized Loss Positions for Fixed Maturities and Equity Securities

 

The following table shows the fair value and gross unrealized losses aggregated by investment category and length of time that individual fixed maturity securities and equity securities have been in a continuous unrealized loss position, as of the dates indicated:

 

     March 31, 2013  
     Less than twelve months      Twelve months or more      Total  
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 
     (in millions)  

Fixed maturities(1)

                 

U.S. Treasury securities and obligations of U.S. government authorities and agencies

   $ 1,375      $ 44      $ 3      $ 0      $ 1,378      $ 44  

Obligations of U.S. states and their political subdivisions

     590        9        0        0        590        9  

Foreign government bonds

     2,315        55        97        6        2,412        61  

Corporate securities

     29,738        1,237        5,446        553        35,184        1,790  

Commercial mortgage-backed securities

     1,476        19        140        5        1,616        24  

Asset-backed securities

     495        2        3,092        478        3,587        480  

Residential mortgage-backed securities

     1,130        8        216        15        1,346        23  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 37,119      $ 1,374      $ 8,994      $ 1,057      $ 46,113      $ 2,431  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities, available-for-sale

   $ 327      $ 16      $ 2      $ 0      $ 329      $ 16  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes $439 million of fair value and $46 million of gross unrealized losses at March 31, 2013, on securities classified as held-to-maturity, a portion of which are not reflected in “AOCI.”

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

     December 31, 2012  
     Less than twelve months      Twelve months or more      Total  
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
     Fair Value      Gross
Unrealized
Losses
 
     (in millions)  

Fixed maturities(1)

                 

U.S. Treasury securities and obligations of U.S. government authorities and agencies

   $ 2,191      $ 33      $ 42      $ 2      $ 2,233      $ 35  

Obligations of U.S. states and their political subdivisions

     343        5        5        0        348        5  

Foreign government bonds

     5,426        55        167        11        5,593        66  

Corporate securities

     25,051        599        7,961        1,057        33,012        1,656  

Commercial mortgage-backed securities

     525        3        185        14        710        17  

Asset-backed securities

     911        11        3,545        720        4,456        731  

Residential mortgage-backed securities

     773        4        259        29        1,032        33  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 35,220       $ 710      $ 12,164      $ 1,833      $ 47,384       $ 2,543  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities, available-for-sale

   $ 961      $ 55      $ 0      $ 0      $ 961      $ 55  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes $526 million of fair value and $67 million of gross unrealized losses at December 31, 2012, on securities classified as held-to-maturity, a portion of which are not reflected in “AOCI.”

 

The gross unrealized losses on fixed maturity securities at March 31, 2013 and December 31, 2012, are composed of $1,997 million and $1,866 million related to high or highest quality securities based on NAIC or equivalent rating and $434 million and $677 million, related to other than high or highest quality securities based on NAIC or equivalent rating, respectively. At March 31, 2013, the $1,057 million of gross unrealized losses of twelve months or more were concentrated in the finance, utility, and consumer non-cyclical sectors of the Company’s corporate securities. At December 31, 2012, the $1,833 million of gross unrealized losses of twelve months or more were concentrated in asset-backed securities, and in the finance and consumer cyclical sectors of the Company’s corporate securities. In accordance with its policy described in Note 2, the Company concluded that an adjustment to earnings for other-than-temporary impairments for these securities was not warranted at March 31, 2013 or December 31, 2012. These conclusions are based on a detailed analysis of the underlying credit and cash flows on each security. The gross unrealized losses are primarily attributable to foreign currency exchange rate movements, general credit spread widening and increased liquidity discounts. At March 31, 2013, the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before the anticipated recovery of its remaining amortized cost basis.

 

At March 31, 2013, $1 million of the gross unrealized losses represented declines in value of greater than 20%, $1 million of which had been in that position for less than six months. At December 31, 2012, $6 million of the gross unrealized losses represented declines in value of greater than 20%, $4 million of which had been in that position for less than six months. In accordance with its policy described in Note 2, the Company concluded that an adjustment for other-than-temporary impairments for these equity securities was not warranted at March 31, 2013 or December 31, 2012.

 

5. VARIABLE INTEREST ENTITIES

 

In the normal course of its activities, the Company enters into relationships with various special purpose entities and other entities that are deemed to be variable interest entities (“VIEs”). A VIE is an entity that either (1) has equity investors that lack certain essential characteristics of a controlling financial interest (including the

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

ability to control activities of the entity, the obligation to absorb the entity’s expected losses and the right to receive the entity’s expected residual returns) or (2) lacks sufficient equity to finance its own activities without financial support provided by other entities, which in turn would be expected to absorb at least some of the expected losses of the VIE.

