Prudential Annuities Life Assurance
Corporation
(Exact Name of Registrant as Specified in its Charter)
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Connecticut
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06-1241288
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(State or Other Jurisdiction
of Incorporation or Organization)
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(I.R.S. Employer
Identification Number)
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One Corporate Drive
Shelton, Connecticut 06484
(203) 926-1888
(Address and Telephone Number of Registrant’s
Principal Executive Offices)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
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No
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Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or 15(d) of the Act.
Yes
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No
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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
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No
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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
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No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
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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. (Check one):
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Large accelerated filer
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Non-accelerated filer
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Smaller reporting company
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Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act.) Yes
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No
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Indicate the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant:
Voting: NONE Non-voting: NONE
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest
practicable date:
As of March 15, 2011, 25,000 shares of the registrant’s Common Stock (par value
$100) consisting of 100 voting shares and 24,900 non-voting shares, were outstanding. As of such date, Prudential Annuities, Inc., formerly known as American Skandia, Inc., an indirect wholly owned subsidiary of Prudential Financial, Inc., a New
Jersey corporation, owned all of the registrant’s Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
THE INFORMATION REQUIRED TO BE FURNISHED PURSUANT TO PART III OF THIS FORM 10-K IS SET FORTH IN, AND IS HEREBY INCORPORATED BY REFERENCE
HEREIN FROM, THE DEFINITIVE PROXY STATEMENT OF PRUDENTIAL FINANCIAL, INC. FOR THE ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON MAY 10, 2011, TO BE FILED BY PRUDENTIAL FINANCIAL, INC. WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO REGULATION
14A NOT LATER THAN 120 DAYS AFTER DECEMBER 31, 2010.
Prudential Annuities Life Assurance Corporation meets the
conditions set
forth in General Instruction (I) (1) (a) and (b) on Form 10-K and
is therefore filing this Form 10-K with the reduced disclosure format.
TABLE OF CONTENTS
Forward-Looking Statements
Certain of the statements included in this Annual Report on Form 10-K, 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 Annuities Life
Assurance Corporation. There can be no assurance that future developments affecting Prudential Annuities Life Assurance Corporation 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 or valuation of business acquired; (9) changes in our financial strength or credit ratings; (10) investment losses, defaults and counterparty
non-performance; (11) competition in our product lines and for personnel; (12) changes in tax law; (13) regulatory or legislative changes, including the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act;
(14) inability to protect our intellectual property rights or claims of infringement of the intellectual property rights of others; (15) adverse determinations in litigation or regulatory matters and our exposure to contingent liabilities;
(16) 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; (17) ineffectiveness of risk management policies and
procedures in identifying, monitoring and managing risks; (18) interruption in telecommunication, information technology or other operational systems or failure to maintain the security, confidentiality or privacy of sensitive data on such
systems; and (19) changes in statutory or U.S. GAAP accounting principles, practices or policies . Prudential Annuities Life Assurance Corporation does not intend, and is under no obligation, to update any particular forward-looking statement
included in this document. See “Risk Factors” included in this Annual Report on Form 10-K for a discussion of certain risks relating to our businesses and investment in our securities.
PART 1
Item 1. Business
Overview
Prudential Annuities Life Assurance Corporation (the “Company”, “we”, or “our”), formerly known as American
Skandia Life Assurance Corporation, with its principal offices in Shelton, Connecticut, is an indirect wholly-owned subsidiary of Prudential Financial, Inc. (“Prudential Financial”), a New Jersey corporation. The Company is a direct wholly
owned subsidiary of Prudential Annuities, Inc. (“PAI”), formerly known as American Skandia, Inc., which in turn is an indirect wholly owned subsidiary of Prudential Financial. On December 19, 2002, Skandia Insurance Company Ltd.
(publ) (“Skandia”), an insurance company organized under the laws of the Kingdom of Sweden, and the ultimate parent company of the Company prior to May 1, 2003, entered into a definitive purchase agreement (the “Acquisition
Agreement”) with Prudential Financial, whereby Prudential Financial would acquire the Company and certain of its affiliates (the “Acquisition”) and would be authorized to use the American Skandia name through April, 2008. On
May 1, 2003, the Acquisition was consummated. Thus, the Company is now an indirect wholly owned subsidiary of Prudential Financial. During 2007, we began the process of changing the Company’s name and the names of various legal entities
that include the “American Skandia” name, as required by the terms of the Acquisition. The Company’s name was changed effective January 1, 2008.
The Company was established in 1988 and is a significant provider of variable annuity contracts for the individual market in the United States. The Company’s products are sold primarily to
individuals to provide for long-term savings and retirement needs and to address the economic impact of premature death, estate planning concerns and supplemental retirement income. The investment performance of the registered investment companies
supporting the variable annuity contracts, which is principally correlated to equity market performance, can significantly impact the market for the Company’s products.
PAI, the direct parent of the Company, may make additional capital contributions to the Company, as needed, to enable the Company to comply with its reserve requirements and fund expenses in connection
with its business. Generally, PAI is under no obligation to make such contributions and its assets do not back the benefits payable under the Company’s annuity contracts and life insurance. During 2010 and 2009, PAI made no capital
contributions to the Company. During 2008, PAI made capital contribution of $540.8 million to the Company.
Products
The Company has sold a wide array of annuities, including deferred and immediate variable annuities that are registered with the United
States Securities and Exchange Commission (the “SEC”), which may also include (1) fixed interest rate allocation options, subject to a market value adjustment, and registered with the SEC, and (2) fixed-rate allocation options
not subject to a market value adjustment and not registered with the SEC. In addition, the Company has a relatively small in force block of variable life insurance policies, but it no longer actively sells such policies.
Beginning in March 2010, the Company ceased offering its existing variable annuity products (and where offered, the companion market
value adjustment option) to new investors upon the launch of a new product in each of Pruco Life Insurance Company and Pruco Life Insurance Company of New Jersey (which are affiliates of the Company within the Prudential Annuities business unit of
Prudential Financial). In general, the new product line offers the same optional living benefits and optional death benefits as offered by the Company’s existing variable annuities. However, subject to applicable contractual provisions and
administrative rules, the Company will continue to accept subsequent purchase payments on inforce contracts under existing annuity products. These initiatives were implemented to create operational and administrative efficiencies by offering a
single product line of annuity products from a more limited group of legal entities. In addition, by limiting its variable annuity offerings to a single product line sold through one insurer (and its affiliate, for New York sales), the Prudential
Annuities business unit of Prudential Financial expects to convey a more focused, cohesive brand in the marketplace.
The
Company’s variable annuities provide its customers with tax-deferred asset accumulation together with a base death benefit and a suite of optional guaranteed death and living benefits. The benefit features contractually guarantee the
contractholder a return of no less than (1) total deposits made to the contract less any partial withdrawals (“return of net deposits”), (2) total deposits made to the contract less any partial withdrawals plus a minimum return
(“minimum return”), and/or (3) the highest contract value on a specified date minus any withdrawals (“contract value”). These guarantees may include benefits that are payable in the event of death, annuitization or at
specified dates during the accumulation period and withdrawal and income benefits payable during specified periods. Our latest optional living benefits guarantee, among other features, the ability to make withdrawals based on the highest daily
contract value plus a minimum return, credited for a period of time. This highest daily guaranteed contract value is accessible through periodic withdrawals for the life of the contractholder, and not as a lump-sum surrender value.
Our variable annuity investment options provide our customers with the opportunity to invest in proprietary and non-proprietary mutual
funds, frequently under asset allocation programs, and fixed-rate accounts. The investments made by customers in the proprietary and non-proprietary mutual funds generally represent separate account interests that provide a return linked to an
underlying investment portfolio. The general account investments made in the fixed-rate accounts are credited with interest at rates we determine, subject to certain minimums. We also offer fixed annuities that provide a guarantee of principal and
interest credited at rates we determine, subject to certain contractual minimums. Certain investments made in the fixed-rate accounts of our variable annuities and certain fixed annuities impose a market value adjustment if the invested amount is
not held to maturity. Based on the contractual terms the market value adjustment can be positive, resulting in an additional amount for the contractholder, or negative, resulting in a deduction from the contractholder’s account value or
redemption proceeds.
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The primary risk exposures of our variable annuity contracts relate to actual deviations
from, or changes to, the assumptions used in the original pricing of these products, including equity market returns, interest rates, market volatility, timing of annuitization and withdrawals, contract lapses and contractholder mortality. The rate
of return we realize from our variable annuity contracts will vary based on the extent of the differences between our actual experience and the assumptions used in the original pricing of these products. As part of our risk management strategy we
hedge or limit our exposure to certain of these risks primarily through a combination of product design elements, such as an asset transfer feature, externally purchased hedging instruments and affiliated reinsurance arrangements with Pruco
Reinsurance, Ltd. (“Pruco Re”) and The Prudential Insurance Company of America (“Prudential Insurance”). Our returns can also vary by contract based on our risk management strategy, including the impact of any capital markets
movements that we may hedge in the affiliate, the impact on that portion of our variable annuity contracts that benefit from the asset transfer feature and the impact of risks that are not able to be hedged.
As of December 31, 2010 approximately $42.1 billion or 79% of total variable annuity account values contain a living benefit
feature, compared to approximately $36.3 billion or 76% as of December 31, 2009. As of December 31, 2010 approximately $29.0 billion or 69% of variable annuity account values with living benefit features included an asset transfer feature
in the product design, compared to approximately $21.6 billion or 59% as of December 31, 2009. The asset transfer feature, included in the design of certain optional living benefits, transfers assets between the variable investments selected by
the annuity contractholder and, depending on the benefit feature, a fixed rate account in the general account or a bond portfolio within the separate account. The potential transfers are based on the static mathematical formula used with the
particular optional benefit which considers a number of factors, including the impact of investment performance on the contractholder’s total account value. In general, negative investment performance may result in transfers to either a fixed
rate account in the general account or a bond portfolio within the separate account, and positive investment performance may result in transfers back to contractholder-selected investments. Overall, the asset transfer feature is designed to help
mitigate our exposure to equity market risk and market volatility. Beginning in 2009, our offerings of optional living benefit features associated with variable annuity products all include an asset transfer feature, and in 2009 we discontinued any
new sales of optional living benefit features without an asset transfer feature. Other product design elements we utilize for certain products to manage these risks include investment option restrictions and minimum issuance age requirements.
As mentioned above, in addition to our asset transfer feature, we also manage certain risks associated with our variable
annuity products through hedging programs and affiliated reinsurance arrangements. Primarily in the reinsurance affiliates, we purchase equity options and futures as well as interest rate derivatives are purchased to hedge certain optional living
benefit features accounted for as embedded derivatives against changes in equity markets, interest rates, and market volatility. Historically, the hedging strategy sought to generally match the sensitivities of the embedded derivative liability as
defined by GAAP, excluding the impact of the market-perceived risk of non-performance, with capital market derivatives and options. In the third quarter of 2010, the hedging strategy was revised as, in the current low interest rate environment,
management of the company and reinsurance affiliates does not believe the GAAP value of the embedded derivative liability to be an appropriate measure for determining the hedge target. The new hedge target continues to be grounded in a GAAP/capital
markets valuation framework but incorporates modifications to the risk-free return assumption to account for the fact that the underlying customer separate account funds which support these living benefits are invested in assets that contain risk.
Consistent with sound risk management practices, management of the company and reinsurance affiliates evaluates hedge levels versus the target given the overall capital considerations of our ultimate parent Company, Prudential Financial Inc., and
prevailing capital market conditions and may decide to temporarily hedge to an amount that differs from the hedge target definition. This new strategy will result in differences each period between the change in the value of the embedded derivative
liability as defined by GAAP and the change in the value of the hedge positions, potentially increasing volatility in GAAP earnings in the reinsurance affiliate, and increasing volatility in the amortization of deferred acquisition and other costs
of the Company as a result of the gross profit impact.
In the second quarter of 2009, we began the expansion of our hedging
program to include a portion of the market exposure related to the overall capital position of our variable annuity business, including the impact of certain statutory reserve exposures. These capital hedges primarily consisted of equity-based total
return swaps that were designed to partially offset changes in our capital position resulting from market driven changes in certain living and death benefit features of our variable annuity products. During the second quarter of 2010, we terminated
the capital hedge program in lieu of a new program managed at the Prudential Financial parent company level that more broadly addresses equity market exposure of the overall statutory capital of Prudential Financial as a whole, under stress
scenarios.
Marketing and Distribution
The Company has sold its annuity products through multiple distribution channels, including (1) independent broker-dealer firms and financial planners; (2) broker-dealers that are members of the
New York Stock Exchange, including “wirehouse” and regional broker-dealer firms; and (3) broker-dealers affiliated with banks or that specialize in marketing to customers of banks. Although the Company has sold in each of those
distribution channels, the majority of the Company’s sales have come from the independent broker-dealer firms and financial planners. The Company has selling agreements with over eight hundred broker-dealer firms and financial institutions.
Underwriting and Pricing
We earn asset administration fees and other fees determined as a percentage of the average assets of the proprietary mutual funds in our variable annuity products. We also earn mortality and expense fees
and other fees for various insurance-related options and features, including optional guaranteed death and living benefit features, based on the average daily net asset value of the annuity separate accounts or the amount of guaranteed value under
the optional living benefit, as applicable. We also receive fees from certain affiliated and unaffiliated underlying non-proprietary mutual funds (or their affiliates) for administrative services that we perform. We priced our variable annuities,
including optional guaranteed death and living benefits, based on an evaluation of the risks assumed and considering applicable hedging costs. We priced our fixed annuities as well as the fixed-rate accounts of our variable annuities based on
assumptions as to investment
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returns, expenses and persistency. Competition also influences our pricing. We seek to maintain a spread between the return on our general account invested assets and the interest we credit on
our fixed annuities and the fixed-rate accounts of our variable annuities. For assets transferred to a fixed rate account in the general account pursuant to the asset transfer feature discussed above, we earn a spread for the difference between the
return on our general account invested assets and the interest credited, similar to our fixed annuities. To encourage persistency, most of our variable and fixed annuities have surrender or withdrawal charges for a specified number of years.
Reserves
We
establish and carry as liabilities actuarially-determined reserves for future policy benefits that we believe will meet our future obligations for our in force annuity contracts, including the death benefit and living benefit guarantee features
associated with some of these contracts. We base these reserves on assumptions we believe to be appropriate for investment yield, persistency, expenses, withdrawal rates, mortality rates, as well as margins for adverse deviation. Certain of the
living benefit guarantee features on variable annuity contracts are accounted for as embedded derivatives and are carried at fair value. The fair values of these benefit features are calculated as the present value of future expected benefit
payments to customers less the present value of assessed rider fees attributable to the embedded derivative feature, and are based on management’s expectation of how a market participant would value these embedded derivative liabilities. These
features are generally reinsured with an affiliated company. We establish liabilities for policyholders’ account balances that represent cumulative gross premium payments plus credited interest and/or fund performance, less withdrawals, and all
applicable mortality and expense charges.
Reinsurance
The Company uses reinsurance as part of its risk management and capital management strategies for certain of its optional living benefit features.
During 2009, the Company entered into two reinsurance agreements with an affiliate as part of its risk management and capital management
strategies. Effective August 24, 2009, the Company entered into a coinsurance agreement with Pruco Reinsurance, Ltd (“Pruco Re”) providing for the 100% reinsurance of its Highest Daily Lifetime 6 Plus (“HD6 Plus”) and
Spousal Highest Daily Lifetime 6 Plus (“SHD6 Plus”) benefit features sold on certain of its annuities. Effective June 30, 2009, the Company entered into a coinsurance agreement with Pruco Re providing for the 100% reinsurance of its
Highest Daily Lifetime 7 Plus (“HD7 Plus”) and Spousal Highest Daily Lifetime 7 Plus (“SHD7 Plus”) benefit features sold on certain of its annuities.
During 2008, the Company entered into three reinsurance agreements with an affiliate as part of its risk management and capital management strategies. Effective January 28, 2008, the Company entered
into a coinsurance agreement with an affiliate, Pruco Re providing for the 100% reinsurance of its Highest Daily Lifetime Seven (“HD7”) and Spousal Highest Daily Lifetime Seven (“SHD7”) benefit features sold on certain of its
annuities. Effective January 28, 2008, the Company entered into a coinsurance agreement with Pruco Re providing for the 100% reinsurance of its Guaranteed Return Option Plus (“GRO Plus”) benefit feature sold on certain of its
annuities. This agreement was amended effective January 1, 2010 to include a form of the GRO Plus benefit feature (“GRO Plus II”) on business issued after November 16, 2009.
Effective January 28, 2008 the Company
entered into a coinsurance agreement with Pruco Re providing for the 100% reinsurance of its Highest Daily Guaranteed Return Option (“HD GRO”) benefit feature sold on certain of its annuities. This agreement was amended effective
January 1, 2010 to include a form of the HD GRO benefit feature (“HD GRO II”) on business issued after November 16, 2009.
Regulatory Environment
In order to continue to market annuity products,
the Company must meet or exceed the statutory capital and surplus requirements of the state insurance regulators of the states in which it conducts business. Statutory accounting practices differ from U.S. GAAP in two major respects. First, under
statutory accounting practices, the acquisition costs of new business are charged to expense, while under U.S. GAAP they are initially deferred and amortized over a period of time. Second, under statutory accounting practices, the required additions
to statutory reserves for new business in some cases may initially exceed the statutory revenues attributable to such business. These practices result in a reduction of statutory income and surplus at the time of recording new business.
Insurance companies are subject to Risk Based Capital (“RBC”) guidelines, monitored by state insurance regulators that measure
the ratio of the Company’s statutory surplus with certain adjustments to its required capital, based on the risk characteristics of its insurance liabilities and investments. Required capital is determined by statutory formulas that consider
risks related to the type and quality of invested assets, insurance-related risks associated with the Company’s products, interest rate risks and general business risks. The RBC calculations are intended to assist regulators in measuring the
adequacy of the Company’s statutory capitalization.
The Company considers RBC implications in its asset/liability
management strategies. Each year, the Company conducts a thorough review of the adequacy of its statutory insurance reserves and other actuarial liabilities. The review is performed to ensure that the Company’s statutory reserves are computed
in accordance with accepted actuarial standards, reflect all contractual obligations, meet the requirements of state laws and regulations and include adequate provisions for any other actuarial liabilities that need to be established. All
significant statutory reserve changes are reviewed by the Board of Directors and are subject to approval by the State of Connecticut Insurance Department (the “Insurance Department”). The Company believes that its statutory capital is
adequate for its currently anticipated levels of risk as measured by applicable regulatory guidelines.
Changes in statutory
capital requirements for our variable annuity products under an NAIC initiative known as “C-3 Phase II” became effective as of December 31, 2005.
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The NAIC has developed a set of financial relationships or tests known as the Insurance
Regulatory Information System (“IRIS”) to assist state regulators in monitoring the financial condition of insurance companies and identifying companies that require special attention or action by insurance regulatory authorities.
Insurance companies generally submit data annually to the NAIC, which in turn analyzes the data using prescribed financial data ratios, each with defined “usual ranges.” Generally, regulators will begin to investigate or monitor an
insurance company if its ratios fall outside the usual ranges for four or more of the ratios. If an insurance company has insufficient capital, regulators may act to reduce the amount of insurance it can issue. The Company is not currently subject
to regulatory scrutiny based on these ratios.
Effective with the annual reporting period ending December 31, 2010, the
NAIC adopted revisions to the Annual Financial Reporting Model Regulation, or the Model Audit Rule, related to auditor independence, corporate governance and internal control over financial reporting. The adopted revisions require that we file
reports with the state insurance departments regarding our assessment of internal controls over financial reporting.
The
Company is subject to the regulations of the Insurance Department. A detailed financial statement in the prescribed form (the “Annual Statement”) is filed with the Insurance Department each year covering the Company’s operations for
the preceding year and its financial position as of the end of that year. Regulation by the Insurance Department includes periodic examinations to verify the accuracy of our contract liabilities and reserves. The Company’s books and accounts
are subject to review by the Insurance Department at all times. A full examination of the Company’s operations is conducted periodically by the Insurance Department and under the auspices of the NAIC. In May of 2007, the Connecticut insurance
regulator completed a routine financial examination of the Company for the five year period ended December 31, 2005, and found no material deficiencies.
The Company is subject to regulation under the insurance laws of all jurisdictions in which it operates. The laws of the various jurisdictions establish supervisory agencies with broad administrative
powers with respect to various matters, including licensing to transact business, overseeing trade practices, licensing agents, approving contract forms, establishing reserve requirements, fixing maximum interest rates on life insurance contract
loans and minimum rates for accumulation of surrender values, prescribing the form and content of required financial statements and regulating the type and amounts of permitted investments. The Company is required to file the Annual Statement with
supervisory agencies in each of the jurisdictions in which it does business, and its operations and accounts are subject to examination by these agencies at regular intervals.
Although the federal government generally does not directly regulate the business of insurance, federal initiatives often have an impact on our business in a variety of ways. Certain insurance products of
the Company are subject to various federal securities laws and regulations. In addition, current and proposed federal measures that may significantly affect the insurance business include regulation of insurance company solvency, employee benefit
regulation, the removal of barriers preventing banks from engaging in the insurance business, tax law changes affecting the taxation of insurance companies and the tax treatment of insurance products and its impact on the relative desirability of
various personal investment vehicles.
Finally, although the Company itself is not registered as a broker-dealer with the SEC
or the Financial Industry Regulatory Authority (“FINRA”), those who sell the Company’s variable annuities generally are subject to FINRA and SEC regulations. Of particular note, FINRA adopted Rule 2330, which establishes sales
practices standards and supervisory requirements specifically targeted to variable annuities. Rule 2330 represents additional FINRA regulation of variable annuities, and does not replace existing FINRA rules. Such regulations may have a significant
impact on the Company’s variable annuity business.
Insurance Reserves
State insurance laws require us to analyze the adequacy of our reserves annually. The respective appointed actuaries must each submit an
opinion that our reserves, when considered in light of the assets we hold with respect to those reserves, make adequate provision for our contractual obligations and related expenses.
Market Conduct Regulation
State insurance laws and regulations include
numerous provisions governing the marketplace activities of insurers, including provisions governing the form and content of disclosure to consumers, illustrations, advertising, sales practices and complaint handling. State regulatory authorities
generally enforce these provisions through periodic market conduct examinations.
Insurance Guaranty Association Assessments
Each state has insurance guaranty association laws under which insurers doing business in the state are members and may be
assessed by state insurance guaranty associations for certain obligations of insolvent insurance companies to policyholders and claimants. Typically, states assess each member insurer in an amount related to the member insurer’s proportionate
share of the business written by all member insurers in the state. While we cannot predict the amount and timing of any future assessments on the Company under these laws, we have established reserves that we believe are adequate for assessments
relating to insurance companies that are currently subject to insolvency proceedings.
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State Securities Regulation
Certain states may deem our variable annuity products as “securities” within the meaning of state securities laws. As securities, variable annuities may be subject certain requirements. Also,
sales activities with respect to these products generally are subject to state securities regulation. Such regulation may affect sales and related activities for these products.
Federal Regulation
Our variable annuity products and our registered market
value adjustment options, generally are “securities” within the meaning of federal securities laws, registered under the federal securities laws and subject to regulation by the SEC and FINRA. Although the federal government does not
comprehensively regulate the business of insurance, federal legislation and administrative policies in several areas, including financial services regulation, taxation and pension and welfare benefits regulation, can significantly affect the
insurance industry. Congress also periodically considers and is considering laws affecting privacy of information and genetic testing that could significantly and adversely affect the insurance industry.
In view of recent events involving certain financial institutions, it is possible that the U.S. federal government will heighten its
oversight of companies in the financial services industry such as us, including possibly through a federal system of insurance regulation. Indeed, the Dodd-Frank Act establishes a Federal Insurance Office within the Department of the Treasury to be
headed by a director appointed by the Secretary of the Treasury. While not having a general supervisory or regulatory authority over the business of insurance, the director of this office will perform various functions with respect to insurance
(other than health insurance), including serving as a non-voting member of the Financial Stability Oversight Council (the “Council”) and making recommendations to the Council regarding insurers to be designated for stricter regulation. The
director is also required to conduct a study on how to modernize and improve the system of insurance regulation in the United States, including by increased national uniformity through either a federal charter or effective action by the states.
U.S Tax Legislation
Current U.S. federal income tax laws generally permit certain holders to defer taxation on the build-up of value of annuities and life insurance products until payments are actually made to the
policyholder or other beneficiary and to exclude from taxation the death benefit paid under a life insurance contract. Congress from time to time considers legislation that could make our products less attractive to consumers, including legislation
that would reduce or eliminate the benefit of this deferral on some annuities and insurance products, as well as other types of changes that could reduce or eliminate the attractiveness of annuities and life insurance products to consumers such as
changes to estate tax. The estate tax was completely eliminated for 2010, but modified carryover basis rules applied for property acquired from decedent’s dying in that year. The estate tax has been reinstated through 2012 with a five million
individual exemption, a 35% maximum rate and step-up in basis rules for property acquired from a decedent. Estates of decedents who died in 2010 can choose between the rules that were in effect in 2010 or the new rules. It is unclear what Congress
will do with respect to the estate tax after 2012.
Legislative or regulatory changes could also impact the amount of taxes
that we pay, thereby affecting our consolidated net income. For example, the U.S. Treasury Department and the Internal Revenue Service intend to address through regulations the methodology to be followed in determining the dividends received
deduction, or DRD, related to variable life insurance and annuity contracts. The DRD reduces the amount of dividend income subject to U.S. tax and is a significant component of the difference between our actual tax expense and expected tax amount
determined using the federal statutory tax rate of 35%. On February 14, 2011, the Obama Administration released the “General Explanations of the Administration’s Revenue Proposals.” Although the Administration has not released
proposed statutory language, one proposal would change the method used to determine the amount of the DRD. A change in the DRD, including the possible retroactive or prospective elimination of this deduction through regulation or legislation, could
increase actual tax expense and reduce our net income.
There is generally uncertainty regarding US taxes both for individuals
and corporations in light of the fact that many provisions recently enacted or extended will sunset by the end of 2012. In addition, the recommendations made by the President’s bipartisan National Commission on Fiscal Responsibility and Reform
and other deficit reduction panels suggest the need to reform the US Tax Code. In addition, Congress plans to hold a number of hearings during 2011 devoted to tax reform. It is unclear whether or when Congress may take up overall tax reform and what
would be the impact of reform on the Company and its products.
For additional discussion of possible tax legislative and
regulatory risks that could affect our business, see “Risk Factors.”
USA Patriot Act
The USA Patriot Act of 2001, enacted in response to the terrorist attacks on September 11, 2001, contains anti-money laundering and
financial transparency laws and mandates the implementation of various regulations applicable to broker-dealers and other financial services companies, including insurance companies. The Patriot Act seeks to promote cooperation among financial
institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. The increased obligations of financial institutions to identify their customers, watch for and report suspicious
transactions, respond to requests for information by regulatory authorities and law enforcement agencies, and share information with other financial institutions require the implementation and maintenance of internal practices, procedures and
controls.
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Legislative and Regulatory Reforms
Federal and state regulators are devoting substantial attention to the variable annuity business. As a result of publicity relating to
widespread perceptions of industry abuses, numerous legislative and regulatory reforms have been proposed or adopted with respect to sales practices, disclosure, arbitrations, and other issues. It is difficult to predict at this time whether changes
resulting from new laws and regulations will affect our product offerings and, if so, to what degree.
Privacy Regulation
Federal and state law and regulation require financial institutions and other businesses to protect the security and confidentiality of
personal information, including health-related and customer information and to notify customers and other individuals about their policies and practices relating to their collection and disclosure of health-related and customer information and their
practices relating to protecting the security and confidentiality of that information. State laws regulate use and disclosure of social security numbers, federal and state laws require notice to affected individuals, law enforcement, regulators and
others if there is a breach of the security of certain personal information, including social security numbers, and require all holders of certain personal information to protect the security of the data. Federal regulations require financial
institutions and creditors to implement effective programs to detect, prevent, and mitigate identity theft. Federal and state laws and regulations regulate the ability of financial institutions to make telemarketing calls and to send unsolicited
e-mail messages to consumers and customers. Federal law and regulation regulate the permissible uses of certain personal information, including consumer report information. Federal and state governments and regulatory bodies may be expected to
consider additional or more detailed regulation regarding these subjects and the privacy and security of personal information.
Holding
Company Regulation
We are subject to the Connecticut insurance holding company law which requires us to register with the
insurance department and to furnish annually financial and other information about the operations of the Company. Generally, all transactions with affiliates that affect the Company must be fair and reasonable and, if material, require prior notice
and approval or non-disapproval by the Connecticut insurance department.
Most states, including the states in which our U.S.
insurance companies are domiciled, have insurance laws that require regulatory approval of a direct or indirect change of control of an insurer or an insurer’s holding company. Laws such as these that apply to us prevent any person from
acquiring control of Prudential Financial or of our insurance subsidiaries unless that person has filed a statement with specified information with the insurance regulators and has obtained their prior approval. Under most states’ statutes,
acquiring 10% or more of the voting stock of an insurance company or its parent company is presumptively considered a change of control, although such presumption may be rebutted. Accordingly, any person who acquires 10% or more of the voting
securities of Prudential Financial without the prior approval of the insurance regulators of the states in which our U.S. insurance companies are domiciled will be in violation of these states’ laws and may be subject to injunctive action
requiring the disposition or seizure of those securities by the relevant insurance regulator or prohibiting the voting of those securities and to other actions determined by the relevant insurance regulator.
Currently, there are several proposals to amend state insurance holding company laws to increase the scope of regulation of insurance
holding companies (such as Prudential Financial). The International Association of Insurance Supervisors (the “IAIS) and the National Association of Insurance Commissioners (the “NAIC”) have promulgated model laws for adoption
internationally and in the United States that would provide for “group wide” supervision of Prudential Financial as an insurance holding company in addition to the current regulation of Prudential Financial’s insurance subsidiaries.
While the timing of their adoption and content will vary by jurisdiction, we have identified the following areas of focus in these model laws: (1) uniform standards for insurer corporate governance; (2) group-wide supervision of insurance
holding companies; (3) adjustments to risk-based capital calculations to account for group-wide risks; and (4) additional regulatory and disclosure requirements for insurance holding companies. At this time, we cannot predict with any
degree of certainty what additional capital requirements, compliance costs or other burdens these requirements may impose on Prudential Financial.
In addition, many state insurance laws require prior notification of state insurance departments of a change in control of a non-domiciliary insurance company doing business in that state. While these
pre-notification statutes do not authorize the state insurance departments to disapprove the change in control, they authorize regulatory action in the affected state if particular conditions exist such as undue market concentration. Any future
transactions that would constitute a change in control of Prudential Financial may require prior notification in those states that have adopted pre-acquisition notification laws.
Other
We are subject to the laws and regulations of states and other
jurisdictions concerning the identification, reporting and escheatment of unclaimed or abandoned funds, and we are subject to audit and examination for compliance with these requirements. We are currently being examined by a third party auditor on
behalf of 30 U.S. jurisdictions for compliance with the unclaimed property laws of these jurisdictions.
Dodd-Frank Wall Street Reform and
Consumer Protection Act
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and
Consumer Protection Act (“Dodd-Frank”), which effects comprehensive changes to the regulation of financial services in the United States and subjects us to substantial additional federal regulation. Dodd-Frank directs existing and
newly-created government agencies and bodies to conduct certain studies and promulgate regulations implementing the law, a process anticipated to occur over the next few years. We cannot predict with any certainty the results of the studies or the
requirements of the regulations ultimately adopted or how Dodd-Frank and such regulations will affect the
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financial markets generally, impact our business, credit or financial strength ratings, results of operations, cash flows or financial condition or make it advisable or require us to hold or
raise additional capital.
Key aspects we have identified to date of Dodd-Frank’s potential impact on us include:
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Prudential Financial will become subject, as a savings and loan holding company, to the examination, enforcement and supervisory authority of the
Board of Governors of the Federal Reserve System (“FRB”) after the transfer to the FRB of the existing authority of the Office of Thrift Supervision (expected to occur July 21, 2011). The FRB will have authority, among other powers,
to impose capital requirements on Prudential Financial after the transfer date. Pursuant to the “Collins Amendment” included in Dodd-Frank, the FRB must establish minimum leverage and risk-based capital requirements for savings and loan
holding companies (including Prudential Financial) and other institutions that are not less than those applicable to insured depository institutions. These requirements will become generally applicable to Prudential Financial on July 21, 2015
(five years after Dodd-Frank’s enactment) except, for purposes of calculating Tier 1 capital, new issuances of debt and equity capital will be immediately subject to the requirements. The risk-based capital requirements currently
applicable to most bank holding companies and insured depository institutions are based on the 1988 Capital Accord (“Basel I”) of the Basel Committee on Banking Supervision (the “Basel Committee”); U.S. federal bank regulatory
agencies have also adopted new risk-based capital guidelines for large, internationally active banking organizations based on revisions to Basel I issued by the Basel Committee in 2004 (“Basel II”). In December 2010, the Basel Committee
released its final framework for strengthening international capital and liquidity regulation (“Basel III”). Basel III, when implemented by U.S. regulation and fully phased-in, will require bank holding companies and insured depository
institutions to maintain substantially more capital, with a greater emphasis on common equity, and to comply with liquidity coverage and net stable funding standards, including the imposition of a counter-cyclical capital buffer. The “Collins
Amendment” requires the FRB to adopt regulations imposing a continuing “floor” of the Basel I-based capital requirements in cases where the Basel II-based capital requirements and any changes in capital regulations resulting from
Basel III otherwise would permit lower requirements. In December 2010, the FRB published for comment proposed regulations implementing this requirement, including a proposal to permit flexibility in the application of certain capital requirements
imposed by Dodd-Frank to non-bank financial companies such as Prudential Financial. We cannot predict what capital regulations the FRB will promulgate under these authorizations, either generally or as applicable to insurance-based organizations. We
cannot predict how the FRB will exercise general supervisory authority over us as to the Company’s business practices.
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Dodd-Frank establishes a Financial Stability Oversight Council (“Council”) which is authorized to subject non-bank financial companies
such as Prudential Financial to stricter prudential standards (a “Designated Financial Company”) if the Council determines that material financial distress at Prudential Financial or the scope of Prudential Financial’s activities
could pose a threat to financial stability of the U.S. If so designated, Prudential Financial would become subject to unspecified stricter prudential standards, including stricter requirements and limitations relating to risk-based capital,
leverage, liquidity and credit exposure, as well as overall risk management requirements, management interlock prohibitions and a requirement to maintain a plan for rapid and orderly dissolution in the event of severe financial distress. The
“Collins Amendment” capital requirements referred to above would apply when adopted by the FRB (i.e., the 5-year grandfathering would no longer be available). The FRB could also require the issuance of capital securities automatically
convertible to equity in the event of financial distress, require enhanced public disclosures to support market evaluation of risk profile and impose short-term debt limits. If Prudential Financial or a subsidiary were so designated, failure to meet
defined measures of financial condition could result in: limits on capital distributions, acquisitions and/or asset growth; requirements for a capital restoration plan and capital raising; limitations on transactions with affiliates; management
changes and asset sales; and, if the FRB and the Council determined Prudential Financial (or the designated subsidiary) posed a grave threat to the financial stability of the U.S., further limits on acquisitions or combinations, restrictions on
product offerings and/or requirements to sell assets. In January 2011, the Council published for comment proposed regulations setting forth the criteria by which it will determine Designated Financial Companies. We cannot predict whether Prudential
Financial or a subsidiary will be designated as a Designated Financial Company.
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Prudential Financial will become, as a savings and loan holding company (and if designated as a Designated Financial Company), subject to stress
tests to be promulgated by the FRB in consultation with the newly-created Federal Insurance Office (discussed below) to determine whether, on a consolidated basis, Prudential Financial has the capital necessary to absorb losses as a result of
adverse economic conditions. We cannot predict how the stress tests will be designed or conducted or whether the results thereof will cause us to alter our business practices or affect the perceptions of regulators, rating agencies, customers,
counterparties or investors of our financial strength.
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The Council may recommend that state insurance regulators or other regulators apply new or heightened standards and safeguards for activities or
practices we and other insurers or other financial services companies engage in that could create or increase the risk that significant liquidity, credit or other problems spread among financial companies. We cannot predict whether any such
recommendations will be made or their effect on our business, results of operations, cash flows or financial condition.
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As a savings and loan holding company, Prudential Financial will become subject to the “Volcker Rule” provisions of Dodd-Frank
prohibiting, subject to the rule’s exceptions, “proprietary trading” and the sponsorship of, and investment in,
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funds (referred to in Dodd-Frank as hedge funds or private equity funds) that rely on certain exemptions from the Investment Company Act of 1940, as amended (collectively, “covered
funds”). In January 2011, the Council provided recommendations on the implementation of the Volcker Rule, and the FRB is to promulgate regulations thereunder within nine months thereafter. The rule becomes effective on the earlier of one year
after adoption of regulations or July 21, 2012 (two years after Dodd-Frank’s enactment), and activities and investments must be brought into compliance within two years thereafter, subject to exceptions. We presently believe that the
“permitted activities” exceptions to the rule should be interpreted in a manner that does not require our insurance subsidiaries to materially alter their securities trading or investing practices, but there can be no assurance that the
regulations promulgated will so provide. The Council recommendations expressly direct the FRB and other agencies to consider whether the “permitted activities” exception should apply to separate account investments. Further, the Council
stated that the agencies will need to consider a process to assess insurance company investment laws since the Volcker Rule’s “permitted activities” for insurers are conditioned on the banking agencies, after consultation with the
Council and state insurance regulators, not having jointly determined a state’s laws insufficient to protect the insurer’s safety and soundness or the financial stability of the U.S. If the Volcker Rule were interpreted to prohibit
insurance company investments in covered funds, or to apply the aggregate limit of 3% of Tier 1 capital to Prudential Financial’s coinvestment in covered funds sponsored by our Prudential Real Estate Investors (PREI), Prudential Investment
Management (PIM) or other operations, our insurance subsidiaries could be required to dispose of covered fund investments. Furthermore, our PREI and PIM investment covered funds in which we coinvest (in both insurance and non-insurance subsidiaries)
which are directly affected by the Volcker Rule prohibitions which, among other things, limit permanent investment by a sponsoring company in any one fund to no more than 3% of fund capital, limit covered fund marketing except to bona fide trust,
fiduciary or investment advisory customers, prohibit covered transactions between a fund and the sponsoring company and prohibit the use of the sponsoring company’s name in the fund’s name. It is possible that regulations with respect to
the foregoing provisions could require us to dispose of covered fund investments, significantly alter our business practices in these operations and/or diminish the attractiveness of our covered fund products to clients. If Prudential Financial were
a Designated Financial Company but not a savings and loan holding company, the foregoing prohibitions would not apply but Prudential Financial could be subject, pursuant to future FRB rulemaking, to additional capital requirements for, and
quantitative limits on, proprietary trading and sponsorship of, and investment in, covered funds. In addition, actions taken by other financial entities in response to the Volcker Rule could potentially negatively affect the market for, returns from
or liquidity of Prudential Financial’s investments in covered funds affiliated with such other financial entities.
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Dodd-Frank creates a new framework for regulation of the over-the-counter (“OTC”) derivatives markets which could impact various
activities of Prudential Global Funding (“PGF”), Prudential Financial and its insurance subsidiaries, which use derivatives for various purposes (including hedging interest rate, foreign currency and equity market exposures). Dodd-Frank
generally requires swaps, subject to a determination by the Commodity Futures Trading Commission (“CFTC”) or SEC as to which swaps are covered, with all counterparties except non-financial end users to be executed through a centralized
exchange or regulated facility and to be cleared through a regulated clearinghouse. Swap dealers and major swap participants (“MSPs”) are subject to capital and margin (i.e., collateral) requirements that will be imposed by the applicable
prudential regulator or the CFTC or SEC, as well as business conduct rules and reporting requirements. While we believe Prudential Financial and PGF and our insurance subsidiaries should not be considered dealers or MSPs subject to the capital and
margin requirements, the final regulations adopted could provide otherwise, which could substantially increase the cost of hedging and the related operations. A determination by the Secretary of the Treasury not to exclude foreign currency swaps and
forwards from the foregoing requirements also could have that result. PGF intermediates swaps between Prudential entities (other than PFI) and third parties, and it is possible that PGF’s standardized intra-Company transactions might be
required to be executed through an exchange, cleared centrally with posted margin, potentially defeating PGF’s key function; if so, Prudential entities might directly enter into swaps with third parties, potentially increasing the economic
costs of hedging. The SEC and CFTC are required to determine whether and how “stable value contracts” should be treated as swaps and, although we believe otherwise, various other products offered by our insurance subsidiaries might be
treated as swaps; if regulated as swaps, we cannot predict how the rules would be applied to such products or the effect on their profitability or attractiveness to our clients. Finally, the new regulatory scheme imposed on all market participants
may increase the costs of hedging generally and banking institutions (with which we enter into a substantial portion of our derivatives) will be required to conduct at least a portion of their OTC derivatives businesses outside their depositary
institutions. The affiliates through which these institutions will conduct their OTC derivatives businesses might be less creditworthy than the depository institutions themselves, and “netting” of counterparty exposures with non-banks will
not be allowed, potentially affecting the credit risk these counterparties pose to us and the degree to which we or an affiliate are able to enter into transactions with these counterparties. We cannot predict the effect of the foregoing on our
hedging costs, our hedging strategy or implementation thereof or whether we will need or choose to increase and/or change the composition of the risks we do not hedge.
