10-Q 1 d234453d10q.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 September 30, 2011

 

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 October 31, 2011, 470 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.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

               Page
Number
 

PART I FINANCIAL INFORMATION

  
   Item 1.   

Financial Statements:

  
     

Unaudited Interim Consolidated Statements of Financial Position as of September  30, 2011 and December 31, 2010

     1   
     

Unaudited Interim Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010

     2   
     

Unaudited Interim Consolidated Statements of Equity for the nine months ended September 30, 2011 and 2010

     3   
     

Unaudited Interim Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010

     4   
     

Notes to Unaudited Interim Consolidated Financial Statements

     5   
     

Unaudited Interim Supplemental Combining Financial Information:

  
     

Unaudited Interim Supplemental Financial Statements of Financial Position as of September 30, 2011 and December 31, 2010

     129   
     

Unaudited Interim Supplemental Financial Statements of Operations for the three months ended September 30, 2011 and 2010

     130   
     

Unaudited Interim Supplemental Financial Statements of Operations for the nine months ended September 30, 2011 and 2010

     131   
     

Notes to Unaudited Interim Supplemental Combining Financial Information

     132   
   Item 2.   

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

    

134
  
   Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

     299   
   Item 4.   

Controls and Procedures

     299   

PART II OTHER INFORMATION

  
   Item 1.   

Legal Proceedings

     300   
   Item 1A.   

Risk Factors

     300   
   Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

     301   
   Item 6.   

Exhibits

     301   

SIGNATURES

     302   


Table of Contents

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, 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 recently enacted 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, including possible difficulties in integrating and realizing the projected results of acquisitions, including risks associated with the acquisition of certain insurance operations in Japan; (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, 2010 for discussion of certain risks relating to our businesses and investment in our securities.


Table of Contents

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, before and after its demutualization on December 18, 2001. “Prudential,” the “Company,” “we” and “our” refer to our consolidated operations before and after demutualization.

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

 

PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Financial Position

September 30, 2011 and December 31, 2010 (in millions, except share amounts)

 

    September 30,
2011
    December 31,
2010
 

ASSETS

   

Fixed maturities, available for sale, at fair value (amortized cost: 2011-$238,534; 2010- $187,754)(1)

  $ 252,112      $ 194,983  

Fixed maturities, held to maturity, at amortized cost (fair value: 2011-$5,484; 2010- $5,477)(1)

    5,195        5,226  

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

    19,535        17,771  

Other trading account assets, at fair value

    6,562        4,225  

Equity securities, available for sale, at fair value (cost: 2011-$7,082; 2010- $6,469)

    7,462        7,741  

Commercial mortgage and other loans (includes $219 and $364 measured at fair value under the fair value option at September 30, 2011 and December 31, 2010, respectively)(1)

    34,401        31,831  

Policy loans

    11,483        10,667  

Other long-term investments (includes $338 and $258 measured at fair value under the fair value option at September 30, 2011 and December 31, 2010, respectively)(1)

    7,903        6,171  

Short-term investments

    7,907        5,297  
 

 

 

   

 

 

 

Total investments

    352,560       283,912   

Cash and cash equivalents(1)

    15,526        12,915  

Accrued investment income(1)

    2,820        2,377  

Deferred policy acquisition costs

    16,278        16,435  

Other assets(1)

    16,923        16,439  

Separate account assets(1)

    207,366        207,776  
 

 

 

   

 

 

 

TOTAL ASSETS

  $ 611,473      $ 539,854   
 

 

 

   

 

 

 

LIABILITIES AND EQUITY

   

LIABILITIES

   

Future policy benefits

  $ 169,391      $ 133,874  

Policyholders’ account balances

    134,560        106,441  

Policyholders’ dividends

    5,420        3,378  

Securities sold under agreements to repurchase

    6,234        5,885  

Cash collateral for loaned securities

    3,189        2,171  

Income taxes

    8,319        6,353  

Short-term debt

    2,899        1,982  

Long-term debt

    23,920        23,653  

Other liabilities(1)

    12,371        15,413  

Separate account liabilities(1)

    207,366        207,776  
 

 

 

   

 

 

 

Total liabilities

    573,669       506,926   
 

 

 

   

 

 

 

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; 660,110,939 and 660,110,810 shares issued at September 30, 2011 and December 31, 2010, respectively)

    6        6  

Class B Stock ($.01 par value; 10,000,000 shares authorized; 2,000,000 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively)

    0        0  

Additional paid-in capital

    24,257        24,223  

Common Stock held in treasury, at cost (188,213,961 and 176,312,047 shares at September 30, 2011 and December 31, 2010, respectively)

    (11,738     (11,173

Accumulated other comprehensive income (loss)

    5,292        2,978  

Retained earnings

    19,332        16,381  
 

 

 

   

 

 

 

Total Prudential Financial, Inc. equity

    37,149        32,415  
 

 

 

   

 

 

 

Noncontrolling interests

    655        513  
 

 

 

   

 

 

 

Total equity

    37,804        32,928  
 

 

 

   

 

 

 

TOTAL LIABILITIES AND EQUITY

  $ 611,473      $ 539,854  
 

 

 

   

 

 

 

 

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

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

1


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Operations

Three and Nine Months Ended September 30, 2011 and 2010 (in millions, except per share amounts)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2011             2010             2011             2010      

REVENUES

        

Premiums

   $ 6,092     $ 4,654     $ 17,892     $ 13,500  

Policy charges and fee income

     958       761       2,911       2,436  

Net investment income

     3,333       3,016       9,778       8,800  

Asset management fees and other income

     2,006       1,457       3,823       3,211  

Realized investment gains (losses), net:

        

Other-than-temporary impairments on fixed maturity securities

     (402     (435     (1,606     (2,198

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

     286       345       1,233       1,715  

Other realized investment gains (losses), net

     2,644       119       3,319       2,687  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total realized investment gains (losses), net

     2,528       29       2,946       2,204  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     14,917       9,917       37,350       30,151  
  

 

 

   

 

 

   

 

 

   

 

 

 

BENEFITS AND EXPENSES

        

Policyholders’ benefits

     6,208       4,538       17,676       13,668  

Interest credited to policyholders’ account balances

     1,463       1,174       3,477       3,640  

Dividends to policyholders

     679       512       1,961       1,547  

Amortization of deferred policy acquisition costs

     1,786       (6     2,888       1,412  

General and administrative expenses

     2,447       1,949       7,138       5,619  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total benefits and expenses

     12,583       8,167       33,140       25,886  
  

 

 

   

 

 

   

 

 

   

 

 

 
        

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

     2,334       1,750       4,210       4,265  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expense

     848       524       1,370       1,301  
  

 

 

   

 

 

   

 

 

   

 

 

 

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

     1,486       1,226       2,840       2,964  

Equity in earnings of operating joint ventures, net of taxes

     67       14       183       33  
  

 

 

   

 

 

   

 

 

   

 

 

 

INCOME FROM CONTINUING OPERATIONS

     1,553       1,240       3,023       2,997  

Income (loss) from discontinued operations, net of taxes

     (9     2       21       20  
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME

     1,544       1,242       3,044       3,017  

Less: Income (loss) attributable to noncontrolling interests

     10       (2     64       (1
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME ATTRIBUTABLE TO PRUDENTIAL FINANCIAL, INC

   $ 1,534     $ 1,244     $ 2,980     $ 3,018  
  

 

 

   

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE (See Note 8)

        

Financial Services Businesses

        

Basic:

        

Income from continuing operations attributable to Prudential Financial, Inc. per share of Common Stock