 

If the Company determines that it is the VIE’s “primary beneficiary,” it consolidates the VIE. There are currently two models for determining whether or not the Company is the “primary beneficiary” of a VIE. The first relates to those VIEs that have the characteristics of an investment company and for which certain other conditions are true. These conditions are that (1) the Company does not have the implicit or explicit obligation to fund losses of the VIE and (2) the VIE is not a securitization entity, asset-backed financing entity or an entity that was formerly considered a qualified special-purpose entity. In this model the Company is the primary beneficiary if it stands to absorb a majority of the VIE’s expected losses or to receive a majority of the VIE’s expected residual returns and would be required to consolidate the VIE.

 

For all other VIEs, the Company is the primary beneficiary if the Company has (1) the power to direct the activities of the VIE that most significantly impact the economic performance of the entity and (2) the obligation to absorb losses of the entity that could be potentially significant to the VIE or the right to receive benefits from the entity that could be potentially significant. If both conditions are present the Company would be required to consolidate the VIE.

 

Consolidated Variable Interest Entities for which the Company is the Investment Manager

 

The Company is the investment manager of certain asset-backed investment vehicles (commonly referred to as collateralized debt obligations, or “CDOs”) and certain other vehicles for which the Company earns fee income for investment management services, including certain investment structures which the Company’s asset management business invests with other co-investors in investment funds referred to as feeder funds. The Company sells or syndicates investments through these vehicles, principally as part of the strategic investing activity of the Company’s asset management businesses. Additionally, the Company may invest in securities issued by these vehicles. CDOs raise capital by issuing debt securities, and use the proceeds to purchase investments, typically interest-bearing financial instruments. The Company analyzes these relationships to determine whether it has (1) the power to direct the activities of the VIE that most significantly impact the economic performance of the entity and (2) the obligation to absorb losses of the entity that could be potentially significant to the VIE or the right to receive benefits from the entity that could be potentially significant and thus is the primary beneficiary. This analysis includes a review of (1) the Company’s rights and responsibilities as investment manager, (2) fees received by the Company and (3) other interests (if any) held by the Company. The Company is not required to provide, and has not provided, material financial or other support to any VIE for which it is the investment manager.

 

The Company has determined that it is the primary beneficiary of certain VIEs for which it is the asset manager, including certain CDOs and other investment structures, as it meets both conditions listed above. The table below reflects the carrying amount and balance sheet caption in which the assets and liabilities of consolidated VIEs for which the Company is the investment manager are reported. The assets of these VIEs are restricted and must be used first to settle liabilities of the VIE. The creditors of these VIEs do not have recourse to the Company in excess of the assets contained within the VIE.

 

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PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

     March 31,
2013
     December 31,
2012
 
     (in millions)  

Fixed maturities, available-for-sale

   $ 88      $ 87  

Other trading account assets

     1,867        1,409  

Commercial mortgage and other loans

     82        127  

Other long-term investments

     0        22  

Cash and cash equivalents

     511        9  

Accrued investment income

     6        0  

Other assets

     70        1  
  

 

 

    

 

 

 

Total assets of consolidated VIEs

   $ 2,624      $ 1,655  
  

 

 

    

 

 

 

Notes issued by consolidated VIEs

   $ 1,896      $ 1,577  

Other liabilities

     402        0  
  

 

 

    

 

 

 

Total liabilities of consolidated VIEs

   $ 2,298      $ 1,577  
  

 

 

    

 

 

 

 

As included in the table above, notes issued by consolidated VIEs are reported on the Consolidated Statements of Financial Position within “Notes issued by consolidated VIEs.” Recourse is limited to the assets of the respective VIE and does not extend to the general credit of Prudential Financial. As of March 31, 2013, the maturities of these obligations were over five years.

 

The Company also consolidates a VIE whose beneficial interests are wholly-owned by consolidated subsidiaries. This VIE is not included in the table above and the Company does not currently intend to sell these beneficial interests to third parties.

 

Other Consolidated Variable Interest Entities

 

The Company is the primary beneficiary of certain VIEs in which the Company has invested, as part of its investment activities. Included among these structured investments are structured investments issued by a VIE that manages yen-denominated investments coupled with cross-currency coupon swap agreements thereby creating synthetic dual currency investments. The Company’s involvement in the structuring of these investments combined with its economic interest indicates that the Company is the primary beneficiary. The Company has not provided material financial or other support that was not contractually required to these VIEs. The table below reflects the carrying amount and balance sheet caption in which the assets and liabilities of consolidated VIEs for which the Company is not the investment manager are reported. These liabilities primarily comprise