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Dodd-Frank establishes a Federal Insurance Office within the Department of the Treasury to be headed by a director appointed by the Secretary of the
Treasury. While not having a general supervisory or regulatory authority over the business of insurance, the director of this office will perform various functions with respect to insurance (other than health insurance), including serving as a
non-voting member of the Council and making recommendations to the Council regarding insurers (potentially including the Company) to be designated for stricter regulation. The director is also required to conduct a study on how to modernize and
improve the system of insurance regulation in the United States, including by increased national uniformity through either a federal charter or effective action by the states.
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Dodd-Frank authorizes the FRB to require a savings and loan holding company or a Designated Financial Company to place its financial activities in
an intermediate holding company separate from non-financial activities (as defined for purposes of the Bank Holding Company Act) and imposes restrictions on transactions between the two businesses. While our non-financial activities are relatively
minor, the imposition of such a requirement on us could be burdensome and costly to implement. Dodd-Frank directs the U.S. Government Accountability Office to study and report to Congressional committees within eighteen months of Dodd-Frank’s
enactment regarding the adequacy of the federal regulatory framework which permits savings and loan holding companies to engage in non-financial activities and the consequence of prohibiting such activities.
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Title II of Dodd-Frank provides that a financial company may be subject to a special orderly liquidation process outside the federal bankruptcy
code, administered by the FDIC as receiver, upon a determination (with the approval of the director of the Federal Insurance Office if – as is true with respect to Prudential Financial – the largest United States subsidiary is an insurer)
that the company is in default or in danger of default and presents a systemic risk to U.S. financial stability. Were Prudential Financial subject to such a proceeding, our U.S. insurance subsidiaries would remain subject to rehabilitation and
liquidation proceedings under state law, although the FDIC has discretion and authority to initiate resolution of an insurer under state law if its state insurance regulator has not filed the appropriate judicial action within 60 days of a
systemic risk determination. However, our non-insurance U.S. subsidiaries engaged in financial activities would be subject to any special orderly liquidation process so commenced. We cannot predict how creditors of Prudential Financial or its
insurance and non-insurance subsidiaries, including the holders of Prudential Financial debt, will evaluate this potential or whether it will impact our financing or hedging costs.
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Dodd-Frank establishes the Bureau of Consumer Financial Protection (“CFPB”) as an independent agency within the FRB to regulate consumer
financial products and services offered primarily for personal, family or household purposes, with rule-making and enforcement authority over unfair, deceptive or abusive practices. Insurance products and services are not within the CFPB’s
general jurisdiction, and broker-dealers and investment advisers are not subject to the CFPB’s jurisdiction when acting in their registered capacity. Retirement service providers such as us could become subject to the CFPB’s jurisdiction,
but only if the Department of Labor and the Department of the Treasury agree. Otherwise, we believe we offer a very limited number of products subject to CFPB regulation and the impact of Dodd-Frank on our operations in this regard should not be
material; however, it is possible that the regulations promulgated by the CFPB will assert jurisdiction more expansively than we anticipate.
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Dodd-Frank includes various securities law reforms that may affect our business practices and the liabilities and/or exposures associated therewith,
including:
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In January 2011, the SEC staff issued a study that recommends that the SEC adopt a uniform federal fiduciary standard of conduct for registered
broker-dealers and investment advisers that provide retail investors personalized investment advice about securities, consider harmonization of the regulation applicable to investment advisers and broker dealers functions taking into account the
best elements of each regime and conduct rulemakings or provide guidance to facilitate the implementation of a federal fiduciary standard of care. The SEC staff study acknowledges that Dodd-Frank provides that the offering of proprietary products
would not be a per se violation of any new standard of care and that broker-dealers selling proprietary or a limited range of products could be permitted to make certain disclosures about their limited product offerings and obtain customer consents
or acknowledgements.
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The SEC and other regulators are required to promulgate regulations requiring the securitizer, and possibly the originator, of certain asset-backed
securities to retain at least 5% of the credit risk of securities sold, which may apply to activities of our investment management segment if the regulations promulgated treat us as a securitizer or an originator.
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Dodd-Frank imposes various assessments on financial companies, including: ex-post assessments to provide funds necessary to repay any borrowing and
to cover the costs of any special resolution of a financial company conducted under Title II (although the FDIC is to take into account assessments otherwise imposed under state insurance guaranty funds); if Prudential Financial were to become
a Designated Financial Company, assessments to fund a newly-created Office of Financial Research which, among other things, assists the Council; and assessments for the costs of new regulation by the FRB. We are unable to estimate these costs at
this time.
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We cannot predict with any certainty whether these possible outcomes will occur or the effect
they may have on the financial markets or on our business, results of operations, cash flows and financial condition.
Segments
The Company currently operates as one reporting segment. Revenues, net income and total assets for this segment can be
found on the Company’s Statements of Financial Position as of December 31, 2010 and 2009 and Statements of Operations and Comprehensive Income for the year ended December 31, 2010, year ended December 31, 2009, and year ended
December 31, 2008. The Company’s total assets as of December 31, 2010, 2009, and 2008 were $57.3 billion, $51.9 billion, and $39.6 billion, respectively. Revenues and assets generated from the Company’s variable life and
qualified plan product offerings have been insignificant in comparison to the revenues and assets generated from the Company’s core product, variable annuities.
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Employees
The Company has no employees. As of November 2008, the Company’s employees were transferred to Prudential Insurance.
Item 1A. Risk Factors
You should
carefully consider the following risks. These risks could materially affect our business, results of operations or financial condition or cause our actual results to differ materially from those expected or those expressed in any forward looking
statements made by or on behalf of the Company. These risks are not exclusive, and additional risks to which we are subject include, but are not limited to, the factors mentioned under “Forward-Looking Statements” above and the risks
described elsewhere in this Annual Report on Form 10-K.
The Company is indirectly owned by Prudential Financial. It is
possible that we may need to rely on our parent company to meet our capital, liquidity and other needs in the future.
Market fluctuations and general economic, market and political conditions may adversely affect our business and profitability.
Our business and our results of operations were materially adversely affected by adverse conditions in the global
financial markets and adverse economic conditions generally that began in the second half of 2007. While conditions in the global financial markets have improved, with favorable results for our business, our business, results of operations and
financial condition may be adversely affected, possibly materially, if these conditions recur.
Even under relatively
favorable market conditions, our insurance and annuities products, as well as our investment returns and our access to and cost of financing, are sensitive to fixed income, equity, real estate and other market fluctuations and general economic,
market and political conditions. These fluctuations and conditions could adversely affect our results of operations, financial position and liquidity, including in the following respects:
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The profitability of many of our insurance and annuities products depends in part on the value of the separate accounts supporting these products,
which fluctuate substantially depending on the foregoing conditions.
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A change in market conditions, including prolonged periods of high inflation, could cause a change in consumer sentiment adversely affecting
persistency of our long-term savings and protection products. A prolonged period of low interest rates could cause persistency of these products to vary from that anticipated and adversely affect profitability (as further described below).
Similarly, changing economic conditions and unfavorable public perception of financial institutions can influence customer behavior, including but not limited to increasing claims or surrenders.
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Lapses and surrenders of variable life and annuity products and withdrawals of assets from other investment products may increase if a market
downturn, increased market volatility or other market conditions result in customers becoming dissatisfied with their investments or products.
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A market decline could further result in guaranteed minimum benefits contained in many of our variable annuity products being higher than current
account values or our pricing assumptions would support, requiring us to materially increase reserves for such products and may cause customers to retain contracts in force in order to benefit from the guarantees, thereby increasing their cost to
us. Any increased cost may or may not be more than offset by the favorable impact of greater persistency from prolonged fee streams. Our valuation of the liabilities for the minimum benefits contained in many of our variable annuity products
requires us to consider the market perception of our risk of non-performance, and a decrease in our own credit spreads resulting from ratings upgrades or other events or market conditions could cause the recorded value of these liabilities to
increase, which in turn could adversely affect our results of operations and financial position.
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Market conditions determine the availability and cost of the reinsurance protection we purchase. Accordingly, we may be forced to incur additional
expenses for reinsurance or may not be able to obtain sufficient reinsurance on acceptable terms which could adversely affect the profitability of future business or our willingness to write future business.
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Hedging instruments we and our affiliates hold to manage product and other risks might not perform as intended or expected resulting in higher
realized losses and unforeseen cash needs. Market conditions can limit availability of hedging instruments and also further increase the cost of executing product related hedges and such costs may not be recovered in the pricing of the underlying
products being hedged. We execute our hedges through an affiliate that, in turn, may execute hedges with unaffiliated counterparties. Accordingly, our hedging strategies depend on the performance of this affiliate and on the performance of its
unaffiliated counterparties to such hedges. These unaffiliated counterparties may fail to perform for various reasons resulting in unhedged exposures and losses on uncollateralized positions.
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We have significant investment portfolios, including but not limited to corporate and asset-backed securities, equities and commercial real estate.
Economic conditions as well as adverse capital market conditions, including but not limited to a lack of buyers in the marketplace, volatility, credit spread changes, benchmark interest rate changes and declines in value of underlying collateral
will impact the credit quality, liquidity and value of our investments, potentially resulting in higher capital charges and unrealized or realized losses, the latter especially if we were to need to sell a significant amount of investments under
such conditions. For example, a widening of credit spreads increases the net unrealized loss position of our investment portfolio and may ultimately result in increased realized losses. Values of our investments can also be
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impacted by reductions in price transparency, changes in assumptions or inputs we use in estimating fair value and changes in investor confidence and preferences, potentially resulting in higher
realized or unrealized losses. Volatility can make it difficult to value certain of our securities if trading becomes less frequent. Valuations may include assumptions or estimates that may have significant period to period changes which could have
a material adverse effect on our results of operations or financial condition, and in certain cases under U.S. GAAP such period to period changes in the value of investments are not recognized in our results of operations or consolidated statements
of financial condition.
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Opportunities for investment of available funds at appropriate returns may be limited, including due to the current low interest rate environment.
or other factors, with a possible negative impact on our overall results. The consequences of holding cash for long periods of time may result in increased purchase of derivatives for duration management purposes. The increased use of derivatives
may increase the volatility of our U.S. GAAP results and our statutory capital.
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Regardless of market conditions, certain investments we hold, including private bonds and commercial mortgages, are relatively illiquid. If we
needed to sell these investments, we may have difficulty doing so in a timely manner at a price that we could otherwise realize.
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Fluctuations in our operating results and the impact on our investment portfolio may impact the Company’s tax profile and its ability to
optimally utilize tax attributes.
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Adverse capital market conditions have in the past, and could in the
future, significantly affect our ability to meet liquidity needs, our access to capital and our cost of capital.
Adverse
capital market conditions have affected and may affect in the future the availability and cost of borrowed funds and could impact our ability to refinance existing borrowings, thereby ultimately impacting our profitability and ability to support or
grow our businesses. We need liquidity to pay our operating expenses and interest on our debt and replace certain maturing debt obligations. The principal sources of our liquidity are insurance premiums, annuity considerations cash flow from our
investment portfolio, and fees from separate account assets. Sources of liquidity in normal markets also include debt instruments, including securities lending, repurchase agreements and commercial paper.
Disruptions, uncertainty and volatility in the financial markets limited and, to the extent they persist or recur, may limit in the
future our access to capital required to operate our business. These market conditions may in the future limit our ability to replace, in a timely manner, maturing debt obligations and access the capital necessary to grow our business, or replace
capital withdrawn by customers. As a result, under such conditions we may be forced to delay raising capital, bear an unattractive cost of capital or be unable to access capital at any price, which could decrease our profitability and significantly
reduce our financial flexibility. Actions we might take to access financing may in turn cause rating agencies to reevaluate our ratings. Our ability to borrow funds from our affiliates through their commercial paper borrowings or otherwise may also
be dependent upon market conditions. Our internal sources of liquidity may prove to be insufficient.
The Risk Based Capital,
or RBC, ratio is a primary measure by which we and state insurance regulators evaluate our capital adequacy. We have managed the Company’s RBC ratio to a level consistent with a “AA” ratings objective; however, rating agencies take
into account a variety of factors in assigning ratings in addition to RBC levels. RBC is determined by statutory rules that consider risks related to the type and quality of the invested assets, insurance-related risks associated with our products,
interest rate risks and general business risks. The RBC ratio calculations are intended to assist insurance regulators in measuring the adequacy of our statutory capitalization. Our failure to meet applicable RBC requirements or minimum statutory
capital and surplus requirements could subject us to further examination or corrective action by state insurance regulators. Our failure to maintain our RBC ratio at desired levels could also adversely impact our competitive position. In addition,
RBC ratios may impact our credit and claims paying ratings.
Disruptions in the capital markets could adversely affect our
ability to access sources of liquidity, as well as threaten to reduce our capital below a level that is consistent with our existing ratings objectives. Therefore, we may need to take actions, which may include but are not limited to:
(1) further access sources of capital; (2) undertake capital management activities, including reinsurance transactions; (3) undertake further asset sales or internal asset transfers; (4) seek temporary or permanent changes to
regulatory rules; and (5) maintain greater levels of cash balances or for longer periods thereby reducing investment returns. Certain of these actions may require regulatory approval and/or agreement of counterparties which are outside of our
control or have economic costs associated with them.
We have experienced and may experience additional downgrades in our
financial strength or credit ratings. A downgrade or potential downgrade in our financial strength or credit ratings could increase the number or value of policies being surrendered, increase our borrowing costs and/or hurt our relationships with
creditors or trading counterparties.
Financial strength ratings, which are sometimes referred to as
“claims-paying” ratings, represent the opinions of rating agencies regarding the financial ability of an insurance company to meet its obligations under an insurance policy, and are important factors affecting public confidence in an
insurer and its competitive position in marketing products. Credit ratings represent the opinions of rating agencies regarding an entity’s ability to repay its indebtedness. A downgrade in our financial strength or credit ratings could
potentially, among other things, limit our ability to market products, reduce our competitiveness, increase the number or value of policy surrenders and withdrawals, increase our borrowing costs and potentially make it more difficult to borrow
funds, adversely affect the availability of financial guarantees, such as letters of credit, cause additional collateral requirements or other required payments under certain agreements, allow counterparties to terminate derivative agreements with
our affiliated derivatives counterparty, and/or hurt our relationships with creditors, distributors or trading counterparties thereby potentially negatively affecting our profitability, liquidity and/or capital. In addition, we consider our own risk
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of non-performance in determining the fair value of our liabilities, including insurance liabilities that are classified as embedded derivatives under U.S. GAAP. Therefore, changes in our credit
or financial strength ratings may affect the fair value of our liabilities.
We cannot predict what additional actions rating
agencies may take, or what actions we may take in response to the actions of rating agencies, which could adversely affect our business. As with other companies in the financial services industry, our ratings could be downgraded at any time and
without notice by any rating agency.
Interest rate fluctuations or prolonged periods of low interest rates could adversely
affect our business and profitability and require us to increase reserves and statutory capital.
Our insurance and
annuities products and our investment returns are sensitive to interest rate fluctuations, and changes in interest rates could adversely affect our investment returns and results of operations, including in the following respects:
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Some of our products expose us to the risk that changes in interest rates will reduce the spread between the amounts that we are required to pay
under the contracts and the rate of return we are able to earn on our general account investments supporting the contracts. When interest rates decline, we have to reinvest the cash income from our investments in lower yielding instruments,
potentially reducing net investment income. Since many of our policies and contracts have guaranteed minimum interest or crediting rates or limit the resetting of interest rates, the spreads could decrease and potentially become negative. When
interest rates rise, we may not be able to replace the assets in our general account as quickly with the higher yielding assets needed to fund the higher crediting rates necessary to keep these products and contracts competitive.
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When interest rates rise, policy loans and surrenders and withdrawals of life insurance policies and annuity contracts may increase as policyholders
seek to buy products with perceived higher returns, requiring us to sell investment assets potentially resulting in realized investment losses, or requiring us to accelerate the amortization of DAC (as defined below).
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A decline in interest rates accompanied by unexpected prepayments of certain investments could result in reduced investments and a decline in our
profitability. An increase in interest rates accompanied by unexpected extensions of certain lower yielding investments could result in a decline in our profitability.
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Changes in the relationship between long-term and short-term interest rates could adversely affect the profitability of some of our products.
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Changes in interest rates could increase our costs of financing.
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Our mitigation efforts with respect to interest rate risk are primarily focused on maintaining an investment portfolio with diversified maturities
that has a weighted average duration that is approximately equal to the duration of our estimated liability cash flow profile. However, our estimate of the liability cash flow profile may turn out to be inaccurate. Due to these and other factors we
may need to liquidate investments prior to maturity at a loss in order to satisfy liabilities or be forced to reinvest funds in a lower rate environment. Although we take measures to manage the economic risks of investing in a changing interest rate
environment, we may not be able to effectively mitigate, and we may sometimes choose based on economic considerations and other factors not to fully mitigate, the interest rate risk of our assets relative to our liabilities.
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Recent periods have been characterized by low interest rates. A prolonged period during which interest
rates remain at levels lower than those anticipated may result in greater costs associated with certain of our product features which guarantee death benefits or income streams for stated periods or for life; higher costs for derivative instruments
used to hedge certain of our product risks; or shortfalls in investment income on assets supporting policy obligations, each of which may require us to record charges to increase reserves. In addition to compressing spreads and reducing net
investment income, such an environment may cause policies to remain in force for longer periods than we anticipated in our pricing, potentially resulting in greater claims costs than we expected and resulting in lower overall returns on business in
force. In addition, certain statutory capital requirements are based on formulas or models that consider interest rates, and a prolonged period of low interest rates may increase the statutory capital we are required to hold as well as the amount of
assets we must maintain to support statutory reserves.
Losses due to defaults by others, including issuers of investment
securities or reinsurance, bond insurers and derivative instrument counterparties, downgrades in the ratings of securities we hold or of bond insurers, insolvencies of insurers in jurisdictions where we write business and other factors affecting our
counterparties or the value of their securities could adversely affect the value of our investments, the realization of amounts contractually owed to us, result in assessments or additional statutory capital requirements or reduce our profitability
or sources of liquidity.
Issuers and borrowers whose securities or loans we hold, customers, vendors, trading
counterparties, counterparties under swaps and other derivative contracts with us or our affiliates, reinsurers, clearing agents, exchanges, clearing houses and other financial intermediaries and guarantors, including bond insurers, may default on
their obligations to us or be unable to perform service functions that are significant to our business due to bankruptcy, insolvency, lack of liquidity, adverse economic conditions, operational failure, fraud or other reasons. Such defaults,
instances of which have occurred in recent periods, could have an adverse effect on our results of operations and financial condition. A downgrade in the ratings of bond insurers could also result in declines in the value of our fixed maturity
investments supported by guarantees from bond insurers.
In addition, we and our affiliates use derivative instruments to
hedge various risks, including certain guaranteed minimum benefits contained in many of our variable annuity products. We and our affiliates enter into a variety of derivative instruments, including options, forwards,
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interest rate, credit default and currency swaps with a number of counterparties. Amounts that we expect to collect under current and future contracts, including, but not limited to reinsurance
contracts, are subject to counterparty risk. Our obligations under our products are not changed by our hedging activities and we are liable for our obligations even if these derivative counterparties, including reinsurers, do not pay us or our
affiliates. This is a more pronounced risk to us in view of the recent stresses suffered by financial institutions. Such defaults could have a material adverse effect on our financial condition and results of operations.
Under state insurance guaranty association laws, we are subject to assessments, based on the share of business we write in the relevant
jurisdiction, for certain obligations of insolvent insurance companies to policyholders and claimants.
Guarantees within
certain of our products that protect policyholders may decrease our earnings or increase the volatility of our results of operations or financial position under U.S. GAAP if our hedging or risk management strategies prove ineffective or
insufficient.
Certain of our products, including especially our variable annuity products, include guarantees of income
streams for stated periods or for life. Downturns in equity markets, increased equity volatility, or (as discussed above) reduced interest rates could result in an increase in the valuation of liabilities associated with such products, resulting in
increases in reserves and reductions in net income. We use a variety of affiliated reinsurance, hedging and risk management strategies, including product features, to mitigate these risks in part. These strategies may, however, not be fully
effective. We and our affiliates may also choose not to fully hedge these risks. Hedging instruments may not effectively offset the costs of guarantees or may otherwise be insufficient in relation to our obligations. Hedging instruments also may not
change in value correspondingly with associated liabilities due to equity market or interest rate conditions or other reasons. We sometimes choose to hedge these risks on a basis that does not correspond to their anticipated or actual impact upon
our results of operations or financial position under U.S. GAAP. For example, during the third quarter of 2010 we and our affiliates have begun to hedge certain risks associated with variable annuity products on a basis that does not fully
correspond to the associated U.S. GAAP liability. Changes from period to period in the valuation of these policy benefits, and in the amount of our obligations effectively hedged, will result in volatility in our results of operations and financial
position under U.S. GAAP. Estimates and assumptions we make in connection with hedging activities may fail to reflect or correspond to our actual long-term exposure in respect of our guarantees. Further, the risk of increases in the costs of our
guarantees not covered by our hedging and other capital and risk management strategies may become more significant due to changes in policyholder behavior driven by market conditions or other factors. The above factors, individually or collectively,
may have a material adverse effect on our results of operations, financial condition or liquidity.
Our profitability may
decline if mortality rates, morbidity rates or persistency rates differ significantly from our pricing expectations.
We
set prices for many of our insurance and annuity products based upon expected claims and payment patterns, using assumptions for mortality rates, or likelihood of death, and morbidity rates, or likelihood of sickness, of our policyholders. In
addition to the potential effect of natural or man-made disasters, significant changes in mortality or morbidity could emerge gradually over time, due to changes in the natural environment, the health habits of the insured population, treatment
patterns and technologies for disease or disability, the economic environment, or other factors. Pricing of our insurance and deferred annuity products are also based in part upon expected persistency of these products, which is the probability that
a policy or contract will remain in force from one period to the next. Persistency may be significantly impacted by the value of guaranteed minimum benefits contained in many of our variable annuity products being higher than current account values
in light of poor equity market performance or extended periods of low interest rates as well as other factors. Persistency could be adversely affected generally by developments affecting client perception of us, including perceptions arising from
adverse publicity. Results may also vary based on differences between actual and expected premium deposits and withdrawals for these products. The development of a secondary market for life insurance, including life settlements or
“viaticals” and investor owned life insurance, and third-party investor strategies in the annuities business, could adversely affect the profitability of existing business and our pricing assumptions for new business. Significant
deviations in actual experience from our pricing assumptions could have an adverse effect on the profitability of our products. Although some of our products permit us to increase premiums or adjust other charges and credits during the life of the
policy or contract, the adjustments permitted under the terms of the policies or contracts may not be sufficient to maintain profitability. Some of our products do not permit us to increase premiums or adjust other charges and credits or limit those
adjustments during the life of the policy or contract. Even if permitted under the policy or contract, we may not be able or willing to raise premiums or adjust other charges sufficiently, or at all, for regulatory or competitive reasons.
If our reserves for future policyholder benefits and claims are inadequate, we may be required to increase our reserves,
which would adversely affect our results of operations and financial condition.
We establish and carry reserves to pay
future policyholder benefits and claims. Our reserves do not represent an exact calculation of liability, but rather are actuarial or statistical estimates based on data and models that include many assumptions and projections which are inherently
uncertain and involve the exercise of significant judgment, including as to the levels of and/or timing of receipt or payment of premiums, benefits, claims, expenses, interest credits, investment results (including equity market returns),
retirement, mortality, morbidity and persistency. We cannot determine with precision the ultimate amounts that we will pay for, or the timing of payment of, actual benefits, claims and expenses or whether the assets supporting our policy
liabilities, together with future premiums, will be sufficient for payment of benefits and claims. If we conclude that our reserves, together with future premiums, are insufficient to cover future policy benefits and claims, we would be required to
increase our reserves and incur income statement charges for the period in which we make the determination, which would adversely affect our results of operations and financial condition.
For certain of our products, market performance and interest rates (as well as the regulatory environment, as discussed further below)
impact the level of statutory reserves and statutory capital we are required to hold, and may have an adverse effect on returns on capital associated
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with these products. For example, equity market declines in the fourth quarter of 2008 caused a significant increase in the level of statutory reserves and statutory capital we were required to
hold.
We may be required to accelerate the amortization of deferred policy acquisition costs, or DAC, or be required to
establish a valuation allowance against deferred income tax assets, either of which could adversely affect our results of operations and financial condition.
Deferred policy acquisition costs, or DAC, represent the costs that vary with and are related primarily to the acquisition of new and renewal insurance and annuity contracts, and we amortize these costs
over the expected lives of the contracts. Management, on an ongoing basis, tests the DAC recorded on our balance sheet to determine if the amount is recoverable under current assumptions. In addition, we regularly review the estimates and
assumptions underlying DAC for those products for which we amortize DAC in proportion to gross profits or gross margins. Given changes in facts and circumstances, these tests and reviews could lead to reductions in DAC that could have an adverse
effect on the results of our operations and our financial condition. Significant or sustained equity market declines as well as investment losses could result in acceleration of amortization of the DAC related to variable annuity and variable life
contracts, resulting in a charge to income. As discussed earlier, the amortization of DAC is also sensitive to changes in interest rates.
Deferred income tax represents the tax effect of the differences between the book and tax basis of assets and liabilities. Deferred tax assets are assessed periodically by management to determine if they
are realizable. Factors in management’s determination include the performance of the business the ability to generate capital gains from a variety of sources, and tax planning strategies. If based on available information, it is more likely
than not that the deferred income tax asset will not be realized then a valuation allowance must be established with a corresponding charge to net income. Such charges could have a material adverse effect on our results of operations or financial
position.
Our valuation of fixed maturity, equity and trading securities may include methodologies, estimations and
assumptions that are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our results of operations or financial condition.
During periods of market disruption, it may be difficult to value certain of our securities, such as sub-prime mortgage backed
securities, if trading becomes less frequent and/or market data becomes less observable. There may be cases where certain asset classes that were in active markets with significant observable data become inactive or for which data becomes
unobservable due to the current financial environment or market conditions. As a result, valuations may include inputs and assumptions that are less observable or require greater estimation and judgment as well as valuation methods which are more
complex. These values may not be ultimately realizable in a market transaction, and such values may change very rapidly as market conditions change and valuation assumptions are modified. Decreases in value may have a material adverse effect on our
results of operations or financial condition.
The decision on whether to record an other-than-temporary impairment or
write-down is determined in part by management’s assessment of the financial condition and prospects of a particular issuer, projections of future cash flows and recoverability of the particular security. Management’s conclusions on such
assessments are highly judgmental and include assumptions and projections of future cash flows which may ultimately prove to be incorrect as assumptions, facts and circumstances change.
Our business is heavily regulated and changes in regulation may reduce our profitability.
Our business is subject to comprehensive regulation and supervision, the primary purpose of which is to protect our customers. Many of the laws and regulations to which we are subject are regularly
re-examined, and existing or future laws and regulations may become more restrictive or otherwise adversely affect our operations. The financial market dislocations we have experienced have produced, and are expected to continue to produce,
extensive changes in existing laws and regulations, and regulatory frameworks, applicable to our business. We are subject to the rules and regulations of the SEC relating to public reporting and disclosure and corporate governance matters. The
Sarbanes-Oxley Act of 2002 and rules and regulations adopted in furtherance of that Act have substantially increased the requirements in these and other areas for the Company and certain of our affiliates.
Many insurance regulatory and other governmental or self-regulatory bodies have the authority to review our products and business
practices and those of our agents and employees and to bring regulatory or other legal actions against us if, in their view, our practices, or those of our agents or employees, are improper. These actions can result in substantial fines, penalties
or prohibitions or restrictions on our business activities and could adversely affect our business, reputation, results of operations or financial condition. For a discussion of material pending litigation and regulatory matters, see
“Contingent Liabilities and Regulatory Matters” in the Notes to Financial Statements included in this Annual Report on Form 10-K.
Insurance regulators have begun to implement significant changes in the way in which industry participants must determine statutory reserves and statutory capital, particularly for products with embedded
options and guarantees such as variable annuities, and are considering further potentially significant changes in these requirements. Regulatory capital requirements based on scenario testing have already gone into effect for variable annuity
products, and new reserving requirements for these products were implemented as of the end of 2009. The timing and extent of further changes to the statutory reporting framework are uncertain.
Currently, there are several proposals to amend state insurance holding company laws to increase the scope of the regulation of insurance
holding companies (such as Prudential Financial). These proposals include imposing standards for insurer corporate governance, group-wide supervision of insurance holding companies, adjustments to risk-based capital calculations to account for
group-wide risks, and additional regulatory and disclosure requirements for insurance holding companies. In addition, state insurance regulators have focused attention on
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U.S. insurance solvency regulation pursuant to the NAIC’s “Solvency Modernization Initiative.” At this time, we cannot predict with any degree of certainty what additional capital
requirements, compliance costs or other burdens these requirements may impose on us or on Prudential Financial.
Compliance
with applicable laws and regulations is time consuming and personnel-intensive, and changes in these laws and regulations may materially increase our direct and indirect compliance and other expenses of doing business, thus having a material adverse
effect on our financial condition or results of operations.
See “Business—Regulation” for further discussion of the impact of
regulations on our business.
The enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act will subject
Prudential Financial and its subsidiaries (including the Company) to substantial additional federal regulation and we cannot predict the effect on our business, results of operations, cash flows or financial condition.
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act
(“Dodd-Frank”), which effects comprehensive changes to the regulation of financial services in the United States and subjects Prudential Financial and its subsidiaries (including the Company) to substantial additional federal regulation.
Dodd-Frank directs existing and newly-created government agencies and bodies to promulgate regulations implementing the law, a process anticipated to occur over the next few years. We cannot predict with any certainty the requirements of the
regulations ultimately adopted or how Dodd-Frank and such regulations will affect the financial markets generally, impact our business, credit or financial strength ratings, results of operations, cash flows or financial condition or advise or
require us, Prudential Financial or other affiliates to hold or raise additional capital. Key aspects we have identified to date of Dodd-Frank’s potential impact on Prudential Financial and its subsidiaries (including the Company) include:
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Prudential Financial will become subject, as a savings and loan holding company, to regulation by the Board of Governors of the Federal Reserve
System (“FRB”), which will have authority, among other powers, to impose capital requirements on it and its subsidiaries. We cannot predict what capital regulations the FRB will promulgate or how the FRB will exercise general supervisory
authority over Prudential Financial or its subsidiaries (such as the Company).
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If designated by the newly established Financial Stability Oversight Council (“Council”) as a systemically significant company, Prudential
Financial (including potentially its subsidiaries) would become subject to unspecified stricter prudential standards, including stricter requirements and limitations relating to risk-based capital, leverage, liquidity and credit exposure, as well as
overall risk management requirements, management interlock prohibitions and a requirement to maintain a plan for rapid and orderly dissolution in the event of severe financial distress. Failure to meet defined measures of financial condition could
result in substantial restrictions on their businesses. We cannot predict whether Prudential Financial or a subsidiary (such as the Company) will be so designated.
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Prudential Financial will become subject, as a savings and loan holding company (and if designated as a systemically significant company) to stress
tests to be promulgated by the FRB which could cause it to alter its business practices or affect the perceptions of regulators, rating agencies, customers, counterparties or investors of its financial strength.
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The Council could recommend new or heightened standards and safeguards for activities or practices Prudential Financial and other financial services
companies engage in. We cannot predict whether any such recommendations will be made or their effect on the business, results of operations, cash flows or financial condition of Prudential Financial and its subsidiaries (including the Company).
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As a savings and loan holding company, Prudential Financial and its subsidiaries will become subject to the “Volcker Rule” provisions of
Dodd-Frank prohibiting, subject to the rule’s exceptions, “proprietary trading” and the sponsorship of, and investment in, funds (referred to in Dodd-Frank as hedge funds or private equity funds) that rely on certain exemptions from
the Investment Company Act of 1940, as amended (collectively, “covered funds”). It is possible that regulations could require Prudential Financial and its subsidiaries to dispose of covered fund investments, significantly alter their
business practices in these operations and/or diminish the attractiveness of their covered fund products to clients. In addition, actions taken by other financial entities in response to the Volcker Rule could potentially negatively affect the
market for, returns from or liquidity of our investments in covered funds affiliated with such other financial entities.
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Dodd-Frank creates a new framework for regulation of the over-the-counter (“OTC”) derivatives markets which could impact various
activities of Prudential Global Funding (“PGF”), Prudential Financial, the Company and our insurance affiliates, which use derivatives for various purposes (including hedging interest rate, foreign currency and equity market exposures).
Final regulations adopted could substantially increase the cost of hedging and related operations, affect the profitability of our products or their attractiveness to our clients or cause us to alter our hedging strategy or implementation thereof or
increase and/or change the composition of the risks we do not hedge.
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Dodd-Frank establishes a Federal Insurance Office within the Department of the Treasury which will perform various functions with respect to
insurance and will conduct a study on how to modernize and improve the system of insurance regulation in the United States, including by increased national uniformity through either a federal charter or effective action by the states.
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The FRB could require Prudential Financial to legally separate its financial and non-financial activities. While its non-financial activities are
relatively minor, the imposition of such a requirement on it could be burdensome and costly to implement.
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Title II of Dodd-Frank provides that a financial company such as Prudential Financial may be subject to a special orderly liquidation process
outside the federal bankruptcy code, administered by the FDIC as receiver, upon a determination that the company is in default or in danger of default and presents a systemic risk to U.S. financial stability. We cannot predict how creditors of
Prudential Financial or its subsidiaries (such as the Company) will evaluate this potential or whether it will impact their financing or hedging costs.
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Dodd-Frank includes various securities law reforms that may affect Prudential Financial’ and its subsidiaries’ business practices and the
liabilities and/or exposures associated therewith.
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Dodd-Frank will and could impose various assessments on Prudential Financial and its subsidiaries, which we are unable to estimate at this time.
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See “Business—Regulation” for further discussion of the impact of Dodd-Frank on the
businesses of Prudential Financial and its subsidiaries.
Changes in U.S. federal income tax law could make some of our
products less attractive to consumers and increase our tax costs.
Current U.S. federal income tax laws generally permit
certain holders to defer taxation on the build-up of value of annuities and life insurance products until payments are actually made to the policyholder or other beneficiary and to exclude from taxation the death benefit paid under a life insurance
contract. Congress from time to time considers legislation that could make our products less attractive to consumers, including legislation that would reduce or eliminate the benefit of this deferral on some annuities and insurance products, such as
a reduction in income tax rates, as well as other types of changes that could reduce or eliminate the attractiveness of annuities and life insurance products to consumers, such as changes to the estate tax.
For example, the estate tax was completely eliminated for 2010, but modified carryover basis rules applied for property acquired from
decedent’s dying in that year. The estate tax has been reinstated through 2012 with a $5 million individual exemption, a 35% maximum rate and step-up in basis rules for property acquired from a decedent. Estates of decedents who died in 2010
can choose between the rules that were in effect in 2010 or the new rules. It is unclear what Congress will do with respect to the estate tax after 2012. This uncertainty makes estate planning difficult and may impact sales of our products.
Congress, as well as state and local governments, also considers from time to time legislation that could increase the amount
of corporate taxes we pay.
The U.S. Treasury Department and the Internal Revenue Service have indicated that they intend to
address through regulations the methodology to be followed in determining the dividends received deduction, or DRD, related to variable life insurance and annuity contracts. The DRD reduces the amount of dividend income subject to tax and is a
significant component of the difference between our actual tax expense and the expected tax amount determined using the federal statutory tax rate of 35%. A change in the DRD, including the possible retroactive or prospective elimination of this
deduction through regulations or legislation, could increase our actual tax expense and reduce our net income.
On
February 14, 2011, the Obama Administration released the “General Explanations of the Administration’s Revenue Proposals.” Although the Administration has not released proposed statutory language, the Revenue Proposals include
proposals which, if enacted, would affect the taxation of life insurance companies and certain life insurance products. The proposals would also change the method used to determine the amount of dividend income received by a life insurance company
on assets held in separate accounts used to support products, including variable life insurance and variable annuity contracts that are eligible for the DRD. If proposals of this type were enacted, the Company’s sale of variable products could
be adversely affected and the Company’s actual tax expense could increase, thereby reducing earnings.
There is generally
uncertainty regarding U.S. taxes both for individuals and corporations in light of the fact that many tax provisions recently enacted or extended will sunset by the end of 2012. In addition, the recommendations made by the President’s
bipartisan National Commission on Fiscal Responsibility and Reform and other deficit reduction panels suggest the need to reform the U.S. Tax Code. In addition, Congress plans to hold a number of hearings during 2011 devoted to tax reform. It is
unclear whether or when Congress may take up overall tax reform and what would be the impact of reform on the Company and its products. However even in the absence of overall tax reform, the large federal deficit, as well as the budget constraints
faced by many states and localities, increases the likelihood that Congress and state and local governments will raise revenue by enacting legislation increasing the taxes paid by individuals and corporations. This can be accomplished either by
raising rates or otherwise changing the tax rules. While higher tax rates increase the benefits of tax deferral on the build-up of value of annuities and life insurance, making our products more attractive to consumers, legislation that reduces or
eliminates deferral would have a potential negative effect on our products. In addition, changes in the tax rules that result in higher corporate taxes will increase the Company’s actual tax expense, thereby reducing earnings.
The products we sell have different tax characteristics, in some cases generating tax deductions. The level of profitability of certain
of our products is significantly dependent on these characteristics and our ability to continue to generate taxable income, which is taken into consideration when pricing products and is a component of our capital management strategies. Accordingly,
changes in tax law, our ability to generate taxable income, or other factors impacting the availability or value of the tax characteristics generated by our products, could impact
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product pricing and returns or require us to reduce our sales of these products or implement other actions that could be disruptive to our businesses.
Legal and regulatory actions are inherent in our business and could adversely affect our results of operations or financial position
or harm our business or reputation.
We are, and in the future may be, subject to legal and regulatory actions in the
ordinary course of our business. Some of these proceedings have been brought on behalf of various alleged classes of complainants. In certain of these matters, the plaintiffs are seeking large and/or indeterminate amounts, including punitive or
exemplary damages. Legal liability or adverse publicity in respect of these or future legal or regulatory actions could have an adverse affect on us or cause us reputational harm, which in turn could harm our business prospects.
Material pending litigation and regulatory matters affecting us, and certain risks to our businesses presented by such matters, are
discussed under “Contingent Liabilities and Regulatory Matters” in the Notes to Financial Statements included in this Annual Report on Form 10-K. Our litigation and regulatory matters are subject to many uncertainties, and given their
complexity and scope, their outcome cannot be predicted. Our reserves for litigation and regulatory matters may prove to be inadequate. It is possible that our results of operations or cash flow in a particular quarterly or annual period could be
materially affected by an ultimate unfavorable resolution of pending litigation and regulatory matters depending, in part, upon the results of operations or cash flow for such period. In light of the unpredictability of the Company’s litigation
and regulatory matters, it is also possible that in certain cases an ultimate unfavorable resolution of one or more pending litigation or regulatory matters could have a material adverse effect on the Company’s financial position.
We may not be able to protect our intellectual property and may be subject to infringement claims.
We rely on a combination of contractual rights with third parties and copyright, trademark, patent and trade secret laws to establish and
protect our intellectual property. Although we endeavor to protect our rights, third parties may infringe or misappropriate our intellectual property. We may have to litigate to enforce and protect our copyrights, trademarks, patents, trade secrets
and know-how or to determine their scope, validity or enforceability. This would represent a diversion of resources that may be significant and our efforts may not prove successful. The inability to secure or protect our intellectual property assets
could have a material adverse effect on our business and our ability to compete.
We may be subject to claims by third parties
for (i) patent, trademark or copyright infringement, (ii) breach of copyright, trademark or license usage rights, or (iii) misappropriation of trade secrets. Any such claims and any resulting litigation could result in significant
expense and liability for damages. If we were found to have infringed or misappropriated a third-party patent or other intellectual property right, we could in some circumstances be enjoined from providing certain products or services to our
customers or from utilizing and benefiting from certain methods, processes, copyrights, trademarks, trade secrets or licenses. Alternatively, we could be required to enter into costly licensing arrangements with third parties or implement a costly
work around. Any of these scenarios could have a material adverse effect on our business and results of operations.
The
occurrence of natural or man-made disasters could adversely affect our results of operations and financial condition.
The
occurrence of natural disasters, including hurricanes, floods, earthquakes, tornadoes, fires, explosions, pandemic disease and man-made disasters, including acts of terrorism and military actions, could adversely affect our results of operations or
financial condition, including in the following respects:
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Catastrophic loss of life due to natural or man-made disasters could cause us to pay benefits at higher levels and/or materially earlier than
anticipated and could lead to unexpected changes in persistency rates.
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A natural or man-made disaster could result in losses in our investment portfolio or the failure of our counterparties to perform, or cause
significant volatility in global financial markets.
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A terrorist attack affecting financial institutions in the United States or elsewhere could negatively impact the financial services industry in
general and our business operations, investment portfolio and profitability in particular. In August 2004, the U.S. Department of Homeland Security identified our Newark, New Jersey facilities, along with those of several other financial
institutions in New York and Washington, D.C., as possible targets of a terrorist attack.
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Pandemic disease, caused by a virus such as H5N1, the “avian flu” virus, or H1N1, the “swine flu” virus, could have a severe
adverse effect on our business. The potential impact of such a pandemic on our results of operations and financial position is highly speculative, and would depend on numerous factors, including: in the case of the avian flu virus, the probability
of the virus mutating to a form that can be passed easily from human to human; the effectiveness of vaccines and the rate of contagion; the regions of the world most affected; the effectiveness of treatment for the infected population; the rates of
mortality and morbidity among various segments of the insured versus the uninsured population; the collectability of reinsurance; the possible macroeconomic effects of a pandemic on the Company’s asset portfolio; the effect on lapses and
surrenders of existing policies, as well as sales of new policies; and many other variables.