   $ 3.12     $ 2.49     $ 5.97     $ 5.34  

Income (loss) from discontinued operations, net of taxes

     (0.02     0.01       0.04       0.04  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Prudential Financial, Inc. per share of Common Stock

   $ 3.10     $ 2.50     $ 6.01     $ 5.38  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Income from continuing operations attributable to Prudential Financial, Inc. per share of Common Stock

   $ 3.08     $ 2.46     $ 5.89     $ 5.27  

Income (loss) from discontinued operations, net of taxes

     (0.02     0.00       0.04       0.04  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Prudential Financial, Inc. per share of Common Stock

   $ 3.06     $ 2.46     $ 5.93     $ 5.31  
  

 

 

   

 

 

   

 

 

   

 

 

 

Closed Block Business

        

Basic and Diluted:

        

Income from continuing operations attributable to Prudential Financial, Inc. per share of Class B Stock

   $ 10.50     $ 33.50     $ 15.00     $ 243.50  

Income from discontinued operations, net of taxes

     0.00       0.50       0.00       0.50  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Prudential Financial, Inc. per share of Class B Stock

   $ 10.50     $ 34.00     $ 15.00     $ 244.00  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

2


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Equity(1)

Nine Months Ended September 30, 2011 and 2010 (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, 2010

  $ 6     $ 24,223     $ 16,381     $ (11,173   $ 2,978     $ 32,415     $ 513     $ 32,928  

Common Stock acquired

          (750       (750     0       (750

Contributions from noncontrolling interests

                10       10  

Distributions to noncontrolling interests

                (15     (15

Consolidations/deconsolidations of noncontrolling interests

      0             0       54       54  

Stock-based compensation programs

      34       (29     185         190         190  

Comprehensive income:

               

Net income

        2,980           2,980       64       3,044  

Other comprehensive income, net of tax

            2,314       2,314       29       2,343  
           

 

 

   

 

 

   

 

 

 

Total comprehensive income

              5,294       93       5,387  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2011

  $ 6     $ 24,257     $ 19,332     $ (11,738   $ 5,292     $ 37,149     $ 655     $ 37,804  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    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, 2009

  $ 6     $ 23,235     $ 13,787     $ (11,390   $ (443   $ 25,195     $ 534     $ 25,729  

Contributions from noncontrolling interests

              0       6       6  

Distributions to noncontrolling interests

              0       (19     (19

Consolidations/deconsolidations of noncontrolling interests

      (2           (2     (1     (3

Stock-based compensation programs

      (11     (11     185         163         163  

Comprehensive income:

               

Net income

        3,018           3,018       (1     3,017  

Other comprehensive income, net of tax

            5,172        5,172       3       5,175  
           

 

 

   

 

 

   

 

 

 

Total comprehensive income

              8,190       2       8,192  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2010

  $ 6     $ 23,222     $ 16,794     $ (11,205   $ 4,729      $ 33,546     $ 522     $ 34,068  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

3


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Unaudited Interim Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2011 and 2010 (in millions)

 

     2011     2010  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income

   $ 3,044     $ 3,017  

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

    

Realized investment (gains) losses, net

     (2,946     (2,204

Policy charges and fee income

     (826     (705

Interest credited to policyholders’ account balances

     3,477       3,639  

Depreciation and amortization

     202       (56

Gains on trading account assets supporting insurance liabilities, net

     (179     (720

Change in:

    

Deferred policy acquisition costs

     (12     (829

Future policy benefits and other insurance liabilities

     4,759       3,115  

Other trading account assets

     340       (669

Income taxes

     359       (1,539

Other, net

     2,603       1,555  
  

 

 

   

 

 

 

Cash flows from operating activities

     10,821       4,604  
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Proceeds from the sale/maturity/prepayment of:

    

Fixed maturities, available for sale

     31,857       20,703  

Fixed maturities, held to maturity

     336       333  

Trading account assets supporting insurance liabilities and other trading account assets

     18,883       31,169  

Equity securities, available for sale

     2,823       1,898  

Commercial mortgage and other loans

     3,138       3,067  

Policy loans

     1,521       1,263  

Other long-term investments

     1,556       750  

Short-term investments

     16,799       16,522  

Payments for the purchase/origination of:

    

Fixed maturities, available for sale

     (38,963     (27,860

Fixed maturities, held to maturity

     (38     (155

Trading account assets supporting insurance liabilities and other trading account assets

     (20,317     (31,592

Equity securities, available for sale

     (2,335     (1,872

Commercial mortgage and other loans

     (4,598     (3,530

Policy loans

     (1,334     (1,163

Other long-term investments

     (1,252     (641

Short-term investments

     (16,858     (15,436

Acquisition of Subsidiaries, net of cash acquired.

     (2,321     0  

Other, net

     119       414  
  

 

 

   

 

 

 

Cash flows used in investing activities

     (10,984     (6,130
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Policyholders’ account deposits

     18,632       16,840  

Policyholders’ account withdrawals

     (17,047     (16,944

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

     1,356       (515

Cash dividends paid on Common Stock

     (51     (42

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

     207       554  

Common Stock acquired

     (695     0  

Common Stock reissued for exercise of stock options

     89       78  

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

     1,229       2,623  

Repayments of debt (maturities longer than 90 days)

     (891     (2,544

Excess tax benefits from share-based payment arrangements

     13       11  

Other, net

     (249     197  
  

 

 

   

 

 

 

Cash flows from financing activities

     2,593       258  
  

 

 

   

 

 

 

Effect of foreign exchange rate changes on cash balances

     181       77  

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     2,611       (1,191

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

     12,915       13,164  
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 15,526     $ 11,973  
  

 

 

   

 

 

 

NON-CASH TRANSACTIONS DURING THE PERIOD

    

Treasury Stock shares issued for stock-based compensation programs

   $ 73     $ 70  

 

See Notes to Unaudited Interim Consolidated Financial Statements

 

4


Table of Contents

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, investment management, and real estate services. 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 real estate and relocation services business as well as 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, except for the adjustment described below under “Out of Period Adjustment.” 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, 2010.

 

The Company’s Gibraltar Life Insurance Company, Ltd. (“Gibraltar Life”) consolidated operations and the recently acquired AIG Star Life Insurance Co., Ltd., AIG Edison Life Insurance Company, AIG Financial Assurance Japan K.K., and AIG Edison Service Co., Ltd. (collectively the “Star and Edison Businesses”) use a November 30 fiscal year end for purposes of inclusion in the Company’s Consolidated Financial Statements. Therefore, the Consolidated Financial Statements as of September 30, 2011, include the assets and liabilities of Gibraltar Life and the Star and Edison Businesses as of August 31, 2011 and the results of operations for Gibraltar Life for the three and nine months ended August 31, 2011. The Consolidated Financial Statements as of September 30, 2011, include the results of operations for the Star and Edison Businesses from February 1, 2011, the acquisition date, through August 31, 2011.

 

5


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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.

 

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.

 

Out of Period Adjustment

 

In the first quarter of 2011, the Company recorded an out of period adjustment that decreased “Income from continuing operations before income taxes and equity in earnings of operating joint ventures” by $95 million. The adjustment is related to the amortization of unrealized losses associated with U.S. dollar denominated collateralized mortgage-backed securities held by the Gibraltar Life Insurance Company, Ltd. consolidated operations (“Gibraltar Life operations”), which were reclassified from available for sale to held to maturity in December 2008. The adjustment, which had no impact on the carrying value of these securities, resulted from using the contractual maturities of the securities rather than the expected effective duration of the securities as the basis for the amortization of the unrealized losses that existed when the securities were reclassified. The adjustment had no impact on adjusted operating income, the Company’s measure of segment performance, and is not material to any previously reported quarterly or annual financial statements. For further information on the presentation of segment results and a definition of adjusted operating income, see Note 11.