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There can be
no assurance that our business continuation plans and insurance coverages would be effective in mitigating any negative effects on our operations or profitability in the event of a terrorist attack or other disaster.
Climate change, and its regulation, may affect the prospects of companies and other entities whose securities we hold and other
counterparties, including reinsurers, and affect the value of investments, including real estate investments that we hold. Our current
18
evaluation is that the near term effects of climate change and climate change regulation on the Company are not material, but we cannot predict the long term impacts on us from climate change or
its regulation.
Our risk management policies and procedures may leave us exposed to unidentified or unanticipated risk,
which could adversely affect our business or result in losses.
Our policies, procedures and controls to monitor and
manage risks, including hedging programs through which we and our affiliates utilize derivative financial instruments, may not be fully effective in achieving their purposes and may leave us and our affiliates exposed to unidentified and
unanticipated risks. The Company and its affiliates use models in these hedging programs and many other aspects of their operations, including but not limited to the estimation of actuarial reserves, the amortization of deferred acquisition costs
and the valuation of business acquired, and the valuation of certain other assets and liabilities. These models rely on assumptions and projections that are inherently uncertain. Management of operational, legal and regulatory risks requires, among
other things, policies, procedures and controls to record properly and verify a large number of transactions and events, and these policies, procedures and controls may not be fully effective.
Interruption in telecommunication, information technology and other operational systems, or a failure to maintain the security,
confidentiality or privacy of sensitive data residing on such systems, could harm our business.
We depend heavily on our
telecommunication, information technology and other operational systems and on the integrity and timeliness of data we use to run our businesses and service our customers. These systems may fail to operate properly or become disabled as a result of
events or circumstances wholly or partly beyond our control. Further, we face the risk of operational and technology failures by others, including clearing agents, exchanges and other financial intermediaries and of vendors and parties to which we
outsource the provision of services or business operations. If these parties do not perform as anticipated, we may experience operational difficulties, increased costs and other adverse effects on our business. These risks are heightened by our
offering of increasingly complex products, such as those that feature automatic asset transfer or re-allocation strategies, and by our employment of complex investment, trading and hedging programs.
Despite our implementation of a variety of security measures, our information technology and other systems could be subject to physical
or electronic break-ins, unauthorized tampering or other security breaches, resulting in a failure to maintain the security, confidentiality or privacy of sensitive data, including personal information relating to customers.
Interruption in telecommunication, information technology and other operational systems, or a failure to maintain the security,
confidentiality or privacy of sensitive data residing on such systems, whether due to actions by us or others, could delay or disrupt our ability to do business and service our customers, harm our reputation, subject us to regulatory sanctions and
other claims, lead to a loss of customers and revenues and otherwise adversely affect our business.
Item 1B. Unresolved Staff Comments
None
Item 2. Properties
The Company occupies office space in Shelton, Connecticut, which is leased from an affiliate, Prudential Annuities Information Services
and Technology Corporation, formerly known as American Skandia Information Services and Technology Corporation.
Item 3. Legal Proceedings
We are subject to legal and regulatory actions in the ordinary course of our businesses, including class action lawsuits. Our pending legal and regulatory actions include proceedings specific to the
Company and proceedings generally applicable to business practices in the industry in which we operate. We may be subject to class action lawsuits and other litigation alleging, among other things, that we made improper or inadequate disclosures in
connection with the sale of annuity products or charged excessive or impermissible fees on these products, recommended unsuitable products to customers, mishandled customer accounts or breached fiduciary duties to customers. We are also subject to
litigation arising out of our general business activities, such as our investments and contracts, and could be exposed to claims or litigation concerning certain business or process patents. Regulatory authorities from time to time make inquiries
and conduct investigations and examinations relating particularly to us and our products. In addition, we, along with other participants in the business in which we engage, may be subject from time to time to investigations, examinations and
inquiries, in some cases industry-wide, concerning issues or matters upon which such regulators have determined to focus. In some of our pending legal and regulatory actions, parties are seeking large and/or indeterminate amounts, including punitive
or exemplary damages. The outcome of a litigation or regulatory matter, and the amount or range of potential loss at any particular time, is inherently uncertain.
Summary
The Company’s litigation and regulatory matters are
subject to many uncertainties, and given their complexity and scope, their outcome cannot be predicted. It is possible that results of operations or cash flow of the Company in a particular quarterly or annual period could be materially affected by
an ultimate unfavorable resolution of pending litigation and regulatory matters depending, in part, upon the results of operations or cash flow for such period. In light of the unpredictability of the Company’s litigation and regulatory
matters, it is also possible that in certain cases an ultimate unfavorable resolution of one or more pending litigation or regulatory matters could have a material adverse effect on the Company’s financial position. Management believes,
however, that, based on information currently known to it, the ultimate
19
outcome of all pending litigation and regulatory matters, after consideration of applicable reserves and rights to indemnification, is not likely to have a material adverse effect on the
Company’s financial position. See Note 12 to Financial Statements included herein for additional discussion of our litigation and regulatory matters.
20
PART II
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company is a wholly owned subsidiary of PAI. There is no public market for the Company’s common stock.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations, or
“MD&A”, is omitted pursuant to General Instruction I(2)(a) of Form 10-K. The management narrative for Prudential Annuities Life Assurance Corporation (“PALAC”), that follows should be read in conjunction with the
Forward-Looking Statements and related notes included below the Table of Contents, “Risk Factors”, and the Financial Statements and related notes included in this Annual Report on Form 10-K.
This Management’s narrative addresses the financial condition of PALAC, formerly known as American Skandia Life Assurance
Corporation as of December 31, 2010, compared with December 31, 2009, and its results of operations for the years ended December 31, 2010 and 2009.
Overview
The Company has sold a wide array of annuities, including
(1) deferred and immediate variable annuities that are registered with the SEC, including fixed interest rate allocation options that are offered in certain of our variable annuities and are registered because of their market value adjustment
feature and (2) fixed-rate allocation options in certain of our variable and fixed annuities that are not registered with the SEC. In addition, the Company has in force a relatively small block of variable life insurance policies, but it no
longer actively sells such policies. The markets in which the Company operates are subject to regulatory oversight with particular emphasis placed on company solvency and sales practices. These markets are also subject to increasing competitive
pressure as the legal barriers that have historically segregated the markets of the financial services industry, have been changed through both legislative and judicial processes. Regulatory changes have opened the insurance industry to competition
from other financial institutions, particularly banks and mutual funds that are positioned to deliver competing investment products through large, stable distribution channels.
Beginning in March 2010, the Company ceased offering its existing variable annuity products (and where offered, the companion market
value adjustment option) to new investors upon the launch of a new product in each of Pruco Life Insurance Company and Pruco Life Insurance Company of New Jersey (which are affiliates of the Company within the Prudential Annuities business unit of
Prudential Financial). In general, the new product line offers the same optional living benefits and optional death benefits as offered by the Company’s existing variable annuities. However, subject to applicable contractual provisions and
administrative rules, the Company will continue to accept subsequent purchase payments on inforce contracts under existing annuity products. These initiatives were implemented to create operational and administrative efficiencies by offering a
single product line of annuity products from a more limited group of legal entities. In addition, by limiting its variable annuity offerings to a single product line sold through one insurer (and its affiliate, for New York sales), the Prudential
Annuities business unit of Prudential Financial expects to convey a more focused, cohesive brand in the marketplace.
In
addition to policy charges and fee income, the Company earns revenues from asset administration fees calculated on the average separate account fund balances. The Company’s operating expenses principally consist of insurance benefits provided,
general business expenses, commissions and other costs of selling and servicing the various products it sold.
The
Company’s profitability depends principally on its ability to price and manage risk on insurance products, to attract and retain customer assets, and to manage expenses. Specific drivers of our profitability include:
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our ability to price our products at a level that enables us to earn a margin over the cost of providing benefits and the expense of acquiring
customers and administering those products;
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our mortality and morbidity experience on annuity products;
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our persistency experience, which affects our ability to recover the cost of acquiring new business over the lives of the contracts;
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our cost of administering insurance contracts
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our ability to manage and control our operating expenses, including overhead;
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our returns on invested assets, including the impact of credit losses, net of the amounts we credit to policyholders’ accounts;
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the amount of assets under management and changes in their fair value, which affect the amount of asset administration fees we receive;
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our ability to generate favorable investment results through asset liability management and strategic and tactical asset allocation;
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our ability to maintain our financial strength ratings; and
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our, and our reinsurance affiliates’ ability to manage risk and exposures, including the degree to which, and the effectiveness of, hedging
these risks and exposures.
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In addition, factors such as regulation, competition, interest rates, taxes,
market fluctuations and general economic, market and political conditions affect the Company’s profitability. See “Risk Factors” for a discussion of risks that have affected and may affect in the future our business, results of
operations or financial condition, or cause our actual results to differ materially from those expected or those expressed in any forward looking statements made by or on behalf of the Company.
Application of Critical Accounting Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, or GAAP, requires the application of accounting policies that often
involve a significant degree of judgment. Management, on an ongoing basis, reviews estimates and assumptions used in the preparation of financial statements. If management determines that modifications in assumptions and estimates are appropriate
given current facts and circumstances, results of operations and financial position as reported in the Financial Statements could change significantly.
The following sections discuss the accounting policies applied in preparing our financial statements that management believes are most dependent on the application of estimates and assumptions and require
management’s most difficult, subjective, or complex judgements.
Deferred Policy Acquisition and Other Costs
We capitalize costs that vary with and are related primarily to the acquisition of new and renewal annuity contracts. These costs
primarily include commissions, costs of policy issuance and other variable expenses that are incurred in producing new business. In addition, we also defer costs associated with sales inducements related to our variable annuity contracts. Sales
inducements are amounts that are credited to the policyholder’s account balance as an inducement to purchase the contract. For additional information about sales inducements, see Note 6 to the Financial Statements. We amortize these deferred
policy acquisition costs, or DAC, and deferred sales inducements (“DSI”), over the expected lives of the contracts, based on our estimates of the level and timing of gross profits. As described in more detail below, in calculating DAC and
DSI amortization we are required to make assumptions about investment returns, mortality, persistency, and other items that impact our estimates of the level and timing of gross profits. As of December 31, 2010, DAC and DSI were $1,540 million
and $796.5 million, respectively.
Amortization methodologies
DAC and DSI are amortized over the expected life of the policy in proportion to estimated gross profits. DAC and DSI are also subject to
recoverability testing which we perform at the end of each reporting period to ensure that each balance does not exceed the present value of estimated gross profits. In calculating gross profits, we consider mortality, persistency, and other
elements as well as rates of return on investments associated with these contracts and the cost related to our guaranteed minimum death and guaranteed minimum income benefits. In addition, in calculating gross profits, we include the profits and
losses related to contracts issued by the Company that are reported in affiliated legal entities other than the Company as a result of, for example, reinsurance agreements with those affiliated entities. The Company is an indirect subsidiary of
Prudential Financial (an SEC registrant) and has extensive transactions and relationships with other subsidiaries of Prudential Financial, including reinsurance agreements, as discussed in Note 13 to the Consolidated Financial Statements.
Incorporating all product-related profits and losses in gross profits, including those that are reported in affiliated legal entities, produces a DAC amortization pattern representative of the economics of the products. For a further discussion of
the amortization of DAC, see “—Results of Operations.”
Total gross profits include both actual experience and
estimates of gross profits for future periods. We regularly evaluate and adjust the related DAC and DSI balances with a corresponding charge or credit to current period earnings for the effects of our actual gross profits and changes in our
assumptions regarding estimated future gross profits. Adjustments to the DAC and DSI balances include the impact to our estimate of total gross profits of the annual review of assumptions, our quarterly adjustments for current period experience, and
our quarterly adjustments for market performance. Each of these adjustments is further discussed below in “- Annual assumptions review and quarterly adjustments.”
In addition to the gross profit components mentioned above, we also include the impact of the embedded derivatives associated with certain of the optional living benefit features of our variable annuity
contracts and related hedging activities in actual gross profits used as the basis for calculating current period amortization, including any impacts that are recorded in the reinsurance affiliate. Historically, we also included the impact of these
embedded derivatives and related hedging activities, excluding the impact of the market-perceived risk of our own non-performance, in our estimate of total gross profits used to determine the DAC and DSI amortization rates. In the third quarter of
2010, the hedging strategy of the Company and reinsurance affiliates was revised, which resulted in a change in how certain gross profit components are used to determine the DAC and DSI amortization rates. For additional information regarding the
change in hedging strategy see “Item 1. Business – Products”. As of the third quarter of 2010, management’s best estimate of the total gross profits associated with these optional living benefit features and related hedge
positions is based on the updated hedge target definition. However, total gross profits for these purposes includes the difference between the value of the hedge target liability and asset value only to the extent this net amount is determined by
management to be other than temporary, as well as the impact of assumption updates on the valuation of the hedge target liability. The determination of whether the difference between the value of the hedge target liability and asset value is
other-than-temporary is based on an evaluation of the effectiveness of the hedge program. Management generally expects differences between the value of the hedge target liability and asset value to be temporary and to reverse over time. Such
differences would not be included in total gross profits for purposes of determining the amortization rates. However, based on the effectiveness of the hedge program, management may determine that the difference between the value of the hedge target
liability and the asset value is other-than-temporary and would include that amount in
22
management’s best estimate of total gross profits for setting the DAC and DSI amortization rates. Management may also decide to temporarily hedge to an amount that differs from the target
hedge definition, given overall capital considerations of our ultimate parent, Prudential Financial and its subsidiaries, as a whole, and prevailing market conditions. The impact from temporarily hedging to an amount that differs from the hedge
target definition, as well as the results of the capital hedge program we began in the second quarter of 2009 and modified in 2010, are not considered in calculating total gross profits used to determine amortization rates nor included in actual
gross profits used in calculating current period amortization.
Annual assumptions review and quarterly adjustments
Annually, during the third quarter, we perform a comprehensive review of the assumptions used in estimating gross profits
for future periods. Although we review these assumptions on an ongoing basis throughout the year, we generally only update these assumptions and adjust the DAC and DSI balances during the third quarter, unless a material change that we feel is
indicative of a long term trend is observed in an interim period. Over the last several years, the Company’s most significant assumption updates resulting in a change to expected future gross profits and the amortization of DAC and DSI have
been related to lapse experience and other contractholder behavior assumptions, mortality, and revisions to expected future rates of returns on investments. We expect these assumptions to be the ones most likely to cause potential significant
changes in the future. The impact on our results of operations of changes in these assumptions can be offsetting and we are unable to predict their movement or offsetting impact over time.
The quarterly adjustments for current period experience referred to above reflect the impact of differences between actual gross profits
for a given period and the previously estimated expected gross profits for that period. To the extent each period’s actual experience differs from the previous estimate for that period, the assumed level of total gross profits may change. In
these cases, we recognize a cumulative adjustment to all previous periods’ amortization, also referred to as an experience true-up adjustment.
The quarterly adjustments for market performance referred to above reflect the impact of changes to our estimate of total gross profits to reflect actual fund performance. A significant portion of gross
profits for our variable annuity contracts are dependent upon the total rate of return on assets held in separate account investment options. This rate of return influences the fees we earn, costs we incur associated with the guaranteed minimum
death and guaranteed minimum income benefit features related to our variable annuity contracts, as well as other sources of profit. Returns that are higher than our expectations for a given period produce higher than expected account balances, which
increase the fees we earn and decrease the costs we incur associated with the guaranteed minimum death and guaranteed minimum income benefit features related to our variable annuity contracts, resulting in higher expected future gross profits and
lower DAC and DSI amortization for the period. The opposite occurs when returns are lower than our expectations.
The
near-term future rate of return assumptions used in evaluating DAC and DSI are derived using a reversion to the mean approach, a common industry practice. Under this approach, we consider actual returns over a period of time and initially adjust
future projected returns over a four year period so that the assets grow at the long-term expected rate of return for the entire period. If the projected future rate of return over a four year period is greater than our maximum future rate of
return, we use our maximum future rate of return. As of December 31, 2010, our long-term expected rates of return across all asset types for variable annuity products is 7.4% per annum, and reflect among other assumptions, an expected rate
of return of 9.3% per annum for equity type assets including a 5.7% annual weighted average rate of return on fixed income investments. Unless there is a sustained interim deviation, our long-term expected rate of return assumptions generally
are not impacted by short-term market fluctuations. As of December 31, 2010, our near-term maximum future rate of return under the reversion to the mean approach for variable annuities contracts was 9.3% per annum. Included in this blended
maximum future rate are assumptions for returns on various asset classes, including a 13% per annum maximum rate of return on equity investments including a 5.7% annual weighted average rate of return on fixed income investments.
We update the projected future rate of return and our estimate of total gross profits each quarter to reflect the result of the reversion
to the mean approach. These market performance related adjustments to our estimate of total gross profits result in cumulative adjustments to prior amortization, reflecting the application of the new required rate of amortization to all prior
periods’ gross profits. The new required rate of amortization is also applied prospectively to future gross profits in calculating amortization in future periods. As of December 31, 2010, our expected rate of return for the next four years
across all asset types is 6.1% per annum. These rates represent a weighted average of our expected rates of return across all contract groups. For some contract groups, our expected rate of return for the next four years equals our current
maximum future rates of return, as the near-term projected future rate of return under the reversion to the mean approach is greater than our maximum future rate of return. For certain contract groups relating to variable annuities issued in 2009
and 2010, the expected rate of return over the next four years is under 6.1% per annum, reflecting the impact of more favorable markets in 2009 and 2010 and the reversion to the mean approach.
Sensitivity
DAC and DSI are more sensitive to changes in our future rate of return assumptions due primarily to the significant portion of gross profits that is dependent upon the total rate of return on assets held
in separate account investment options, and the shorter average life of the contracts.
The following table provides a
demonstration of the sensitivity of each of these balances relative to our future rate of return assumptions by quantifying the adjustments to each balance that would be required assuming both an increase and a decrease in our future rate of return
by 100 basis points. The sensitivity includes an increase and decrease of 100 basis points to both the near-term future rate of return assumptions used over the next four years, and the long-term expected rate of return used thereafter. While the
information below is for illustrative purposes only and does not reflect our expectations regarding future rate of return assumptions, it is a near-term, reasonably likely hypothetical change that illustrates the potential impact of such a change.
The information provided in the table below considers only the
23
direct effect of changes in our future rate of return on the DAC and DSI balances and not changes in any other assumptions such as persistency, mortality, or expenses included in our evaluation
of DAC. Further, this information does not reflect changes in reserves, such as the reserves for the guaranteed minimum death and optional living benefit features of our variable annuity products, or the impact that changes in such reserves may have
on the DAC and DSI balances.
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December 31, 2010
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Increase/
(Reduction) in
DAC
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Increase/
(Reduction) in
DSI
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(in millions)
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Increase in future rate of return by 100 basis points
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$
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32
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$
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13
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Decrease in future rate of return by 100 basis points
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$
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(32
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$
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(13
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For a discussion of our
actual DAC and DSI adjustments for the years ended December 31, 2010 and 2009 , see “—Results of Operations”
Valuation of Business Acquired
In addition to DAC and DSI, we also
recognize an asset for valuation of business acquired (“VOBA”). As of December 31, 2010, VOBA balance was $32.5 million. VOBA represents the present value of future profits embedded in acquired businesses, and is determined by
estimating the net present value of future cash flows from the contracts in force at the date of acquisition. VOBA is amortized over the effective life of the acquired contracts. For additional information about VOBA including its bases for
amortization, see Note 5 of the financial statements. VOBA is also subject to recoverability testing at the end of each reporting period to ensure that balance does not exceed the present value of total anticipated gross profits.
Valuation of Investments, Including Derivatives, and the Recognition of Other-than-Temporary Impairments
Our investment portfolio consists of public and private fixed maturity securities, commercial mortgage and other loans, equity securities,
derivative financial instruments, and other long-term investments. Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices or the values of securities. Derivative financial
instruments we generally use include swaps, options, and futures and may be exchange-traded or contracted over-the-counter with an affiliate. We are also party to financial instruments that contain derivative instruments that are
“embedded” in the financial instruments. Management believes the following accounting policies related to investments, including derivatives, are most dependent on the application of estimates and assumptions. Each of these policies is
discussed further within other relevant disclosures related to the investments and derivatives, as referenced below.
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Valuation of investments, including derivatives
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Recognition of other-than-temporary impairments
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Determination of the valuation allowance for losses on commercial mortgage and other loans
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We present our investments classified as available for sale, including fixed maturity and equity securities, our investments classified
as trading, and derivatives, and our embedded derivatives at fair value in the statements of financial position. For additional information regarding the key estimates and assumptions surrounding the determination of fair value of fixed maturity and
equity securities, as well as derivative instruments, embedded derivatives and other investments, see Note 10 to the Financial Statements.
For our investments classified as available for sale, the impact of changes in fair value is recorded as an unrealized gain or loss in “Accumulated other comprehensive income (loss), net,” a
separate component of equity. For our investments classified as trading, the impact of changes in fair value is recorded within “Asset administration fees and other income.” In addition, investments classified as available for sale are
subject to impairment reviews to identify when a decline in value is other-than-temporary. For a discussion of our policies regarding other-than-temporary declines in investment value and the related methodology for recording other-than-temporary
impairments of fixed maturity and equity securities, see Note 2 to the Financial Statements.
Commercial mortgage and other
loans are carried primarily at unpaid principal balances, net of unamortized premiums or discounts and a valuation allowance for losses. For a discussion of our policies regarding the valuation allowance for commercial mortgage and other loans see
Note 2 to the Financial Statements.
Future policy benefits
The Company’s liability for future policy benefits is primarily comprised liabilities for guarantee benefits related to certain
nontraditional long-duration life and annuity contracts, which are discussed more fully in Note 6. These reserves represent reserves for the guaranteed minimum death and optional living benefit features on our variable annuity products. The optional
living benefits are primarily accounted for as embedded derivatives, with fair values calculated as the present value of future expected benefit payments to customers less the present value of assessed rider fees attributable to the embedded
derivative feature. For additional information regarding the valuation of these optional living benefit features, see Note 10 to the financial statements.
In establishing reserves for guaranteed minimum death and income benefits related to variable annuity contracts, we must make estimates and assumptions about the timing of annuitization, contract lapses
and contractholder mortality, as well as interest rates and equity market returns. Assumptions relating to contractholder behavior, such as the timing of annuitization and contract lapses, are based on our experience by
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contract group, and vary by product type and year of issuance. Our dynamic lapse rate assumption applies a different lapse rate on a contract by contract basis based on a comparison of the
guaranteed minimum death or income benefit and the current policyholder account value as well as other factors such as the applicability of any surrender charges. In-the-money contracts are those with a guaranteed minimum benefit in excess of the
current policyholder account value. Since in-the-money contracts are less likely to lapse, we apply a lower lapse rate assumption to these contracts. As an example, the lapse rate assumptions for contracts that are not in-the-money and out of their
surrender charge period average between 10% and 20% per year, and the lapse rate assumptions for contracts that are in-the-money and out of their surrender charge period average between 0% and 20% per year. Mortality assumptions are
generally based on our historical experience or standard industry tables, and also vary by contract group. Unless a material change in contractholder behavior or mortality experience that we feel is indicative of a long term trend is observed in an
interim period, we generally update assumptions related to contractholder behavior and mortality in the third quarter of each year by considering the actual results that have occurred during the period from the most recent update to the expected
amounts. Over the last several years, the Company’s most significant assumption updates that have resulted in changes to our reserves for guaranteed minimum death and income benefits have been related to lapse experience and other
contractholder behavior assumptions and revisions to expected future rates of returns on investments. The Company expects these assumptions to be the ones most likely to cause significant changes in the future. Changes in these assumptions can be
offsetting and can also impact our DAC and other balances as discussed above. Generally, we do not expect our actual mortality trends to change significantly in the short-term, and to the extent these trends may change we expect such changes to be
gradual over the long-term.
The future rate of return assumptions used in establishing reserves for guaranteed minimum death
and income benefits related to variable annuities contracts are derived using a reversion to the mean approach, a common industry practice. For additional information regarding our future expected rate of return assumptions and our reversion to the
mean approach see, “—Deferred Policy Acquisition and Other Costs.” The following table provides a demonstration of the sensitivity of the reserves for guaranteed minimum death benefit (“GMDB”) and guaranteed minimum income
benefit (“GMIB”) related to variable annuity contracts relative to our future rate of return assumptions by quantifying the adjustments to the reserves that would be required assuming both a 100 basis point increase and decrease in our
future rate of return. The sensitivity includes an increase and decrease of 100 basis points to both the near-term future rate of return assumptions used over the next four years, and the long-term expected rate of return used thereafter. While the
information below is for illustrative purposes only and does not reflect our expectations regarding future rate of return assumptions, it is a near-term, reasonably likely change that illustrates the potential impact of such a change. This
information considers only the direct effect of changes in our future rate of return on operating results due to the change in the reserve balance and not changes in any other assumptions such as persistency, mortality, or expenses included in our
evaluation of the reserves, or any changes on DAC or other balances, discussed above in “—Deferred Policy Acquisition and Other Costs.”
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December 31, 2010
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Increase/(Reduction) in
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GMDB/GMIB Reserves
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(in millions)
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Decrease in future rate of return by 100 basis points
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$
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31
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Increase in future rate of return by 100 basis points
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$
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(24)
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For a discussion of
adjustments to the reserves for guaranteed minimum death and income benefits for the years ended December 31, 2010 and 2009 , see “—Results of Operations”.
The Company’s liability for future policy benefits also includes reserves based on the present value of estimated future payments to or on behalf of policyholders related to contracts that have
annuitized, where the timing and amount of payment depends on policyholder mortality, less the present value of future net premiums. Expected mortality is generally based on the Company’s historical experience or standard industry tables.
Interest rate assumptions are based on factors such as market conditions and expected investment returns. Although mortality and interest rate assumptions are “locked-in” upon the issuance of new insurance or annuity business with fixed
and guaranteed terms, significant changes in experience or assumptions may require the Company to provide for expected future losses on a product by establishing premium deficiency reserves.
Taxes on Income
Our effective tax rate is based on income, non-taxable and non-deductible items, statutory tax rates and tax planning opportunities available in the various jurisdictions in which we operate. Inherent in
determining our annual tax rate are judgments regarding business plans, planning opportunities and expectations about future outcomes.
Tax regulations require items to be included in the tax return at different times from the items reflected in the financial statements. As a result, the effective tax rate reflected in the financial
statements is different than the actual rate applied on the tax return. Some of these differences are permanent such as expenses that are not deductible in our tax return, and some differences are temporary, reversing over time, such as valuation of
insurance reserves. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in future years for which we have already recorded the tax benefit in
our income statement. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expenditures for which we have already taken a deduction in our tax return but have not yet
recognized in our financial statements.
The application of U.S. GAAP requires us to evaluate the recoverability of our
deferred tax assets and establish a valuation allowance if necessary to reduce our deferred tax asset to an amount that is more likely than not to be realized. Considerable judgment is required in determining whether a valuation allowance is
necessary, and if so, the amount of such valuation allowance. In evaluating the need for a valuation allowance we consider many factors, including: (1) the nature of the deferred tax assets and liabilities; (2) whether they are ordinary
25
or capital; (3) in which tax jurisdictions they were generated and the timing of their reversal; (4) taxable income in prior carryback years as well as projected taxable earnings
exclusive of reversing temporary differences and carryforwards; (5) the length of time that carryovers can be utilized in the various taxing jurisdictions; (6) any unique tax rules that would impact the utilization of the deferred tax
assets; and (7) any tax planning strategies that we would employ to avoid a tax benefit from expiring unused. Although realization is not assured, management believes it is more likely than not that the deferred tax assets, net of valuation
allowances, will be realized.
Our accounting represents management’s best estimate of future events that can be
appropriately reflected in the accounting estimates. Certain changes or future events, such as changes in tax legislation, geographic mix of earnings and completion of tax audits could have an impact on our estimates and effective tax rate. For
example, the dividends received deduction, or DRD, reduces the amount of dividend income subject to tax and is a significant component of the difference between our actual tax expense and the expected amount determined using the federal statutory
tax rate of 35%. The U.S. Treasury Department and the Internal Revenue Service, or IRS, intend to address through regulations the methodology to be followed in determining the DRD related to variable life insurance and annuity contracts. On
February 14, 2011, the Obama Administration released the “General Explanations of the Administration’s Revenue Proposals.” Although the Administration has not released proposed statutory language, one proposal would change the
method used to determine the amount of the DRD. A change in the DRD, including the possible retroactive or prospective elimination of this deduction through regulation or legislation, could increase our actual tax expense and reduce our net income.
U.S. GAAP prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its
financial statements uncertain tax positions that a company has taken or expects to take on tax returns. The application of this guidance is a two-step process, the first step being recognition. We determine whether it is more likely than not, based
on the technical merits, that the tax position will be sustained upon examination. If a tax position does not meet the more likely than not recognition threshold, the benefit of that position is not recognized in the financial statements. The second
step is measurement. We measure the tax position as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate resolution with a taxing authority that has full knowledge of all relevant information. This
measurement considers the amounts and probabilities of the outcomes that could be realized upon ultimate settlement using the facts, circumstances, and information available at the reporting date.
An increase or decrease in our effective tax rate by one percent would have resulted in an increase or decrease in consolidated income
from continuing operations in 2010 of $5.4 million.
Reserves for Contingencies
A contingency is an existing condition that involves a degree of uncertainty that will ultimately be resolved upon the occurrence of
future events. Under U.S. GAAP, reserves for contingencies are required to be established when the future event is probable and its impact can be reasonably estimated. An example is the establishment of a reserve for losses in connection with an
unresolved legal matter. The initial reserve reflects management’s best estimate of the probable cost of ultimate resolution of the matter and is revised accordingly as facts and circumstances change and, ultimately, when the matter is brought
to closure. In situations in which the Company is to be indemnified by Skandia, there will be no financial impact on the Statements of Operations and Comprehensive Income.
Accounting Pronouncements Adopted and Recently Issued Pronouncements
See
Note 2 to the Financial Statements for a discussion of adopted and newly issued accounting pronouncements.
The Company’s
Changes in Financial Position and Results of Operations are described below.
26
Changes in Financial Position
2010 versus 2009
Total assets increased by $5.3 billion, from $51.9
billion at December 31, 2009 to $57.2 billion at December 31, 2010. Separate account assets increased by $6.8 billion, primarily driven by market appreciation, positive net flows and transfers of balances from the general account to the
separate accounts primarily as a result of transfers from a customer elected dollar cost averaging (“DCA”) program and the asset transfer feature embedded, in some of our optional living benefit features, as discussed above. Additionally,
reinsurance recoverables increased by $146.5 million driven by an increase in the reinsured liability for living benefit embedded derivatives primarily driven by an increase in the present value of future expected benefit payments driven by lower
interest rates as well as a updates of the inputs used in the valuation of the embedded derivatives. The reinsured liability increased related to an update to reduce expected lapse rate assumption based on evolving experience, partially offset by
updates to the market perceived risk of our non-performance resulting from the increase in the fair value of embedded derivative liabilities. Also contributing to the increase in total assets was an increase in deferred policy acquisition costs
(“DAC”) of $128.5 million mainly due to capitalized costs on new business sales, partially offset by amortization on current year gross profits. Partially offsetting the above increases in total assets were decreases in fixed maturities
and short term investments of $1.0 billion and $477.5 million, respectively, driven by lower general account balances due to the aforementioned transfers related to the DCA program and the asset transfer feature. Also serving as a partial offset was
lower income tax receivable of $230.4 million.
During the period, total liabilities increased by $5.3 billion, from $50.0
billion at December 31, 2009 to $55.3 billion at December 31, 2010. Separate account liabilities increased by $6.8 billion offsetting the increase in separate accounts assets above. Additionally, future policy benefits and other
policyholder liabilities increased by $120.0 million driven by an increase in the liability for living benefit embedded derivatives, as discussed above. Partially offsetting the above increases in total liabilities was a decrease in
policyholders’ account balances of $1.6 billion primarily driven by transfers of customer account values to the separate account from the general account as a result of transfers from a customer elected DCA program and the asset transfer
feature.
Results of Operations
2010 versus 2009 Comparison
Net Income
Net income increased $338.0 million from $83.6 million in 2009 to $421.6 million in 2010. The gain is driven by a $513.1 million increase
in income from operations before income taxes, as discussed below, partially offset by a $175.1 million increase in income tax expense.
The increase in income from operations before taxes was driven by an increase in fee income, net of higher distribution costs, due to higher average variable annuity asset balances invested in separate
accounts. The increase in average separate account asset balances was due to positive net flows, net market appreciation, and net transfers of balances from the general account to the separate accounts during 2010. The transfer of balances from the
general account were approximately $1.4 billion, primarily related to both transfers from the DCA program and net transfers from the asset transfer feature, in some of our optional living benefit features. The asset transfer feature is part of the
overall product design, and as a result of market improvements, transferred balances out of the fixed-rate account in our general account to the separate accounts during 2010. Also included within the increase was an $80.3 million favorable variance
in the mark-to-market on derivative positions associated with our capital hedging program. Results for 2009 included $76.1 million of mark-to-market losses on these capital hedges driven by favorable market conditions during the year. Results for
2010 included $4.2 million of mark-to-market gains on these capital hedges. During the second quarter of 2010, we terminated the capital hedge program in lieu of a new program managed at the Prudential Financial level that more broadly addresses
equity market exposure of the overall statutory capital of Prudential Financial as a whole and its subsidiaries, under stress scenarios. Additionally, the above increase in income from operation before income taxes included a favorable variance from
lower amortization of deferred policy acquisition and other costs, and more favorable adjustments to the reserves for the guaranteed minimum death and income benefit features of our variable annuity products, as discussed in more detail below.
We amortize deferred policy acquisition and other costs over the expected lives of the contracts based on the level and
timing of gross profits on the underlying product. In calculating gross profits, we consider mortality, persistency, and other elements as well as rates of return on investments associated with these contracts and include profits and losses related
to these contracts that are reported in affiliated legal entities other than the Company as a result of, for example, reinsurance agreements with those affiliated entities. The Company is an indirect subsidiary of Prudential Financial (an SEC
registrant) and has extensive transactions and relationships with other subsidiaries of Prudential Financial, including reinsurance agreements, as discussed in Note 13 to the Financial Statements. Incorporating all product-related profits and losses
in gross profits, including those that are reported in affiliated legal entities, produces a DAC amortization pattern representative of the economics of the products.
Included in the favorable variance from lower amortization of deferred policy acquisition and other costs mentioned above, was a $137.8 million favorable variance in amortization related to the impact of
the mark-to-market of the reinsured liability for living benefit embedded derivatives and related hedge positions. This impact primarily relates to updates to the inputs used in the valuation of the reinsured liability for living benefit embedded
derivatives, primarily due to reductions in the expected lapse rate assumption based on actual experience in 2010. Also contributing to lower deferred policy acquisition and other costs amortization is the impact of a change in our market-perceived
non-performance risk (“NPR”), and lower amortization rates used as a basis for amortizing deferred policy acquisition and other costs, as discussed below. We incorporate the market-perceived risk of non-performance of our affiliates’
in the valuation of the embedded derivatives associated with our living benefit features on our variable annuity contracts. Beginning in the first quarter of 2009, in light of developments including rating agency downgrades to the financial strength
ratings of the Company, we incorporated an additional spread over LIBOR into
27
the discount rate used in the valuation of the embedded derivative liabilities to reflect an increase in the market perceived risk of our non-performance, thereby reducing the value of the
embedded derivative liabilities. Partially offsetting this favorable variance was higher amortization of deferred policy acquisition and other costs due to higher gross profits, primarily from the higher fee income, as discussed above.
As shown in the following table, pretax income for the year ended December 31, 2010 included $150.7 million of benefits related to
adjustments to the reserves for the guaranteed minimum death and income benefit features of our variable annuity products and to our estimate of total gross profits used as a basis for amortizing deferred policy acquisition and other costs, compared
to $132.1 million of benefits included in the year ended December 31, 2009, resulting in a favorable variance of $18.6 million. This variance is discussed in more detail below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2010
|
|
|
Year Ended December 31, 2009
|
|
|
|
|
Amortization
of DAC
and Other
Costs (1)
|
|
|
Reserves
for
GMDB /
GMIB (2)
|
|
|
Total
|
|
|
Amortization
of DAC
and Other
Costs (1)
|
|
|
Reserves
for GMDB
/ GMIB (2)
|
|
|
Total
|
|
|
|
|
(in thousands)
|
|
|
Quarterly market performance adjustments
|
|
$
|
18,552
|
|
|
$
|
12,324
|
|
|
$
|
30,876
|
|
|
$
|
68,675
|
|
|
$
|
66,085
|
|
|
$
|
134,760
|
|
|
Annual review / assumption updates
|
|
|
113,333
|
|
|
|
(5,114)
|
|
|
|
108,219
|
|
|
|
(19,008)
|
|
|
|
14,493
|
|
|
|
(4,515)
|
|
|
Quarterly adjustments for current period experience
|
|
|
(36,290)
|
|
|
|
47,914
|
|
|
|
11,624
|
|
|
|
(12,069)
|
|
|
|
13,931
|
|
|
|
1,862
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
95,595
|
|
|
$
|
55,124
|
|
|
$
|
150,719
|
|
|
$
|
37,598
|
|
|
$
|
94,509
|
|
|
$
|
132,107
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Amounts reflect (charges) or benefits for (increases) or decreases, respectively, in the amortization of deferred policy acquisition, or DAC, and
other costs.
|
|
|
(2)
|
Amounts reflect (charges) or benefits for reserve (increases) or decreases, respectively, related to the guaranteed minimum death and income
benefit, or GMDB / GMIB, features of our variable annuity products.
|
As shown in the table above, results
for both periods include the impact of the annual reviews of the assumptions used in the reserve for the guaranteed minimum death and income benefit features of our variable annuity products and in our estimate of total gross profits used as a basis
for amortizing deferred policy acquisition and other costs. The year ended December 31, 2010 included a $108.2 million of benefits from these annual reviews, primarily related to reductions in lapse rate assumptions and more favorable
assumptions relating to fee income. The year ended December 31, 2009 included $4.5 million of charges from these annual reviews, primarily related to reductions in the future rate of return assumptions applied to the underlying assets
associated with our variable annuity products. Partially offsetting the impact of the updated future rate of return assumptions for 2009 were benefits related to the impact of lower mortality and higher investment spread assumptions.
The $30.9 million of benefits for 2010 relating to the quarterly market performance adjustments shown in the table above are attributable
to changes to our estimate of total gross profits to reflect actual fund performance. The following table shows the actual quarterly rate of return on variable annuity account values for the four quarters of 2010 compared to our previously expected
quarterly rate of return used in our estimate of total gross profits.
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
2010
|
|
Second Quarter
2010
|
|
Third Quarter
2010
|
|
Fourth Quarter
2010
|
|
Actual rate of return
|
|
3.3%
|
|
(4.6)%
|
|
8.1%
|
|
5.9%
|
|
Expected rate of return
|
|
1.8%
|
|
1.8%
|
|
2.0%
|
|
1.7%
|
Actual returns
exceeded our expected returns for 2010 which increased our estimates of total gross profits and decreased our estimate of future expected claims costs associated with the guaranteed minimum death and income benefit features of our variable annuity
products, by establishing a new, higher starting point for the variable annuity account values used in estimating those items for future periods. The expected rates of return in 2010 for some contract groups was based upon our maximum future rate of
return under the reversion to the mean approach, as discussed below. The overall increase in our estimate of total gross profits and decrease in our estimate of future expected claims costs results in a lower required rate of amortization and lower
required reserve provisions, which are applied to all prior periods. The resulting cumulative adjustment to prior amortization and reserve provisions was a $30.9 million benefit for 2010 as shown in the table above.
The $134.8 million of benefits for 2009 relating to the quarterly market performance adjustments is attributable to a similar impact on
gross profits of market value increases in the underlying assets associated with our variable annuity products, reflecting financial market conditions during the period. The benefit in 2009 is higher than that in 2010 due to a greater difference in
2009 between the actual rates of return and the expected rates of return, which are detailed further below.
As mentioned
above, we derive our near-term future rate of return assumptions using a reversion to the mean approach, a common industry practice. Under this approach, we consider actual returns over a period of time and initially adjust future projected returns
over a four year period so that the assets are projected to grow at the long-term expected rate of return for the entire period. The near-term future projected return across all contract groups is 6.1% per annum as of December 31, 2010, or
1.5% per quarter. Beginning in the fourth quarter of 2008 and continuing through the fourth quarter of 2010, the projected near-term future annual rate of return calculated using the reversion to the mean approach for some contract groups was
greater than our maximum future rate of return assumption across all asset types for this
28
business. In those cases, we utilize the maximum future rate of return over the four year period, thereby limiting the impact of the reversion to the mean on our estimate of total gross profits.
The near-term blended maximum future rate of return, for these impacted contract groups, under the reversion to the mean approach is 9.3% at the end of 2010. Included in the blended maximum future rate are assumptions for returns on various asset
classes, including a 5.7% annual weighted average rate of return on fixed income investments and a 13% annual maximum rate of return on equity investments.
The $11.6 million benefit for the year ended December 31, 2010 and the $1.8 million benefit for the year ended December 31, 2009 for the quarterly adjustments for current period experience and
other updates shown in the table above primarily reflect the impact of differences between actual gross profits for the period and the previously estimated expected gross profits for the period, as well as an update for current and future expected
claims costs associated with the guaranteed minimum death and income benefit features of our variable annuity products. To the extent each period’s actual experience differs from the previous estimate for that period, the assumed level of total
gross profits may change, and a cumulative adjustment to previous periods’ amortization, also referred to as an experience true-up adjustment, may be required in the current period. This adjustment to previous periods’ amortization is in
addition to the direct impact of actual gross profits on current period amortization and the market performance related adjustment to our estimates of gross profits for future periods. The experience true-up adjustments for deferred policy
acquisition and other costs for the year ended December 31, 2010 reflect an increase in amortization due to less favorable than expected gross profits, resulting primarily from the charges related to the mark-to-market of embedded derivatives
and related hedge positions associated with our living benefit features. The adjustment for the reserves for the guaranteed minimum death and income benefit features of our variable annuity products in the year ended December 31, 2010 primarily
reflects a reserve decrease driven by lower than expected actual contract guarantee claim costs, more favorable lapse experience, and higher than expected fee income. The experience true-up adjustments for deferred policy acquisition and other costs
for the year ended December 31, 2009 reflect an increase in amortization due to lower than expected realized gains activity. The adjustment for the reserves for the guaranteed minimum death and income benefit features of our variable annuity
products in the year ended December 31, 2009 primarily reflects higher than expected fee income due to market value increases, partially offset by higher than expected contract guaranteed claims due to lower than expected lapses.
Revenues
Revenues
increased $438.5 million, from $1,136.5 million for the year ended December 31, 2009 to $1,574.0 million for the year ended December 31, 2010. Premiums increased $16.0 million, from $13.4 million for the year ended December 31, 2009
to $29.4 million for the year ended December 31, 2010, reflecting an increase in funds from customers electing to enter into the payout phase of their annuity contracts.
Policy charges and fee income increased $348.4 million, from $392.8 million for the year ended December 31, 2009 to $741.2 million for the year ended December 31, 2010 driven by higher fee
income primarily driven by an increase in average variable annuity asset balances invested in separate accounts. The increase in average separate account asset balances was due to positive net flows, net market appreciation, and net transfers of
balances from the fixed-rate option in the general account to the separate accounts over the past twelve months relating to both a customer elected dollar cost averaging program and an asset transfer feature in some of our optional living benefit
features. The increase in optional benefit charges was primarily offset in realized investment gains, net as these features are reinsured with affiliates. Also included in the above increases was a $27.0 million benefit in the year ended
December 31, 2010 from refinements based on review and settlement of reinsurance contracts and $40.8 million of lower charges from market value adjustments related to the Company’s MVA option driven by market conditions and transfer of
assets to the separate account primarily due to the asset transfer feature.
Net investment income decreased $117.6 million
from $494.7 million for the year ended December 31, 2009 to $377.1 million for the year ended December 31, 2010 as a result lower average annuity account values in the general account also resulting from transfers from the fixed-rate
option in the general account to the separate accounts, as discussed above.
Asset administration fees and other income
increased $92.5 million, from $197.7 million for the year ended December 31, 2009 to $290.2 million for the year ended December 31, 2010 as a result of higher average variable annuity asset balances invested in separate accounts, as
discussed above.
Realized investment gains, net, increased by $99.0 million from $37.0 million for the year ended
December 31, 2009 to $136.0 million for the year ended December 31, 2010. This increase was driven by an increase in net realized investment gains on fixed maturities primarily in our MVA and general account portfolios, driven by the sale
of assets in a low interest rate environment. Also contributing to above increase was a favorable variance primarily related to mark-to-market losses in 2009 on derivative positions associated with our capital hedging program. This variance was
partially offset by an unfavorable variance in the mark-to-market of embedded derivatives and related hedge positions associated with our non-reinsured living benefit features of our variable annuity products, including the impact of our
market-perceived non-performance risk.
Benefits and Expenses
Benefits and expenses decreased $74.7 million from $1,103.4 million for the year ended December 31, 2009 to $1,028.7 million for the year ended December 31, 2010.
Policyholders’ benefits increased $36.5 million, from a benefit of $4.4 million for the year ended December 31, 2009 to a
charge of $40.9 million for the year ended December 31, 2010, primarily driven by the impact of the adjustments to the reserves for the guaranteed minimum death and income benefit features of our variable annuity products, as previously
discussed.
Interest credited to policyholders’ account balances decreased $37.3 million, from $409.1 million for the
year ended December 31, 2009 to $371.8 million for the year ended December 31, 2010, due to lower interest credited to policyholders’ account balances of $94.6 driven by
29
lower average annuity account values in the fixed-rate option of the general account. Also contributing to the decrease was a decrease in deferred sales inducements (“DSI”) amortization
of $35.6 million relating the impact of the adjustments to our estimate of total gross profits used as a basis for amortizing DSI and the impact of the mark-to-market of the reinsured liability for living benefit embedded derivatives and related
hedge positions, as discussed above. Partially offsetting the above decreases was $89.4 million of higher DSI amortization primarily driven by the impact of higher gross profits primarily from fee income.
Amortization of deferred policy acquisition costs decreased by $117.2 million, from $319.8 million for the year ended December 31,
2009 to $202.6 million for the year ended December 31, 2010, due to lower amortization of $158.8 relating to the impact of the mark-to-market of the reinsured liability for living benefit embedded derivatives and related hedge positions, and
the impact of the adjustments to our estimate of total gross profits used as a basis for amortizing DAC, as discussed above. Partially offsetting the above decreases was higher amortization of $41.5 million due to the impact of higher gross profits
primarily related to higher fee income.
General, administrative and other expenses increased by $43.3 million, from $370.2
million for the year ended December 31, 2009 to $413.5 million for the year ended December 31, 2010, primarily due to $25.6 million of higher interest expense driven by increased borrowings at the end of 2009, primarily to fund new
business sales, and $20.6 million of higher commission expense, net of capitalization, primarily driven by higher asset based commission from higher average variable annuity asset balances invested in separate accounts.
Income Taxes
Shown
below is our income tax provision for the years ended December 31, 2010, 2009 and 2008, separately reflecting the impact of certain significant items. Also presented below is the income tax provision that would have resulted from application of
the statutory 35% federal income tax rate in each of these periods.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
|
(in millions)
|
|
|
Tax provision
|
|
$
|
123.7
|
|
|
$
|
(51.4)
|
|
|
$
|
(39.2)
|
|
|
Impact of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non taxable investment income
|
|
|
55.7
|
|
|
|
56.9
|
|
|
|
24.4
|
|
|
Tax credits
|
|
|
11.1
|
|
|
|
6.1
|
|
|
|
8.4
|
|
|
Prior year adjustments
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
State income taxes, net of federal benefit
|
|
|
0.6
|
|
|
|
(1.7)
|
|
|
|
0.3
|
|
|
Other
|
|
|
(0.3)
|
|
|
|
1.3
|
|
|
|
(0.6)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax provision at statutory rate
|
|
$
|
190.8
|
|
|
$
|
11.2
|
|
|
$
|
(6.7)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our income tax provision amounted to an income tax expense of $123.7 million in 2010 compared to a benefit
of $51.4 million in 2009. The increase in income tax expense primarily reflects the increase in pre-tax income from continuing operations for the year ended December 31, 2010.
We employ various tax strategies, including strategies to minimize the amount of taxes resulting from realized capital gains.
For additional information regarding income taxes, see Note 8 to the Financial Statements.
Liquidity and Capital Resources
Overview
Liquidity refers to the ability to generate sufficient cash resources to meet the payment obligations of the Company. Capital refers to
the long term financial resources available to support the operation of our business, fund business growth, and provide a cushion to withstand adverse circumstances. The ability to generate and maintain sufficient liquidity and capital depends on
the profitability of our business, general economic conditions and our access to the capital markets through our affiliates as described herein.
Management monitors the liquidity of Prudential Financial, Prudential Insurance and the Company on a daily basis and projects borrowing and capital needs over a multi-year time horizon through our
quarterly planning process. We believe that cash flows from the sources of funds presently available to us are sufficient to satisfy the current liquidity requirements, of Prudential Financial, Prudential Insurance and the Company, including
reasonably foreseeable contingencies.
We continue to refine our metrics for capital management. These refinements to the
current framework, which is primarily based on statutory risk based capital measures, are designed to more appropriately reflect risks associated with our businesses on a consistent basis across the Company. In addition, we continue to use an
economic capital framework for making certain business decisions. Similar to our planning and management process for liquidity, we also use a disciplined framework to ensure the availability of adequate capital under reasonably foreseeable
contingencies.
The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law on July 21, 2010, could
result in the imposition of new capital, liquidity and other requirements on Prudential Financial and the Company. See Item 1. Business -”Regulatory Environment” for information regarding the potential effects of the Dodd-Frank Act on
the Company and its affiliates.
On November 23, 2010, the Company paid an ordinary dividend of $330 million and an
extraordinary dividend of $140 million to Prudential Financial.
30
General Liquidity
Our liquidity is managed to ensure stable, reliable and cost-effective sources of cash flows to meet all of our obligations. Liquidity is
provided by a variety of sources, as described more fully below, including portfolios of liquid assets. Our investment portfolios are integral to the overall liquidity of our operations. We segment our investment portfolios and employ an
asset/liability management approach specific to the requirements of our product lines. This enhances the discipline applied in managing the liquidity, as well as the interest rate and credit risk profiles, of each portfolio in a manner consistent
with the unique characteristics of the product liabilities. We use a projection process for cash flows from operations to ensure sufficient liquidity to meet projected cash outflows, including claims. The impact of Prudential Funding, LLC’s
financing capacity on liquidity (as described below) is considered in the internal liquidity measures of the Company.
Liquidity is measured against internally developed benchmarks that take into account the characteristics of both the asset portfolio and
the liabilities that they support. The results are affected substantially by the overall asset type and quality of our investments.
Cash Flow
The principal sources of the Company’s liquidity are
annuity considerations, investment and fee income, and investment maturities and sales, as well as internal borrowings. The principal uses of that liquidity include benefits, claims, and payments to policyholders and contractholders in connection
with surrenders, withdrawals and net policy loan activity. Other uses of liquidity include commissions, general and administrative expenses, purchases of investments, and payments in connection with financing activities. As discussed above, in March
2010, the Company ceased offering its existing variable annuity products to new investors upon the launch of a new product by certain affiliates. Therefore, the Company expects its overall level of cash flows to decrease going forward.
We believe that the cash flows from our operations are adequate to satisfy our current liquidity requirements including under reasonably
foreseeable stress scenarios. The continued adequacy of this liquidity will depend upon factors such as future securities market conditions, changes in interest rate levels, policyholder perceptions of our financial strength, and the relative safety
of competing products, each of which could lead to reduced cash inflows or increased cash outflows. In addition, market volatility can impact the level of capital required to support our businesses. Our cash flows from investment activities result
from repayments of principal, proceeds from maturities and sales of invested assets, net of amounts reinvested. The primary liquidity risks with respect to these cash flows are the risk of default by debtors or bond insurers, our
counterparties’ willingness to extend repurchase and/or securities lending arrangements, commitments to invest and market volatility. We closely manage these risks through our credit risk management process and regular monitoring of our
liquidity position.
In managing our liquidity, we also consider the risk of policyholder and contractholder withdrawals of
funds earlier than our assumptions when selecting assets to support these contractual obligations. We use surrender charges and other contract provisions to mitigate the extent, timing and profitability impact of withdrawals of funds by customers
from annuity contracts and deposit liabilities.
Liquid Assets
Liquid assets include cash, cash equivalents, short-term investments, most fixed maturities that are not designated as held to maturity
and public equity securities. As of December 31, 2010 and December 31, 2009, the Company had liquid assets of $5.8 billion and $7.4 billion, respectively, which includes a portion financed with asset-based financing. The portion of liquid
assets comprised of cash and cash equivalents and short-term investments was $0.2 billion and $0.8 billion as of December 31, 2010 and December 31, 2009, respectively. We consider attributes of the various categories of liquid assets (for
example, type of asset and credit quality) in calculating internal liquidity measures in order to evaluate the adequacy of our operations’ liquidity under a variety of stress scenarios. We believe that the liquidity profile of our assets is
sufficient to satisfy current liquidity requirements, including under foreseeable stress scenarios.
Given the size and
liquidity profile of our investment portfolios, we believe that claim experience varying from our projections does not constitute a significant liquidity risk. Our asset/liability management process takes into account the expected maturity of
investments and expected claim payments as well as the specific nature and risk profile of the liabilities. Historically, there has been no significant variation between the expected maturities of our investments and the payment of claims.
Our liquidity is managed through access to substantial investment portfolios as well as a variety of instruments available
for funding and/or managing cash flow mismatches, including from time to time those arising from claim levels in excess of projections. To the extent we need to pay claims in excess of projections, we may borrow temporarily or sell investments
sooner than anticipated to pay these claims, which may result in increased borrowing costs or realized investment gains or losses affecting results of operations.
We believe that borrowing temporarily or selling investments earlier than anticipated will not have a material impact on our liquidity. Payment of claims and sale of investments earlier than anticipated
would have an impact on the reported level of cash flow from operating and investing activities, respectively, in our financial statements.
Prudential Funding, LLC
Prudential Funding, LLC, or Prudential Funding, a
wholly owned subsidiary of Prudential Insurance, serves as an additional source of financing to meet our working capital needs up to limits established with the applicable insurance regulators. Prudential Funding borrows funds in the capital markets
primarily through the direct issuance of commercial paper.
31
Capital
The Risk Based Capital, or RBC, ratio is a primary measure by which we evaluate the capital adequacy of the Company. Prudential Financial manages its domestic insurance subsidiaries’ RBC ratios to a
level that is consistent with the ratings targets for those subsidiaries and in excess of the minimum levels required by applicable insurance regulations. RBC is determined by statutory guidelines and formulas that consider, among other things,
risks related to the type and quality of the invested assets, insurance-related risks associated with an insurer’s products, interest rate risks and general business risks. The RBC ratio calculations are intended to assist insurance regulators
in measuring the adequacy of an insurer’s statutory capitalization. The reporting of RBC measures is not intended for the purpose of ranking any insurance company or for use in connection with any marketing, advertising or promotional
activities.
The level of statutory capital of the Company can be materially impacted by interest rate and equity market
fluctuations, changes in the values of derivatives, the level of impairments recorded, credit quality migration of investment portfolio, among other items. Further, the recapture of business subject to reinsurance arrangements due to defaults by, or
credit quality migration affecting, the reinsurers could result in higher required statutory capital levels. The level of statutory capital of the Company is also affected by statutory accounting rules which are subject to change by insurance
regulators.
Prudential Financial recently changed the focus of its capital hedge program from the equity price risk
associated with the annuities business to a broader view of equity market exposure of the statutory capital of Prudential Financial and its subsidiaries, as a whole. In the second quarter of 2010, the capital hedge program was terminated as
described under “—Results of Operations” and equity index-linked derivative transactions were entered into that are designed to mitigate the overall impact on statutory capital of a severe equity market stress event on Prudential
Financial and its subsidiaries, as whole. A portion of the derivatives related to the new program were purchased by the Company. The program now focuses on tail risk rather than general equity market declines in order to protect statutory capital in
a more cost-effective manner under stress scenarios. Prudential Financial assesses the composition of the hedging program on an ongoing basis and may change it from time to time based on an evaluation of its risk position or other factors.
In addition to hedging the equity market exposure as mentioned above, we also manage certain risks associated with our
variable annuity products through hedging programs and affiliated reinsurance arrangements. Primarily in the reinsurance affiliate, we purchase equity options and futures as well as interest rate derivatives are purchased to hedge certain optional
living benefit features accounted for as embedded derivatives against changes in equity markets, interest rates, and market volatility. Historically, the hedging strategy sought to generally match the sensitivities of the embedded derivative
liability as defined by GAAP, excluding the impact of the market-perceived risk of non-performance, with capital market derivatives and options. In the third quarter of 2010, the hedging strategy was revised as, in the current low interest rate
environment, management of the company and reinsurance affiliates does not believe the GAAP value of the embedded derivative liability to be an appropriate measure for determining the hedge target. For additional information regarding the change in
hedging strategy see “Item 1. Business – Products”.
Certain of the Company’s statutory reserves are ceded
to an affiliated offshore captive reinsurance company. A reinsurance trust is established by the affiliated offshore captive reinsurance company to satisfy reinsurance reserve credit requirements. These reserve credits allow the Company to reduce
the level of statutory capital it is required to hold. Reinsurance credit reserve requirements can move materially in either direction due to changes in equity markets and interest rates, actuarial assumptions and other factors. Higher reinsurance
credit reserve requirements would necessitate depositing additional assets in the statutory reserve credit trusts, while lower reinsurance credit reserve requirements would allow assets to be removed from the statutory reserve credit trusts. We
expect Prudential Financial would satisfy those additional needs through a combination of funding the reinsurance credit trusts with available cash, certain hedge assets or collateral associated with the hedge positions, and loans from Prudential
Financial and/or affiliates. Prudential Financial also continues to evaluate other options to address reserve credit needs such as obtaining letters of credit. Funding was provided to the captive reinsurance trusts of $178 million for the second
quarter of 2010 to meet increased reserve credit requirements due to unfavorable equity market conditions and lower interest rates, and an additional $334 million was provided for the third quarter of 2010 due to an update of actuarial assumptions
based on an annual review, most notably a decrease in expected future lapse rates, partially offset by favorable equity market conditions. Due to favorable equity market conditions and higher interest rates in the fourth quarter of 2010, our need to
fund the captive reinsurance trusts has declined by $907 million.
Item 7A. Quantitative and Qualitative
Disclosures About Market Risk
Risk Management and Market Risk
As an indirect wholly-owned subsidiary of Prudential Financial, the Company benefits from the risk management strategies implemented by
its parent. Risk management includes the identification and measurement of various forms of risk, establishment of acceptable risk thresholds, and creation of processes intended to maintain risks within these thresholds while optimizing returns on
the underlying assets or liabilities. Prudential Financial considers risk management an integral part of managing its core businesses.
Market risk is the risk of change in the value of financial instruments as a result of absolute or relative changes in interest rates, foreign currency exchange rates, equity prices or commodity prices.
To varying degrees, the investment activities supporting all of the Company’s products and services generate market risks. Market risks incurred and the strategies for managing these risks vary by product.
With respect to our fixed-rate accounts in our variable annuity products, the Company incurs market risk primarily in the form of
interest rate risk. The Company manages this risk through asset/liability management strategies that seek to closely approximate the interest rate sensitivity, but not necessarily the exact cash flow characteristics, of the assets with the estimated
interest rate sensitivity of the product
32
liabilities. The Company also mitigates this risk through a MVA provision on the Company’s fixed investment option. This MVA provision limits interest rate risk when a contractholder
withdraws funds or transfers funds to variable investment options before the end of the guarantee period. The Company’s overall objective in these strategies is to limit the net change in value of assets and liabilities arising from interest
rate movements. While it is more difficult to measure the interest sensitivity of the Company’s insurance liabilities than that of the related assets, to the extent the Company can measure such sensitivities the Company believes that interest
rate movements will generate asset value changes that substantially offset changes in the value of the liabilities relating to the underlying products. Certain products supported by general account investments also expose us to the risk that changes
in interest rates will reduce the spread between the amounts that we are required to pay under the contracts and the rate of return we are able to earn on our general account investments supporting the contracts. In a declining or sustained low
interest rate environment, our ability to achieve desired spreads can become limited by minimum guaranteed crediting rates associated with some of our variable annuity products.
For variable annuities, excluding the fixed-rate accounts associated in these products, we are exposed to the risk that asset-based fees
may decrease as a result of declines in assets under management due to changes in investment prices. The risk of decreased asset based and asset administration fees could also impact our estimates of total gross profits used as a basis for
amortizing deferred policy acquisition and other costs. While a decrease in our estimates of total gross profits would accelerate amortization and decrease net income in a given period, it would not affect our cash flow or liquidity position.
For variable annuity products with minimum guaranteed death benefits and variable annuity products with living benefits such
as guaranteed minimum income, withdrawal, and accumulation benefits, we also face the risk that declines in the value of underlying investments as a result of interest rate, equity market, or market volatility changes may increase our net exposure
to the guarantees under these contracts. As part of our risk management strategy, we utilize product design elements such as asset allocation restriction, an asset transfer feature and minimum purchase age requirements, in addition to externally
purchased hedging instruments and affiliated reinsurance arrangements to limit our market risk exposure to the benefit features of certain of our variable annuity contracts. See Note 11 to the Financial Statements for a discussion of our use of
interest rate and equity based derivatives. See Note 6 to our Financial Statements for additional information about the guaranteed minimum death benefits associated with our variable annuity contracts, and the guaranteed minimum income, withdrawal,
and accumulation benefits associated our variable annuity contracts.
For risk management purposes we perform stress scenario
testing to monitor the impact of extreme, but realistic adverse market events on our capital adequacy and liquidity. This testing allows us to assess the sensitivity of our business to market factors and identify any concentrations of risk. The
regulatory capital levels and liquidity of the Company in particular are closely monitored to ensure they remain consistent with our rating objectives. Changes to these ratings could impact Prudential Financial’s borrowing costs, our ability to
access alternative sources of liquidity, and our ability to market certain products. For additional information regarding our liquidity and capital resources see “Management’s Discussion and Analysis of Financial Results of
Operations—Liquidity and Capital Resources.” Market fluctuations or changes in market conditions could also cause a change in consumer sentiment adversely affecting our sales and persistency. For additional information regarding the
potential impacts of interest rate and other market fluctuations as well as general economic and market conditions on our businesses and profitability see Item 1A. “Risk Factors.”
Asset/Liability Management
The Company’s asset/liability management strategies seek to match the interest rate sensitivity of the assets to that of the underlying liabilities and to construct asset mixes consistent with
product features, such as interest crediting strategies. The Company seeks to maintain interest rate and equity exposures within established ranges, which are periodically adjusted, based on market conditions and the design of related insurance
products sold to customers. The Company’s risk managers, who work with portfolio and asset managers but under separate management, establish investment risk limits for exposures to any issuer, or type of security and oversee efforts to manage
risk within policy constraints set by management and approved by the Board of Directors of our ultimate parent Company, Prudential Financial.
We use duration and convexity analyses to measure price sensitivity to interest rate changes. Duration measures the relative sensitivity of the fair value of a financial instrument to changes in interest
rates. Convexity measures the rate of change of duration with respect to changes in interest rates. We seek to manage our interest rate exposure by matching the relative sensitivity of asset and liability values to interest rate changes, or
controlling “duration mismatch” of assets and liabilities. We have target duration mismatch constraints. As of December 31, 2010 and 2009, the difference between the pre-tax duration of assets and the target duration of liabilities in
our duration managed portfolios was within our constraint limits. We consider risk-based capital implications in our asset/liability management strategies.
The Company also performs portfolio stress testing as part of its regulatory cash flow testing. In this testing, the Company evaluates the impact of altering its interest-sensitive assumptions under
various moderately adverse interest rate environments. These interest-sensitive assumptions relate to the timing and amounts of redemptions and pre-payments of fixed-income securities and lapses and surrenders of insurance products. The Company
evaluates any shortfalls that this cash flow testing reveals to determine if there is a need to increase statutory reserves or adjust portfolio management strategies.
Market Risk Related to Interest Rate Risk
Fluctuations in interest
rates can potentially impact the Company’s profitability and cash flows. At December 31, 2010, 88% of assets held under management by the Company are in non-guaranteed separate accounts for which the Company’s interest rate and equity
market exposure is not significant, as the contractholder assumes substantially all of the investment risk. Of the remaining 12% of assets, the interest rate risk from contracts that carry interest rate exposure is managed through an asset/liability
matching program which takes into account estimates of the risk variables of the insurance liabilities supported by the assets.
33
At December 31, 2010, the Company held fixed maturity investments in its general
account that are sensitive to changes in interest rates. These securities are held in support of the Company’s fixed immediate annuities, fixed supplementary contracts, the fixed investment option offered in its variable life insurance
contracts, and in support of the Company’s target solvency capital.
The Company assesses interest rate sensitivity for
its financial assets, financial liabilities and derivatives using hypothetical test scenarios which assume both upward and downward 100 basis point parallel shifts in the yield curve from prevailing interest rates. The following tables set forth the
potential loss in fair value from a hypothetical 100 basis point upward shift at December 31, 2010 and 2009, because this scenario results in the greatest net exposure to interest rate risk of the hypothetical scenarios tested at those dates.
While the test scenario is for illustrative purposes only and does not reflect management’s expectations regarding future interest rates or the performance of fixed income markets, it is a near-term, reasonably possible hypothetical change that
illustrates the potential impact of such events. These test scenarios do not measure the changes in value that could result from non-parallel shifts in the yield curve, which would be expected to produce different changes in discount rates for
different maturities. As a result, the actual loss in fair value from a 100 basis point change in interest rates could be different from that indicated by these calculations.
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2010
|
|
|
|
|
Notional
|
|
|
Fair
Value
|
|
|
Hypothetical Fair
Value
After + 100
Basis Point
Parallel
Yield Curve
Shift
|
|
|
Hypothetical
Change
in
Fair Value
|
|
|
|
|
|
|
|
(in millions)
|
|
|
Financial Assets with Interest Rate Risk:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities, available for sale
|
|
|
|
|
|
|
$5,536
|
|
|
|
$5,347
|
|
|
|
$(188)
|
|
|
Commercial loans
|
|
|
|
|
|
|
431
|
|
|
|
415
|
|
|
|
(17)
|
|
|
Policy Loans
|
|
|
|
|
|
|
14
|
|
|
|
16
|
|
|
|
2
|
|
|
Derivatives (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Swaps
|
|
|
$ 1,425
|
|
|
|
34
|
|
|
|
(5)
|
|
|
|
(39)
|
|
|
Options
|
|
|
10,310
|
|
|
|
12
|
|
|
|
9
|
|
|
|
(3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Estimated Potential Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$(245)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Excludes variable annuity optional living benefits accounted for as embedded derivatives as the Company
has generally entered into reinsurance agreements to transfer the risk related to these optional living benefits to an affiliate as part of its risk management strategy.
|
|
|
|
|
December 31, 2009
|
|
|
|
|
Notional
|
|
|
Fair
Value
|
|
|
Hypothetical Fair
Value
After + 100
Basis Point
Parallel
Yield Curve
Shift
|
|
|
Hypothetical
Change
in
Fair
Value
|
|
|
|
|
|
|
|
(in millions)
|
|
|
Financial Assets with Interest Rate Risk:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities, available for sale
|
|
|
|
|
|
|
$6,494
|
|
|
|
$6,233
|
|
|
|
$(261)
|
|
|
Commercial loans
|
|
|
|
|
|
|
373
|
|
|
|
358
|
|
|
|
(15)
|
|
|
Policy Loans
|
|
|
|
|
|
|
13
|
|
|
|
13
|
|
|
|
-
|
|
|
Derivatives (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Swaps
|
|
|
$ 1,716
|
|
|
|
(13)
|
|
|
|
(57)
|
|
|
|
(44)
|
|
|
Options
|
|
|
40
|
|
|
|
4
|
|
|
|
4
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Estimated Potential Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$(320)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Excludes variable annuity optional living benefits accounted for as embedded derivatives as the Company has generally entered into reinsurance
agreements to transfer the risk related to these optional living benefits to an affiliate as part of its risk management strategy.
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The tables above do not
include approximately $5.7 billion of insurance reserve and deposit liabilities as of December 31, 2010 and $7.2 billion as of December 31, 2009 which are not considered financial liabilities. We believe that the interest rate
sensitivities of these insurance liabilities offset, in large measure, the interest rate risk of the financial assets set forth in these tables.
The estimated changes in fair values of the financial assets shown above relate to assets invested in support of the Company’s insurance liabilities, but do not include separate account assets
associated with products for which investment risk is borne primarily by the separate account contractholders rather than the Company.
The Company’s deferred annuity products offer a fixed investment option which subjects the Company to interest rate risk. The fixed option guarantees a fixed-rate of interest for a period of time
selected by the contractholder. Guarantee period options available range from one to ten years. Withdrawal of funds or transfer of funds to variable investment options, before the end of the guarantee period subjects the contractholder to an MVA,
with respect to the Company’s fixed investment options that provide for assessment of an MVA. In the event of
34
rising interest rates, which generally make the fixed maturity securities underlying the guarantee less valuable, the MVA could be negative. In the event of declining interest rates, which
generally make the fixed maturity securities underlying the guarantee more valuable, the MVA could be positive. The resulting increase or decrease in the value of the fixed option, from calculation of the MVA, should substantially offset the
decrease or increase in the market value of the securities underlying the guarantee. However, the Company still takes on the default risk for the underlying securities and the interest rate risk of reinvestment of interest payments.
Market Risk Related to Equity Prices
The Company has a portfolio of equity investments consisting of mutual funds, which are held in support of a deferred compensation program. In the event of a decline in market values of underlying
securities, the value of the portfolio would decline; however the accrued benefits payable under the related deferred compensation program would decline by a corresponding amount.
For equity investments within the separate accounts, the investment risk is borne primarily by the separate account contractholder rather
than by the Company. As part of its risk management strategy the Company generally reinsures to affiliates the risks related to variable annuity optional living benefits accounted for as embedded derivatives. In addition to the hedging program in
the reinsurance affiliates, we expanded our hedging program in the second quarter of 2009 to include a portion of the market exposure related to our overall capital position of our variable annuity business, including the impact of certain statutory
reserve exposures. These capital hedges primarily consisted of equity-based total return swaps that are designed to partially offset changes in our capital position resulting from market driven changes in certain living and death benefit features of
our variable annuity products. Our estimated equity price risk associated with these capital hedges as of December 31, 2009 was a $31 million benefit, estimated based on a hypothetical 10% decline in equity benchmark market levels, which would
partially offset an overall decline in our capital position related to the equity market decline. In 2010, Prudential Financial changed the focus of its capital hedge program from the equity price risk associated with the annuities business to a
broader view of equity market exposure of the statutory capital of Prudential Financial and its subsidiaries, as a whole. In the second quarter of 2010, the capital hedge program was terminated and equity index-linked derivative transactions were
entered into that are designed to mitigate the overall impact on statutory capital of a severe equity market stress event on Prudential Financial and its subsidiaries, as a whole. A portion of the derivatives related to the new program were
purchased by the Company. The program now focuses on tail risk rather than general equity market declines in order to protect statutory capital in a more cost-effective manner under stress scenarios. Prudential Financial assesses the composition of
the hedging program on an ongoing basis and may change it from time to time based on an evaluation of its risk position or other factors. Our estimated equity price risk associated with these capital hedges as of December 31, 2010 was a $2
million benefit, estimated based on a hypothetical 10% decline in equity benchmark market levels, which would partially offset an overall decline in our capital position related to the equity market decline.
Item 8. Financial Statements and Supplementary Data
Information required with respect to this Item 8 regarding Financial Statements and Supplementary Data is set forth commencing on
page F-3 hereof. See Index to Financial Statements elsewhere in this Annual Report.
Item 9. Changes in
and Disagreements with Independent Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Management’s Annual Report on Internal Control Over Financial Reporting as of December 31, 2010 is included in Part II, Item 8 of this Annual Report on Form 10-K.
In order to ensure that the information we must disclose in our filings with the SEC is recorded, processed, summarized, and reported on
a timely basis, the Company’s management, including our Chief Executive Officer and Chief Financial Officer, have reviewed and evaluated the effectiveness of our disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and
15d-15(e), as of December 31, 2010. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2010, our disclosure controls and procedures were effective. No change in the
Company’s internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f) and 15d-15(f) occurred during the year ended December 31, 2010 that has materially affected or is reasonably likely to materially affect our
internal control over financial reporting.
Item 9B. Other Information
None.
35
PART III
Item 10. Directors, Executive Officers, and Corporate Governance
We have adopted a code of business conduct and ethics, known as “Making the Right Choices”, which applies to our Chief Executive Officer, Chief Financial Officer, and our Controller, as well as
to our directors and all other employees. Making the Right Choices is posted at www.investor.prudential.com.
In addition, we
have adopted Corporate Governance Guidelines, which we refer to as our “Corporate Governance Principles and Practices.” Our Corporate Governance Principles and Practices are available free of charge at
www.investor.prudential.com
.
Item 14. Principal Accountant Fees and Services
The Audit Committee of the Board of Directors of Prudential Financial has appointed PricewaterhouseCoopers LLP as the independent auditor
of Prudential Financial and certain of its domestic and international subsidiaries, including the Company. The Audit Committee has established a policy requiring its pre-approval of all audit and permissible non-audit services provided by the
independent auditor. The specific information called for by this item is hereby incorporated by reference to the section entitled “Item 2 – Ratification of the Appointment of Independent Auditors” in Prudential Financial’s
definitive proxy statement for the Annual Meeting of Shareholders to be held on May 10, 2011, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after December 31, 2010.
36
PART IV
Item 15. Exhibits and Financial Statement Schedules
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(1) Financial Statements
|
|
Financial Statements of the Company are listed in the accompanying “Index to Financial Statements” on page F-1 hereof and are filed as part of this
Report.
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(2) Financial Statement Schedules
|
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None.*
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(3)
Exhibits
|
|
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2.
|
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None.
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3.
|
|
(i) Certificate Restating the Certificate of Incorporation of American Skandia Life Assurance Corporation, dated February 8, 1988 is incorporated by
reference to the Company’s Form 10-K, Registration No. 33-44202, filed March 27, 2004.
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(ii) Certificate of Amendment to the Restated Certificate of Incorporation of American Skandia Life Assurance Corporation, dated December 17, 1999 is
incorporated by reference to the Company’s Form 10-K, Registration No. 33-44202, filed March 27, 2004.
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(iii) By-Laws of American Skandia Life Assurance Corporation, as amended June 17, 1998, are incorporated by reference to the Company’s Form 10-K,
Registration No. 33-44202, filed March 27, 2004.
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(iv) Certificate of Amendment changing the name from American Skandia Life Assurance Corporation to Prudential Annuities Life Assurance Corporation, dated
June 11, 2007 is filed herewith
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(v) By-Laws of Prudential Annuities Life Assurance Corporation, as amended and restated July 24, 2007, are filed herewith.
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4.
|
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As of March 15, 2011, 25,000 shares of the registrant’s Common Stock (par value $100) consisting of 100 voting shares and 24,900 non-voting shares, were
outstanding. As of such date, Prudential Annuities, Inc. formerly known as American Skandia, Inc., an indirect wholly owned subsidiary of Prudential Financial, Inc., a New Jersey corporation, owned all of the registrant’s Common Stock. In
addition to that Common Stock, the registrant has issued market-value adjusted annuities from its general account, which are registered under the Securities Act of 1933. See, e.g., 333-136996.
|
|
|
|
|
9.
|
|
None.
|
|
|
|
|
10.
|
|
None.
|
|
|
|
|
11.
|
|
Not applicable.
|
|
|
|
|
12.
|
|
Not applicable.
|
|
|
|
|
13.
|
|
Not applicable.
|
|
|
|
|
14.
|
|
We have adopted a code of business conduct and ethics, known as “Making the Right Choices”, which applies to our Chief Executive Officer, Chief
Financial Officer, and our Controller, as well as to our directors and all other employees. Making the Right Choices is posted at www.investor.prudential.com. In addition, we have adopted Corporate Governance Guidelines, which we refer to as our
“Corporate Governance Principles and Practices.” Our Corporate Governance Principles and Practices are available free of charge at www.investor.prudential.com.
|
|
|
|
|
16.
|
|
None.
|
|
|
|
|
18.
|
|
None.
|
|
|
|
|
21.
|
|
Not applicable.
|
|
|
|
|
22.
|
|
None.
|
|
|
|
|
23.
|
|
Not applicable.
|
37
|
|
|
|
|
24.
|
|
Powers of Attorney are filed herewith.
|
|
|
|
|
31.1
|
|
Section 302 Certification of the Chief Executive Officer.
|
|
|
|
|
31.2
|
|
Section 302 Certification of the Chief Financial Officer.
|
|
|
|
|
32.1
|
|
Section 906 Certification of the Chief Executive Officer.
|
|
|
|
|
32.2
|
|
Section 906 Certification of the Chief Financial Officer.
|
* Schedules are omitted because they are either not applicable or because the information required therein is included in the Notes to Financial Statements.
38
SIGNATURES
Pursuant to the requirements of Section 13, or 15 (d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Shelton, and state of Connecticut on the 11
th
day of March 2011.
PRUDENTIAL ANNUITIES LIFE ASSURANCE CORPORATION
(Registrant)
|
|
|
|
|
|
|
|
|
|
|
By:
|
|
/s/ Thomas J. Diemer
|
|
|
|
|
|
|
|
Thomas J. Diemer
|
|
|
|
|
|
|
|
Chief Financial Officer and Director
|
|
|
|
|
|
(Principal Financial Officer and Principal Accounting Officer)
|
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf
of the Registrant and in the capacities indicated on March 15, 2011.
|
|
|
|
|
|
|
Name
|
|
|
|
Title
|
|
|
|
|
|
*Richard Vaccaro
|
|
|
|
Director
|
|
Richard Vaccaro
|
|
|
|
|
|
|
|
|
|
* Bernard J. Jacob
|
|
|
|
Director
|
|
Bernard J. Jacob
|
|
|
|
|
|
|
|
|
|
* George Gannon
|
|
|
|
Director
|
|
George Gannon
|
|
|
|
|
|
|
|
|
|
* Robert Falzon
|
|
|
|
Director
|
|
Robert Falzon
|
|
|
|
|
|
|
|
|
|
* Daniel Kane
|
|
|
|
Director
|
|
Daniel Kane
|
|
|
|
|
|
|
|
|
|
* Thomas J. Diemer
|
|
|
|
Chief Financial Officer and Director
|
|
Thomas J. Diemer
|
|
|
|
|
|
|
|
|
|
/s/ Stephen Pelletier
|
|
|
|
Chief Executive Officer, President and Director
|
|
Stephen Pelletier
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* By
: /s/ Thomas J. Diemer
|
|
|
|
|
|
|
|
Thomas J. Diemer
|
|
|
|
|
|
|
|
(Attorney-in-Fact)
|
|
|
39
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT
PRUDENTIAL ANNUITIES LIFE ASSURANCE CORPORATION
Financial Statements and
Report of Independent Registered Public Accounting Firm
Years Ended December 31, 2010 and 2009
PRUDENTIAL ANNUITIES LIFE ASSURANCE CORPORATION
INDEX TO FINANCIAL STATEMENTS
F-1
Management’s Annual Report on Internal Control Over Financial Reporting
Management of Prudential Annuities Life Assurance Corporation (the “Company”) is responsible for establishing
and maintaining adequate internal control over financial reporting. Management conducted an assessment of the effectiveness, as of December 31, 2010, of the Company’s internal control over financial reporting, based on the framework
established
in Internal Control—Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment under that framework, management concluded that the Company’s
internal control over financial reporting was effective as of December 31, 2010.
Our internal control over financial
reporting is a process designed by or under the supervision of our principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect transactions and dispositions of assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the Company’s assets that could have a material effect on our financial statements.
Because of
its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
This Annual
Report does not include an attestation report of the Company’s registered public accounting firm, PricewaterhouseCoopers LLP, regarding the internal control over financial reporting. Management’s report was not subject to attestation by
the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report.
March 15, 2011
F-2
HOLD FOR PWC OPINION LETTER
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholder of
Prudential Annuities Life Assurance
Corporation:
In our opinion, the accompanying statements of financial position and the related statements of operations and
comprehensive income, of stockholder’s equity and of cash flows present fairly, in all material respects, the financial position of Prudential Annuities Life Assurance Corporation (an indirect, wholly owned subsidiary of Prudential Financial,
Inc.) at December 31, 2010 and December 31, 2009, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States
of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 2 of the
financial statements, the Company changed its method of determining and recording other-than-temporary impairment for debt securities on January 1, 2009.