 

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; trading account assets; 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 prepayment assumptions based on data from widely accepted third-party data sources or internal estimates. In addition to prepayment assumptions, cash flow estimates vary based on 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

 

6


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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 asset-backed and mortgage-backed securities rated below AA, 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).”

 

“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.”

 

“Other trading account assets, at fair value” consist primarily of investments, 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 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 “Accumulated other comprehensive income (loss).” 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 declared.

 

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. Commercial mortgage loans are broken down by class which is based on property type (industrial properties, retail, office, multi-family/apartment, hospitality, and other). 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 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

 

7


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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 according to the contractual terms of the loan agreement will not all be collected. 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 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 according to the contractual terms of the loan agreement will not be collected.

 

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

 

8


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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 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. Historical credit migration, loss rates and loss severity factors are updated each quarter based on the Company’s actual loan experience, and are considered together with other relevant qualitative factors in making the final portfolio reserve calculations.

 

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.

 

9


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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 greater than three months and less than twelve months when purchased, other than those debt instruments meeting this 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 broker-dealer operations are marked-to-market through “Asset management fees and other income.”

 

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, recoveries of principal on previously impaired 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.

 

Under the authoritative guidance for the recognition and presentation of other-than-temporary impairments for debt securities, an other-than-temporary impairment must be recognized in earnings for a debt security in an unrealized loss position when an entity either (a) has the intent to sell the debt security or (b) more likely than not

 

10


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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 guidance requires that the Company analyze 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 foreign currency denominated security in an unrealized loss position approaches maturity.

 

Under the authoritative guidance for the recognition and presentation of other-than-temporary impairments, 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 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 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 “Accumulated other comprehensive income (loss).”

 

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 prepayment assumptions, and are based on data from widely accepted third-party data sources or internal estimates. In addition to prepayment assumptions, cash flow estimates include 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.

 

11


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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 in insurance, investment and international businesses, and treasury operations to manage the interest rate and currency characteristics of assets or liabilities and to mitigate volatility, upon translation to U.S. dollars, 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 non-broker-dealer related 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 were also used in a derivative broker-dealer capacity in the Company’s global commodities group to meet the needs of clients by structuring transactions that allow clients to manage their exposure to interest rates, foreign exchange rates, indices or prices of securities and commodities. The Company’s global commodities group was sold on July 1, 2011. See Note 3 for further details. Realized and unrealized changes in fair value of derivatives used in these dealer related operations are included in “Income from discontinued operations, net of taxes” in the periods in which the changes occur. Cash flows from such derivatives are reported in the operating activities section of the Unaudited Interim Consolidated Statements of Cash Flows.

 

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 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

 

12


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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 “Accumulated other comprehensive income (loss)” 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 “Accumulated other comprehensive income (loss)” 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.” The 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 “Accumulated other comprehensive income (loss)” 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.

 

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 “Accumulated other comprehensive income (loss)” 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 derivative are clearly and closely related to the economic characteristics of the remaining component

 

13


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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 derivative 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 derivative 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 April 2011, the Financial Accounting Standards Board (“FASB”) issued updated guidance clarifying which restructurings constitute troubled debt restructurings. It is intended to assist creditors in their evaluation of whether conditions exist that constitute a troubled debt restructuring. This new guidance is effective for the first interim or annual reporting period beginning on or after June 15, 2011 and should be applied retrospectively to the beginning of the annual reporting period of adoption. The Company’s adoption of this guidance in the third quarter of 2011 did not have a material effect on the Company’s consolidated financial position, results of operations, or financial statement disclosures.

 

In December 2010, the FASB issued authoritative guidance for business combinations that modifies the first step of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform the second step of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with existing authoritative guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. This new guidance is effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2010. The Company’s adoption of this guidance effective January 1, 2011 did not have a material effect on the Company’s consolidated financial position, results of operations, and financial statement disclosures.

 

In December 2010, the FASB issued authoritative guidance that specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. This guidance expands the supplemental pro forma disclosures required for business combinations to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination(s) included in the reported pro forma revenue and earnings. This new guidance is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company adopted this guidance prospectively for business combinations for which the acquisition date is on or after January 1, 2011. The disclosures included in Note 3 reflect this guidance.

 

In July 2010, the FASB issued updated guidance that requires enhanced disclosures related to the allowance for credit losses and the credit quality of a company’s financing receivable portfolio. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The Company adopted this guidance effective December 31, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning after

 

14


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

December 15, 2010. The required disclosures are included above and in Note 4. In January 2011, the FASB deferred the disclosures required by this guidance related to troubled debt restructurings. These disclosures are effective for the first interim or annual reporting period beginning on or after June 15, 2011, concurrent with the effective date of guidance for determining what constitutes a troubled debt restructuring. The disclosures required by this guidance related to troubled debt restructurings were adopted in the third quarter of 2011 and are included above and in Note 4.

 

In April 2010, the FASB issued authoritative guidance clarifying that an insurance entity should not consider any separate account interests in an investment held for the benefit of policyholders to be the insurer’s interests, and should not combine those interests with its general account interest in the same investment when assessing the investment for consolidation, unless the separate account interests are held for a related party policyholder, whereby consolidation of such interests must be considered under applicable variable interest guidance. This guidance is effective for interim and annual reporting periods beginning after December 15, 2010 and retrospectively to all prior periods upon the date of adoption, with early adoption permitted. The Company’s adoption of this guidance effective January 1, 2011 did not have a material effect on the Company’s consolidated financial position, results of operations, and financial statement disclosures.

 

In January 2010, the FASB issued updated guidance that requires new fair value disclosures about significant transfers between Level 1 and 2 measurement categories and separate presentation of purchases, sales, issuances, and settlements within the roll forward of Level 3 activity. Also, this updated fair value guidance clarifies the disclosure requirements about level of disaggregation and valuation techniques and inputs. This new guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of Level 3 activity, which are effective for interim and annual reporting periods beginning after December 15, 2010. The Company adopted the guidance effective for interim and annual reporting periods beginning after December 15, 2009 on January 1, 2010. The Company adopted the guidance effective for interim and annual reporting periods beginning after December 15, 2010 on January 1, 2011. The required disclosures are provided in Note 13.

 

Future Adoption of New Accounting Pronouncements

 

In September 2011, the FASB issued updated guidance regarding the application of the goodwill impairment test. The updated guidance allows an entity to first perform a qualitative assessment to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is not necessary. However, if an entity concludes otherwise, then it must perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the impairment loss, if any. An entity has the option to bypass the qualitative assessment for any reporting unit in any period and to proceed directly to performing the first step of the two-step goodwill impairment test. An entity may resume performing the qualitative assessment in any subsequent period. The updated guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The Company is currently assessing the impact of this guidance on the Company’s financial statement disclosures but does not expect it to impact its consolidated financial position or results of operations.

 

In June 2011, the FASB issued updated guidance regarding the presentation of comprehensive income. The updated guidance eliminates the option to present components of other comprehensive income as part of the

 

15


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

statement of changes in stockholders’ equity. Under the updated guidance, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The updated guidance does not change the items that are reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. In October 2011, the FASB proposed a deferral of the requirement to separately present reclassifications from the components of other comprehensive income to the components of net income on the face of the financial statements. If the deferral is effective, companies would still be required to adopt the other requirements of the updated guidance. This updated guidance is effective for the first interim or annual reporting period beginning after December 15, 2011 and should be applied retrospectively. The Company expects this guidance to impact its financial statement presentation but not to impact the Company’s consolidated financial position or results of operations.