New York, New York
March 15, 2011
F-3
Prudential Annuities Life Assurance Corporation
Statements of Financial Position
December 31, 2010 and 2009 (in thousands, except share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
Fixed maturities available for sale,
at fair value (amortized cost, 2010: $4,964,264 2009: $6,056,960)
|
|
$
|
5,456,221
|
|
|
$
|
6,493,887
|
|
|
Trading account assets, at fair value
|
|
|
79,605
|
|
|
|
79,892
|
|
|
Equity securities available for sale, at fair value (cost, 2010:$14,484 2009: $17,085)
|
|
|
17,587
|
|
|
|
18,612
|
|
|
Commercial mortgage and other loans
|
|
|
431,432
|
|
|
|
373,080
|
|
|
Policy loans
|
|
|
13,905
|
|
|
|
13,067
|
|
|
Short-term investments
|
|
|
228,383
|
|
|
|
705,846
|
|
|
Other long-term investments
|
|
|
75,476
|
|
|
|
2,995
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments
|
|
|
6,302,609
|
|
|
|
7,687,379
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
|
487
|
|
|
|
71,548
|
|
|
Deferred policy acquisition costs
|
|
|
1,540,028
|
|
|
|
1,411,571
|
|
|
Accrued investment income
|
|
|
62,392
|
|
|
|
77,004
|
|
|
Reinsurance recoverable
|
|
|
187,062
|
|
|
|
40,597
|
|
|
Income taxes receivable
|
|
|
-
|
|
|
|
230,427
|
|
|
Valuation of business acquired
|
|
|
32,497
|
|
|
|
52,596
|
|
|
Deferred sales inducements
|
|
|
796,507
|
|
|
|
801,876
|
|
|
Receivables from parent and affiliates
|
|
|
51,221
|
|
|
|
119,300
|
|
|
Investment receivable on open trades
|
|
|
8,435
|
|
|
|
7,984
|
|
|
Other assets
|
|
|
10,355
|
|
|
|
7,056
|
|
|
Separate account assets
|
|
|
48,275,343
|
|
|
|
41,448,712
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
$
|
57,266,936
|
|
|
$
|
51,956,050
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDER’S EQUITY
|
|
|
|
|
|
|
|
|
|
LIABILITIES
|
|
|
|
|
|
|
|
|
|
Policyholders’ account balances
|
|
$
|
5,319,359
|
|
|
$
|
6,894,651
|
|
|
Future policy benefits and other policyholder liabilities
|
|
|
412,872
|
|
|
|
292,921
|
|
|
Payables to parent and affiliates
|
|
|
127,502
|
|
|
|
76,439
|
|
|
Cash collateral for loaned securities
|
|
|
87,210
|
|
|
|
263,617
|
|
|
Income Tax Payable
|
|
|
132,455
|
|
|
|
-
|
|
|
Short-term borrowing
|
|
|
205,054
|
|
|
|
54,585
|
|
|
Long-term borrowing
|
|
|
600,000
|
|
|
|
775,000
|
|
|
Other liabilities
|
|
|
198,757
|
|
|
|
242,216
|
|
|
Separate account liabilities
|
|
|
48,275,343
|
|
|
|
41,448,712
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL LIABILITIES
|
|
$
|
55,358,552
|
|
|
$
|
50,048,141
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments and Contingent Liabilities (See Note 12)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDER’S EQUITY
|
|
|
|
|
|
|
|
|
|
Common stock, $100 par value; 25,000 shares, authorized, issued and outstanding
|
|
$
|
2,500
|
|
|
$
|
2,500
|
|
|
Additional paid-in capital
|
|
|
974,921
|
|
|
|
974,921
|
|
|
Retained earnings
|
|
|
749,751
|
|
|
|
798,170
|
|
|
Accumulated other comprehensive income (loss)
|
|
|
181,212
|
|
|
|
132,318
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholder’s equity
|
|
$
|
1,908,384
|
|
|
$
|
1,907,909
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL LIABILITIES AND STOCKHOLDER’S EQUITY
|
|
$
|
57,266,936
|
|
|
$
|
51,956,050
|
|
|
|
|
|
|
|
|
|
|
|
See Notes to Financial Statements
F-4
Prudential Annuities Life Assurance Corporation
Statements of Operations and Comprehensive Income
Years ended December 31, 2010, 2009, and 2008 (in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums
|
|
$
|
29,477
|
|
|
$
|
13,431
|
|
|
$
|
20,391
|
|
|
Policy charges and fee income
|
|
|
741,190
|
|
|
|
392,753
|
|
|
|
632,440
|
|
|
Net investment income
|
|
|
377,109
|
|
|
|
494,733
|
|
|
|
320,088
|
|
|
Asset administration fees and other income
|
|
|
290,210
|
|
|
|
197,672
|
|
|
|
197,114
|
|
|
Realized investment gains (losses), net:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other-than-temporary impairments on fixed maturity securities
|
|
|
(42,228)
|
|
|
|
(23,497)
|
|
|
|
(25,771)
|
|
|
Other-than-temporary impairments on fixed maturity securities transferred to Other Comprehensive Income
|
|
|
39,224
|
|
|
|
11,890
|
|
|
|
-
|
|
|
Other realized investment gains (losses), net
|
|
|
139,043
|
|
|
|
48,574
|
|
|
|
71,824
|
|
|
Total realized investment gains (losses), net
|
|
|
136,039
|
|
|
|
36,967
|
|
|
|
46,053
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
$
|
1,574,025
|
|
|
$
|
1,135,556
|
|
|
$
|
1,216,086
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Policyholders’ benefits
|
|
|
40,911
|
|
|
|
4,414
|
|
|
|
329,295
|
|
|
Interest credited to policyholders’ account balances
|
|
|
371,798
|
|
|
|
409,057
|
|
|
|
279,744
|
|
|
Amortization of deferred policy acquisition costs
|
|
|
202,568
|
|
|
|
319,806
|
|
|
|
228,836
|
|
|
General, administrative and other expenses
|
|
|
413,466
|
|
|
|
370,162
|
|
|
|
397,477
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total benefits and expenses
|
|
$
|
1,028,743
|
|
|
$
|
1,103,439
|
|
|
$
|
1,235,352
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations before income taxes
|
|
$
|
545,282
|
|
|
$
|
32,117
|
|
|
$
|
(19,266)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
(28,619)
|
|
|
|
(239,796)
|
|
|
|
-
|
|
|
Deferred
|
|
|
152,320
|
|
|
|
188,355
|
|
|
|
(39,224)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax (benefit) expense
|
|
|
123,701
|
|
|
|
(51,441)
|
|
|
|
(39,224)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCOME
|
|
$
|
421,581
|
|
|
$
|
83,558
|
|
|
$
|
19,958
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in net unrealized investment gains (losses), net of taxes
|
|
|
48,894
|
|
|
|
146,971
|
|
|
|
(8,483)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE INCOME
|
|
$
|
470,475
|
|
|
$
|
230,529
|
|
|
$
|
11,475
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See Notes to Financial Statements
F-5
Prudential Annuities Life Assurance Corporation
Statements of Stockholder’s Equity
Years ended December 31, 2010, 2009, and 2008 (in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
Additional
Paid-in
Capital
|
|
|
Retained
Earnings
|
|
|
Accumulated
Other
Comprehensive
Income (Loss)
|
|
|
Total
Stockholder’s
Equity
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2007
|
|
$
|
2,500
|
|
|
$
|
434,096
|
|
|
$
|
709,142
|
|
|
$
|
2,537
|
|
|
$
|
1,148,275
|
|
|
Net income
|
|
|
-
|
|
|
|
-
|
|
|
|
19,958
|
|
|
|
-
|
|
|
|
19,958
|
|
|
Distribution from/(to) parent
|
|
|
-
|
|
|
|
540,825
|
|
|
|
-
|
|
|
|
-
|
|
|
|
540,825
|
|
|
Other comprehensive income, net of taxes
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(8,483)
|
|
|
|
(8,483)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2008
|
|
$
|
2,500
|
|
|
$
|
974,921
|
|
|
$
|
729,100
|
|
|
$
|
(5,946)
|
|
|
$
|
1,700,575
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
-
|
|
|
|
-
|
|
|
|
83,558
|
|
|
|
-
|
|
|
|
83,558
|
|
|
Impact of adoption of new guidance for other-than-temporary impairments of debt securities, net of taxes
|
|
|
-
|
|
|
|
-
|
|
|
|
8,707
|
|
|
|
(8,707)
|
|
|
|
-
|
|
|
Distribution from/(to) parent
|
|
|
-
|
|
|
|
-
|
|
|
|
(23,195)
|
|
|
|
-
|
|
|
|
(23,195)
|
|
|
Other comprehensive income, net of taxes
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
146,971
|
|
|
|
146,971
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2009
|
|
$
|
2,500
|
|
|
$
|
974,921
|
|
|
$
|
798,170
|
|
|
$
|
132,318
|
|
|
$
|
1,907,909
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
-
|
|
|
|
-
|
|
|
|
421,581
|
|
|
|
-
|
|
|
|
421,581
|
|
|
Dividends to Parent
|
|
|
|
|
|
|
|
|
|
|
(470,000)
|
|
|
|
|
|
|
|
(470,000)
|
|
|
Other comprehensive income, net of taxes
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
48,894
|
|
|
|
48,894
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2010
|
|
$
|
2,500
|
|
|
$
|
974,921
|
|
|
$
|
749,751
|
|
|
$
|
181,212
|
|
|
$
|
1,908,384
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See Notes to Financial Statements
F-6
Prudential Annuities Life Assurance Corporation
Statements of Cash Flows
Years ended
December 31, 2010, 2009, and 2008 (in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
421,581
|
|
|
$
|
83,558
|
|
|
$
|
19,958
|
|
|
Adjustments to reconcile net income to net cash from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Policy charges and fee income
|
|
|
91,816
|
|
|
|
171,087
|
|
|
|
(12,088)
|
|
|
Realized investment (gains) losses, net
|
|
|
(136,039)
|
|
|
|
(36,967)
|
|
|
|
(46,055)
|
|
|
Amortization and depreciation
|
|
|
(16,328)
|
|
|
|
(12,874)
|
|
|
|
36,463
|
|
|
Interest credited to policyholders’ account balances
|
|
|
231,522
|
|
|
|
333,043
|
|
|
|
237,392
|
|
|
Change in:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Future policy benefit reserves
|
|
|
165,209
|
|
|
|
2,192
|
|
|
|
308,268
|
|
|
Accrued investment income
|
|
|
13,816
|
|
|
|
14,698
|
|
|
|
(78,671)
|
|
|
Trading account assets
|
|
|
1,425
|
|
|
|
(9,721)
|
|
|
|
(35,108)
|
|
|
Net receivable (payable) to affiliates
|
|
|
109,411
|
|
|
|
(34,208)
|
|
|
|
12,914
|
|
|
Deferred sales inducements
|
|
|
17,273
|
|
|
|
(147,163)
|
|
|
|
(167,493)
|
|
|
Deferred policy acquisition costs
|
|
|
(108,633)
|
|
|
|
(335,045)
|
|
|
|
(188,629)
|
|
|
Income taxes payable (receivable)
|
|
|
336,553
|
|
|
|
(51,660)
|
|
|
|
(39,202)
|
|
|
Reinsurance recoverable
|
|
|
(229,099)
|
|
|
|
(117,214)
|
|
|
|
(99,274)
|
|
|
Other, net
|
|
|
(41,695)
|
|
|
|
(117,216)
|
|
|
|
67,394
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows From (Used In) Operating Activities
|
|
$
|
856,812
|
|
|
$
|
(257,490)
|
|
|
$
|
15,869
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from the sale/maturity of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities, available for sale
|
|
$
|
1,917,959
|
|
|
$
|
7,208,289
|
|
|
$
|
9,744,227
|
|
|
Equity securities, available for sale
|
|
|
7,478
|
|
|
|
13,900
|
|
|
|
35
|
|
|
Commercial mortgage and other loans
|
|
|
14,018
|
|
|
|
57,393
|
|
|
|
7,249
|
|
|
Trading account assets
|
|
|
6,230
|
|
|
|
9,733
|
|
|
|
-
|
|
|
Policy loans
|
|
|
822
|
|
|
|
45
|
|
|
|
3,723
|
|
|
Other long-term investments
|
|
|
589
|
|
|
|
445
|
|
|
|
-
|
|
|
Short term investments
|
|
|
5,097,995
|
|
|
|
5,566,265
|
|
|
|
15,500,254
|
|
|
Payments for the purchase/origination of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities, available for sale
|
|
|
(676,652)
|
|
|
|
(3,090,497)
|
|
|
|
(18,330,076)
|
|
|
Equity securities, available for sale
|
|
|
(5,000)
|
|
|
|
(19,636)
|
|
|
|
-
|
|
|
Commercial mortgage and other loans
|
|
|
(72,504)
|
|
|
|
(61,445)
|
|
|
|
(340,523)
|
|
|
Trading account assets
|
|
|
(4,574)
|
|
|
|
(24,061)
|
|
|
|
-
|
|
|
Policy loans
|
|
|
(2,620)
|
|
|
|
(319)
|
|
|
|
(4,177)
|
|
|
Other long-term investments
|
|
|
(48,979)
|
|
|
|
(14,428)
|
|
|
|
-
|
|
|
Short-term investments
|
|
|
(4,620,729)
|
|
|
|
(6,017,771)
|
|
|
|
(15,608,847)
|
|
|
Notes receivable from parent and affiliates, net
|
|
|
10,906
|
|
|
|
-
|
|
|
|
-
|
|
|
Other, net
|
|
|
(663)
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows From (Used in) Investing Activities
|
|
$
|
1,624,276
|
|
|
$
|
3,627,913
|
|
|
$
|
(9,028,135)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital contribution from/(Distribution to) Parent
|
|
$
|
(470,000)
|
|
|
$
|
(23,195)
|
|
|
$
|
540,825
|
|
|
Decrease in future fees payable to PAI, net
|
|
|
-
|
|
|
|
(749)
|
|
|
|
(11,422)
|
|
|
Cash collateral for loaned securities
|
|
|
(176,407)
|
|
|
|
(5,843)
|
|
|
|
215,384
|
|
|
Securities sold under agreement to repurchase
|
|
|
(602)
|
|
|
|
602
|
|
|
|
-
|
|
|
Proceeds from the issuance of debt (maturities longer than 90 days)
|
|
|
-
|
|
|
|
600,000
|
|
|
|
-
|
|
|
Repayments of debt (maturities longer than 90 days)
|
|
|
(175,000)
|
|
|
|
(4,547)
|
|
|
|
(500,453)
|
|
|
Net increase (decrease) in short-term borrowing
|
|
|
150,469
|
|
|
|
(131,683)
|
|
|
|
(9,012)
|
|
|
Drafts outstanding
|
|
|
16,158
|
|
|
|
4,017
|
|
|
|
(24,834)
|
|
|
Policyholders’ account balances
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
2,767,101
|
|
|
|
3,364,812
|
|
|
|
12,971,413
|
|
|
Withdrawals
|
|
|
(4,663,868)
|
|
|
|
(7,128,838)
|
|
|
|
(4,143,783)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows From (Used in) Financing Activities
|
|
$
|
(2,552,149)
|
|
|
$
|
(3,325,424)
|
|
|
$
|
9,038,118
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents
|
|
|
(71,061)
|
|
|
|
44,999
|
|
|
|
25,852
|
|
|
Cash and cash equivalents, beginning of period
|
|
|
71,548
|
|
|
|
26,549
|
|
|
|
697
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS, END OF PERIOD
|
|
$
|
487
|
|
|
$
|
71,548
|
|
|
$
|
26,549
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes paid (received)
|
|
$
|
(212,852)
|
|
|
$
|
(11)
|
|
|
$
|
(42)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
36,554
|
|
|
$
|
11,608
|
|
|
$
|
56,916
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See Notes to Financial Statements
F-7
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
Prudential Annuities Life Assurance Corporation (the “Company”, “we”, or “our”), formerly known as American Skandia Life Assurance Corporation, with its principal offices in
Shelton, Connecticut, is an indirect wholly-owned subsidiary of Prudential Financial, Inc. (“Prudential Financial”), a New Jersey corporation. The Company is a wholly-owned subsidiary of Prudential Annuities, Inc., (“PAI”),
formerly known as American Skandia, Inc., which in turn is an indirect wholly-owned subsidiary of Prudential Financial. On December 19, 2002, Skandia Insurance Company Ltd. (publ) (“Skandia”), an insurance company organized under the
laws of the Kingdom of Sweden, and the ultimate parent company of the Company prior to May 1, 2003, entered into a definitive purchase agreement (the “Acquisition Agreement”) with Prudential Financial whereby Prudential Financial
would acquire the Company and certain of its affiliates (the “Acquisition”) and would be authorized to use the American Skandia name through April, 2008. On May 1, 2003, the Acquisition was consummated. Thus, the Company is now an
indirect wholly owned subsidiary of Prudential Financial. During 2007, the Company began the process of changing its name and names of various legal entities that include the “American Skandia” name, as required by the terms of the
Acquisition. The Company’s name was changed effective January 1, 2008.
The Company develops long-term savings and
retirement products, which are distributed through its affiliated broker/dealer company, Prudential Annuities Distributors, Incorporated. (“PAD”), formerly known as American Skandia Marketing, Incorporated. The Company issued variable
deferred and immediate annuities for individuals and groups in the United States of America and its territories.
Beginning in
March 2010, the Company ceased offering its existing variable annuity products (and where offered, the companion market value adjustment option) to new investors upon the launch of a new product in each of Pruco Life Insurance Company and Pruco Life
Insurance Company of New Jersey (which are affiliates of the Company within the Prudential Annuities business unit of Prudential Financial). In general, the new product line offers the same optional living benefits and optional death benefits as
offered by the Company’s existing variable annuities. However, subject to applicable contractual provisions and administrative rules, the Company will continue to accept subsequent purchase payments on inforce contracts under existing annuity
products.
The Company is engaged in a business that is highly competitive because of the large number of stock and mutual
life insurance companies and other entities engaged in marketing insurance products, and individual and group annuities.
PAI
intends to make additional capital contributions to the Company, as needed, to enable it to comply with its reserve requirements and fund expenses in connection with its business. The Company has complied with the National Association of Insurance
Commissioner’s (“NAIC”) Risk-Based Capital (“RBC”) reporting requirements and has total adjusted capital well above required capital. Generally, PAI is under no obligation to make such contributions and its assets do not
back the benefits payable under the Company’s policyholder contracts. During 2010 and 2009, PAI made no capital contributions to the Company. During 2008, PAI made capital contribution of $540.8 million to the Company.
Basis of presentation
The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The Company has extensive transactions and
relationships with Prudential Financial affiliates, as more fully described in Note 13. Due to these relationships, it is possible that the terms of these transactions are not the same as those that would result from transactions among wholly
unrelated parties.
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; valuation of
business acquired and its amortization; amortization of sales inducements; valuation of investments including derivatives and the recognition of other-than-temporary impairments; future policy benefits including guarantees; provision for income
taxes and valuation of deferred tax assets; reserves for contingent liabilities, including reserves for losses in connection with unresolved legal matters.
F-8
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS
Reclassifications
Certain amounts in prior periods have been reclassified to conform to the current period presentation.
Investments and Investment-Related Liabilities
The Company’s principal investments are fixed maturities; trading account assets; equity securities; commercial mortgage and other loans; policy loans; other long-term investments, including joint
ventures, limited partnerships; and short-term investments. Investments and investment-related liabilities also include securities repurchase and resale agreements and securities lending transactions. The accounting policies related to each 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 10 for additional information regarding the determination of fair value. 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 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 as well as the impact of the
Company’s adoption on January 1, 2009 of new authoritative guidance for the recognition and presentation of other-than-temporary impairments for debt securities. Unrealized gains and losses on fixed maturities classified as “available
for sale,” net of tax, and the effect on deferred policy acquisition costs, valuation of business acquired, deferred sales inducements and future policy benefits that would result from the realization of unrealized gains and losses, are
included in “Accumulated other comprehensive income (loss).”
Trading account assets
, at fair value,
represents the equity securities held in support of a deferred compensation plan and investments. These instruments are carried at fair value. Realized and unrealized gains and losses on trading account assets are reported in “Asset
administration fees and other income.” Interest and dividend income from these investments are reported in “Net investment income.”
Equity securities, available for sale
are comprised of common stock, and non-redeemable 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, deferred sales inducements, valuation of business acquired, and future policy benefits 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 and agricultural 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).
Commercial mortgage and other loans originated
and held for investment are generally carried at unpaid principal balance, net of unamortized premiums or discounts and an allowance for losses.
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 impaired loans, including 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 3 for additional information about the
Company’s past due loans.
F-9
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (
continued
)
The Company discontinues accruing interest on impaired loans after the loans become 90
days delinquent as to principal or interest payments, or earlier when the Company has doubts about collectability. When a loan is deemed to be impaired, any accrued but uncollectible interest on the impaired loan and other loans backed by the same
collateral, if any, is charged to interest income in the period the loan is deemed to be impaired. 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, 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 our 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 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 3 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.
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, default probability and loss severity factors by property type. Historical
credit migration, default 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. “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.
Policy loans
are carried at unpaid principal balances. Interest income on policy loans is recognized in net investment income at
the contract interest rate when earned. Policy loans are fully collateralized by the cash surrender value of the associated insurance policies.
F-10
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (
continued
)
Short-term investments
primarily consist of investments in certain money market
funds as well as highly liquid debt instruments with a maturity of greater than three months and less than twelve months when purchased. These investments are generally carried at fair value.
Securities repurchase and resale agreements
that satisfy certain criteria are treated as collateralized financing arrangements.
These agreements are carried at the amounts at which the securities will be subsequently resold or reacquired, as specified in the respective agreements. For securities purchased under agreements to resell, the Company’s policy is to take
possession or control of the securities and to value the securities daily. Securities to be resold are the same, or substantially the same, as the securities received. For securities sold under agreements to repurchase, the market value of the
securities to be repurchased is monitored, and additional collateral is obtained where appropriate, to protect against credit exposure. Securities to be repurchased are the same, or substantially the same as those sold. Income and expenses related
to these transactions executed within the insurance subsidiary used to earn spread income are reported as “Net investment income,” however, for transactions used to borrow funds, the associated borrowing cost is reported as interest
expense (included in “General and administrative expenses”).
Securities loaned
transactions are
treated as financing arrangements and are recorded at the amount of cash received. The Company obtains collateral in an amount equal to 102% and 105% of the fair value of the domestic and foreign securities, respectively. The Company monitors the
market value of the securities loaned on a daily basis with additional collateral obtained as necessary. Substantially all of the Company’s securities loaned transactions are with large brokerage firms. Income and expenses associated with
securities loaned transactions used to earn spread income are generally reported as “Net investment income;” however, for securities loaned transactions used for funding purposes the associated rebate is reported as interest expense
(included in “General and administrative expenses”).
Other long-term investments
consist of the
Company’s investments in joint ventures and limited partnerships, as well as wholly-owned investment real estate and other investments. Joint venture and partnership interests are generally accounted for using the equity method of accounting.
In certain instances in which the Company’s partnership interest is so minor (generally less than 3%) that it exercises virtually no influence over operating and financial policies, the Company applies the cost method of accounting. The
Company’s income from investments in joint ventures and partnerships accounted for using the equity method or cost method is included in “Net investment income.” The carrying value of these investments is written down, or impaired, to
fair value when a decline in value is considered to be other-than-temporary. In applying the equity method or the cost method (including assessment for other-than-temporary impairment), the Company uses financial information provided by the
investee, which is generally received on a one quarter lag.
Realized investment gains (losses)
are computed using the
specific identification method. Realized investment gains and losses are generated from numerous sources, including the sale of fixed maturity securities, equity securities, investments in joint ventures and limited partnerships and other types of
investments, as well as adjustments to the cost basis of investments for net other than temporary impairments recognized in earnings. Realized investment gains and losses are also generated from prepayment premiums received on private fixed maturity
securities, allowance for losses on commercial mortgage and other loans, and fair value changes on embedded derivatives and free-standing derivatives that do not qualify for hedge accounting treatment.
The Company’s available for sale 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.
In addition, in April 2009, the Financial
Accounting Standards Board (FASB) revised the authoritative guidance for the recognition and presentation of other-than-temporary impairments for debt securities. The Company early adopted this guidance on January 1, 2009. Prior to the adoption
of this guidance the Company was required to record an other-than-temporary impairment for a debt security unless it could assert that it had both the intent and ability to hold the security for a period of time sufficient to allow for a recovery in
its fair value to its amortized cost basis. This revised guidance indicates that 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 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
F-11
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (
continued
)
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, the difference is recorded as an other-than-temporary impairment.
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, 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 two 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).” Prior to the adoption of this guidance in 2009, an other-than-temporary impairment
recognized in earnings for debt securities was equal to the total difference between amortized cost and fair value at the time of impairment.
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.
Derivative Financial Instruments
Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices or the values of securities. Derivative financial instruments generally used
by the Company include swaps, options, and futures 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. Values can be affected by changes in interest rates, foreign exchange rates, equity risks, credit spreads, market volatility 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.
Derivatives are used to manage the characteristics
of the Company’s asset/liability mix, and to manage the interest rate and currency characteristics of assets or liabilities. Additionally, derivatives may be used to seek to reduce exposure to interest rate, credit, and foreign currency, and
equity risks associated with assets held or expected to be purchased or sold, and liabilities incurred or expected to be incurred.
Derivatives are recorded either as assets, within “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 its counterparty for which a master netting arrangement has been executed. As discussed below and in Note 11, all realized and unrealized
changes in fair value of derivatives, with the exception of the effective portion of cash flow hedges, are recorded in current earnings. Cash flows from these derivatives are reported in the operating and investing activities sections in the
Statements of Cash Flows.
F-12
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (
continued
)
The Company designates derivatives as either (1) 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), or (2) a derivative that does not qualify for hedge accounting.
To qualify for hedge accounting treatment, a derivative must be highly effective in mitigating the designated risk of the hedged item.
Effectiveness of the hedge is formally assessed at inception and throughout the life of the hedging relationship. Even if a derivative qualifies for hedge accounting treatment, there may be an element of ineffectiveness of the hedge. Under such
circumstances, the ineffective portion is recorded in “Realized investment gains (losses), net.”
The Company
formally documents at inception all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives
designated as cash flow hedges to specific assets and liabilities on the balance sheet or to specific forecasted transactions.
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.
If it is determined that a derivative no longer qualifies as an effective 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 amortized 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 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.” 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 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 either separated from the host
contract, carried at fair value, and changes in its fair value are included in “Realized investment gains (losses), net” or 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.” The Company has sold variable annuity products, which may include guaranteed benefit features that are accounted for as embedded derivatives. The Company has entered into reinsurance agreements to
transfer the risk related to the embedded derivatives contained in certain insurance product to affiliates. These reinsurance agreements are derivatives and have been accounted in the same manner as the embedded derivative.
Cash and cash equivalents
Cash and cash equivalents include cash on hand, money market instruments, and other debt instruments with maturities of three months or less when purchased, other than cash equivalents that are included
in “Trading account assets, at fair value.” The
F-13
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (
continued
)
Company also engages in overnight borrowing and lending of funds with Prudential
Financial and affiliates which are considered cash and cash equivalents.
Valuation of business acquired
As a result of purchase accounting, the Company reports a financial asset representing the VOBA. VOBA is determined by estimating the net
present value of future cash flows from contracts in force in the acquired business at the date of acquisition. VOBA balances are subject to recoverability testing, in the manner in which it was acquired, at the end of each reporting period to
ensure that the balance does not exceed the present value of anticipated gross profits. Future positive cash flows generally include fees and other charges assessed to the contracts as long as they remain in force as well as fees collected upon
surrender, if applicable, while future negative cash flows include costs to administer contracts and benefit payments. The Company amortizes VOBA over the effective life of the acquired contracts. VOBA is amortized in proportion to estimated gross
profits arising from the contracts and anticipated future experience, which is evaluated regularly. The effect of changes in estimated gross profits on unamortized VOBA is reflected in “General and administrative expenses” in the period
such estimates of expected future profits are revised.
Deferred policy acquisition costs
Costs that vary with and that are related primarily to the production of new insurance and annuity business are deferred to the extent
such costs are deemed recoverable from future profits. Such DAC costs include commissions, costs of policy issuance and underwriting, and variable field office expenses that are incurred in producing new business. In each reporting period,
capitalized DAC is amortized to “Amortization of deferred policy acquisition costs,” net of the accrual of imputed interest on DAC balances. DAC is subject to recoverability testing at the end of each reporting period to ensure that the
balance does not exceed the present value of anticipated gross profits, less benefits and maintenance expenses,. DAC, for applicable products, is adjusted for the impact of unrealized gains or losses on investments as if these gains or losses had
been realized, with corresponding credits or charges included in “Accumulated other comprehensive income (loss).”
Policy acquisition costs are deferred and amortized over the expected life of the contracts (approximately 25 years) in proportion to
gross profits arising principally from investment results, mortality and expense margins, and surrender charges, based on historical and anticipated future experience, which is updated periodically. The Company uses a reversion to the mean approach
to derive the future rate of return assumptions. However, if the projected future rate of return calculated using this approach is greater than the maximum future rate of return assumption, the maximum future rate of return is utilized. In addition
to the gross profit components previously mentioned, we also include the impact of the embedded derivatives associated with certain optional living benefit features of the Company’s variable annuity contracts and related hedging activities in
actual gross profits used as the basis for calculating current period amortization, regardless of which affiliated legal entity this activity occurs. In calculating gross profits, profits and losses related to contracts issued by the Company that
are reported in affiliated legal entities other than the Company as a result of, for example, reinsurance agreement with those affiliated entities, are also included. Incorporating all product-related profits and losses in gross profits, including
those that are reported in affiliated legal entities, produces a DAC amortization pattern representative of the economics of the products. The effect of changes to estimated gross profits on unamortized deferred acquisition costs is reflected in the
period such estimated gross profits are revised.
For some products, policyholders can elect to modify product benefits,
features, rights or coverages by exchanging a contract for a new contract or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. These transactions are known as internal replacements. For
internal replacement transactions, except those that involve the addition of a nonintegrated contract feature that does not change the existing base contract, the unamortized DAC is immediately charged to expense if the terms of the new policies are
not substantially similar to those of the former policies. If the new terms are substantially similar to those of the earlier policies, the DAC is retained with respect to the new policies and amortized over the expected life of the new policies.
Reinsurance recoverables
Reinsurance recoverables include corresponding payables and receivables associated with reinsurance arrangements with affiliates. For additional information about these arrangements see Note 13 to the
Financial Statements.
F-14
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (
continued
)
Separate account assets and liabilities
Separate account assets are reported at fair value and represent segregated funds that are invested for certain policyholders.
“Separate account assets” are predominantly shares in Advanced Series Trust formerly known as American Skandia Trust co-managed by AST Investment Services, Incorporated (“ASISI”) formerly known as American Skandia Investment
Services, Incorporated and Prudential Investments LLC, which utilizes various fund managers as sub-advisors. The remaining assets are shares in other mutual funds, which are managed by independent investment firms. The contractholder has the option
of directing funds to a wide variety of investment options, most of which invest in mutual funds. The investment risk on the variable portion of a contract is borne by the contractholder, except to the extent of minimum guarantees by the Company,
which are not separate account liabilities. The assets of each account are legally segregated and are generally not subject to claims that arise out of any other business of the Company. The investment income and gains or losses for separate
accounts generally accrue to the policyholders and are not included in the Company’s results of operations and Comprehensive Income. Mortality, policy administration and surrender charges on the accounts are included in “Policy charges and
fee income”. Asset administration fees calculated on account assets are included in “Asset administration fees.” Separate account liabilities primarily represent the contractholder’s account balance in separate account assets.
Deferred sales inducements
The Company provides sales inducements to contractholders, which primarily reflect an up-front bonus added to the contractholder’s initial deposit for certain annuity contracts. These costs are
deferred and recognized in “Deferred sales inducements”. They are amortized using the same methodology and assumptions used to amortize DAC. Sales inducements balances are subject to recoverability testing at the end of each reporting
period to ensure that the capitalized amounts do not exceed the present value of anticipated gross profits. The Company records amortization of deferred sales inducements in “Interest credited to policyholders’ account balances.”
Other assets and other liabilities
“Other assets” consist primarily of accruals for asset administration fees. “Other assets” also consist of state insurance licenses. Licenses to do business in all states have been
capitalized and reflected at the purchase price of $4.0 million. Due to the adoption of authoritative guidance on accounting for Goodwill and Other Intangible Assets, the cost of the licenses is no longer being amortized but is subjected to an
annual impairment test. As of December 31, 2010, the Company estimated the fair value of the state insurance licenses to be in excess of book value and, therefore, no impairment charge was required.
“Other liabilities” consist primarily of accrued expenses, technical overdrafts and a liability to the participants of a
deferred compensation plan. Other liabilities may also include derivative instruments in a net liability position. Derivative instruments normally classified as other long term investments were reclassified as other liabilities at December 31,
2009 as they were in a net liability position.
Future policy benefits
The Company’s liability for future policy benefits is primarily comprised of liabilities for guarantee benefits related to certain
nontraditional long-duration life and annuity contracts, which are discussed more fully in Note 6. These reserves represent reserves for the guaranteed minimum death and optional living benefit features on our variable annuity products. The optional
living benefits are primarily accounted for as embedded derivatives, with fair values calculated as the present value of future expected benefit payments to customers less the present value of assessed rider fees attributable to the embedded
derivative feature. For additional information regarding the valuation of these optional living benefit features, see Note 10 to the financial statements.
The Company’s liability for future policy benefits also includes reserves based on the present value of estimated future payments to or on behalf of policyholders related to contracts that have
annuitized, where the timing and amount of payment depends on policyholder mortality, less the present value of future net premiums. Expected mortality is generally based on the Company’s historical experience or standard industry tables.
Interest rate assumptions are based on factors such as market conditions and expected investment returns. Although mortality and interest rate assumptions are “locked-in” upon the issuance of new insurance or annuity business with fixed
and guaranteed terms, significant changes in experience or assumptions may require the Company to provide for expected future losses on a product by establishing premium deficiency reserves.
Policyholders’ account balances
The Company’s liability
for policyholders’ account balances represents the contract value that has accrued to the benefit of the policyholder as of the balance sheet date. This liability is generally equal to the accumulated account deposits, plus interest credited,
less policyholder withdrawals and other charges assessed against the account balance. These policyholders’ account balances also include provision for benefits under non-life contingent payout annuities and certain unearned revenues.
F-15
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (
continued
)
Contingent liabilities
Amounts related to contingent liabilities are accrued if it is probable that a liability has been incurred and an amount is reasonably
estimable. Management evaluates whether there are incremental legal or other costs directly associated with the ultimate resolution of the matter that are reasonably estimable and, if so, they are included in the accrual.
Insurance revenue and expense recognition
Revenues for variable deferred annuity contracts consist of charges against contractholder account values or separate accounts for mortality and expense risks, administration fees, surrender charges and
an annual maintenance fee per contract. Revenues for mortality and expense risk charges and administration fees are recognized as assessed against the contractholder. Surrender charge revenue is recognized when the surrender charge is assessed
against the contractholder at the time of surrender. Benefit reserves for the variable investment options on annuity contracts represent the account value of the contracts and are included in “Separate account liabilities.”
Revenues for variable immediate annuity and supplementary contracts with life contingencies consist of certain charges against
contractholder account values including mortality and expense risks and administration fees. These charges and fees are recognized as revenue when assessed against the contractholder. Benefit reserves for variable immediate annuity contracts
represent the account value of the contracts and are included in “Separate account liabilities.”
Revenues for fixed
immediate annuity and fixed supplementary contracts with and without life contingencies consist of net investment income. In addition, revenues for fixed immediate annuity contracts with life contingencies also consist of single premium payments
recognized as annuity considerations when received. Benefit reserves for these contracts are based on applicable actuarial standards with assumed interest rates that vary by contract year. Reserves for contracts without life contingencies are
included in “Policyholders’ account balances” while reserves for contracts with life contingencies are included in “future policy benefits and other policyholder liabilities.” Assumed interest rates ranged from 1.00% to
8.25% at December 31, 2010, and from 1.09% to 8.25% at December 31, 2009.
Revenues for variable life insurance
contracts consist of charges against contractholder account values or separate accounts for mortality and expense risk fees, administration fees, cost of insurance fees, taxes and surrender charges. Certain contracts also include charges against
premium to pay state premium taxes. All of these charges are recognized as revenue when assessed against the contractholder. Benefit reserves for variable life insurance contracts represent the account value of the contracts and are included in
“Separate account liabilities.”
Certain individual annuity contracts provide the holder a guarantee that the
benefit received upon death or annuitization will be no less than a minimum prescribed amount. These benefits are accounted for as insurance contracts and are discussed in further detail in Note 6. The Company also provides contracts with certain
living benefits that are treated as embedded derivatives from an accounting perspective. These contracts are discussed in further detail in Note 6.
Premiums, benefits and expenses are stated net of reinsurance ceded to other companies. Estimated reinsurance recoverables and the cost of reinsurance are recognized over the life of the reinsured
policies using assumptions consistent with those used to account for the underlying policies.
Asset administration fees
In accordance with an agreement with ASISI, the Company receives fee income calculated on contractholder separate
account balances invested in the Advanced Series Trust. In addition, the Company receives fees calculated on contractholder separate account balances invested in funds managed by companies other than ASISI. Asset administration fees are recognized
as income when earned. These revenues are recorded as “Asset administration fees” in the Statements of Operations and Comprehensive Income.
Income taxes
The Company is a member of the consolidated federal
income tax return of Prudential Financial and primarily files separate company state and local tax returns. Pursuant to the tax allocation arrangement with Prudential Financial, total federal income tax expense is determined on a separate company
basis. Members with losses record tax benefits to the extent such losses are recognized in the consolidated federal tax provision.
F-16
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS
(continued)
Deferred income taxes are recognized, based on enacted rates, when assets and
liabilities have different values for financial statement and tax reporting purposes. A valuation allowance is recorded to reduce a deferred tax asset to the amount expected to be realized.
Future fees payable to PAI
In a series of transactions with PAI,
the Company sold certain rights to receive a portion of future fees and contract charges expected to be realized on designated blocks of deferred annuity contracts. The proceeds from the sales were recorded as a liability and were being amortized
over the remaining surrender charge period of the designated contracts using the interest method. As of December 31, 2009, the proceeds were fully amortized into income and the liability was extinguished.
Adoption of New accounting pronouncements
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 required disclosures are
included above and in Note 3. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning after December 15, 2010. The Company will provide these required disclosures in
the interim reporting period ending March 31, 2011. In January 2011, the FASB deferred the disclosures required by this guidance related to troubled debt restructurings. The disclosures will be effective, and the Company will provide these
disclosures, concurrent with the effective date of proposed guidance for determining what constitutes a troubled debt restructuring.
In March 2010, the FASB issued updated guidance that amends and clarifies the accounting for credit derivatives embedded in interests in securitized financial assets. This new guidance eliminates the
scope exception for embedded credit derivatives (except for those that are created solely by subordination) and provides new guidance on how the evaluation of embedded credit derivatives is to be performed. This new guidance is effective for the
first interim reporting period beginning after June 15, 2010. The Company’s adoption of this guidance effective with the interim reporting period ending September 30, 2010 did not have a material effect on the Company’s 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 effective
portions of this guidance on January 1, 2010. The required disclosures are provided in Note 10 and Note 11. The Company will provide the required disclosures about purchases, sales, issuances, and settlements in the roll forward of Level 3
activity in the interim reporting period ending March 31, 2011.
In June 2009, the FASB issued authoritative guidance
which changes the analysis required to determine whether or not an entity is a variable interest entity (“VIE”). In addition, the guidance changes the determination of the primary beneficiary of a VIE from a quantitative to a qualitative
model. Under the new qualitative model, the primary beneficiary must have both the ability to direct the activities of the VIE and the obligation to absorb either losses or gains that could be significant to the VIE. This guidance also changes when
reassessment is needed, as well as requires enhanced disclosures, including the effects of a company’s involvement with a VIE on its financial statements. This guidance is effective for interim and annual reporting periods beginning after
November 15, 2009. In February 2010, the FASB issued updated guidance which defers, except for disclosure requirements, the impact of this guidance for entities that (1) possess the attributes of an investment company, (2) do not
require the reporting entity to fund losses, and (3) are not financing vehicles or entities that were formerly classified as qualified special purpose entities (“QSPE’s”). The Company’s adoption of this guidance effective
January 1, 2010 did not have a material effect on the Company’s financial position, results of operations, and financial statement disclosures.
In June 2009, the FASB issued authoritative guidance which changes the accounting for transfers of financial assets, and is effective for transfers of financial assets occurring in interim and annual
reporting periods beginning after November 15, 2009. It removes the concept of a QSPE from the guidance for transfers of financial assets and removes the exception from applying the guidance for consolidation of variable interest entities to
qualifying special-purpose entities. It changes the criteria for achieving sale accounting when transferring a financial asset and changes the initial recognition of retained beneficial interests. The guidance also defines “participating
interest” to establish specific conditions for reporting a transfer of a portion of a financial asset as a sale. The Company’s adoption of this guidance effective January 1, 2010 did not have a material effect on the Company’s
financial position, results of operations, and financial statement disclosures.
F-17
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (
continued
)
In September 2009, the FASB issued updated guidance for the fair value measurement of
investments in certain entities that calculate net asset value per share including certain alternative investments. This guidance allows companies to determine the fair value of such investments using net asset value (“NAV”) if the fair
value of the investment is not readily determinable and the investee entity issues financial statements in accordance with measurement principles for investment companies. Use of this practical expedient is prohibited if it is probable the
investment will be sold at something other than NAV. This guidance also requires new disclosures for each major category of alternative investments. This guidance does not apply to the Company’s investments in joint ventures and limited
partnerships that are generally accounted for under the equity method or cost method. It is effective for the first annual or interim reporting period ending after December 15, 2009. The Company’s adoption of this guidance effective
December 31, 2009 did not have a material effect on the Company’s financial position, results of operations, or financial statement disclosures.
In August 2009, the FASB issued updated guidance for the fair value measurement of liabilities. This guidance provides clarification on how to measure fair value in circumstances in which a quoted price
in an active market for the identical liability is not available. This guidance also clarifies that restrictions preventing the transfer of a liability should not be considered as a separate input or adjustment in the measurement of fair value. The
Company will adopt this guidance effective with the annual reporting period ended December 31, 2009. The Company is currently assessing the impact of this guidance on the Company’s financial position, results of operations, and financial
statement disclosures.
In June 2009, the FASB issued authoritative guidance for the FASB’s
Accounting Standards Codification
TM
as the source of
authoritative U.S. GAAP. The Codification is not intended to change U.S. GAAP but is a new structure which organizes accounting pronouncements by accounting topic. This guidance is effective for financial statements issued for interim and annual
periods ending after September 15, 2009. The Company’s adoption of this guidance effective with the interim reporting period ending September 30, 2009 impacts the way the Company references U.S. GAAP standards in the financial
statements.
In April 2009, the FASB revised the authoritative guidance for disclosures about fair value of financial
instruments. This new guidance requires disclosures about fair value of financial instruments for interim reporting periods similar to those included in annual financial statements. This guidance is effective for interim reporting periods ending
after June 15, 2009. The Company adopted this guidance effective with the interim period ending June 30, 2009.
In
April 2009, the FASB revised the authoritative guidance for the recognition and presentation of other-than-temporary impairments. This new guidance amends the other-than-temporary impairment guidance for debt securities and expands the presentation
and disclosure requirements of other-than-temporary impairments on debt and equity securities in the financial statements. This guidance also requires that the required annual disclosures for debt and equity securities be made for interim reporting
periods. This guidance does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. This guidance is effective for interim and annual reporting periods ending after June 15,
2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted this guidance effective on January 1, 2009, which resulted in a net after-tax increase to retained earnings and decrease to accumulated other
comprehensive income (loss) of $8.7 million, as of January 1, 2009. The disclosures required by this new guidance are provided in Note 3. See “Realized investment gains (losses)” above for more information.
In April 2009, the FASB revised the authoritative guidance for fair value measurements and disclosures to provide guidance on
(1) estimating the fair value of an asset or liability if there was a significant decrease in the volume and level of trading activity for these assets or liabilities, and (2) identifying transactions that are not orderly. Further, this
new guidance requires additional disclosures about fair value measurements in interim and annual periods. This guidance is effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. Early
adoption is permitted for periods ending after March 15, 2009. The Company’s early adoption of this guidance effective January 1, 2009 did not have a material effect on the Company’s financial position or results of operations.
The disclosures required by this revised guidance are provided in Note 10.
In September 2008, the FASB Emerging Issues Task
Force (“EITF”) reached consensus on issuers’ accounting for liabilities measured at fair value with a third-party credit enhancement. The consensus concluded that (a) the issuer of a liability (including debt) with a third-party
credit enhancement that is inseparable from the liability, shall not include the effect of the credit enhancement in the fair value measurement of the liability; (b) the issuer shall disclose the existence of any third-party credit enhancement
on such liabilities, and (c) in the period of adoption the issuer shall disclose the valuation techniques used to measure the fair value of such liabilities and disclose any changes from valuation techniques used in prior periods. The
Company’s adoption of this guidance on a prospective basis effective January 1, 2009 did not have a material effect on the Company’s financial position or results of operations.
F-18
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (
continued
)
In June 2008, the FASB EITF reached consensus on the following issues contained in
authoritative guidance for derivative instruments and hedging activities for determining whether an instrument (or an embedded feature) is indexed to an entity’s own stock: (1) how an entity should evaluate whether an instrument (or
embedded feature) is indexed to the entity’s own stock; (2) how the currency in which the strike price of an equity-linked financial instrument (or embedded equity-linked feature) is denominated affects the determination of whether the
instrument is indexed to the entity’s own stock; (3) how an issuer should account for equity-linked financial instruments issued to investors for purposes of establishing a market-based measure of the grant-date fair value of employee
stock options. This guidance clarifies what instruments qualify as indexed to an entity’s own stock and are thereby eligible for equity classification
.
The Company’s adoption of this guidance effective January 1, 2009 did not
have a material effect on the Company’s financial position or results of operations.
In April 2008, the FASB revised the
authoritative guidance for the determination of the useful life intangible assets. This new guidance amends the list of factors an entity should consider in developing renewal or extension assumptions used to determine the useful life of recognized
intangible assets. This guidance is effective for fiscal years and interim periods beginning after December 15, 2008, with the guidance for determining the useful life of a recognized intangible asset being applied prospectively to intangible
assets acquired after the effective date and the disclosure requirements being applied prospectively to all intangible assets recognized as of, and after, the effective date. The Company’s adoption of this guidance effective January 1,
2009 did not have a material effect on the Company’s financial position or results of operations.
In March 2008, the
FASB issued authoritative guidance for derivative instruments and hedging activities which amends and expands the disclosure requirements for derivative instruments and hedging activities by requiring companies to provide enhanced disclosures about
(a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for , and (c) how derivative instruments and related hedged items affect an entity’s financial position,
financial performance, and cash flows. The Company’s adoption of this guidance effective January 1, 2009 did not have a material effect on the Company’s financial position or results of operations. The required disclosure is included
in Note 11.
In February 2008, the FASB revised the authoritative guidance for the accounting for transfers of financial
assets and repurchase financing transactions. The new guidance provides recognition and derecognition guidance for a repurchase financing transaction, which is a repurchase agreement that relates to a previously transferred financial asset between
the same counterparties, that is entered into contemporaneously with or in contemplation of, the initial transfer. The guidance is effective for fiscal years beginning after November 15, 2008. The Company’s adoption of this guidance on a
prospective basis effective January 1, 2009 did not have a material effect on the Company’s financial position or results of operations.
In February 2008, the FASB revised the authoritative guidance which delays the effective date of the authoritative guidance related to fair value measurements and disclosures for nonfinancial assets and
nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those
fiscal years. The Company’s adoption of this guidance effective January 1, 2009 did not have a material effect on the Company’s financial position or results of operations.
Future Adoption of New Accounting Pronouncements
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 new 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
that are incurred in transactions with independent third parties or employees as well as the portion of employee compensation costs related to underwriting, policy issuance and processing, medical inspection, and contract selling for successfully
negotiated contracts. Additionally, an entity may capitalize as a deferred acquisition cost only those advertising costs meeting the capitalization criteria for direct-response advertising. This change is effective for fiscal years beginning after
December 15, 2011 and interim periods within those years. Early adoption as of the beginning of a fiscal year is permitted. The guidance is to be applied prospectively upon the date of adoption, with retrospective application permitted, but not
required. The Company will adopt this guidance effective January 1, 2012. The Company is currently assessing the impact of the guidance on the Company’s consolidated financial position, results of operations, and financial statement
disclosures.
F-19
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (
continued
)
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 is not expected to have a material effect on the Company’s financial position, results of operations, and financial statement disclosures.
Reclassifications
Certain amounts in the prior years have been reclassified to
conform to the current year presentation.
Fixed Maturities and Equity Securities
The following tables provide additional information relating to fixed maturities and equity securities (excluding investments classified as trading) as of December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
|
|
Amortized
Cost
|
|
|
Gross
Unrealized
Gains
|
|
|
Gross
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
Other-than-
temporary
impairments
in AOCI (3)
|
|
|
|
|
(in thousands)
|
|
|
Fixed maturities, available for sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and obligations of U.S. government authorities and agencies
|
|
$
|
187,394
|
|
|
$
|
5,911
|
|
|
$
|
-
|
|
|
$
|
193,305
|
|
|
$
|
-
|
|
|
Obligations of U.S. states and their political subdivisions
|
|
|
69,567
|
|
|
|
7,949
|
|
|
|
-
|
|
|
|
77,516
|
|
|
|
-
|
|
|
Foreign government bonds
|
|
|
122,152
|
|
|
|
14,361
|
|
|
|
-
|
|
|
|
136,513
|
|
|
|
-
|
|
|
Corporate securities
|
|
|
3,554,569
|
|
|
|
396,747
|
|
|
|
366
|
|
|
|
3,950,950
|
|
|
|
(235)
|
|
|
Asset-backed securities (1)
|
|
|
207,373
|
|
|
|
14,387
|
|
|
|
7,790
|
|
|
|
213,970
|
|
|
|
(12,200)
|
|
|
Commercial mortgage-backed securities
|
|
|
455,972
|
|
|
|
34,597
|
|
|
|
-
|
|
|
|
490,569
|
|
|
|
-
|
|
|
Residential mortgage-backed securities (2)
|
|
|
367,237
|
|
|
|
26,161
|
|
|
|
-
|
|
|
|
393,398
|
|
|
|
(76)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities, available for sale
|
|
$
|
4,964,264
|
|
|
$
|
500,113
|
|
|
$
|
8,156
|
|
|
$
|
5,456,221
|
|
|
$
|
(12,511)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities, available for sale
|
|
$
|
14,484
|
|
|
$
|
3,150
|
|
|
$
|
47
|
|
|
$
|
17,587
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 $6.0 million of net unrealized gains on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date.
|
F-20
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
|
3.
|
INVESTMENTS
(continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
|
|
|
Amortized
Cost
|
|
|
Gross
Unrealized
Gains
|
|
|
Gross
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
Other-than-
temporary
impairments
in
AOCI (3)
|
|
|
|
|
(in thousands)
|
|
|
Fixed maturities, available for sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and obligations of U.S. government authorities and agencies
|
|
$
|
271,796
|
|
|
$
|
647
|
|
|
$
|
9,964
|
|
|
$
|
262,479
|
|
|
$
|
-
|
|
|
Obligations of U.S. states and their political subdivisions
|
|
|
68,764
|
|
|
|
5,352
|
|
|
|
-
|
|
|
|
74,116
|
|
|
|
-
|
|
|
Foreign government bonds
|
|
|
124,134
|
|
|
|
10,866
|
|
|
|
-
|
|
|
|
135,000
|
|
|
|
-
|
|
|
Corporate securities
|
|
|
4,466,408
|
|
|
|
395,682
|
|
|
|
6,788
|
|
|
|
4,855,302
|
|
|
|
(236)
|
|
|
Asset-backed securities (1)
|
|
|
206,996
|
|
|
|
17,245
|
|
|
|
10,402
|
|
|
|
213,839
|
|
|
|
(14,452)
|
|
|
Commercial mortgage-backed securities
|
|
|
541,409
|
|
|
|
15,102
|
|
|
|
7,929
|
|
|
|
548,582
|
|
|
|
-
|
|
|
Residential mortgage-backed securities (2)
|
|
|
377,453
|
|
|
|
27,193
|
|
|
|
77
|
|
|
|
404,569
|
|
|
|
(88)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities, available for sale
|
|
$
|
6,056,960
|
|
|
$
|
472,087
|
|
|
$
|
35,160
|
|
|
$
|
6,493,887
|
|
|
$
|
(14,776)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities, available for sale
|
|
$
|
17,085
|
|
|
$
|
1,997
|
|
|
$
|
470
|
|
|
$
|
18,612
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 $6.2 million of net unrealized gains on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date.
|
The amortized cost and fair value of fixed maturities by contractual maturities at December 31, 2010 is shown below:
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale
|
|
|
|
|
Amortized
Cost
|
|
|
Fair value
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
Due in one year or less
|
|
$
|
208,441
|
|
|
$
|
213,806
|
|
|
Due after one year through five years
|
|
|
2,435,880
|
|
|
|
2,684,523
|
|
|
Due after five years through ten years
|
|
|
829,259
|
|
|
|
926,490
|
|
|
Due after ten years
|
|
|
460,102
|
|
|
|
533,465
|
|
|
Commercial mortgage backed securities
|
|
|
455,972
|
|
|
|
490,569
|
|
|
Residential mortgage-backed securities
|
|
|
367,237
|
|
|
|
393,398
|
|
|
Asset-backed securities
|
|
|
207,373
|
|
|
|
213,970
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
4,964,264
|
|
|
$
|
5,456,221
|
|
|
|
|
|
|
|
|
|
|
|
Actual maturities may differ from contractual maturities because issuers 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 gross investment gains (losses), as well as losses on
impairments of both fixed maturities and equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
Fixed maturities, available for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from sales
|
|
$
|
1,422,218
|
|
|
$
|
6,471,090
|
|
|
$
|
9,664,156
|
|
|
|
|
Proceeds from maturities/repayments
|
|
|
497,378
|
|
|
|
710,653
|
|
|
|
68,993
|
|
|
|
|
Gross investment gains from sales, prepayments and maturities
|
|
|
131,492
|
|
|
|
231,977
|
|
|
|
69,587
|
|
|
|
|
Gross investment losses from sales and maturities
|
|
|
(1,801)
|
|
|
|
(1,731)
|
|
|
|
(38,664)
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity and equity security impairments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net writedowns for other-than-temporary impairment losses on fixed maturities recognized in earnings (1)
|
|
$
|
(3,004)
|
|
|
$
|
(11,607)
|
|
|
$
|
(25,771)
|
|
|
|
|
Writedowns for other-than-temporary impairment losses on equity securities
|
|
|
-
|
|
|
|
(1,936)
|
|
|
|
(452)
|
|
|
|
|
(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.
|
F-21
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
|
3.
|
INVESTMENTS
(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 table sets forth the amount of pretax 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
|
|
Year
Ended
December 31,
2010
|
|
|
Year
Ended
December 31,
2009
|
|
|
|
|
(in thousands)
|
|
|
(in thousands)
|
|
|
Balance, beginning of period
|
|
$
|
13,038
|
|
|
$
|
-
|
|
|
Credit losses remaining in retained earnings related to adoption of new authoritative guidance on January 1,
2009
|
|
|
-
|
|
|
|
6,397
|
|
|
Credit loss impairments previously recognized on securities which matured, paid down, prepaid or were sold during the
period
|
|
|
(1,027
|
)
|
|
|
(3,227
|
)
|
|
Credit loss impairments previously recognized on securities impaired to fair value during the period (1)
|
|
|
-
|
|
|
|
-
|
|
|
Credit loss impairment recognized in the current period on securities not previously impaired
|
|
|
-
|
|
|
|
2,156
|
|
|
Additional credit loss impairments recognized in the current period on securities previously impaired
|
|
|
2,029
|
|
|
|
7,223
|
|
|
Increases due to the passage of time on previously recorded credit losses
|
|
|
609
|
|
|
|
702
|
|
|
Accretion of credit loss impairments previously recognized due to an increase in cash flows expected to be
collected
|
|
|
(501
|
)
|
|
|
(213
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2010
|
|
$
|
14,148
|
|
|
$
|
13,038
|
|
|
|
|
|
|
|
|
|
|
|
(1) Represents circumstances where the Company determined in the
current period that it intends to sell the security or it is more likely than not that it will be required to sell the security before recovery of the security’s amortized cost.
Trading Account Assets
The following table sets forth the
composition of the Company’s trading account assets as of the dates indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
Amortized
Cost
|
|
|
Fair
Value
|
|
|
Amortized
Cost
|
|
|
Fair
Value
|
|
|
|
|
(in thousands)
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset-backed securities
|
|
|
66,205
|
|
|
|
70,831
|
|
|
|
63,410
|
|
|
|
70,199
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
$
|
66,205
|
|
|
$
|
70,831
|
|
|
$
|
63,410
|
|
|
$
|
70,199
|
|
|
Equity securities
|
|
|
8,132
|
|
|
|
8,774
|
|
|
|
9,603
|
|
|
|
9,693
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total trading account assets
|
|
$
|
74,337
|
|
|
$
|
79,605
|
|
|
$
|
73,013
|
|
|
$
|
79,892
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The net change in unrealized gains (losses) from trading account assets still held at period end, recorded
within “Asset administration fees and other income” were $1.6 million, $10.1 million and $5.4 million during year ended December 31, 2010, 2009 and 2008 respectively.
F-22
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
|
3.
|
INVESTMENTS
(
continued
)
|
Commercial mortgage and other loans
The following table provides the breakdown of the gross carrying values of commercial mortgage and other loans by property
type as of December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
Amount
|
|
|
% of
Total
|
|
|
Amount
|
|
|
% of
Total
|
|
|
|
|
($ in thousands)
|
|
|
Commercial mortgage and other loans by property type
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office buildings
|
|
|
$49,248
|
|
|
|
11.3%
|
|
|
|
$51,167
|
|
|
|
13.6%
|
|
|
Retail stores
|
|
|
62,078
|
|
|
|
14.3%
|
|
|
|
64,528
|
|
|
|
17.1%
|
|
|
Apartment complexes
|
|
|
124,709
|
|
|
|
28.7%
|
|
|
|
98,732
|
|
|
|
26.3%
|
|
|
Industrial Buildings
|
|
|
142,003
|
|
|
|
32.7%
|
|
|
|
120,594
|
|
|
|
32.1%
|
|
|
Hospitality
|
|
|
8,524
|
|
|
|
2.0%
|
|
|
|
8,614
|
|
|
|
2.3%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total commercial mortgage loans
|
|
|
386,562
|
|
|
|
89.0%
|
|
|
|
343,635
|
|
|
|
91.4%
|
|
|
Agricultural property loans
|
|
|
47,850
|
|
|
|
11.0%
|
|
|
|
32,342
|
|
|
|
8.6%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total commercial mortgage and other loans
|
|
|
434,412
|
|
|
|
100.0%
|
|
|
|
375,977
|
|
|
|
100.0%
|
|
|
Valuation allowance
|
|
|
(2,980)
|
|
|
|
|
|
|
|
(2,897)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net commercial mortgage and other loans
|
|
|
$431,432
|
|
|
|
|
|
|
|
$373,080
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The commercial mortgage and other loans are geographically dispersed throughout the United States,
Canada and Asia with the largest concentrations California (22%), New York (20%), Ohio (11%), and New Hampshire (6%) at December 31, 2010.
Activity in the allowance for losses for all commercial loans, for the years ended December 31, is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
|
(in thousands)
|
|
|
Allowance for losses, beginning of year
|
|
$
|
2,897
|
|
|
$
|
218
|
|
|
$
|
168
|
|
|
Addition to / (release of) allowance for losses
|
|
|
83
|
|
|
|
2,679
|
|
|
|
50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for losses, end of year
|
|
$
|
2,980
|
|
|
$
|
2,897
|
|
|
$
|
218
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table sets forth the allowance for credit losses and the recorded investment in commercial
mortgage and other loans as of December 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
Mortgage
Loans
|
|
|
Agricultural
Property
Loans
|
|
|
Total
|
|
|
|
|
(in thousands)
|
|
|
Allowance for Credit Losses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending Balance: individually evaluated for impairment
|
|
$
|
416
|
|
|
$
|
-
|
|
|
$
|
416
|
|
|
Ending Balance: collectively evaluated for impairment
|
|
|
2,410
|
|
|
|
154
|
|
|
|
2,564
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Ending Balance
|
|
$
|
2,826
|
|
|
$
|
154
|
|
|
$
|
2,980
|
|
|
Recorded Investment: (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending Balance: individually evaluated for impairment
|
|
$
|
3,782
|
|
|
$
|
-
|
|
|
$
|
3,782
|
|
|
Ending Balance: collectively evaluated for impairment
|
|
|
382,780
|
|
|
|
47,850
|
|
|
|
430,630
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Ending Balance
|
|
$
|
386,562
|
|
|
$
|
47,850
|
|
|
$
|
434,412
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Recorded investment reflects the balance sheet carrying value gross of related allowance
|
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 at December 31, 2010 had a recorded investment of $3.8 million
and a related allowance of $0.4 million, all related to the hospitality property type.
F-23
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
3. INVESTMENTS
(
continued
)
The following tables set forth the credit quality indicators as of December 31,
2010 based upon the recorded investment gross allowance for credit losses:
Commercial mortgage loans
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt Service Coverage Ratio
|
|
|
|
|
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
|
|
|
Loan-to-Value Ratio
|
|
(in thousands)
|
|
|
|
|
|
0%-49.99%
|
|
$
|
36,868
|
|
|
$
|
12,127
|
|
|
$
|
30,407
|
|
|
$
|
3,750
|
|
|
$
|
74,144
|
|
|
$
|
23,736
|
|
|
$
|
181,032
|
|
|
50%-59.99%
|
|
|
6,795
|
|
|
|
-
|
|
|
|
-
|
|
|
|
11,186
|
|
|
|
1,495
|
|
|
|
-
|
|
|
|
19,476
|
|
|
60%-69.99%
|
|
|
-
|
|
|
|
-
|
|
|
|
6,680
|
|
|
|
55,286
|
|
|
|
4,864
|
|
|
|
2,137
|
|
|
|
68,967
|
|
|
70%-79.99%
|
|
|
-
|
|
|
|
-
|
|
|
|
24,362
|
|
|
|
5,030
|
|
|
|
-
|
|
|
|
14,782
|
|
|
|
44,174
|
|
|
80%-89.99%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
54,175
|
|
|
|
54,175
|
|
|
90%-100%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
10,000
|
|
|
|
10,000
|
|
|
Greater than 100%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,782
|
|
|
|
-
|
|
|
|
4,956
|
|
|
|
8,738
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Commercial Mortgage and Other Loans
|
|
$
|
43,663
|
|
|
$
|
12,127
|
|
|
$
|
61,449
|
|
|
$
|
79,034
|
|
|
$
|
80,503
|
|
|
$
|
109,786
|
|
|
$
|
386,562
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other mortgage loans - agricultural properties
|
|
|
|
|
|
|
|
Debt Service Coverage Ratio
|
|
|
|
|
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
|
|
|
Loan-to-Value Ratio
|
|
(in thousands)
|
|
|
|
|
|
0%-49.99%
|
|
$
|
9,418
|
|
|
$
|
-
|
|
|
$
|
480
|
|
|
$
|
10,371
|
|
|
$
|
12,610
|
|
|
$
|
-
|
|
|
$
|
32,879
|
|
|
50%-59.99%
|
|
|
-
|
|
|
|
12.091
|
|
|
|
2,880
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
14,971
|
|
|
60%-69.99%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
70%-79.99%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
80%-89.99%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
90%-100%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Greater than 100%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Agricultural
|
|
$
|
9,418
|
|
|
$
|
12,091
|
|
|
$
|
3,360
|
|
|
$
|
10,371
|
|
|
$
|
12,610
|
|
|
$
|
-
|
|
|
$
|
47,850
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total commercial mortgage and other loans
|
|
|
|
|
|
|
|
Debt Service Coverage Ratio
|
|
|
|
|
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
|
|
|
Loan-to-Value Ratio
|
|
(in thousands)
|
|
|
|
|
|
0%-49.99%
|
|
$
|
46,286
|
|
|
$
|
12,127
|
|
|
$
|
30,887
|
|
|
$
|
14,121
|
|
|
$
|
86,754
|
|
|
$
|
23,736
|
|
|
$
|
213,911
|
|
|
50%-59.99%
|
|
|
6,795
|
|
|
|
12,091
|
|
|
|
2,880
|
|
|
|
11,186
|
|
|
|
1,495
|
|
|
|
-
|
|
|
|
34,447
|
|
|
60%-69.99%
|
|
|
-
|
|
|
|
-
|
|
|
|
6,680
|
|
|
|
55,286
|
|
|
|
4,864
|
|
|
|
2,137
|
|
|
|
68,967
|
|
|
70%-79.99%
|
|
|
-
|
|
|
|
-
|
|
|
|
24,362
|
|
|
|
5,030
|
|
|
|
-
|
|
|
|
14,782
|
|
|
|
44,174
|
|
|
80%-89.99%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
54,175
|
|
|
|
54,175
|
|
|
90%-100%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
10,000
|
|
|
|
10,000
|
|
|
Greater than 100%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,782
|
|
|
|
-
|
|
|
|
4,956
|
|
|
|
8,738
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Commercial Mortgage and Agricultural
|
|
$
|
53,081
|
|
|
$
|
24,218
|
|
|
$
|
64,809
|
|
|
$
|
89,405
|
|
|
$
|
93,113
|
|
|
$
|
109,786
|
|
|
$
|
434,412
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See Note 2 for further discussion regarding the credit quality of other loans.
F-24
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
3. INVESTMENTS
(
continued
)
As of December 31, 2010, all commercial mortgage and other loans were in current
status including $5.0 million of office loans and $3.8 million of hospitality loans in non-accrual status.
Other Long-Term Investments
The following table provides information relating to other long-term investments as of December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
Joint ventures and limited partnerships
|
|
$
|
24,476
|
|
|
$
|
2,995
|
|
|
Derivatives (1)
|
|
|
51,000
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other long-term investments
|
|
$
|
75,476
|
|
|
$
|
2,995
|
|
|
|
|
|
|
|
|
|
|
|
Duration of Gross Unrealized Loss Positions for Fixed Maturities and Equity Securities
The following table shows the fair value and gross unrealized losses aggregated by investment category and length of time that individual
fixed maturities and equity securities have been in a continuous unrealized loss position, as of December 31, 2010 and 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
|
|
Less than twelve
months
(1)
|
|
|
Twelve months
or more
(1)
|
|
|
Total
|
|
|
|
|
Fair
Value
|
|
|
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
Unrealized
Losses
|
|
|
|
|
(in thousands)
|
|
|
Fixed maturities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and obligations of U.S. government authorities and agencies
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
Corporate securities
|
|
|
50,071
|
|
|
|
366
|
|
|
|
62
|
|
|
|
-
|
|
|
|
50,133
|
|
|
|
366
|
|
|
Commercial mortgage-backed securities
|
|
|
4,992
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
4,992
|
|
|
|
-
|
|
|
Asset-backed securities
|
|
|
25,905
|
|
|
|
199
|
|
|
|
42,402
|
|
|
|
7,591
|
|
|
|
68,307
|
|
|
|
7,790
|
|
|
Residential mortgage-backed securities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
80,968
|
|
|
$
|
565
|
|
|
$
|
42,464
|
|
|
$
|
7,591
|
|
|
$
|
123,432
|
|
|
$
|
8,156
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities, available for sale
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
746
|
|
|
$
|
47
|
|
|
$
|
746
|
|
|
$
|
47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
|
|
|
Less than twelve
months
(1)
|
|
|
Twelve months
or more
(1)
|
|
|
Total
|
|
|
|
|
Fair
Value
|
|
|
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
Unrealized
Losses
|
|
|
|
|
(in thousands)
|
|
|
Fixed maturities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and obligations of U.S. government authorities and agencies
|
|
$
|
240,337
|
|
|
$
|
9,911
|
|
|
$
|
1,648
|
|
|
$
|
53
|
|
|
$
|
241,985
|
|
|
$
|
9,964
|
|
|
Corporate securities
|
|
|
101,915
|
|
|
|
1,727
|
|
|
|
114,094
|
|
|
|
5,061
|
|
|
|
216,009
|
|
|
|
6,788
|
|
|
Commercial mortgage-backed securities
|
|
|
5,104
|
|
|
|
25
|
|
|
|
128,593
|
|
|
|
7,904
|
|
|
|
133,697
|
|
|
|
7,929
|
|
|
Asset-backed securities
|
|
|
9,886
|
|
|
|
4,979
|
|
|
|
37,384
|
|
|
|
5,423
|
|
|
|
47,270
|
|
|
|
10,402
|
|
|
Residential mortgage-backed securities
|
|
|
646
|
|
|
|
77
|
|
|
|
-
|
|
|
|
-
|
|
|
|
646
|
|
|
|
77
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
357,888
|
|
|
$
|
16,719
|
|
|
$
|
281,719
|
|
|
$
|
18,441
|
|
|
$
|
639,607
|
|
|
$
|
35,160
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities, available for sale
|
|
$
|
5,090
|
|
|
$
|
375
|
|
|
$
|
698
|
|
|
$
|
95
|
|
|
$
|
5,788
|
|
|
$
|
470
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-28
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
|
3.
|
INVESTMENTS
(
continued
)
|
The gross unrealized losses, related to fixed maturities at December 31, 2010 and
December 31, 2009 are composed of $6.1 million and $30.6 million related to high or highest quality securities based on NAIC or equivalent rating and $2.0 million and $4.5 million, respectively, related to other than high or highest quality
securities based on NAIC or equivalent rating. At December 31, 2010, $4.7 million of the gross unrealized losses represented declines in value of greater than 20%, $916 thousand of which had been in that position for less than six months as
compared to $7.3 million at December 31, 2009 that represented declines in value of greater than 20%, none of which had been in that position for less than six months. At December 31, 2010, the $7.6 million of gross unrealized losses of
twelve months or more were concentrated in asset backed securities. At December 31, 2009, the $18.4 million of gross unrealized losses of twelve months or more were concentrated in asset backed securities, and in the manufacturing services and
finance sectors of the Company’s corporate securities. In accordance with its policy described in Note 2, the Company concluded that an adjustment to earnings for other-than-temporary impairments for these securities was not warranted at
December 31, 2010 or December 31, 2009. These conclusions are based on a detailed analysis of the underlying credit and cash flows on each security. The gross unrealized losses are primarily attributable to credit spread widening and
increased liquidity discounts. At December 31, 2010 the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before the anticipated recovery of its remaining
amortized cost basis.
At December 31, 2010 and December 31, 2009, there were no gross unrealized losses, related to
equity securities that represented declines of greater than 20%. Perpetual preferred securities have characteristics of both debt and equity securities. Since an impairment model similar to fixed maturity securities is applied to these securities,
an other-than-temporary impairment has not been recognized on certain perpetual preferred securities that have been in a continuous unrealized loss position for twelve months or more as of December 31, 2010 and December 31, 2009. In
accordance with its policy described in Note 2, the Company concluded that an adjustment for other-than-temporary impairments for these equity securities was not warranted at December 31, 2010 or December 31, 2009.
Securities Pledged and Special Deposits
The Company pledges as collateral investment securities it owns to unaffiliated parties through certain transactions, including securities lending, securities sold under agreements to repurchase and
future contracts. At December 31, the carrying value of investments pledged to third parties as reported in the Statements of Financial Position included the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
( in thousands)
|
|
|
Fixed maturity securities, available for sale – all other
|
|
$
|
84,248
|
|
|
$
|
249,360
|
|
|
Other trading account assets
|
|
|
-
|
|
|
|
3,971
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities pledged
|
|
$
|
84,248
|
|
|
$
|
253,331
|
|
|
|
|
|
|
|
|
|
|
|
The carrying amount of the associated liabilities supported by the pledged collateral was $87.2 million and
$264.2 million at December 31, 2010 and December 31, 2009, respectively, which was “Cash collateral for loaned securities”.
Fixed maturities of $5.0 million and $4.9 million at December 31, 2010 and 2009, respectively, were on deposit with governmental authorities or trustees as required by certain insurance laws.
|
4.
|
DEFERRED POLICY ACQUISITION COSTS
|
The balances of and changes in DAC as of and for the years ended December 31, 2010, 2009 and 2008, are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
Balance, beginning of year
|
|
|
$1,411,571
|
|
|
$
|
1,247,131
|
|
|
$
|
1,042,823
|
|
|
Capitalization of commissions, sales and issue expenses
|
|
|
311,201
|
|
|
|
654,851
|
|
|
|
417,465
|
|
|
Amortization – Impact of assumption and experience unlocking and true-ups
|
|
|
64,645
|
|
|
|
32,681
|
|
|
|
(143,368
|
)
|
|
Amortization – All Other
|
|
|
(267,212
|
)
|
|
|
(352,487
|
)
|
|
|
(85,468
|
)
|
|
Changes in unrealized investment gains and losses
|
|
|
19,823
|
|
|
|
(170,605
|
)
|
|
|
15,679
|
|
|
Balance, end of year
|
|
|
$1,540,028
|
|
|
$
|
1,411,571
|
|
|
$
|
1,247,131
|
|
|
|
|
|
|
|
F-29
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
|
5.
|
VALUATION OF BUSINESS ACQUIRED
|
Details of VOBA and related interest and gross amortization for the years ended
December 31, 2010, 2009, and 2008 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
|
Balance, beginning of year
|
|
$
|
52,596
|
|
|
$
|
78,382
|
|
|
$
|
118,566
|
|
|
Amortization – Impact of assumption and experience unlocking and true-ups (1)
|
|
|
(1,494
|
)
|
|
|
(2,020
|
)
|
|
|
(16,938
|
)
|
|
Amortization – All other (1)
|
|
|
(10,295
|
)
|
|
|
(14,017
|
)
|
|
|
(32,017
|
)
|
|
Interest(2)
|
|
|
2,965
|
|
|
|
3,735
|
|
|
|
5,830
|
|
|
Change in unrealized gains/losses
|
|
|
(11,275
|
)
|
|
|
(13,083
|
)
|
|
|
2,941
|
|
|
Impact of adoption of SOP 05-01
|
|
|
-
|
|
|
|
(401
|
)
|
|
|
-
|
|
|
|
|
|
|
|
|
Balance, end of year
|
|
$
|
32,497
|
|
|
$
|
52,596
|
|
|
$
|
78,382
|
|
|
|
|
|
|
|
|
|
(1)
|
The weighted average remaining expected life of VOBA was approximately 4.29 years from the date of acquisition.
|
|
|
(2)
|
The interest accrual rate for the VOBA related to the businesses acquired was 4.97%, 5.24% and 5.72% for years ended December 31,
2010, 2009, and 2008.
|
The following table provides estimated future amortization, net of interest, for the
periods indicated (in thousands):
|
|
|
|
|
|
|
2011
|
|
$
|
7,844
|
|
|
2012
|
|
|
5,663
|
|
|
2013
|
|
|
3,889
|
|
|
2014
|
|
|
2,939
|
|
|
2015
|
|
|
2,306
|
|
|
2016 and thereafter
|
|
|
9,856
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
32,497
|
|
|
|
|
|
|
|
|
6.
|
CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS
|
The Company has issued traditional variable annuity contracts through its separate accounts for which investment income and investment gains and losses accrue directly to, and investment risk is borne by,
the contractholder. The Company has also issued variable annuity contracts with general and separate account options where the Company contractually guarantees to the contractholder a return of no less than (1) total deposits made to the
contract less any partial withdrawals (“return of net deposits”), (2) total deposits made to the contract less any partial withdrawals plus a minimum return (“minimum return”), or (3) the highest contract value on a
specified date minus any withdrawals (“contract value”). These guarantees include benefits that are payable in the event of death, annuitization or at specified dates during the accumulation period and withdrawal and income benefits
payable during specified periods. The Company has also issued annuity contracts with market value adjusted investment options (“MVAs”), which provide for a return of principal plus a fixed-rate of return if held to maturity, or,
alternatively, a “market adjusted value” if surrendered prior to maturity or if funds are allocated to other investment options. The market value adjustment may result in a gain or loss to the Company, depending on crediting rates or an
indexed rate at surrender, as applicable.
The assets supporting the variable portion of both traditional variable annuities
and certain variable contracts with guarantees are carried at fair value and reported as “Separate account assets” with an equivalent amount reported as “Separate account liabilities.” Amounts assessed against the contractholders
for mortality, administration, and other services are included within revenue in “Policy charges and fee income” and changes in liabilities for minimum guarantees are generally included in “Policyholders’ benefits”. In 2010,
2009 and 2008, there were no gains or losses on transfers of assets from the general account to a separate account.
For those
guarantees of benefits that are payable in the event of death, the net amount at risk is generally defined as the current guaranteed minimum death benefit in excess of the current account balance at the balance sheet date. The Company’s primary
risk exposures for these contracts relates to actual deviations from, or changes to, the assumptions used in the original pricing of these products, including equity market returns, contract lapses and contractholder mortality.
For guarantees of benefits that are payable at annuitization, the net amount at risk is generally defined as the present value of the
minimum guaranteed annuity payments available to the contractholder determined in accordance with the terms of the contract in excess of the current account balance. The Company’s primary risk exposures for these contracts relates to actual
deviations
F-30
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
|
6.
|
CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS
(
continued)
|
from, or changes to, the assumptions used in the original pricing of these products,
including equity market returns, timing of annuitization, contract lapses and contractholder mortality.
For guarantees of
benefits that are payable at withdrawal, the net amount at risk is generally defined as the present value of the minimum guaranteed withdrawal payments available to the contractholder determined in accordance with the terms of the contract in excess
of the current account balance. For guarantees of accumulation balances, the net amount at risk is generally defined as the guaranteed minimum accumulation balance minus the current account balance. The Company’s primary risk exposures for
these contracts relates to actual deviations from, or changes to, the assumptions used in the original pricing of these products, including equity market returns, interest rates, market volatility or contractholder behavior.
The Company’s contracts with guarantees may offer more than one type of guarantee in each contract; therefore, the amounts listed
may not be mutually exclusive. The liabilities related to the net amount at risk are reflected within “Future policy benefits.” As of December 31, 2010 and 2009, the Company had the following guarantees associated with its contracts,
by product and guarantee type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2010
|
|
|
December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
In the Event
of Death
|
|
|
At
Annuitization/
Accumulation (1)
|
|
|
In the Event
of Death
|
|
|
At
Annuitization/
Accumulation (1)
|
|
|
Variable Annuity Contracts
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
Return of Net Deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Account value
|
|
|
$43,815,528
|
|
|
|
N/A
|
|
|
|
$39,399,293
|
|
|
|
N/A
|
|
|
|
|
|
|
|
|
Net amount at risk
|
|
|
$976,802
|
|
|
|
N/A
|
|
|
|
$2,306,298
|
|
|
|
N/A
|
|
|
|
|
|
|
|
|
Average attained age of contractholders
|
|
|
62 years
|
|
|
|
N/A
|
|
|
|
61 years
|
|
|
|
N/A
|
|
|
|
|
|
|
|
|
Minimum return or contract value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Account value
|
|
|
$9,218,554
|
|
|
|
$42,097,269
|
|
|
|
$8,443,796
|
|
|
|
$36,337,463
|
|
|
|
|
|
|
|
|
Net amount at risk
|
|
|
$1,238,415
|
|
|
|
$1,568,201
|
|
|
|
$1,588,270
|
|
|
|
$2,028,026
|
|
|
|
|
|
|
|
|
Average attained age of contractholders
|
|
|
63 years
|
|
|
|
61 years
|
|
|
|
63 years
|
|
|
|
61 years
|
|
|
|
|
|
|
|
|
Average period remaining until expected annuitization
|
|
|
N/A
|
|
|
|
2 years
|
|
|
|
N/A
|
|
|
|
3 years
|
|
(1) Includes
income and withdrawal benefits described herein
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2010
|
|
|
December 31, 2009
|
|
|
|
|
Unadjusted Value
|
|
|
Adjusted
Value
|
|
|
Unadjusted
Value
|
|
|
Adjusted Value
|
|
|
Market value adjusted annuities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Account value
|
|
$
|
3,111,568
|
|
|
$
|
3,314,734
|
|
|
$
|
4,231,507
|
|
|
$
|
4,467,477
|
|
Account balances of
variable annuity contracts with guarantees were invested in separate account investment options as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2010
|
|
|
December 31,
2009
|
|
|
|
|
(in thousands)
|
|
|
(in thousands)
|
|
|
|
|
|
|
Equity funds
|
|
$
|
27,923,398
|
|
|
$
|
24,269,051
|
|
|
Bond funds
|
|
|
15,396,934
|
|
|
|
10,245,173
|
|
|
Money market funds
|
|
|
4,682,136
|
|
|
|
6,669,055
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
48,002,468
|
|
|
$
|
41,183,279
|
|
|
|
|
|
|
|
|
|
|
|
In addition to the above mentioned amounts invested in separate account investment options, $5.0 billion and
$6.7 million of account balances of variable annuity contracts with guarantees, inclusive of contracts with MVA features, were invested in general account investment options as of December 31, 2010 and 2009, respectively.
F-31
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
|
6.
|
CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS
(
continued)
|
Liabilities for Guarantee Benefits
The table below summarizes the changes in general account liabilities for guarantees on variable contracts. The liabilities for
guaranteed minimum death benefits (“GMDB”) and guaranteed minimum income benefits (“GMIB”) are included in “Future policy benefits” and the related changes in the liabilities are included in “Policyholders’
benefits.” Guaranteed minimum accumulation benefits (“GMAB”), guaranteed minimum withdrawal benefits (“GMWB”), and guaranteed minimum income and withdrawal benefits (“GMIWB”) features are considered to be
bifurcated embedded derivatives and are recorded at fair value. Changes in the fair value of these derivatives, including changes in the Company’s own risk of non-performance, along with any fees attributed or payments made relating to the
derivative are recorded in “Realized investment gains (losses), net.” See Note 10 for additional information regarding the methodology used in determining the fair value of these embedded derivatives. The liabilities for GMAB, GMWB, and
GMIWB are included in “Future policy benefits.” As discussed below, the Company maintains a portfolio of derivative investments that serve as a partial hedge of the risks associated with these products, for which the changes in fair value
are also recorded in “Realized investment gains (losses), net.” This portfolio of derivatives investments does not qualify for hedge accounting treatment under U.S. GAAP.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GMDB
|
|
|
GMAB/
GMWB/
GMIWB
|
|
|
GMIB
|
|
|
Totals
|
|
|
|
|
Variable Annuity
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
Balance as of January 1, 2008
|
|
$
|
42,848
|
|
|
$
|
103,909
|
|
|
$
|
2,323
|
|
|
$
|
149,080
|
|
|
Incurred guarantee benefits - Impact of assumption
and experience unlocking and true-ups (1)
|
|
|
240,093
|
|
|
|
-
|
|
|
|
8,368
|
|
|
|
248,461
|
|
|
Incurred guarantee benefits (1)
|
|
|
52,319
|
|
|
|
2,007,332
|
|
|
|
935
|
|
|
|
2,060,586
|
|
|
Paid guarantee benefits
|
|
|
(55,310
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(55,310
|
)
|
|
|
|
|
|
|
|
Balance as of December 31, 2008
|
|
|
279,950
|
|
|
|
2,111,241
|
|
|
|
11,626
|
|
|
|
2,402,817
|
|
|
|
|
|
|
|
|
Incurred guarantee benefits - Impact of assumption
and experience unlocking and true-ups (1)
|
|
|
(87,363
|
)
|
|
|
-
|
|
|
|
(7,146
|
)
|
|
|
(94,509
|
)
|
|
Incurred guarantee benefits (1)
|
|
|
74,684
|
|
|
|
(2,100,367
|
)
|
|
|
2,603
|
|
|
|
(2,023,080
|
)
|
|
Paid guarantee benefits
|
|
|
(86,076
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(86,076
|
)
|
|
|
|
|
|
|
|
Balance as of December 31, 2009
|
|
|
181,195
|
|
|
|
10,874
|
|
|
|
7,083
|
|
|
|
199,152
|
|
|
|
|
|
|
|
|
Incurred guarantee benefits - Impact of assumption
and experience unlocking and true-ups (1)
|
|
|
(56,363
|
)
|
|
|
-
|
|
|
|
1,238
|
|
|
|
(55,125
|
)
|
|
Incurred guarantee benefits (1)
|
|
|
52,890
|
|
|
|
153,408
|
|
|
|
5,056
|
|
|
|
211,354
|
|
|
Paid guarantee benefits
|
|
|
(47,232
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(47,232
|
)
|
|
|
|
|
|
|
|
Balance as of December 31, 2010
|
|
$
|
130,490
|
|
|
$
|
164,282
|
|
|
$
|
13,377
|
|
|
$
|
308,149
|
|
|
|
|
|
|
|
(1) Incurred guarantee benefits include the portion of assessments established as additions to reserve as
well as changes in estimates affecting the reserves. Also includes changes in the fair value of features considered to be derivatives.