 

In May 2011, the FASB issued updated guidance regarding the fair value measurements and disclosure requirements. The updated guidance clarifies existing guidance related to the application of fair value measurement methods and requires expanded disclosures. This new guidance is effective for the first interim or annual reporting period beginning after December 15, 2011 and should be applied prospectively. The Company expects this guidance to have an impact on its financial statement disclosures but limited, if any, impact on the Company’s consolidated financial position or results of operations.

 

In April 2011, the FASB issued updated guidance regarding the assessment of effective control for repurchase agreements. This new guidance is effective for the first interim or annual reporting period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. The Company is currently assessing the impact of the guidance on the Company’s consolidated financial position, results of operations, and financial statement disclosures.

 

In October 2010, the FASB issued authoritative guidance to address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. Under the amended guidance, acquisition costs are to include only those costs that are directly related to the acquisition or renewal of insurance contracts by applying a model similar to the accounting for loan origination costs. An entity may defer incremental direct costs of contract acquisition with independent third parties or employees that are essential to the contract transaction, as well as the portion of employee compensation, including payroll fringe benefits, and other costs directly related to underwriting, policy issuance and processing, medical inspection, and contract selling for successfully negotiated contracts. This amended guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and permits, but does not require, retrospective application. The Company will adopt this guidance effective January 1, 2012, and expects to apply the retrospective method of adoption. Accordingly upon adoption, “Deferred policy acquisition costs” will be reduced and policy reserves for certain limited payment contracts within “Future policy benefits” will be increased with a corresponding reduction, net of taxes, to “Retained earnings” (and “Total equity”), as a result of acquisition costs previously deferred that are not eligible for deferral under the amended guidance. The Company estimates if the amended guidance were adopted as of September 30, 2011, retrospective adoption would reduce “Deferred policy acquisition costs” by approximately $4.0 billion to $5.0 billion, increase “Future policy benefits” by approximately $0.2 billion to $0.3 billion, and reduce “Total equity” by approximately $2.7 billion to $3.3 billion. Subsequent to the adoption of the guidance, the lower level of costs qualifying for deferral may be only partially offset by a lower level of amortization of “Deferred policy acquisition costs”, and, as such, may initially result in lower earnings in future periods, primarily within the International Insurance and Individual Annuities segments. The impact to the International Insurance segment largely reflects lower deferrals of allocated costs of its proprietary distribution system, while the impact to the Individual Annuities segment

 

16


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

reflects lower deferrals of its wholesaler costs. While the adoption of this amended guidance changes the timing of when certain costs are reflected in the Company’s results of operations, it has no effect on the total acquisition costs to be recognized over time and will have no impact on the Company’s cash flows.

 

3. ACQUISITIONS AND DISPOSITIONS

 

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 are Japanese corporations and their businesses are in Japan.

 

The Star and Edison Businesses primarily distribute individual life insurance, fixed annuities and certain accident and health products with fixed benefits through captive agents, independent agents, and banks. The addition of these operations to the Company’s existing businesses increases its scale in the Japanese insurance market and provides complementary distribution opportunities.

 

Prudential Financial intends to make a Section 338(g) election under the Internal Revenue Code with respect to the acquisition resulting in the acquired entities being treated for U.S. tax purposes as newly-incorporated companies. Under such election, the U.S. tax basis of the assets acquired and liabilities assumed of the Star and Edison Businesses were adjusted as of February 1, 2011 to reflect the consequences of the Section 338(g) election.

 

Although the acquisition of the Star and Edison Businesses included the acquisition of multiple entities, the Company views this as a single acquisition and reports it as such in the following disclosures.

 

17


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Net Assets Acquired

 

The following table presents an allocation of the purchase price to assets acquired and liabilities assumed at February 1, 2011 (the “Acquisition Date”):

 

     (in millions)  

Total invested assets at fair value(1)

   $ 43,103  

Cash and cash equivalents

     1,813  

Accrued investment income

     348  

Value of business acquired (“VOBA”)(2)

     3,769  

Goodwill(2)

     173  

Other assets(1)(2)(4)

     880  
  

 

 

 

Total assets acquired

     50,086  

Future policy benefits(2)(3)

     22,202  

Policyholders’ account balances(2)(3)(5)

     22,785  

Long-term debt

     496  

Other liabilities(2)

     390  

Total liabilities assumed

     45,873  
  

 

 

 

Net assets acquired

   $ 4,213  
  

 

 

 

 

(1) Total invested assets, at fair value, include $55 million of related party assets. Other assets include $86 million of related party assets.
(2) Reflects revisions to prior period presentation for correction of treatment of certain acquired policies and refinements to certain data.
(3) Reflects reclassifications to prior period presentation for correction of classification of certain acquired policies.
(4) Includes $678 million of deferred taxes representing the difference between U.S. GAAP and local tax basis. In accordance with U.S. GAAP, the utilization of deferred tax assets recorded on the statements of financial position as of the acquisition date for Star and Edison are estimated to result in additional tax expense in the future of approximately $440 million.
(5) Includes investment contracts reported at fair value, which exceeded the account value by $646 million.

 

VOBA

 

Value of business acquired (“VOBA”), which is established in accordance with purchase accounting guidance, is an intangible asset associated with the acquired in force insurance contracts representing the difference between the fair value and carrying value of the liabilities, determined as of the acquisition date. The fair value of the liabilities, and hence VOBA, reflects the cost of the capital attributable to the acquired insurance contracts. VOBA will be amortized over the expected life of the contracts in proportion to either gross premiums or gross profits, depending on the type of contract. Total gross profits will include both actual experience as it arises and estimates of gross profits for future periods. The Company will regularly evaluate and adjust the VOBA balance with a corresponding charge or credit to earnings for the effects of actual gross profits and changes in assumptions regarding estimated future gross profits. VOBA is reported as a component of “Other assets” and the amortization of VOBA is reported in “General and administrative expenses.” The proportion of the VOBA balance attributable to each of the product groups associated with this acquisition are as follows: 48% related to accident and health insurance products, 45% related to individual life insurance, and 7% related to fixed annuities.

 

18


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The following table provides estimated future amortization of VOBA, net of interest, relating to the Star and Edison Businesses for the periods indicated.

 

     (in millions)  

Remainder of 2011

   $ 115  

2012

   $ 424  

2013

   $ 367  

2014

   $ 319  

2015

   $ 276  

2016 and thereafter

   $ 2,174  

 

Information regarding the change in VOBA is as follows:

 

     (in millions)  

Balance as of February 1, 2011

   $ 3,769  

Amortization

     (356

Interest

     29  

Foreign currency translation

     233  
  

 

 

 

Balance as of September 30, 2011

   $ 3,675  
  

 

 

 

 

Goodwill

 

As a result of the acquisition of the Star and Edison Businesses, the Company recognized an asset for goodwill representing the excess of the acquisition cost over the net fair value of the assets acquired and liabilities assumed. Goodwill resulting from the acquisition of the Star and Edison Businesses amounted to $173 million. As a result of the intended Section 338(g) election and the assumed repatriation of U.S. GAAP earnings, the Company currently estimates 100% of this amount to be U.S. tax deductible in the future. In accordance with GAAP, goodwill will not be amortized but rather will be tested at least annually for impairment. The test will be performed at the reporting unit level which for this acquisition is the International Insurance segment’s Gibraltar Life and Other operations.