The GMDB liability is determined each period end by estimating the accumulated value of a portion of the total assessments to date less the accumulated value of the death benefits in excess of the account
balance. The GMIB liability is determined each period by estimating the accumulated value of a portion of the total assessments to date less the accumulated value of the projected income benefits in excess of the account balance. The portion of
assessments used is chosen such that, at issue (or, in the case of acquired contracts, at the acquisition date,) the present value of expected death benefits or expected income benefits in excess of the projected account balance and the portion of
the present value of total expected assessments over the lifetime of the contracts are equal. The Company regularly evaluates the estimates used and adjusts the GMDB and GMIB liability balances with an associated charge or credit to earnings, if
actual experience or other evidence suggests that earlier assumptions should be revised.
The GMAB features provide the
contractholder with a guaranteed return of initial account value or an enhanced value if applicable. The most significant of the Company’s GMAB features are the guaranteed return option (“GRO”) features, which includes an asset
transfer feature that reduces the Company’s exposure to these guarantees. The GMAB liability is calculated as the present value of future expected payments to customers less the present value of assessed rider fees attributable to the embedded
derivative feature.
The GMWB features provide the contractholder with a guaranteed remaining balance if the account value is
reduced to zero through a combination of market declines and withdrawals. The guaranteed remaining balance is generally equal to the protected value under the contract, which is initially established as the greater of the account value or cumulative
deposits when
F-32
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
6. CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS
(
continued
)
withdrawals commence, less cumulative withdrawals. The contractholder also has the
option, after a specified time period, to reset the guaranteed remaining balance to the then-current account value, if greater. The GMWB liability is calculated as the present value of future expected payments to customers less the present value of
assessed rider fees attributable to the embedded derivative feature.
The GMIWB features, taken collectively, provide a
contractholder two optional methods to receive guaranteed minimum payments over time, a “withdrawal” option or an “income” option. The withdrawal option (which is available under only one of the Company’s GMIWBs) guarantees
that a contract holder can withdraw an amount each year until the cumulative withdrawals reach a total guaranteed balance. The income option (which varies among the Company’s GMIWBs) in general guarantees the contract holder the ability to
withdraw an amount each year for life (or for joint lives, in the case of any spousal version of the benefit) where such amount is equal to a percentage of a protected value under the benefit. The contractholder also has the potential to increase
this annual amount, based on certain subsequent increases in account value that may occur. Certain GMIWB features include an asset transfer feature that reduces the Company’s exposure to these guarantees. The GMIWB liability is calculated as
the present value of future expected payments to customers less the present value of assessed rider fees attributable to the embedded derivative feature.
As part of its risk management strategy, the Company limits its exposure to these risks through a combination of product design elements, such as an asset transfer feature, and affiliated reinsurance
agreements. The asset transfer feature included in the design of certain optional living benefits, transfers assets between the variable investments selected by the annuity contractholder and, depending on the benefit feature, a fixed rate account
in the general account or a bond portfolio within the separate account. The transfers are based on the static mathematical formula, used with the particular optional benefit, which considers a number of factors, including the impact of investment
performance of the contractholder total account value. In general, negative investment performance may result in transfers to a fixed-rate account in the general account or a bond portfolio within the separate account , and positive investment
performance may result in transfers back to contractholder-selected investments. Other product design elements utilized for certain products to manage these risks include asset allocation restrictions and minimum purchase age requirements. For risk
management purposes the Company segregates the variable annuity living benefit features into those that include the asset transfer feature including certain GMIWB riders and certain GMAB riders that feature the GRO policyholder benefits; and those
that do not include the asset transfer feature, including certain legacy GMIWB, GMWB, GMAB and GMIB riders. Living benefit riders that include the asset transfer feature also include GMDB riders, and as such the GMDB risk in these riders also
benefits from the asset transfer feature.
Sales Inducements
The Company defers sales inducements and amortizes them over the life of the policy using the same methodology and assumptions used to amortize deferred policy acquisition costs. These deferred sales
inducements are included in “Other Assets” in the Company’s Statements of Financial Position. The Company offers various types of sales inducements. These inducements include: (1) a bonus whereby the policyholder’s initial
account balance is increased by an amount equal to a specified percentage of the customer’s initial deposit and (2) additional credits after a certain number of years a contract is held. Changes in deferred sales inducements, reported as
“Interest credited to policyholders’ account balances”, are as follows:
|
|
|
|
|
|
|
|
|
Sales Inducements
|
|
|
|
|
(in thousands)
|
|
|
Beginning Balance as of January 1, 2008
|
|
|
$ 558,821
|
|
|
Capitalizationt
|
|
|
260,268
|
|
|
Amortization - Impact of assumption and experience unlocking and true-ups
|
|
|
(42,133)
|
|
|
Amortization - All other
|
|
|
(50,642)
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2008
|
|
|
726,314
|
|
|
|
|
|
|
|
|
Capitalization
|
|
|
293,388
|
|
|
Amortization - Impact of assumption and experience unlocking and true-ups
|
|
|
6,938
|
|
|
Amortization - All other
|
|
|
(153,163)
|
|
|
Change in unrealized gains/losses
|
|
|
(71,601)
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2009
|
|
|
801,876
|
|
|
|
|
|
|
|
|
Capitalization
|
|
|
182,823
|
|
|
Amortization - Impact of assumption and experience unlocking and true-ups
|
|
|
32,445
|
|
|
Amortization - All other
|
|
|
(232,542)
|
|
|
Change in unrealized gains/losses
|
|
|
11,905
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2010
|
|
|
$ 796,507
|
|
|
|
|
|
|
|
F-33
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
7. REINSURANCE
The Company cedes insurance to other insurers in order to fund the cash strain generated from commission costs on current sales and to
limit its risk exposure. The Company utilizes both affiliated and unaffiliated reinsurance arrangements. On its unaffiliated arrangements, the Company uses primarily modified coinsurance reinsurance arrangements whereby the reinsurer shares in the
experience of a specified book of business. These reinsurance transactions result in the Company receiving from the reinsurer an upfront ceding commission on the book of business ceded in exchange for the reinsurer receiving in the future, a
percentage of the future fees generated from that book of business. Such transfer does not relieve the Company of its primary liability and, as such, failure of reinsurers to honor their obligation could result in losses to the Company. The Company
reduces this risk by evaluating the financial condition and credit worthiness of reinsurers.
On its affiliated arrangements,
the Company uses automatic coinsurance reinsurance arrangements. These agreements cover all significant risks under features of the policies reinsured. The Company is not relieved of its primary obligation to the policyholder as a result of these
reinsurance transactions. These affiliated agreements include the reinsurance of the Company’s GMWB, GMIWB, and GMAB features. These features are considered to be embedded derivatives, and changes in the fair value of the embedded derivative
are recognized through “Realized investment gains (losses), net.” Please see Note 13 for further details around the affiliated reinsurance agreements.
The effect of reinsurance for the years ended December 31, 2010, 2009, and 2008, was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
Unaffiliated
Ceded
|
|
|
Affiliated
Ceded
|
|
|
Net
|
|
|
2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Policy charges and fee income
|
|
$
|
719,263
|
|
|
$
|
21,927
|
|
|
$
|
-
|
|
|
$
|
741,190
|
|
|
Realized investment (losses) gains, net
|
|
$
|
216,875
|
|
|
$
|
-
|
|
|
$
|
(80,836)
|
|
|
$
|
136,039
|
|
|
Policyholders’ benefits
|
|
$
|
41,908
|
|
|
$
|
(997)
|
|
|
$
|
-
|
|
|
$
|
40,911
|
|
|
General, administrative and other expenses
|
|
$
|
418,130
|
|
|
$
|
(1,232)
|
|
|
$
|
(3,432)
|
|
|
$
|
413,466
|
|
|
|
|
|
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Policy charges and fee income
|
|
$
|
406,043
|
|
|
$
|
(13,290)
|
|
|
$
|
-
|
|
|
$
|
392,753
|
|
|
Realized investment (losses) gains, net
|
|
$
|
2,232,850
|
|
|
$
|
-
|
|
|
$
|
(2,195,883)
|
|
|
$
|
36,967
|
|
|
Policyholders’ benefits
|
|
$
|
4,414
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
4,414
|
|
|
General, administrative and other expenses
|
|
$
|
374,509
|
|
|
$
|
(2,337)
|
|
|
$
|
(2,010)
|
|
|
$
|
370,162
|
|
|
|
|
|
|
|
|
2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Policy charges and fee income
|
|
$
|
660,517
|
|
|
$
|
(28,077)
|
|
|
$
|
-
|
|
|
$
|
632,440
|
|
|
Realized investment (losses) gains, net
|
|
$
|
(1,861,957)
|
|
|
$
|
-
|
|
|
$
|
1,908,010
|
|
|
$
|
46,053
|
|
|
Policyholders’ benefits
|
|
$
|
329,724
|
|
|
$
|
(429)
|
|
|
$
|
-
|
|
|
$
|
329,295
|
|
|
General, administrative and other expenses
|
|
$
|
632,361
|
|
|
$
|
(4,231)
|
|
|
$
|
(1,817)
|
|
|
$
|
626,313
|
|
The Company’s
Statements of Financial Position also included reinsurance recoverables from Pruco Reinsurance, LTD (“Pruco Re”) and Prudential Insurance Company of America (“Prudential Insurance”) of $187.1 million at December 31, 2010 and
$40.7 billion at December 31, 2009.
F-34
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
8. INCOME TAXES
The components of income tax expense (benefit) for the years ended December 31, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
|
(in
thousands)
|
|
|
Current tax expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
|
|
$
|
(27,926)
|
|
|
$
|
(239,798)
|
|
|
$
|
-
|
|
|
State and local
|
|
|
(693)
|
|
|
|
2
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
(28,619)
|
|
|
$
|
(239,796)
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
|
|
$
|
152,557
|
|
|
$
|
185,760
|
|
|
$
|
(38,770)
|
|
|
State and local
|
|
|
(237)
|
|
|
|
2,595
|
|
|
|
(454)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
152,320
|
|
|
$
|
188,355
|
|
|
$
|
(39,224)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax expense (benefit) on income from operations
|
|
$
|
123,701
|
|
|
$
|
(51,441)
|
|
|
$
|
(39,224)
|
|
|
Income Tax reported in stockholders’ equity related to:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss)
|
|
|
26,328
|
|
|
|
75,773
|
|
|
|
(4,649)
|
|
|
Cumulative effect of changes in accounting policy
|
|
|
-
|
|
|
|
4,772
|
|
|
|
-
|
|
|
Stock based compensation programs
|
|
|
-
|
|
|
|
-
|
|
|
|
(21)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax expense (benefit)
|
|
$
|
150,029
|
|
|
$
|
29,104
|
|
|
$
|
(43,894)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company’s income (loss) from continuing operations before income taxes includes income (loss) from
domestic operations of $545.3 million, $32.1 million and ($19.3) million, and no income from foreign operations for the years ended December 31, 2010, 2009 and 2008, respectively.
The Company’s actual income tax expense on continuing operations for the years ended December 31, differs from the expected
amount computed by applying the statutory federal income tax rate of 35% to income from continuing operations before income taxes and equity in earnings of operating joint ventures for the following reasons:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
Expected federal income tax expense (benefit)
|
|
$
|
190,848
|
|
|
$
|
11,241
|
|
|
$
|
(6,743)
|
|
|
Non taxable investment income
|
|
|
(55,665)
|
|
|
|
(56,870)
|
|
|
|
(24,418)
|
|
|
Tax credits
|
|
|
(11,136)
|
|
|
|
(6,150)
|
|
|
|
(8,407)
|
|
|
State income taxes, net of federal benefit
|
|
|
(604)
|
|
|
|
1,688
|
|
|
|
(294)
|
|
|
Other
|
|
|
258
|
|
|
|
(1,350)
|
|
|
|
638
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax expense (benefit)
|
|
$
|
123,701
|
|
|
$
|
(51,441)
|
|
|
$
|
(39,224)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-35
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
8. INCOME TAXES
(
continued
)
Deferred tax assets and liabilities at December 31, resulted from the items listed
in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
(in thousands)
|
|
|
Deferred tax assets
|
|
|
|
|
|
|
|
|
|
Insurance reserves
|
|
$
|
301,829
|
|
|
$
|
415,115
|
|
|
Investments
|
|
|
108,698
|
|
|
|
139,761
|
|
|
Compensation reserves
|
|
|
4,401
|
|
|
|
4,714
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax assets
|
|
$
|
414,928
|
|
|
$
|
559,590
|
|
|
|
|
|
|
Deferred tax liabilities
|
|
|
|
|
|
|
|
|
|
VOBA and deferred acquisition cost
|
|
$
|
417,800
|
|
|
$
|
365,998
|
|
|
Net unrealized gains
|
|
|
175,199
|
|
|
|
155,392
|
|
|
Other
|
|
|
12,251
|
|
|
|
49,873
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities
|
|
$
|
605,250
|
|
|
$
|
571,263
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax asset (liability)
|
|
$
|
(190,322)
|
|
|
$
|
(11,673)
|
|
|
|
|
|
|
|
|
|
|
|
The application of U.S. GAAP requires the Company to evaluate the recoverability of deferred tax assets and
establish a valuation allowance if necessary to reduce the deferred tax asset to an amount that is more likely than not expected to be realized. Considerable judgment is required in determining whether a valuation allowance is necessary, and if so,
the amount of such valuation allowance. In evaluating the need for a valuation allowance the Company considers many factors, including: (1) the nature of the deferred tax assets and liabilities; (2) whether they are ordinary or capital;
(3) in which tax jurisdictions they were generated and the timing of their reversal; (4) taxable income in prior carryback years as well as projected taxable earnings exclusive of reversing temporary differences and carryforwards;
(5) the length of time that carryovers can be utilized in the various taxing jurisdictions; (6) any unique tax rules that would impact the utilization of the deferred tax assets; and (7) any tax planning strategies that the Company
would employ to avoid a tax benefit from expiring unused. Although realization is not assured, management believes it is more likely than not that the deferred tax assets, net of valuation allowances, will be realized. The company had no valuation
allowance as of December 31, 2010, and 2009.
Management believes that based on its historical pattern of taxable income,
the Company will produce sufficient income in the future to realize its deferred tax assets. Adjustments to the valuation allowance will be made if there is a change in management’s assessment of the amount of deferred tax asset that is
realizable.
The Company had no unrecognized tax benefits as of December 31, 2010 and 2009.
The Company classifies all interest and penalties related to tax uncertainties as income tax expense. In 2010 and 2009, the Company
recognized nothing in the statement of operations and recognized no liabilities in the statement of financial position for tax-related interest and penalties.
The dividends received deduction (“DRD”) reduces the amount of dividend income subject to U.S. tax and is the primary component of the non-taxable investment income shown in the table above,
and, as such, is a significant component of the difference between the Company’s effective tax rate and the federal statutory tax rate of 35%. The DRD for the current period was estimated using information from 2009, current year results, and
was adjusted to take into account the current year’s equity market performance. The actual current year DRD can vary from the estimate based on factors such as, but not limited to, changes in the amount of dividends received that are eligible
for the DRD, changes in the amount of distributions received from mutual fund investments, changes in the account balances of variable life and annuity contracts, and the Company’s taxable income before the DRD.
F-36
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
8. INCOME TAXES
(
continued
)
In August 2007, the IRS released Revenue Ruling 2007-54, which included, among other
items, guidance on the methodology to be followed in calculating the DRD related to variable life insurance and annuity contracts. In September 2007, the IRS released Revenue Ruling 2007-61. Revenue Ruling 2007-61 suspended Revenue Ruling 2007-54
and informed taxpayers that the U.S. Treasury Department and the IRS intend to address through new regulations the issues considered in Revenue Ruling 2007-54, including the methodology to be followed in determining the DRD related to variable life
insurance and annuity contracts. On February 14, 2011, the Obama Administration released the “General Explanations of the Administration’s Revenue Proposals.” Although the Administration has not released proposed statutory
language, one proposal would change the method used to determine the amount of the DRD. A change in the DRD, including the possible retroactive or prospective elimination of this deduction through regulation or legislation, could increase actual tax
expense and reduce the Company’s net income. These activities had no impact on the Company’s 2008, 2009 or 2010 results.
The Company is not currently under audit by the IRS or any state or local jurisdiction for the years prior to 2009.
In 2009, the Company joined in filing the consolidated federal tax return with its parent, Prudential Financial. For tax years 2009 through 2010, the Company is participating in the IRS’s Compliance
Assurance Program (“CAP”). Under CAP, the IRS assigns an examination team to review completed transactions contemporaneously during these tax years in order to reach agreement with the Company on how they should be reported in the tax
returns. If disagreements arise, accelerated resolutions programs are available to resolve the disagreements in a timely manner before the tax returns are filed. It is management’s expectation this program will shorten the time period between
the filing of the Company’s federal income tax returns and the IRS’s completion of its examination of the returns.
9. STATUTORY NET INCOME AND SURPLUS AND DIVIDEND RESTRICTIONS
The Company is required to prepare statutory financial statements in accordance with accounting practices prescribed or permitted by the
State of Connecticut Insurance Department. Prescribed statutory accounting practices include publications of the NAIC, as well as state laws, regulations and general administrative rules. Statutory accounting practices primarily differ from U.S.
GAAP by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions and valuing investments, deferred taxes, and certain assets on a different basis.
Statutory net income (loss) of the Company amounted to $348.4 million, $266.6 million, and $(322.6) million, for the years ended
December 31, 2010, 2009, and 2008, respectively. Statutory surplus of the Company amounted to $936.0 million and $881.0 million at December 31, 2010 and 2009, respectively.
Without prior approval of its domiciliary commissioner, dividends to shareholders are limited by the laws of the Company’s state of
incorporation, Connecticut. The State of Connecticut restricts dividend payments to the greater of 10% of the prior year’s surplus or net gain from operations from the prior year. Net gain from operations is defined as income after taxes but
prior to realized capital gains, as reported on the Summary of Operations. Based on 2010 results, there is the potential capacity to pay a dividend of $365.6 million without additional approval.
F-37
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
10. FAIR VALUE OF ASSETS AND LIABILITIES
Fair Value Measurement
– Fair value is defined as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date. The authoritative guidance around fair value established a framework for measuring fair value that includes a hierarchy used to classify the inputs used in
measuring fair value. The hierarchy prioritizes the inputs to valuation techniques into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is
significant to the fair value measurement. The levels of the fair value hierarchy are as follows:
Level 1 – Fair value
is based on unadjusted quoted prices in active markets that are accessible to the Company for identical assets or liabilities. These generally provide the most reliable evidence and are used to measure fair value whenever available. Active markets
are defined as having the following characteristics for the measured asset/liability: (i) many transactions, (ii) current prices, (iii) price quotes not varying substantially among market makers, (iv) narrow bid/ask spreads and
(v) most information publicly available. The Company’s Level 1 assets and liabilities primarily include certain cash equivalents and short term investments, equity securities and derivative contracts that are traded in an active exchange
market. Prices are obtained from readily available sources for market transactions involving identical assets or liabilities.
Level 2 – Fair value is based on significant inputs, other than Level 1 inputs, that are observable for the asset or liability,
either directly or indirectly, for substantially the full term of the asset or liability through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets and liabilities, quoted
market prices in markets that are not active for identical or similar assets or liabilities and other market observable inputs. The Company’s Level 2 assets and liabilities include: fixed maturities (corporate public and private bonds, most
government securities, certain asset-backed and mortgage-backed securities, etc.), certain equity securities (mutual funds, which do not actively trade and are priced based on a net asset value), short-term investments and certain cash equivalents
(primarily commercial paper), and certain over-the-counter derivatives. Valuations are generally obtained from third party pricing services for identical or comparable assets or liabilities or through the use of valuation methodologies using
observable market inputs. Prices from services are validated through comparison to trade data and internal estimates of current fair value, generally developed using market observable inputs and economic indicators.
Level 3 – Fair value is based on at least one or more significant unobservable inputs for the asset or liability. These inputs
reflect the Company’s assumptions about the inputs market participants would use in pricing the asset or liability. The Company’s Level 3 assets and liabilities primarily include: certain private fixed maturities and equity securities,
certain manually priced public equity securities and fixed maturities, certain highly structured over-the-counter derivative contracts, and embedded derivatives resulting from certain products with guaranteed benefits. Prices are determined using
valuation methodologies such as option pricing models, discounted cash flow models and other similar techniques. Non-binding broker quotes, which are utilized when pricing service information is not available, are reviewed for reasonableness based
on the Company’s understanding of the market, and are generally considered Level 3. Under certain conditions, based on its observations of transactions in active markets, the Company may conclude the prices received from independent third party
pricing services or brokers are not reasonable or reflective of market activity. In those instances, the Company may choose to over-ride the third-party pricing information or quotes received and apply internally developed values to the related
assets or liabilities. To the extent the internally developed valuations use significant unobservable inputs, they are classified as Level 3. As of December 31, 2010 and 2009 these over-rides on a net basis were not material.
Inactive Markets
- During 2009 and continuing through the first quarter of 2010, the Company observed that the volume and level of
activity in the market for asset-backed securities collateralized by sub-prime mortgages remained at historically low levels. This stood in particular contrast to the markets for other structured products with similar cash flow and credit profiles.
The Company also observed significant implied relative liquidity risk premiums, yields, and weighting of “worst case” cash flows for asset-backed securities collateralized by sub-prime mortgages in comparison with its own estimates for
such securities. In contrast, the liquidity of other spread-based asset classes, such as corporate bonds, high yield and consumer asset-backed securities, such as those collateralized by credit cards or autos, which were previously more correlated
with sub-prime securities, improved beginning in the second quarter of 2009. Based on this information, the Company concluded as of June 30, 2009 and continuing through March 31, 2010 that the market for asset-backed securities
collateralized by sub-prime mortgages was inactive and also determined the pricing quotes it received were based on limited market transactions, calling into question their representation of observable fair value. As a result, the Company considered
both third-party pricing information and an internally developed price based on a discounted cash flow model in determining the fair value of certain of these securities as of June 30, 2009 through March 31, 2010. Based on the unobservable
inputs used in the discounted cash flow model and the limited observable market activity, the Company classified these securities within Level 3 as of June 30, 2009 through March 31, 2010.
Beginning in the second quarter of 2010, the Company observed an increasingly active market, as evidence of orderly transactions in
asset-backed securities collateralized by sub-prime mortgages became more apparent. Additionally, the valuation
F-38
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
10. FAIR VALUE OF ASSETS AND LIABILITIES
(
continued
)
based on the pricing the Company received from independent pricing services was not
materially different from its internal estimates of current market value for these securities. As a result, where third party pricing information based on observable inputs was used to fair value the security, and based on the assessment that the
market has been becoming increasingly active, the Company reported fair values for these asset-backed securities collateralized by sub-prime mortgages in Level 2 since June 30, 2010. As of December 31, 2010, the fair value of these
securities included in Level 2 was $18.3 million included in Fixed Maturities Available for Sale – Asset-Backed Securities.
Asset and Liabilities by Hierarchy Level
-The tables below present the balances of assets and liabilities measured at fair value on a recurring basis, as of the dates indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2010
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
Fixed maturities, available for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government securities
|
|
$
|
-
|
|
|
$
|
193,305
|
|
|
$
|
-
|
|
|
$
|
193,305
|
|
|
State and municipal securities
|
|
|
-
|
|
|
|
77,516
|
|
|
|
-
|
|
|
|
77,516
|
|
|
Foreign government securities
|
|
|
-
|
|
|
|
136,513
|
|
|
|
-
|
|
|
|
136,513
|
|
|
Corporate Securities
|
|
|
-
|
|
|
|
3,876,695
|
|
|
|
74,255
|
|
|
|
3,950,950
|
|
|
Asset-backed securities
|
|
|
-
|
|
|
|
160,113
|
|
|
|
53,857
|
|
|
|
213,970
|
|
|
Commercial mortgage-backed securities
|
|
|
-
|
|
|
|
490,569
|
|
|
|
-
|
|
|
|
490,569
|
|
|
Residential mortgage-backed securities
|
|
|
-
|
|
|
|
393,398
|
|
|
|
-
|
|
|
|
393,398
|
|
|
|
|
|
|
|
|
Sub-total
|
|
$
|
-
|
|
|
$
|
5,328,109
|
|
|
$
|
128,112
|
|
|
$
|
5,456,221
|
|
|
|
|
|
|
|
|
Trading account assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset backed securities
|
|
|
-
|
|
|
|
70,831
|
|
|
|
-
|
|
|
|
70,831
|
|
|
Equity Securities
|
|
|
8,774
|
|
|
|
-
|
|
|
|
-
|
|
|
|
8,774
|
|
|
|
|
|
|
|
|
Sub-total
|
|
$
|
8,774
|
|
|
$
|
70,831
|
|
|
$
|
-
|
|
|
$
|
79,605
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities, available for sale
|
|
|
16,611
|
|
|
|
976
|
|
|
|
-
|
|
|
|
17,587
|
|
|
Short term investments
|
|
|
228,383
|
|
|
|
-
|
|
|
|
-
|
|
|
|
228,383
|
|
|
Cash equivalents
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Other long-term investments
|
|
|
-
|
|
|
|
51,000
|
|
|
|
-
|
|
|
|
51,000
|
|
|
Reinsurance Recoverable
|
|
|
-
|
|
|
|
-
|
|
|
|
186,735
|
|
|
|
186,735
|
|
|
Other Assets
|
|
|
-
|
|
|
|
29,201
|
|
|
|
-
|
|
|
|
29,201
|
|
|
|
|
|
|
|
|
Sub-total excluding separate account assets
|
|
$
|
253,768
|
|
|
$
|
5,480,117
|
|
|
$
|
314,847
|
|
|
$
|
6,048,732
|
|
|
|
|
|
|
|
|
Separate account assets (1)
|
|
|
1,488,369
|
|
|
|
46,786,974
|
|
|
|
-
|
|
|
|
48,275,343
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,742,137
|
|
|
$
|
52,267,091
|
|
|
$
|
314,847
|
|
|
$
|
54,324,075
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Future policy benefits
|
|
|
-
|
|
|
|
-
|
|
|
|
164,283
|
|
|
|
164,283
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
164,283
|
|
|
$
|
164,283
|
|
|
|
|
|
|
|
F-39
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
10. FAIR VALUE OF ASSETS AND LIABILITIES
(
continued
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2009(2)
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
(in thousands)
|
|
|
Fixed maturities, available for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government securities
|
|
$
|
-
|
|
|
$
|
262,479
|
|
|
$
|
-
|
|
|
$
|
262,479
|
|
|
State and municipal securities
|
|
|
-
|
|
|
|
74,116
|
|
|
|
-
|
|
|
|
74,116
|
|
|
Foreign government securities
|
|
|
-
|
|
|
|
133,781
|
|
|
|
1,219
|
|
|
|
135,000
|
|
|
Corporate Securities
|
|
|
-
|
|
|
|
4,791,668
|
|
|
|
63,634
|
|
|
|
4,855,302
|
|
|
Asset-backed securities
|
|
|
-
|
|
|
|
170,045
|
|
|
|
43,794
|
|
|
|
213,839
|
|
|
|
|
|
|
|
|
Commercial mortgage-backed securities
|
|
|
-
|
|
|
|
548,582
|
|
|
|
-
|
|
|
|
548,582
|
|
|
Residential mortgage-backed securities
|
|
|
-
|
|
|
|
404,569
|
|
|
|
-
|
|
|
|
404,569
|
|
|
|
|
|
|
|
|
Sub-total
|
|
$
|
-
|
|
|
$
|
6,385,240
|
|
|
$
|
108,647
|
|
|
$
|
6,493,887
|
|
|
Trading account assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset backed securities
|
|
|
-
|
|
|
|
70,198
|
|
|
|
-
|
|
|
|
70,199
|
|
|
Equity Securities
|
|
|
9,694
|
|
|
|
-
|
|
|
|
-
|
|
|
|
9,693
|
|
|
|
|
|
|
|
|
Sub-total
|
|
$
|
9,694
|
|
|
$
|
70,198
|
|
|
$
|
-
|
|
|
$
|
79,892
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities, available for sale
|
|
|
17,230
|
|
|
|
1,382
|
|
|
|
-
|
|
|
|
18,612
|
|
|
Short term investments
|
|
|
393,163
|
|
|
|
312,683
|
|
|
|
-
|
|
|
|
705,846
|
|
|
Cash equivalents
|
|
|
17
|
|
|
|
68,581
|
|
|
|
-
|
|
|
|
68,598
|
|
|
Reinsurance recoverable
|
|
|
-
|
|
|
|
-
|
|
|
|
40,351
|
|
|
|
40,351
|
|
|
Other Assets
|
|
|
-
|
|
|
|
33,133
|
|
|
|
-
|
|
|
|
33,133
|
|
|
|
|
|
|
|
|
Sub-total excluding separate account assets
|
|
$
|
420,104
|
|
|
$
|
6,871,217
|
|
|
$
|
148,998
|
|
|
$
|
7,440,319
|
|
|
|
|
|
|
|
|
Separate account assets (1)
|
|
|
1,008,077
|
|
|
|
40,440,635
|
|
|
|
-
|
|
|
|
41,448,712
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,428,181
|
|
|
$
|
47,311,852
|
|
|
$
|
148,998
|
|
|
$
|
48,889,031
|
|
|
|
|
|
|
|
|
Future policy benefits
|
|
|
-
|
|
|
|
-
|
|
|
|
10,874
|
|
|
|
10,874
|
|
|
Other liabilities
|
|
|
-
|
|
|
|
8,384
|
|
|
|
53
|
|
|
|
8,437
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
$
|
-
|
|
|
$
|
8,384
|
|
|
$
|
10,927
|
|
|
$
|
19,311
|
|
|
|
|
|
|
|
|
|
(1)
|
Separate account assets represent segregated funds that are invested for certain customers. Investment risks associated with market value changes
are borne by the customers, except to the extent of minimum guarantees made by the Company with respect to certain accounts.
|
|
|
(2)
|
Includes reclassifications to conform to current period presentation.
|
The methods and assumptions the Company uses to estimate fair value of assets and liabilities measured at fair value on a recurring basis
are summarized below. Information regarding Separate Account Assets is excluded as the risk of assets for these categories is primarily borne by our customers and policyholders.
Fixed Maturity Securities
- The fair values of the Company’s public fixed maturity securities are generally based on prices
obtained from independent pricing services. Prices from pricing services are sourced from multiple vendors, and a vendor hierarchy is maintained by asset type based on historical pricing experience and vendor expertise. The Company generally
receives prices from multiple pricing services for each security, but ultimately uses the price from the pricing service highest in the vendor hierarchy based on the respective asset type. To validate reasonability, prices are reviewed by internal
asset managers through comparison with directly observed recent market trades and internal estimates of current fair value, developed using market observable inputs and economic indicators. Consistent with the fair value hierarchy described above,
securities with validated quotes from pricing services are generally reflected within Level 2, as they are primarily based on observable pricing for similar assets and/or other market observable inputs. If the pricing information received from third
party pricing services is not reflective of market activity or other inputs observable in the market, the Company may challenge the price through a formal process with the pricing service. If the pricing service updates the price to be more
consistent in comparison to the presented market observations, the security remains within Level 2.
If the Company ultimately
concludes that pricing information received from the independent pricing service is not reflective of market activity, non-binding broker quotes are used, if available. If the Company concludes the values from both pricing services and brokers are
not reflective of market activity, it may over-ride the information from the pricing service or broker with an internally developed valuation. As of December 31, 2010 and 2009 over-rides on a net basis were not material. Internally developed
valuations or non-binding broker quotes are also used to determine fair value in circumstances where vendor pricing is not available. These estimates may use significant unobservable inputs, which reflect our own assumptions about the inputs market
participants would use in pricing the asset. Circumstances where observable market data are not available may include events such as market illiquidity and credit events related to the security. Pricing service
F-40
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
10. FAIR VALUE OF ASSETS AND LIABILITIES
(
continued
)
over-rides, internally developed valuations and non-binding broker quotes are generally
included in Level 3 in our fair value hierarchy.
The fair value of private fixed maturities, which are primarily comprised of
investments in private placement securities, originated by internal private asset managers, are primarily determined using a discounted cash flow model. In certain cases these models primarily use observable inputs with a discount rate based upon
the average of spread surveys collected from private market intermediaries who are active in both primary and secondary transactions, taking into account, among other factors, the credit quality and industry sector of the issuer and the reduced
liquidity associated with private placements. Generally, these securities have been reflected within Level 2. For certain private fixed maturities, the discounted cash flow model may also incorporate significant unobservable inputs, which reflect
the Company’s own assumptions about the inputs market participants would use in pricing the asset. To the extent management determines that such unobservable inputs are not significant to the price of a security, a Level 2 classification is
made. Otherwise, a Level 3 classification is used.
Private fixed maturities also include debt investments in funds that, in
addition to a stated coupon, pay a return based upon the results of the underlying portfolios. The fair values of these securities are determined by reference to the funds’ net asset value (NAV). Since the NAV at which the funds trade can be
observed by redemption and subscription transactions between third parties, the fair values of these investments have been reflected within Level 2 in the fair value hierarchy.
Trading Account Assets
- Trading account assets consist primarily of asset-backed and equity securities whose fair values are
determined consistent with similar instruments described under “Fixed Maturity Securities” and under “Equity Securities.”
Equity Securities
- Equity Securities consist principally of investments in common and preferred stock of publicly traded companies. The fair values of most publicly traded equity securities are
based on quoted market prices in active markets for identical assets and are classified within Level 1 in the fair value hierarchy. The fair values of preferred equity securities are based on prices obtained from independent pricing services and, in
order to validate reasonability, are compared with directly observed recent market trades. Accordingly, these securities are generally classified within Level 2 in the fair value hierarchy.
Derivative Instruments
- Derivatives are recorded at fair value either as assets, within “Other long-term investments,”
or as liabilities, within “Other liabilities,” except for embedded derivatives which are recorded with the associated host contract. The fair values of derivative contracts are determined based on quoted prices in active exchanges or
through the use of valuation models. The fair values of derivative contracts can be affected by changes in interest rates, foreign exchange rates, credit spreads, market volatility, expected returns, non-performance risk and liquidity as well as
other factors. Liquidity valuation adjustments are made to reflect the cost of exiting significant risk positions, and consider the bid-ask, spread, maturity, complexity, and other specific attributes of the underlying derivative position. Fair
values can also be affected by changes in estimates and assumptions including those related to counterparty behavior used in valuation models.
The majority of the Company’s derivative positions are traded in the over the counter (OTC) derivative market and are classified within Level 2 in the fair value hierarchy. OTC derivatives classified
within Level 2 are valued using models generally accepted in the financial services industry that use actively quoted or observable market input values from external market data providers, third-party pricing vendors and/or recent trading activity.
The fair values of most OTC derivatives, including interest rate and cross currency swaps and single name credit default swaps are determined using discounted cash flow models. These models’ key assumptions include the contractual terms of the
respective contract, along with significant observable inputs, including interest rates, currency rates, credit spreads, equity prices, index dividend yields non-performance risk and volatility, and are classified as Level 2.
To reflect the market’s perception of its own and the counterparty’s non-performance risk, the Company incorporates an
additional spread over London Interbank Offered Rate (“LIBOR”) into the discount rate used in determining the fair value of OTC derivative assets and liabilities which are uncollateralized. Most OTC derivative contract inputs have bid and
ask prices that are actively quoted or can be readily obtained from external market data providers. The Company’s policy is to use mid-market pricing in determining its best estimate of fair value and classify these derivative contracts as
Level 2.
Derivatives classified as Level 3 include first-to-default credit basket swaps and other structured products. These
derivatives are valued based upon models with some significant unobservable market inputs or inputs from less actively traded markets. The fair values of first-to-default credit basket swaps are derived from relevant observable inputs such as:
individual credit default spreads, interest rates, recovery rates and unobservable model-specific input values such as correlation between different credits within the same basket. Other structured options and derivatives are valued using simulation
models such as the Monte Carlo technique. Level 3 methodologies are validated through periodic comparison of the Company’s fair values to broker-dealer values. As of
F-41
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
10. FAIR VALUE OF ASSETS AND LIABILITIES
(
continued
)
December 31, 2010, all derivatives were classified within Level 2. See Note 11 for
more details on the fair value of derivative instruments by primary underlying.
Cash Equivalents and Short-Term
Investments
- Cash equivalents and short-term investments include money market instruments, commercial paper and other highly liquid debt instruments. Money market instruments are generally valued using unadjusted quoted prices in active markets
that are accessible for identical assets and are primarily classified as Level 1. The remaining instruments in the Cash Equivalents and Short-term Investments category are typically not traded in active markets; however, their fair values are based
on market observable inputs and, accordingly, these investments have been classified within Level 2 in the fair value hierarchy.
Other Assets
- Other assets carried at fair value include affiliated bonds within our legal entity whose fair value are determined consistent with similar securities described above under
“Fixed Maturity Securities” managed by affiliated asset managers.
Reinsurance Recoverables
- Reinsurance
recoverables carried at fair value include the reinsurance of our living benefit guarantees on certain of our variable annuities. These guarantees are considered embedded derivatives and are described below in “Future Policy Benefits”. The
reinsurance agreements covering these guarantees are derivatives with fair value determined in the same manner as the embedded derivative guarantee.
Future Policy Benefits
-
Future policy benefits includes embedded derivatives related to guarantees on variable annuity contracts, including GMAB, GMWB and GMIWB. The fair values of the
GMAB, GMWB and GMIWB liabilities are calculated as the present value of future expected benefit payments to customers less the present value of assessed rider fees attributable to the embedded derivative feature. This methodology could result in
either a liability or contra-liability balance, given change capital market conditions and various policyholder behavior assumptions. Since there is no observable active market for the transfer of these obligations, the valuations are calculated
using internally developed models with option pricing techniques. The models are based on a risk neutral valuation framework and incorporate premiums for risks inherent in valuation techniques, inputs, and the general uncertainty around the timing
and amount of future cash flows. The determination of these risk premiums requires the use of management judgment.
The
Company is also required to incorporate the market perceived risk of its own non-performance in the valuation of the embedded derivatives associated with the optional living benefit features. Since insurance liabilities are senior to debt, the
Company believes that reflecting the financial strength ratings of the Company in the valuation of the liability appropriately takes into consideration the Company’s own risk of non-performance. To reflect the market’s perception of its
non-performance risk, the Company incorporates an additional spread over LIBOR into the discount rate used in the valuations of the embedded derivatives associated with its optional living benefit features. The additional spread over LIBOR is
determined taking into consideration publicly available information relating to the financial strength of the Company, as indicated by the credit spreads associated with funding agreements issued by an affiliated company. The Company adjusts these
credit spreads to remove any liquidity risk premium. The additional spread over LIBOR incorporated into the discount rate as of December 31, 2010 generally ranged from 50 to 150 basis points for the portion of the interest rate curve most
relevant to these liabilities. This additional spread is applied at an individual contract level and only to those embedded derivatives in a liability position and not to those in a contra-liability position.
Other significant inputs to the valuation models for the embedded derivatives associated with the optional living benefit features of the
Company’s variable annuity products include capital market assumptions, such as interest rate and implied volatility assumptions, as well as various policyholder behavior assumptions that are actuarially determined, including lapse rates,
benefit utilization rates, mortality rates and withdrawal rates. These assumptions are reviewed at least annually, and updated based upon historical experience and give consideration to any observable market data, including market transactions such
as acquisitions and reinsurance transactions. Since many of the assumptions utilized in the valuation of the embedded derivatives associated with the Company’s optional living benefit features are unobservable and are considered to be
significant inputs to the liability valuation, the liability included in future policy benefits has been reflected within Level 3 in the fair value hierarchy.
Transfers between Levels 1 and 2
-
During the year ended December 31, 2010, there were no material transfers between Level 1 and Level 2.