 

Results of the Star and Edison Businesses since the Acquisition Date

 

The Star and Edison Businesses use a November 30 fiscal year end for purposes of inclusion in the Company’s Consolidated Financial Statements. Due to this one month reporting lag, the Company’s Unaudited Interim Consolidated Financial Statements as of September 30, 2011 include the results for the Star and Edison Businesses from February 1, 2011 through August 31, 2011. The following table presents selected financial information reflecting results for the Star and Edison Businesses for the three months ended August 31, 2011 and from February 1, 2011 through August 31, 2011 that are included in the Company’s Unaudited Interim Consolidated Statements of Operations for the three and nine months ended September 30, 2011, respectively.

 

     Three Months Ended
August 31, 2011
     February 1, 2011 through
August 31, 2011
 
     (in millions)  

Total revenues

   $ 2,195      $ 3,804  

Income from continuing operations

     675        721  

 

The results of the Star and Edison Businesses in the table above include a pre-tax charge of $30 million for estimated claims and expenses arising from the earthquake and tsunami in Japan on March 11, 2011. The results of the Star and Edison Businesses in the table above do not reflect the impact of transaction and integration costs

 

19


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

on the Company’s results. Transaction costs represent costs directly related to effecting the acquisition. Integration costs are costs associated with the integration of the core operations of the Star and Edison Businesses with the Gibraltar Life operations. Both transaction and integration costs are expensed as incurred and are included in “General and administrative expenses.” For the three months ended September 30, 2011, the Company incurred $43 million of integration costs reflected in the International Insurance segment. For the nine months ended September 30, 2011, the Company incurred $119 million of transaction and integration costs reflected in the International Insurance segment and $8 million of costs related to the acquisition reflected in Corporate and Other operations.

 

Supplemental Unaudited Pro Forma Information

 

The following supplemental information presents selected unaudited pro forma information for the Company assuming the acquisition had occurred as of January 1, 2010. This pro forma information does not purport to represent what the Company’s actual results of operations would have been if the acquisition had occurred as of the date indicated or what such results would be for any future periods. The pro forma information does not reflect the impact of future events that may occur, including but not limited to, expense efficiencies arising from the acquisition and also does not give effect to certain one-time charges that the Company expects to incur, such as restructuring and integration costs.

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2011      2010  
     (in millions, except per share amounts)  

Total revenues

   $ 12,020      $ 38,670      $ 33,618  

Income from continuing operations

     1,869        3,188        3,166  

Net income attributable to Prudential Financial, Inc.

     1,873        3,145        3,186  

Earnings per share-Financial Services Businesses Basic:

        

Income from continuing operations attributable to Prudential Financial, Inc. per share of Common Stock

   $ 3.70      $ 6.31      $ 5.49  

Net income attributable to Prudential Financial, Inc. per share of Common Stock

     3.70        6.36        5.52  

Diluted:

        

Income from continuing operations attributable to Prudential Financial, Inc. per share of Common Stock

   $ 3.65      $ 6.23      $ 5.42  

Net income attributable to Prudential Financial, Inc. per share of Common Stock

     3.65        6.27        5.45  

Earnings per share-Closed Block Business Basic and Diluted:

        

Income from continuing operations attributable to Prudential Financial, Inc. per share of Class B Stock

   $ 33.50      $ 15.00      $ 243.50  

Net income attributable to Prudential Financial, Inc. per share of Class B Stock

     34.00        15.00        244.00  

 

20


Table of Contents

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
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011      2010  
     (in millions)  

Global commodities business

   $ (2   $ (10   $ 16      $ 19  

Real estate investments sold or held for sale

     3       1       21        5  

Korean asset management operations

     0       3       0        35  

Mexican asset management operations

     0       6       0        6  

Other

     0       1       0        0  
  

 

 

   

 

 

   

 

 

    

 

 

 

Income from discontinued operations before income taxes

     1       1       37        65  

Income tax expense (benefit)

     10       (1     16        45  
  

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) from discontinued operations, net of taxes

   $ (9   $ 2     $ 21      $ 20  
  

 

 

   

 

 

   

 

 

    

 

 

 

 

On April 6, 2011, the Company entered into a stock and asset purchase agreement with Jefferies Group, Inc. (“Jefferies”), pursuant to which the Company agreed to sell to Jefferies all of the issued and outstanding shares of capital stock of the Company’s subsidiaries that conduct its global commodities business (the “Global Commodities Business”) and certain assets that are primarily used in connection with the Global Commodities Business. Subsidiaries included in the sale are Prudential Bache Commodities, LLC, Prudential Bache Securities, LLC, Bache Commodities Limited, and Bache Commodities (Hong Kong) Ltd. On July 1, 2011, the Company completed the sale and received cash proceeds of $422 million, which includes a final purchase price true-up of $2 million received post closing. Included in the table above for the three and nine months ended September 30, 2011, are after-tax losses of $10 million and $17 million, respectively, recorded in connection with the sale of these operations. This consisted of pre-tax losses of $6 million and $18 million and income tax expense of $4 million and income tax benefit of $1 million, for the three and nine months ended September 30, 2011, respectively.

 

In the first quarter of 2010, the Company signed a definitive agreement to sell Prudential Investment & Securities Co. Ltd. and Prudential Asset Management Co. Ltd., which together comprise the Company’s Korean asset management operations. This transaction closed in the second quarter of 2010. Included within the table above for the nine months ended September 30, 2010, is an after-tax loss of $5 million recorded in connection with the sale of these operations, consisting of a pre-tax gain of $29 million and income tax expense of $34 million. Certain tax benefits related to the sale were recognized in the fourth quarter of 2009 as a result of the change in repatriation assumption of the earnings in these operations.

 

Real estate investments sold or held for sale reflects the income or loss 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:

 

     September 30,
2011
     December 31,
2010
 
     (in millions)  

Total assets

   $ 82      $ 7,068  

Total liabilities

   $ 95      $ 6,646  

 

21


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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:

 

     September 30, 2011  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
     Other-than-
temporary
Impairments
in AOCI(4)
 
     (in millions)  

Fixed maturities, available for sale

              

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

   $ 12,328      $ 2,641      $ 37      $ 14,932      $ 0   

Obligations of U.S. states and their political subdivisions

     2,621        378        18        2,981        0   

Foreign government bonds

     70,352        4,584        119        74,817        0   

Corporate securities

     118,895        9,863        3,007        125,751        (26

Asset-backed securities(1)

     12,561        196        1,828        10,929        (1,226

Commercial mortgage-backed securities

     12,002        614        151        12,465        6   

Residential mortgage-backed securities(2)

     9,775        556        94        10,237        (13
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities, available for sale

   $ 238,534      $ 18,832      $ 5,254      $ 252,112      $ (1,259
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities, available for sale(3)

   $ 7,082      $ 861      $ 481      $ 7,462     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

(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) As of September 30, 2011, perpetual preferred stocks of $1.3 billion were reclassified to “Other Trading Account Assets.” Prior periods were not restated.
(4) 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 $232 million of net unrealized gains on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date.

 

     September 30, 2011  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
     Other-than-
temporary
Impairments
in AOCI(4)
 
     (in millions)  

Fixed maturities, held to maturity

  

Foreign government bonds

   $ 1,257      $ 122      $ 0      $ 1,379      $ 0  

Corporate securities(1)

     1,122        25        72        1,075        0  

Asset-backed securities(2)

     1,250        65        0        1,315        0  

Commercial mortgage-backed securities

     446        79        0        525        0  

Residential mortgage-backed securities(3)

     1,120        70        0        1,190        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities, held to maturity(1)

   $ 5,195      $ 361      $ 72      $ 5,484      $ 0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes notes with amortized cost of $250 million (fair value, $292 million) which have been offset with the associated payables under a netting agreement.
(2) Includes credit tranched securities collateralized by auto loans, credit cards, education loans, and other asset types.
(3) Includes publicly traded agency pass-through securities and collateralized mortgage obligations.
(4) Represents the amount of other-than-temporary impairment losses in “Accumulated other comprehensive income (loss),” or “AOCI,” which were not included in earnings.

 

22


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

     December 31, 2010  
     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

   $ 10,930       $ 663       $ 295       $ 11,298       $ 0  

Obligations of U.S. states and their political subdivisions

     2,254         43         66         2,231         0  

Foreign government bonds

     47,414         2,920         95         50,239         0  

Corporate securities

     93,703         6,503         1,989         98,217         (30

Asset-backed securities(1)

     12,459         214         1,682         10,991         (1,413

Commercial mortgage-backed securities

     11,443         663         69         12,037         1  

Residential mortgage-backed securities(2)

     9,551         491         72         9,970         (13
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities, available for sale

   $ 187,754       $ 11,497       $ 4,268       $ 194,983       $ (1,455
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities, available for sale

   $ 6,469       $ 1,393       $ 121       $ 7,741      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

(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 $606 million of net unrealized gains on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date.

 

     December 31, 2010  
     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

   $ 1,199      $ 84      $ 0      $ 1,283      $ 0  

Corporate securities

     1,059        12        67        1,004        0  

Asset-backed securities(1)

     1,179        48        1        1,226        0  

Commercial mortgage-backed securities

     475        106        0        581        0  

Residential mortgage-backed securities(2)

     1,314        69        0        1,383        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities, held to maturity

   $ 5,226      $ 319      $ 68      $ 5,477      $ 0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes credit tranched securities collateralized by 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.

 

23


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

The amortized cost and fair value of fixed maturities by contractual maturities at September 30, 2011 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

   $ 9,108      $ 9,206      $ 0      $ 0  

Due after one year through five years

     47,158        47,968        76        77  

Due after five years through ten years

     54,326        57,415        369        379  

Due after ten years(1)

     93,604        103,892        1,934        1,998  

Asset-backed securities

     12,561        10,929        1,250        1,315  

Commercial mortgage-backed securities

     12,002        12,465        446        525  

Residential mortgage-backed securities

     9,775        10,237        1,120        1,190  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total(1)

   $ 238,534      $ 252,112      $ 5,195      $ 5,484  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes notes with amortized cost of $250 million (fair value, $292 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.

 

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
September 30,
    Nine Months Ended
September 30,
 
         2011             2010             2011             2010      
     (in millions)  

Fixed maturities, available for sale

        

Proceeds from sales

   $ 8,333     $ 2,562     $ 19,262     $ 8,961  

Proceeds from maturities/repayments

     3,804       3,986       13,062       11,762  

Gross investment gains from sales, prepayments, and maturities

     188       218       630       485  

Gross investment losses from sales and maturities

     (74     (46     (255     (165

Fixed maturities, held to maturity

        

Gross investment gains from prepayments

   $ 0     $ 0     $ 0     $ 0  

Proceeds from maturities/repayments

     68       108       338       332  

Equity securities, available for sale

        

Proceeds from sales

   $ 1,168     $ 512     $ 2,854     $ 1,960  

Gross investment gains from sales

     94       67       403       278  

Gross investment losses from sales

     (106     (13     (176     (49

Fixed maturity and equity security impairments

        

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

   $ (116   $ (90   $ (373   $ (483

Writedowns for impairments on equity securities

     (42     (25     (101     (101

 

(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.

 

24


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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 tables set 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.

 

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
September 30,
2011
    Nine Months
Ended
September 30,
2011
 
     (in millions)  

Balance, beginning of period

   $ 1,419     $ 1,493  

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

     (57     (294

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

     0        (31

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

     8       34  

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

     34       192  

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

     16       43  

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

     (7     (24
  

 

 

   

 

 

 

Balance, end of period

   $ 1,413     $ 1,413  
  

 

 

   

 

 

 

 

     Three Months
Ended
September 30,
2010
    Nine Months
Ended
September 30,
2010
 
     (in millions)  

Balance, beginning of period

   $ 1,775     $ 1,752  

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

     (42     (295

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

     (24     (32

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

     4       134  

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

     26       157  

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

     18       81  

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

     (10     (50
  

 

 

   

 

 

 

Balance, end of period

   $ 1,747     $ 1,747  
  

 

 

   

 

 

 

 

(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.

 

25


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

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:

 

    September 30, 2011     December 31, 2010  
    Amortized
Cost
    Fair
Value
    Amortized
Cost
    Fair
Value
 
    (in millions)  

Short-term investments and cash equivalents

  $ 1,096     $ 1,096     $ 697     $ 697  

Fixed maturities:

       

Corporate securities

    10,085       10,770       9,581       10,118  

Commercial mortgage-backed securities

    2,252       2,320       2,352       2,407  

Residential mortgage-backed securities(1)

    1,812       1,869       1,350       1,363  

Asset-backed securities(2)

    1,450       1,318       1,158       1,030  

Foreign government bonds

    638       648       567       569  

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

    544       572       467       448  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturities

    16,781       17,497       15,475       15,935  

Equity securities

    1,095       942       1,156       1,139  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total trading account assets supporting insurance liabilities

  $ 18,972     $ 19,535     $ 17,328     $ 17,771  
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(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.

 

The net change in unrealized gains and losses from trading account assets supporting insurance liabilities still held at period end, recorded within “Asset management fees and other income” included $12 million and $363 million of gains during the three months ended September 30, 2011 and 2010, respectively, and $120 million and $666 million of gains during the nine months ended September 30, 2011 and 2010, respectively.

 

26


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Other Trading Account Assets

 

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

 

    September 30, 2011     December 31, 2010  
    Amortized
Cost
    Fair
Value
    Amortized
Cost
    Fair
Value
 
    (in millions)  

Short-term investments and cash equivalents

  $ 3     $ 3     $ 3     $ 3  

Fixed Maturities:

       

Asset-backed securities

    713       673       706       661  

Residential mortgage-backed securities

    202       116       301       181  

Corporate securities

    280       284       319       318  

Commercial mortgage-backed securities

    162       120       144       103  

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

    66       72       212       214  

Foreign government bonds

    47       48       25       25  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturities

    1,470       1,313       1,707       1,502  

Other

    16       22       16       20  

Equity securities(1)

    1,736       1,676       548       561  
 

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

  $ 3,225     $ 3,014     $ 2,274     $ 2,086  
 

 

 

   

 

 

   

 

 

   

 

 

 

Derivative instruments

      3,548         2,139  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other trading account assets

  $ 3,225     $ 6,562     $ 2,274     $ 4,225  
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) As of September 30, 2011, perpetual preferred stocks of $1.3 billion were reclassified from “Equity securities, available for sale.” Additionally, $17 million was reclassified from OCI into Asset Management Fees and Other Income. Prior periods were not restated.

 

The net change in unrealized gains and losses from other trading account assets, excluding derivative instruments, still held at period end, recorded within “Asset management fees and other income” included $126 million of losses and $73 million of gains during the three months ended September 30, 2011 and 2010, respectively, and $23 million of losses and $47 million of gains during the nine months ended September 30, 2011 and 2010, 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.

 

27


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

As of September 30, 2011 and December 31, 2010, the Company was not exposed to any concentrations of credit risk of any single issuer greater than 10% of the Company’s stockholders’ equity, other than 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.

 

     September 30, 2011      December 31, 2010  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Investments in Japanese government and government agency securities:

  

Fixed maturities, available for sale

   $ 58,844      $ 62,232      $ 38,647      $ 40,752  

Fixed maturities, held to maturity

     1,257        1,379        1,199        1,283  

Trading account assets supporting insurance liabilities

     463        475        418        424  

Other trading account assets

     41        41        23        24  

Short-term investments

     162        162        0        0  

Cash equivalents

     0        0        0        0  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 60,767      $ 64,289      $ 40,287      $ 42,483  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     September 30, 2011      December 31, 2010  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (in millions)  

Investments in South Korean government and government agency securities:

  

Fixed maturities, available for sale

   $ 4,407      $ 4,914      $ 3,963      $ 4,238  

Fixed maturities, held to maturity

     0        0        0        0  

Trading account assets supporting insurance liabilities

     16        17        17        18  

Other trading account assets

     2        2        1        2  

Short-term investments

     0        0        0        0  

Cash equivalents

     0        0        0        0  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,425      $ 4,933      $ 3,981      $ 4,258  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

28


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Commercial Mortgage and Other Loans

 

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

 

    September 30, 2011     December 31, 2010  
    Amount
(in millions)
    % of
Total
    Amount
(in millions)
    % of
Total
 

Commercial and agricultural mortgage loans by property type:

       

Office buildings

  $ 6,428       20.4   $ 5,803       19.5

Retail

    6,845       21.8       6,388       21.4  

Apartments/Multi-Family

    5,270       16.7       5,140       17.2  

Industrial buildings

    6,944       22.1       6,576       22.1  

Hospitality

    1,539       4.9       1,584       5.3  

Other

    2,404       7.6       2,440       8.2  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial mortgage loans

    29,430       93.5       27,931       93.7  

Agricultural property loans

    2,052       6.5       1,893       6.3  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial and agricultural mortgage loans by property type

    31,482       100.0     29,824       100.0
   

 

 

     

 

 

 

Valuation allowance

    (353       (505  
 

 

 

     

 

 

   

Total net commercial and agricultural mortgage loans by property type

    31,129         29,319    
 

 

 

     

 

 

   

Other loans

       

Uncollateralized loans

    2,040         1,468    

Residential property loans

    1,075         891    

Other collateralized loans

    210         223    
 

 

 

     

 

 

   

Total other loans

    3,325         2,582    

Valuation allowance

    (53       (70  
 

 

 

     

 

 

   

Total net other loans

    3,272         2,512    
 

 

 

     

 

 

   

Total commercial mortgage and other loans(1)

  $ 34,401       $ 31,831    
 

 

 

     

 

 

   

 

(1) Includes loans held at fair value.

 

The commercial mortgage and agricultural property loans are geographically dispersed throughout the United States, Canada and Asia with the largest concentrations in California (27%), New York (11%) and Texas (7%) at September 30, 2011.

 

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

 

    September 30, 2011  
    Commercial
Mortgage
Loans
    Agricultural
Property
Loans
    Residential
Property
Loans
    Other
Collateralized
Loans
    Uncollateralized
Loans
    Total  
    (in millions)  

Allowance for losses, beginning of year

  $ 497     $ 8     $ 17     $ 20     $ 33     $ 575  

Addition to / (release of) allowance of losses

    (157     7       (1     3       0       (148

Charge-offs, net of recoveries

    0       0       0       (6     (15     (21

Change in foreign exchange

    (2     0       0       0       2       0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Ending Balance

  $ 338     $ 15     $ 16     $ 17     $ 20     $ 406  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

29


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

    December 31, 2010  
    Commercial
Mortgage
Loans
    Agricultural
Property
Loans
    Residential
Property
Loans
    Other
Collateralized
Loans
    Uncollateralized
Loans
    Total  
    (in millions)  

Allowance for losses, beginning of year

  $ 639     $ 0     $ 18     $ 20     $ 21     $ 698  

Addition to / (release of) allowance of losses

    (125     8       (2     1       11       (107

Charge-offs, net of recoveries

    (17     0       0       (1     0       (18

Change in foreign exchange

    0       0       1       0       1       2  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Ending Balance

  $ 497     $ 8     $ 17     $ 20     $ 33     $ 575  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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:

 

    September 30, 2011  
    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

  $ 131     $ 6     $ 0     $ 17     $ 0     $ 154  

Ending Balance: collectively evaluated for impairment

    207       9       16       0       20       252  

Ending Balance: loans acquired with deteriorated credit quality

    0       0       0       0       0       0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Ending Balance

  $ 338     $ 15     $ 16     $ 17     $ 20     $ 406  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recorded Investment:(1)

           

Ending balance gross of reserves: individually evaluated for impairment

  $ 1,576     $ 45     $ 0     $ 139     $ 6     $ 1,766  

Ending balance gross of reserves: collectively evaluated for impairment

    27,854       2,007       1,075       71       2,034       33,041  

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

    0       0       0       0       0       0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending balance, gross of reserves

  $ 29,430     $ 2,052     $ 1,075     $ 210     $ 2,040     $ 34,807  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

30


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

    December 31, 2010  
    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

  $ 264     $ 0     $ 0     $ 20     $ 16     $ 300  

Ending Balance: collectively evaluated for impairment

    233       8       17       0       17       275  

Ending Balance: loans acquired with deteriorated credit quality

    0       0       0       0       0       0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Ending Balance

  $ 497     $ 8     $ 17     $ 20     $ 33     $ 575  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recorded Investment:(1)

           

Ending balance gross of reserves: individually evaluated for impairment

  $ 2,279     $ 39     $ 0     $ 147     $ 36     $ 2,501  

Ending balance gross of reserves: collectively evaluated for impairment

    25,652       1,854       891       76       1,432       29,905  

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

    0       0       0       0       0       0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending balance, gross of reserves

  $ 27,931     $ 1,893     $ 891     $ 223     $ 1,468     $ 32,406  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

31


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 amounts due according to the contractual terms of the loan agreement will not all be collected. 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:

 

     As of September 30, 2011  
     Recorded
Investment(1)
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
Before
Allowance(3)
     Interest
Income
Recognized(2)
 
     (in millions)  

With no related allowance recorded:

              

Commercial mortgage loans:

              

Industrial

   $ 0      $ 0      $ 0      $ 1      $ 0  

Retail

     0        0        0        0        0  

Office

     0        0        0        1        0  

Apartments/Multi-Family

     0        0        0        0        0  

Hospitality

     0        0        0        28        0  

Other

     17        18        0        9        1  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial mortgage loans

     17        18        0        39        1  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Agricultural property loans

     1        0        0        1        0  

Residential property loans

     0        0        0        0        0  

Other collateralized loans

     0        0        0        0        0  

Uncollateralized loans

     6        12        0        6        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total with no related allowance

   $ 24      $ 30      $ 0      $ 46      $ 1  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

              

Commercial mortgage loans:

              

Industrial

   $ 37      $ 37      $ 19      $ 32      $ 0  

Retail

     38        38        4        120        1  

Office

     58        140        11        49        0  

Apartments/Multi-Family

     102        102        19        220        3  

Hospitality

     151        151        62        191        1  

Other

     95        95        16        102        3  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial mortgage loans

     481        563        131        714        8  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Agricultural property loans

     18        18        6        13        0  

Residential property loans

     0        0        0        6        0  

Other collateralized loans

     39        39        18        33        2  

Uncollateralized loans

     0        0        0        15        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total with related allowance

   $ 538      $ 620      $ 155      $ 781      $ 10  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total:

              

Commercial mortgage loans

   $ 498      $ 581      $ 131      $ 753      $ 9  

Agricultural property loans

     19        18        6        14        0  

Residential property loans

     0        0        0        6        0  

Other collateralized loans

     39        39        18        33        2  

Uncollateralized loans

     6        12        0        21        0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 562      $ 650      $ 155      $ 827      $ 11  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Recorded investment reflects the balance sheet carrying value gross of related allowance.
(2) The interest income recognized reflects the related year-to-date income, regardless of the impairment timing.
(3) Average recorded investment represents the average of the beginning-of-period and all subsequent quarterly end-of-period balances.

 

32


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

     As of December 31, 2010  
     Recorded
Investment(1)
     Unpaid
Principal
Balance
     Related
Allowance
 
     (in millions)  

With no related allowance recorded:

        

Commercial mortgage loans:

        

Industrial

   $ 0      $ 0      $ 0  

Retail

     0        0        0  

Office

     0        0        0  

Apartments/Multi-Family

     0        0        0  

Hospitality

     64        64        0  

Other

     0        0        0  
  

 

 

    

 

 

    

 

 

 

Total commercial mortgage loans

     64        64        0  
  

 

 

    

 

 

    

 

 

 

Agricultural property loans

     1        1        0  

Residential property loans

     0        0        0  

Other collateralized loans

     0        0        0  

Uncollateralized loans

     0        12        0  
  

 

 

    

 

 

    

 

 

 

Total with no related allowance

   $ 65      $ 77      $ 0  
  

 

 

    

 

 

    

 

 

 

With an allowance recorded:

        

Commercial mortgage loans:

        

Industrial

   $ 18      $ 18      $ 18  

Retail

     155        155        23  

Office

     43        43        10  

Apartments/Multi-Family

     323        323        103  

Hospitality

     218        218        89  

Other

     95        96        21  
  

 

 

    

 

 

    

 

 

 

Total commercial mortgage loans

     852        853        264  
  

 

 

    

 

 

    

 

 

 

Agricultural property loans

     0        0        0  

Residential property loans

     26        31        0  

Other collateralized loans

     29        29        20  

Uncollateralized loans

     35        38        16  
  

 

 

    

 

 

    

 

 

 

Total with related allowance

   $ 942      $ 951      $ 300  
  

 

 

    

 

 

    

 

 

 

Total:

        

Commercial mortgage loans

   $ 916      $ 917      $ 264  

Agricultural property loans

     1        1        0  

Residential property loans

     26        31        0  

Other collateralized loans

     29        29        20  

Uncollateralized loans

     35        50        16  
  

 

 

    

 

 

    

 

 

 

Total

   $ 1,007      $ 1,028      $ 300  
  

 

 

    

 

 

    

 

 

 

 

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

 

Impaired commercial mortgage and other loans with no allowance for losses are loans in which the fair value of the collateral or the net present value of the loans’ expected future cash flows equals or exceeds the recorded investment. The average recorded investment in impaired loans with an allowance recorded, before the

 

33


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

allowance for losses, was $750 million at December 31, 2010. Net investment income recognized on these loans totaled $35 million for the year ended December 31, 2010. See Note 2 for information regarding the Company’s accounting policies for commercial mortgage and other loans.

 

The net carrying value of commercial and other loans held for sale by the Company as of September 30, 2011 and December 31, 2010 was $120 million and $136 million, respectively. In all these transactions, the Company pre-arranges that it will sell the loan to an investor. As of September 30, 2011 and December 31, 2010, 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.

 

The following tables set forth the credit quality indicators as of September 30, 2011, based upon the recorded investment gross of allowance for credit losses.

 

Commercial mortgage loans—Industrial buildings

 

    Debt Service Coverage Ratio—September 30, 2011  
    Greater than
2.0X
    1.8X to 2.0X     1.5X to <1.8X     1.2X to <1.5X     1.0X to <1.2X     Less than
1.0X
    Grand Total  
    (in millions)  

Loan-to-Value Ratio

             

0%-49.99%

  $ 654     $ 176     $ 205     $ 280     $ 69     $ 28     $ 1,412  

50%-59.99%

    420       84       280       283       66       50       1,183  

60%-69.99%

    410       414       547       338       448       90       2,247  

70%-79.99%

    9       10       269       420       296       211       1,215  

80%-89.99%

    0       0       0       236       97       240       573  

90%-100%

    19       0       0       0       0       131       150  

Greater than 100%

    0       16       0       0       18       130       164  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Industrial

  $ 1,512     $ 700     $ 1,301     $ 1,557     $ 994     $ 880     $ 6,944  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Commercial mortgage loans—Retail

 

    Debt Service Coverage Ratio—September 30, 2011  
    Greater than
2.0X
    1.8X to 2.0X     1.5X to <1.8X     1.2X to <1.5X     1.0X to <1.2X     Less than
1.0X
    Grand Total  
    (in millions)  

Loan-to-Value Ratio

             

0%-49.99%

  $ 1,226     $ 147     $ 528     $ 194     $ 24     $ 7     $ 2,126  

50%-59.99%

    972       262       179       92       43       4       1,552  

60%-69.99%

    66       290       919       437       60       17       1,789  

70%-79.99%

    123       34       379       343       147       26       1,052  

80%-89.99%

    0       32       0       30       61       29       152  

90%-100%

    0       0       19       27       44       33       123  

Greater than 100%

    0       0       0       26       25       0       51  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Retail

  $ 2,387     $ 765     $ 2,024     $ 1,149     $ 404     $ 116     $ 6,845  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

34


Table of Contents

PRUDENTIAL FINANCIAL, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements—(Continued)

 

Commercial mortgage loans—Office

 

    Debt Service Coverage Ratio—September 30, 2011  
    Greater than
2.0X
    1.8X to 2.0X     1.5X to <1.8X     1.2X to <1.5X     1.0X to <1.2X     Less than
1.0X
    Grand Total  
    (in millions)  

Loan-to-Value Ratio

             

0%-49.99%

  $ 1,722     $ 224     $ 191     $ 160     $ 22     $ 31     $ 2,350  

50%-59.99%

    521       104       209       200       0       37       1,071  

60%-69.99%

    529       415       60       593       17       54       1,668  

70%-79.99%

    83       0       31       50       209       589       962  

80%-89.99%

    0       0       5       138       71       19       233  

90%-100%

    0       0       17       34       0       9       60  

Greater than 100%

    0       0       17       42       0       25       84  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Office

  $ 2,855     $ 743     $ 530     $ 1,217     $ 319     $ 764     $ 6,428  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Commercial mortgage loans—Apartments/Multi-Family

 

    Debt Service Coverage Ratio—September 30, 2011  
    Greater than
2.0X
    1.8X to 2.0X     1.5X to <1.8X     1.2X to <1.5X     1.0X to <1.2X     Less than
1.0X
    Grand Total  
    (in millions)  

Loan-to-Value Ratio

             

0%-49.99%

  $ 619     $ 175     $ 366     $ 198     $ 194     $ 119     $ 1,671  

50%-59.99%

    50       14       247       130       61       41       543  

60%-69.99%

    402       18       82       240       54       156       952  

70%-79.99%

    179       128       78       655       161       22       1,223  

80%-89.99%

    0       0       118       0       191       138       447  

90%-100%

    0       0       0       0       2       88       90  

Greater than 100%

    0       0       7       36       37       264       344