F-42
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
10. FAIR VALUE OF ASSETS AND LIABILITIES
(
continued
)
Changes in Level 3 assets and liabilities
- The following tables provide a
summary of the changes in fair value of Level 3 assets and liabilities for the twelve months ended December 31, 2010, as well as the portion of gains or losses included in income for the twelve months ended December 31, 2010 attributable
to unrealized gains or losses related to those assets and liabilities still held at December 31, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2010
|
|
|
|
|
Fixed
Maturities,
Available For
Sale –
Corporate
Securities
|
|
|
Fixed
Maturities,
Available
For Sale
–
Foreign
Government
Bonds
|
|
|
Fixed
Maturities,
Available For
Sale
–
Asset-Backed
Securities
|
|
|
Reinsurance
Recoverable
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
Fair value, beginning of period
|
|
$
|
63,634
|
|
|
$
|
1,219
|
|
|
$
|
43,794
|
|
|
$
|
40,351
|
|
|
Total gains or (losses) (realized/unrealized):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in earnings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net
|
|
|
1,083
|
|
|
|
-
|
|
|
|
(1,247)
|
|
|
|
(43,339)
|
|
|
Included in other comprehensive income (loss)
|
|
|
3,072
|
|
|
|
(12)
|
|
|
|
(963)
|
|
|
|
-
|
|
|
Net investment income
|
|
|
4,195
|
|
|
|
(1)
|
|
|
|
17
|
|
|
|
-
|
|
|
Purchases, sales, issuances, and settlements
|
|
|
(10,830)
|
|
|
|
-
|
|
|
|
29,676
|
|
|
|
189,723
|
|
|
Transfers into Level 3 (1)
|
|
|
13,101
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Transfers out of Level 3 (1)
|
|
|
-
|
|
|
|
(1,206)
|
|
|
|
(17,420)
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value, end of period
|
|
$
|
74,255
|
|
|
$
|
-
|
|
|
$
|
53,857
|
|
|
$
|
186,735
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) for the period relating to those Level 3 assets that were still held by the Company at the end of the
period (2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in earnings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
(654)
|
|
|
$
|
(40,069)
|
|
|
Asset administration fees and other income
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
Included in other comprehensive income (loss)
|
|
$
|
3,773
|
|
|
$
|
(13)
|
|
|
$
|
(963)
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
December 31,
2010
|
|
|
|
|
Future
Policy
Benefits
|
|
|
Other
Liabilities
|
|
|
|
|
(in
thousands)
|
|
|
Fair value, beginning of period
|
|
$
|
(10,874)
|
|
|
$
|
(53)
|
|
|
Total gains or (losses) (realized/unrealized):
|
|
|
|
|
|
|
|
|
|
Included in earnings:
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net
|
|
|
45,258
|
|
|
|
53
|
|
|
Purchases, sales, issuances, and settlements
|
|
|
(198,667)
|
|
|
|
-
|
|
|
Transfers into Level 3 (1)
|
|
|
-
|
|
|
|
-
|
|
|
Transfers out of Level 3 (1)
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value, end of period
|
|
$
|
(164,283)
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) for the period relating to those Level 3 assets that were still held by the Company at the end of the
period (2):
|
|
|
|
|
|
|
|
|
|
Included in earnings:
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net
|
|
$
|
42,759
|
|
|
$
|
-
|
|
|
Interest credited to policyholders’ account balances
|
|
$
|
-
|
|
|
$
|
-
|
|
|
Included in other comprehensive income (loss)
|
|
$
|
-
|
|
|
$
|
-
|
|
(1)
Transfers into or out of Level 3 are generally reported as the value as of the beginning of the quarter in which the transfer occurs.
(2) Unrealized gains or losses related to assets still held at the end of the period do not include amortization or accretion of premiums and discounts.
(3) Derivative instruments classified as Other Long-term Investments at December 31, 2008 were reclassified Other
Liabilities at December 31, 2009 as they were in a net liability position.
F-43
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
10. FAIR VALUE OF ASSETS AND LIABILITIES
(
continued
)
Transfers
– Transfers out of Level 3 for Fixed Maturities Available for Sale
– Asset-Backed Securities includes $17.4 million for the year ended December 31, 2010 resulting from the Company’s conclusion that the market for asset-backed securities collateralized by sub-prime mortgages has been becoming
increasingly active, as evidenced by orderly transactions. The pricing received from independent pricing services could be validated by the Company, as discussed in detail above. Other transfers out of Level 3 were typically due to the use of
observable inputs in valuation methodologies as well as the utilization of pricing service information for certain assets that the Company was able to validate. Transfers into Level 3 were primarily the result of unobservable inputs utilized within
valuation methodologies and the use of broker quotes (that could not be validated) when previously, information from third party pricing services (that could be validated) was utilized.
The following table provides a summary of the changes in fair value of Level 3 assets and liabilities for the year ended
December 31, 2009, as well as the portion of gains or losses included in income for the year ended December 31, 2009 attributable to unrealized gains or losses related to those assets and liabilities still held at December 31, 2009.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
Maturities,
Available For
Sale
–
Foreign
Government
Bonds
|
|
|
Fixed
Maturities,
Available
For Sale –
Corporate
Securities
|
|
|
Fixed
Maturities,
Available
For Sale –
Asset-Backed
Securities
|
|
|
Reinsurance
Recoverable
|
|
|
Other
Liabilities (3)
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
Fair value, beginning of period
|
|
$
|
977
|
|
|
$
|
68,559
|
|
|
$
|
21,188
|
|
|
$
|
2,110,146
|
|
|
$
|
(1,496)
|
|
|
Total gains or (losses) (realized/unrealized):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in earnings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net
|
|
|
-
|
|
|
|
(449)
|
|
|
|
(5,173)
|
|
|
|
(2,162,496)
|
|
|
|
1,443
|
|
|
Included in other comprehensive income (loss)
|
|
|
243
|
|
|
|
(8,063)
|
|
|
|
17,767
|
|
|
|
-
|
|
|
|
-
|
|
|
Net investment income
|
|
|
(1)
|
|
|
|
3,637
|
|
|
|
156
|
|
|
|
-
|
|
|
|
-
|
|
|
Purchases, sales, issuances, and settlements
|
|
|
-
|
|
|
|
(963)
|
|
|
|
(1,411)
|
|
|
|
92,701
|
|
|
|
-
|
|
|
Transfers into (out of) Level 3 (1)
|
|
|
-
|
|
|
|
913
|
|
|
|
11,267
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value, end of period
|
|
$
|
1,219
|
|
|
$
|
63,634
|
|
|
$
|
43,794
|
|
|
$
|
40,351
|
|
|
$
|
(53)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) for the period relating to those Level 3 assets that were still held by the Company at the end of the
period (2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in earnings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net
|
|
$
|
-
|
|
|
$
|
(433)
|
|
|
$
|
(4,894)
|
|
|
$
|
(2,092,458)
|
|
|
$
|
1,444
|
|
|
Asset management fees and other income
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
Included in other comprehensive income (loss)
|
|
$
|
243
|
|
|
$
|
(8,025)
|
|
|
$
|
17,767
|
|
|
$
|
-
|
|
|
$
|
-
|
|
F-44
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
10. FAIR VALUE OF ASSETS AND LIABILITIES
(continued)
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2009
|
|
|
|
|
Future Policy
Benefits
|
|
|
|
|
(in
thousands)
|
|
|
Fair value, beginning of period
|
|
$
|
(2,111,241)
|
|
|
Total gains or (losses) (realized/unrealized):
|
|
|
|
|
|
Included in earnings:
|
|
|
|
|
|
Realized investment gains (losses), net
|
|
|
2,195,856
|
|
|
Interest Credited to Policyholder Account Balances (SA Only)
|
|
|
-
|
|
|
Purchases, sales, issuances, and settlements
|
|
|
(95,489)
|
|
|
Transfers into (out of) Level 3 (1)
|
|
|
-
|
|
|
|
|
|
|
|
|
Fair value, end of period
|
|
$
|
(10,874)
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) for the period relating to those Level 3 assets that were still held by the Company at the end of the
period (2):
|
|
|
|
|
|
Included in earnings:
|
|
|
|
|
|
Realized investment gains (losses), net
|
|
$
|
2,125,409
|
|
|
Interest credited to policyholder account
|
|
$
|
-
|
|
|
Included in other comprehensive income (loss)
|
|
$
|
-
|
|
(1)
Transfers into or out of level 3 are generally reported as the value as of the beginning of the quarter in which the transfer occurs.
(2) Unrealized gains or losses related to assets still held at the end of the period do not include amortization or accretion of premiums and discounts.
(3) Derivative instruments classified as Other Long-term Investments at December 31, 2008 were reclassified Other
Liabilities at December 31, 2009 as they were in a net liability position.
Transfers – Transfers into Level 3 for
Fixed Maturities Available for Sale - Asset-Backed include $14.4 million for the year ended December 31, 2009, resulting from the Company’s conclusion that the market for asset-backed securities collateralized by sub-prime mortgages was an
inactive market, as discussed in detail above. In addition to these sub-prime securities, transfers into Level 3 for Fixed Maturities Available for Sale – Corporate Securities and Asset-Backed Securities included transfers resulting from the
use of unobservable inputs within valuation methodologies and the use of broker quotes (that could not be validated) when previously, information from third party pricing services (that could be validated) or models with observable inputs were
utilized.
Transfers out of level 3 for Fixed Maturities Available for Sale – Asset-Backed Securities and –
Corporate Securities were primarily due to the use of observable inputs in valuation methodologies as well as the utilization of pricing service information for certain assets that the Company was able to validate.
Transfers out of level 3 for Separate Account Assets were primarily due to the reclassification of the underlying investment within the
mutual funds as these funds had less exposure to Level 3 securities since the funds switched to vendor prices.
The following
table provides a summary of the changes in fair value of Level 3 assets and liabilities for the year ending December 31, 2008, as well as the portion of gains or losses included in income for twelve months ended December 31, 2008
attributable to unrealized gains or losses related to those assets and liabilities still held at December 31, 2008.
F-45
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
10. FAIR VALUE OF ASSETS AND LIABILITIES
(continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2008
|
|
|
|
|
Fixed Maturities,
Available For Sale
|
|
|
Other Long-
term
Investments
|
|
|
Reinsurance
Recoverable
|
|
|
Future Policy
Benefits
|
|
|
|
|
(in thousands)
|
|
|
Fair value, beginning of period
|
|
$
|
9,502
|
|
|
$
|
(56)
|
|
|
$
|
103,909
|
|
|
$
|
(103,909)
|
|
|
Total gains or (losses) (realized/unrealized):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in earnings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net
|
|
|
414
|
|
|
|
(1,440)
|
|
|
|
1,949,030
|
|
|
|
(1,950,125)
|
|
|
Asset administration fees and other income
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Included in other comprehensive income (loss)
|
|
|
243
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Net investment income
|
|
|
250
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Purchases, sales, issuances, and settlements
|
|
|
96,995
|
|
|
|
-
|
|
|
|
57,207
|
|
|
|
(57,207)
|
|
|
Foreign currency translation
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Transfers into (out of) level 3 (1)
|
|
|
(16,680)
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
Fair value, end of period
|
|
$
|
90,724
|
|
|
$
|
(1,496)
|
|
|
$
|
2,110,146
|
|
|
$
|
(2,111,241)
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) relating to those level 3 assets that were still held by the Company at the end of the period
(2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in earnings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net
|
|
$
|
-
|
|
|
$
|
(1,439)
|
|
|
$
|
1,956,405
|
|
|
$
|
(1,957,501)
|
|
|
Asset administration fees and other income
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
Interest credited to policyholder account
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
Included in other comprehensive income (loss)
|
|
$
|
240
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
(1) Transfers into or
out of level 3 are generally reported as the value as of the beginning of the quarter in which the transfer occurs.
(2)
Unrealized gains or losses related to assets still held at the end of the period do not include amortization or accretion of premiums and discounts.
Transfers –
Net transfers out of Level 3 for Fixed Maturities Available for Sale totaled $16.7 million during the year ended December 31, 2008. Transfers out of Level 3 for these
investments was primarily the result of the use of observable inputs in valuation methodologies as well as the utilization of pricing service information for certain assets that the Company was able to validate.
Fair Value of Financial Instruments
–The Company is required to disclose the fair value of certain financial instruments
including those that are not carried at fair value. For the following financial instruments the carrying amount equals or approximates fair value: fixed maturities classified as available for sale, trading account assets, equity securities,
short-term investments, cash and cash equivalents, separate account assets and long-term and short-term borrowing.
The
following table discloses the Company’s financial instruments where the carrying amounts and fair values may differ:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2010
|
|
|
December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
Carrying value
|
|
|
Fair value
|
|
|
Carrying value
|
|
|
Fair value
|
|
|
|
|
(in thousands)
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Mortgage and other Loans
|
|
$
|
431,432
|
|
|
$
|
465,099
|
|
|
$
|
373,080
|
|
|
$
|
381,557
|
|
|
Policy loans
|
|
$
|
13,905
|
|
|
$
|
18,374
|
|
|
$
|
13,067
|
|
|
$
|
14,796
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment Contracts - Policyholders’ Account Balances
|
|
$
|
58,549
|
|
|
$
|
58,679
|
|
|
$
|
53,599
|
|
|
$
|
52,960
|
|
The fair values
presented above for those financial instruments where the carrying amounts and fair values may differ have been determined by using available market information and by applying market valuation methodologies, as described in more detail below.
Commercial mortgage and other loans
The fair value of commercial mortgage and other loans is primarily based upon the present value of the expected future cash flows discounted at the appropriate U.S. Treasury rate adjusted for the current
market spread for similar quality loans.
F-46
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
10. FAIR VALUE OF ASSETS AND LIABILITIES
(continued)
Policy Loans
The fair value of U.S. insurance policy loans is calculated using a discounted cash flow model based upon current U.S. Treasury rates and historical loan repayment patterns.
Investment Contracts – Policyholders’ Account Balances
Only the portion of policyholders’ account balances related to products that are investment contracts (those without significant mortality or morbidity risk) are reflected in the table above. For
payout annuities and other similar contracts without life contingencies, fair values are derived using discounted projected cash flows based on interest rates that are representative of the Company’s financial strength ratings, and hence
reflects the Company’s own non-performance risk.
11. DERIVATIVE INSTRUMENTS
Types of Derivative Instruments and Derivative Strategies
Interest rate swaps are used by the Company to manage interest rate exposures arising from mismatches between assets and liabilities (including duration mismatches) and to hedge against changes in the
value of assets it anticipates acquiring and other anticipated transactions and commitments. Swaps may be attributed to specific assets or liabilities or may be used on a portfolio basis. Under interest rate swaps, the Company agrees with other
parties to exchange, at specified intervals, the difference between fixed-rate and floating rate interest amounts calculated by reference to an agreed upon notional principal amount. Generally, no cash is exchanged at the outset of the contract and
no principal payments are made by either party. These transactions are entered into pursuant to a master agreement that provides for a single net payment to be made by one counterparty at each due date.
Exchange-traded futures are used by the Company to reduce risks from changes in interest rates, to alter mismatches between the duration
of assets in a portfolio and the duration of liabilities supported by those assets, and to hedge against changes in the value of securities it owns or anticipates acquiring or selling. In exchange-traded futures transactions, the Company agrees to
purchase or sell a specified number of contracts, the values of which are determined by the values of underlying referenced investments, and to post variation margin on a daily basis in an amount equal to the difference in the daily market values of
those contracts. The Company enters into exchange-traded futures and options with regulated futures commission merchants who are members of a trading exchange.
Equity index options are contracts which will settle in cash based on differentials in the underlying indices at the time of exercise and the strike price. The Company uses combinations of purchases and
sales of equity index options to hedge the effects of adverse changes in equity indices within a predetermined range. These hedges do not qualify for hedge accounting.
Currency swaps are used by the Company to reduce risks from changes in currency exchange rates with respect to investments denominated in foreign currencies that the Company either holds or intends to
acquire or sell. Under currency swaps, the Company agrees with other parties to exchange, at specified intervals, the difference between one currency and another at an exchange rate and calculated by reference to an agreed principal amount.
Generally, the principal amount of each currency is exchanged at the beginning and termination of the currency swap by each party. These transactions are entered into pursuant to a master agreement that provides for a single net payment to be made
by one counterparty for payments made in the same currency at each due date.
Credit derivatives are used by the Company to
enhance the return on the Company’s investment portfolio by creating credit exposure similar to an investment in public fixed maturity cash instruments. With credit derivatives the Company sells credit protection on an identified name, or a
basket of names in a first to default structure, and in return receives a quarterly premium. With single name credit default derivatives, this premium or credit spread generally corresponds to the difference between the yield on the referenced
name’s public fixed maturity cash instruments and swap rates, at the time the agreement is executed. With first to default baskets, the premium generally corresponds to a high proportion of the sum of the credit spreads of the names in the
basket. If there is an event of default by the referenced name or one of the referenced names in a basket, as defined by the agreement, then the Company is obligated to pay the counterparty the referenced amount of the contract and receive in return
the referenced defaulted security or similar security.
F-47
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
11. DERIVATIVE INSTRUMENTS
(continued)
The Company has sold variable annuity products, which may include guaranteed benefit
features that are accounted for as embedded derivatives. The Company has entered into reinsurance agreements to transfer the risk related to the embedded derivatives to affiliates. These embedded derivatives are marked to market through
“Realized investment gains (losses), net” based on the change in value of the underlying contractual guarantees, which are determined using valuation models. The affiliates maintain a portfolio of derivative instruments that is intended to
hedge many of the risks related to the above products’ features. The derivatives may include, but are not limited to equity options, total return swaps, interest rate swap options, caps, floors, and other instruments. Also, some variable
annuity products’ optional living benefits feature an asset transfer feature to minimize risks inherent in the Company’s guarantees which reduces the need for hedges.
As mentioned above, in addition to our asset transfer feature, we also manage certain risks associated with our variable annuity products
through hedging programs and affiliated reinsurance arrangements. Primarily in the reinsurance affiliate, we purchase equity options and futures as well as interest rate derivatives are purchased to hedge certain optional living benefit features
accounted for as embedded derivatives against changes in equity markets, interest rates, and market volatility. Historically, the hedging strategy sought to generally match the sensitivities of the embedded derivative liability as defined by GAAP,
excluding the impact of the market-perceived risk of non-performance, with capital market derivatives and options. In the third quarter of 2010, the hedging strategy was revised as, in the current low interest rate environment, management of the
company and reinsurance affiliates does not believe the GAAP value of the embedded derivative liability to be an appropriate measure for determining the hedge target. The new hedge target continues to be grounded in a GAAP/capital markets valuation
framework but incorporates modifications to the risk-free return assumption to account for the fact that the underlying customer separate account funds which support these living benefits are invested in assets that contain risk. Consistent with
sound risk management practices, management of the company and reinsurance affiliates evaluates hedge levels versus the target given the overall capital considerations of our ultimate parent Company, Prudential Financial Inc., and prevailing capital
market conditions and may decide to temporarily hedge to an amount that differs from the hedge target definition. This new strategy will result in differences each period between the change in the value of the embedded derivative liability as
defined by GAAP and the change in the value of the hedge positions, potentially increasing volatility in GAAP earnings in the reinsurance affiliate, and increasing volatility in the amortization of deferred acquisition and other costs of the
Company.
In the second quarter of 2009, the Company began the expansion of our hedging program to include a portion of the
market exposure related to our overall capital position including the impact of certain statutory reserve exposures. These capital hedges primarily consisted of equity-based total return swaps that were designed to partially offset changes in our
capital position resulting from market driven changes in certain living and death benefit features of our variable annuity products. During the second quarter of 2010, we terminated the capital hedge program in lieu of a new program managed at the
Prudential Financial level that more broadly addresses equity market exposure of the overall statutory capital of Prudential Financial and its subsidiaries, as a whole. A portion of the derivatives related to the new program were purchased by the
Company.
The Company invests in fixed maturities that, in addition to a stated coupon, provide a return based upon the
results of an underlying portfolio of fixed income investments and related investment activity. The Company accounts for these investments as available for sale fixed maturities containing embedded derivatives. Such embedded derivatives are marked
to market through “Realized investment gains (losses), net,” based upon the change in value of the underlying portfolio.
The table below provides a summary of the gross notional amount and fair value of derivatives contracts, excluding embedded derivatives which are recorded with the associated host, by the primary
underlying. Many derivative instruments contain multiple underlyings.
F-48
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
11. DERIVATIVE INSTRUMENTS
(continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2010
|
|
|
December 31, 2009
|
|
|
|
|
Notional
Amount
|
|
|
Fair Value
|
|
|
Notional
Amount
|
|
|
Fair Value
|
|
|
|
|
Assets
|
|
|
Liabilities
|
|
|
|
Assets
|
|
|
Liabilities
|
|
|
Qualifying Hedge Relationships
|
|
|
(in thousands)
|
|
|
Currency/Interest Rate
|
|
$
|
36,072
|
|
|
$
|
152
|
|
|
$
|
(2,606)
|
|
|
$
|
5,058
|
|
|
$
|
-
|
|
|
$
|
(642)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Qualifying Hedge Relationships
.
|
|
$
|
36,072
|
|
|
$
|
152
|
|
|
$
|
(2,606)
|
|
|
$
|
5,058
|
|
|
$
|
-
|
|
|
$
|
(642)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-qualifying Hedge Relationships
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Rate
|
|
$
|
913,700
|
|
|
$
|
56,896
|
|
|
$
|
(6,727)
|
|
|
$
|
978,700
|
|
|
$
|
28,741
|
|
|
$
|
(18,083)
|
|
|
Credit
|
|
|
350,050
|
|
|
|
2,810
|
|
|
|
(3,104)
|
|
|
|
358,350
|
|
|
|
3,428
|
|
|
|
(3,995)
|
|
|
Currency/Interest Rate
|
|
|
60,439
|
|
|
|
1,622
|
|
|
|
(6,829)
|
|
|
|
78,553
|
|
|
|
426
|
|
|
|
(7,784)
|
|
|
Equity
|
|
|
10,374,514
|
|
|
|
30,278
|
|
|
|
(21,492)
|
|
|
|
335,411
|
|
|
|
4,273
|
|
|
|
(14,802)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Non-qualifying Hedge Relationships
|
|
$
|
11,698,703
|
|
|
$
|
91,606
|
|
|
$
|
(38,152)
|
|
|
$
|
1,751,014
|
|
|
$
|
36,868
|
|
|
$
|
(44,664)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Derivatives (1)
|
|
$
|
11,734,775
|
|
|
$
|
91,758
|
|
|
$
|
(40,758)
|
|
|
$
|
1,756,072
|
|
|
$
|
36,868
|
|
|
$
|
(45,306)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Excludes embedded derivatives which contain multiple underlyings. The fair value of these embedded
derivatives was a liability of $166.8 million as of June 30, 2010 and a liability of $14.0 million as of December 31, 2009, included in “Future policy benefits” and “Fixed maturities available for sale.”
Cash Flow Hedges
The Company uses currency swaps in its cash flow hedge accounting relationships. This instrument is only designated for hedge accounting
in instances where the appropriate criteria are met. The Company does not use futures, options, credit, and equity or embedded derivatives in any of its cash flow hedge accounting relationships.
The following table provides the financial statement classification and impact of derivatives used in qualifying and non-qualifying hedge
relationships, excluding the offset of the hedged item in an effective hedge relationship:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
|
(in thousands)
|
|
|
Qualifying
Cash Flow Hedges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Currency /Interest Rate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Investment Income
|
|
$
|
61
|
|
|
$
|
3
|
|
|
$
|
-
|
|
|
Other Income
|
|
|
(26)
|
|
|
|
(10)
|
|
|
|
-
|
|
|
|
|
|
|
|
Accumulated Other Comprehensive Income (Loss)(1)
|
|
|
(1,822)
|
|
|
|
(640)
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(1,787)
|
|
|
$
|
(647)
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non- qualifying hedges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized investment gains (losses), net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Rate
|
|
$
|
53,077
|
|
|
$
|
(108,177)
|
|
|
$
|
92,774
|
|
|
Currency/Interest Rate
|
|
|
1,105
|
|
|
|
(4,321)
|
|
|
|
98
|
|
|
Credit
|
|
|
873
|
|
|
|
10,630
|
|
|
|
(8,968)
|
|
|
Equity
|
|
|
(10,865)
|
|
|
|
(78,391)
|
|
|
|
-
|
|
|
Embedded Derivatives (2)
|
|
|
(34,682)
|
|
|
|
1,815
|
|
|
|
(45,842)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-qualifying hedges
|
|
|
9,508
|
|
|
|
(178,444)
|
|
|
|
38,062
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Derivative Impact
|
|
$
|
7,721
|
|
|
$
|
(179,091)
|
|
|
$
|
38,062
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Amounts deferred in Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2) Primarily includes the following: 1) mark-to-market on embedded
derivatives of $153.4 million; 2) fees ceded of $227.2 million; offset by 3) change in reinsurance recoverable of $146.3 million; and 4) fees attributed to embedded derivative of $198.7 million as of December 31, 2010.
|
|
F-49
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
11. DERIVATIVE INSTRUMENTS
(continued)
For the years ended December 31, 2010, 2009 and 2008 the ineffective portion of
derivatives accounted for using hedge accounting was not material to the Company’s results of operations and there were no material amounts reclassified into earnings relating to instances in which the Company discontinued cash flow hedge
accounting because the forecasted transaction did not occur by the anticipated date or within the additional time period permitted by the authoritative guidance for the accounting for derivatives and hedging.
Presented below is a roll forward of current period cash flow hedges in “Accumulated other comprehensive income (loss)” before
taxes:
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
Balance, December 31, 2009
|
|
$
|
(640)
|
|
|
Net deferred losses on cash flow hedges from January 1 to December 31, 2010
|
|
|
(1,260)
|
|
|
Amount reclassified into current period earnings
|
|
|
(562)
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2010
|
|
$
|
(2,462)
|
|
|
|
|
|
|
|
As of December 31, 2010, the Company does not have any qualifying cash flow hedges of forecasted
transactions other than those related to the variability of the payment or receipt of interest or foreign currency amounts on existing financial instruments. The maximum length of time for which these variable cash flows are hedged is 7 years.
Income amounts deferred in “Accumulated other comprehensive income (loss)” as a result of cash flow hedges are included in “Net unrealized investment gains (losses)” in the Statements of Equity.
Credit Derivatives Written
The following tables set forth the Company’s exposure from credit derivatives where the Company has written credit protection, excluding embedded derivatives contained in externally-managed
investments in European markets, by NAIC rating of the underlying credits as of the dates indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2010
|
|
|
|
|
|
|
|
Single Name
|
|
|
First To Default Basket
|
|
|
Total
|
|
|
NAIC
Designation
(1)
|
|
|
Rating Agency
Equivalent
|
|
Notional
|
|
|
Fair Value
|
|
|
Notional
|
|
|
Fair Value
|
|
|
Notional
|
|
|
Fair Value
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
|
Aaa, Aa, A
|
|
$
|
290,000
|
|
|
$
|
2,297
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
290,000
|
|
|
$
|
2,297
|
|
|
|
2
|
|
|
Baa
|
|
|
25,000
|
|
|
|
374
|
|
|
|
-
|
|
|
|
-
|
|
|
|
25,000
|
|
|
|
374
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal Investment Grade
|
|
$
|
315,000
|
|
|
$
|
2,671
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
315,000
|
|
|
$
|
2,671
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
Ba
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal Below Investment Grade
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
$
|
315,000
|
|
|
$
|
2,671
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
315,000
|
|
|
$
|
2,671
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) First-to-default credit swap baskets, which may include credits of varying qualities, are grouped above
based on the lowest credit in the basket. However, such basket swaps may entail greater credit risk than the rating level of the lowest credit.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009
|
|
|
|
|
|
|
Single Name
|
|
|
First To Default Basket
|
|
|
Total
|
|
|
NAIC
Designation
(1)
|
|
Rating Agency
Equivalent
|
|
Notional
|
|
|
Fair
Value
|
|
|
Notional
|
|
|
Fair
Value
|
|
|
Notional
|
|
|
Fair
Value
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
Aaa, Aa, A
|
|
$
|
295,000
|
|
|
$
|
2,868
|
|
|
$
|
1,000
|
|
|
$
|
(4)
|
|
|
$
|
296,000
|
|
|
$
|
2,864
|
|
|
|
|
|
|
|
|
|
|
|
2
|
|
Baa
|
|
|
25,000
|
|
|
|
541
|
|
|
|
-
|
|
|
|
-
|
|
|
|
25,000
|
|
|
|
541
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal Investment Grade
|
|
$
|
320,000
|
|
|
$
|
3,409
|
|
|
$
|
1,000
|
|
|
$
|
(4)
|
|
|
$
|
321,000
|
|
|
$
|
3,405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
Ba
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,500
|
|
|
$
|
(49)
|
|
|
$
|
3,500
|
|
|
$
|
(49)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal Below Investment Grade
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,500
|
|
|
$
|
(49)
|
|
|
$
|
3,500
|
|
|
$
|
(49)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$
|
320,000
|
|
|
$
|
3,409
|
|
|
$
|
4,500
|
|
|
$
|
(53)
|
|
|
$
|
324,500
|
|
|
$
|
3,356
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) First-to-default credit swap baskets, which may include credits of varying qualities, are grouped above
based on the lowest credit in the basket. However, such basket swaps may entail greater credit risk than the rating level of the lowest credit.
F-50
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
11. DERIVATIVE INSTRUMENTS
(continued)
The following table sets forth the composition of the Company’s credit derivatives
where it has written credit protection, excluding embedded derivatives contained in externally-managed investments in European markets, by industry category as of the dates indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2010
|
|
|
December 31, 2009
|
|
|
Industry
|
|
Notional
|
|
|
Fair Value
|
|
|
Notional
|
|
|
Fair Value
|
|
|
|
|
(in thousands)
|
|
|
Corporate Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Manufacturing
|
|
$
|
40,000
|
|
|
$
|
249
|
|
|
$
|
40,000
|
|
|
$
|
395
|
|
|
Services
|
|
|
20,000
|
|
|
|
101
|
|
|
|
20,000
|
|
|
|
130
|
|
|
Energy
|
|
|
20,000
|
|
|
|
220
|
|
|
|
20,000
|
|
|
|
290
|
|
|
Transportation
|
|
|
25,000
|
|
|
|
203
|
|
|
|
30,000
|
|
|
|
270
|
|
|
Retail and Wholesale
|
|
|
20,000
|
|
|
|
189
|
|
|
|
20,000
|
|
|
|
248
|
|
|
Other
|
|
|
190,000
|
|
|
|
1,709
|
|
|
|
190,000
|
|
|
|
2,076
|
|
|
First to Default Baskets(1)
|
|
|
-
|
|
|
|
-
|
|
|
|
4,500
|
|
|
|
(53)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Credit Derivatives
|
|
$
|
315,000
|
|
|
$
|
2,671
|
|
|
$
|
324,500
|
|
|
$
|
3,356
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Credit default baskets may include various industry categories.
|
The Company writes credit derivatives under which the Company is obligated to pay a related party counterparty the referenced amount of
the contract and receive in return the defaulted security or similar security. The Company’s maximum amount at risk under these credit derivatives, assuming the value of the underlying referenced securities become worthless, is $315.0 million
notional of credit default swap (“CDS”) selling protection at December 31, 2010. These credit derivatives generally have maturities of five years or less.
The Company holds certain externally-managed investments in the European market which contain embedded derivatives whose fair value are primarily driven by changes in credit spreads. These investments are
medium term notes that are collateralized by investment portfolios primarily consisting of investment grade European fixed income securities, including corporate bonds and asset-backed securities, and derivatives, as well as varying degrees of
leverage. The notes have a stated coupon and provide a return based on the performance of the underlying portfolios and the level of leverage. The Company invests in these notes to earn a coupon through maturity, consistent with its investment
purpose for other debt securities. The notes are accounted for under U.S. GAAP as available for sale fixed maturity securities with bifurcated embedded derivatives (total return swaps). Changes in the value of the fixed maturity securities are
reported in Stockholders’ Equity under the heading “Accumulated Other Comprehensive Income” and changes in the market value of the embedded total return swaps are included in current period earnings in “Realized investment gains
(losses), net.” The Company’s maximum exposure to loss from these investments was $7.5 million and $7.0 million at December 31, 2010 and December 31, 2009, respectively.
In addition to selling credit protection, the Company has purchased credit protection using credit derivatives in order to hedge specific
credit exposures in the Company’s investment portfolio. As of December 31, 2010 the Company had $35.0 million of outstanding notional amounts reported at fair value as an asset of $3.0 million.
Credit Risk
The
Company is exposed to credit-related losses in the event of non-performance by counterparties to financial derivative transactions. Generally, the credit exposure of the Company’s over-the-counter (OTC) derivative transactions is represented by
the contracts with a positive fair value (market value) at the reporting date after taking into consideration the existence of netting agreements.
The Company has credit risk exposure to an affiliate, Prudential Global Funding, LLC related to its over-the-counter derivative transactions. Prudential Global Funding, LLC manages credit risk with
external counterparties by entering into derivative transactions with highly rated major international financial institutions and other creditworthy counterparties, and by obtaining collateral where appropriate, see Note 13.
Under fair value measurements, the Company incorporates the market’s perceptions of its own and the counterparty’s
non-performance risk in determining the fair value of the portion of its OTC derivative assets and liabilities that are uncollateralized. Credit spreads are applied to the derivative fair values on a net basis by counterparty. To reflect the
Company’s own credit spread a proxy based on relevant debt spreads is applied to OTC derivative net liability positions. Similarly, the Company’s counterparty’s credit spread is applied to OTC derivative net asset positions.
F-51
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
12. CONTINGENT LIABILITIES AND LITIGATION
Contingent Liabilities
On an ongoing basis, our internal supervisory and control functions review the quality of our sales, marketing, administration and
servicing, and other customer interface procedures and practices and may recommend modifications or enhancements. From time to time, this review process results in the discovery of administration, servicing or other errors, including errors relating
to the timing or amount of payments or contract values due to customers. In certain cases, if appropriate, we may offer customers appropriate remediation and may incur charges, including the costs of such remediation, administrative costs and
regulatory fines.
Litigation and Regulatory Matters
The Company is subject to legal and regulatory actions in the ordinary course of our businesses, including class action lawsuits. Our pending legal and regulatory actions include proceedings specific to
the Company and proceedings generally applicable to business practices in the industry in which we operate. We may be subject to class action lawsuits and other litigation alleging, among other things, that we made improper or inadequate disclosures
in connection with the sale of annuity products or charged excessive or impermissible fees on these products, recommended unsuitable products to customers, mishandled customer accounts or breached fiduciary duties to customers. We are also subject
to litigation arising out of our general business activities, such as our investments and contracts, and could be exposed to claims or litigation concerning certain business or process patents. Regulatory authorities from time to time make inquiries
and conduct investigations and examinations relating particularly to us and our products. In addition, we, along with other participants in the business in which we engage, may be subject from time to time to investigations, examinations and
inquiries, in some cases industry-wide, concerning issues or matters upon which such regulators have determined to focus. In some of our pending legal and regulatory actions, parties are seeking large and/or indeterminate amounts, including punitive
or exemplary damages. The outcome of a litigation or regulatory matter, and the amount or range of potential loss at any particular time, is often inherently uncertain.
The Company’s litigation and regulatory matters are subject to many uncertainties, and given their complexity and scope, the outcomes cannot be predicted. It is possible that the results of
operations or the cash flow of the Company in a particular quarterly or annual period could be materially affected by an ultimate unfavorable resolution of pending litigation and regulatory matters depending, in part, upon the results of operations
or cash flow for such period. In light of the unpredictability of the Company’s litigation and regulatory matters, it is also possible that in certain cases an ultimate unfavorable resolution of one or more pending litigation or regulatory
matters could have a material adverse effect on our financial position. Management believes, however, that, based on information currently known to it, the ultimate outcome of all pending litigation and regulatory matters, after consideration of
applicable reserves and rights to indemnification, is not likely to have a material adverse effect on our financial position.
|
13.
|
RELATED PARTY TRANSACTIONS
|
In addition to the following related party transactions, the Company has extensive transactions and relationships with PAI and other affiliates. It is possible that the terms of these transactions are not
the same as those that would result from transactions among unrelated parties.
Expense Charges and Allocations
Many of the Company’s expenses are allocations or charges from Prudential Insurance or other affiliates.
The Company’s general and administrative expenses are charged to the Company using allocation methodologies based on business
processes. Management believes that the methodology is reasonable and reflects costs incurred by Prudential Insurance to process transactions on behalf of the Company. The Company operates under service and lease agreements whereby services of
officers and employees, supplies, use of equipment and office space are provided by Prudential Insurance. Since 2003, general and administrative expenses also include allocations of stock compensation expenses related to a stock option program and a
deferred compensation program sponsored by Prudential Financial.
The Company is charged for its share of employee benefits
expenses. These expenses include costs for funded and non-funded contributory and non-contributory defined benefit pension plans. Some of these benefits are based on earnings and length of service. Other benefits are based on an account balance,
which takes into consideration age, service and earnings during career. The Company’s share of net expense for the pension plans was $4.8 million, $5.6 million and $6.0 million for the twelve months ended December 31, 2010, 2009, and 2008,
respectively.
F-52
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
13. RELATED PARTY TRANSACTIONS
(continued)
Prudential Insurance sponsors voluntary savings plans for the Company’s employees
(“401(k) plans”). The 401(k) plans provide for salary reduction contributions by employees and matching contributions by the Company of up to 4% of annual salary. The expense charged to the Company for the matching contribution to the
401(k) plans was $2.4 million, $3.0 and $2.8 million in 2010, 2009, and 2008, respectively.
Affiliated Asset Administration Income
In accordance with an agreement with ASISI, the Company receives fee income calculated on contractholder separate account
balances invested in the Advanced Series Trust. Income received from ASISI related to this agreement was $238.2 million, $148.3 million, and $159.6 million, for the years ended December 31 2010, 2009, and 2008, respectively. These revenues are
recorded as “Asset administration fees and other income” in the Statements of Operations and Comprehensive Income.
Cost
Allocation Agreements with Affiliates
Certain operating costs (including rental of office space, furniture, and equipment)
have been charged to the Company at cost by Prudential Annuities Information Services and Technology Corporation (“PAIST”), formerly known as American Skandia Information Services and Technology Corporation, an affiliated company. PALAC
signed a written service agreement with PAIST for these services executed and approved by the Connecticut Insurance Department in 1995. This agreement automatically continues in effect from year to year and may be terminated by either party upon 30
days written notice.
Allocated lease expense was $4.1 million, $4.3 million, and $5.2 million, for the years ended
December 31, 2010, 2009, and 2008, respectively. Allocated sub-lease rental income, recorded as a reduction to lease expense was $3.8 million, $3.9 million, and $4.5 million, for the years ended December 31, 2010, 2009, and 2008,
respectively. Assuming that the written service agreement between PALAC and PAIST continues indefinitely, PALAC’s allocated future minimum lease payments and sub-lease receipts per year and in aggregate as of December 31, 2010 are as
follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease
|
|
|
Sub-Lease
|
|
|
2011
|
|
$
|
9,259
|
|
|
$
|
3,581
|
|
|
2012
|
|
|
8,637
|
|
|
|
2,698
|
|
|
2013
|
|
|
8,175
|
|
|
|
2,305
|
|
|
2014
|
|
|
6,732
|
|
|
|
1,144
|
|
|
2015
|
|
|
5,277
|
|
|
|
-
|
|
|
2016 and thereafter
|
|
|
20,668
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
58,748
|
|
|
$
|
9,728
|
|
|
|
|
|
|
|
|
|
|
|
The Company pays commissions and certain other fees to PAD in consideration for PAD’s marketing and
underwriting of the Company’s products. Commissions and fees are paid by PAD to unaffiliated broker-dealers who sell the Company’s products. Commissions and fees paid by the Company to PAD were $408.9 million, $722.6 million, and $464.1
million during the years ended December 31, 2010, 2009, and 2008, respectively.
Reinsurance Agreements
The Company uses reinsurance as part of its risk management and capital management strategies for certain of its optional living benefit
features.
Effective August 24, 2009, the Company entered into a coinsurance agreement with Pruco Reinsurance, Ltd
(“Pruco Re”) providing for the 100% reinsurance of its Highest Daily Lifetime 6 Plus (“HD6 Plus”) and Spousal Highest Daily Lifetime 6 Plus (“SHD6 Plus”) benefit features sold on certain of its annuities. Fees ceded on
this agreement, included in “Realized investments (losses) gains, net” on the financial statements, were $44.7 million and $513 thousand for the years ended December 31, 2010 and 2009, respectively.
Effective June 30, 2009, the Company entered into a coinsurance agreement with Pruco Re providing for the 100% reinsurance of its
Highest Daily Lifetime 7 Plus (“HD7 Plus”) and Spousal Highest Daily Lifetime 7 Plus (“SHD7 Plus”) benefit features sold on certain of its annuities. Fees ceded on this agreement, included in “Realized investments (losses)
gains, net” on the financial statements, were $67.6 million and $20.4 for the years ended December 31, 2010 and 2009, respectively.
F-53
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
13. RELATED PARTY TRANSACTIONS
(continued)
Effective January 28, 2008, the Company entered into a coinsurance agreement with
Pruco Re providing for the 100% reinsurance of its Highest Daily Lifetime Seven (“HD7”) and Spousal Highest Daily Lifetime Seven (“SHD7”) benefit features sold on certain of its annuities. Fees ceded on this agreement, included
in “Realized investments (losses) gains, net” on the financial statements, were $36.9 million, $32.9 million and $12.7 million for the years ended December 31, 2010, 2009 and 2008, respectively.
Effective January 28, 2008, the Company entered into a coinsurance agreement with Pruco Re providing for the 100% reinsurance of its
Guaranteed Return Option Plus (“GRO Plus”) benefit feature sold on certain of its annuities. This agreement was amended effective January 1, 2010 to include a form of the GRO Plus benefit feature (“GRO Plus II”) on business
issued after November 16, 2009.
Fees ceded on this agreement, included in “Realized investments (losses) gains, net” on the financial statements, were $3.8 million, $5.5 million and $590 thousand for the years ended
December 31, 2010, 2009 and 2008, respectively.
Effective January 28, 2008 the Company entered into a coinsurance
agreement with Pruco Re providing for the 100% reinsurance of its Highest Daily Guaranteed Return Option (“HD GRO”) benefit feature sold on certain of its annuities. This agreement was amended effective January 1, 2010 to include a
form of the HD GRO benefit feature (“HD GRO II”) on business issued after November 16, 2009.
Fees ceded on this agreement, included in “Realized investments (losses) gains. net” on the financial statements, were $5.4
million, $2.4 million and $702 thousand for the years ended December 31, 2010, 2009 and 2008, respectively.
Since 2006,
the Company has in place two coinsurance agreements with Pruco Re providing for the 100% reinsurance of its Highest Daily Lifetime Five (“HDLT5”) benefit feature and its Spousal Lifetime Five (“SLT5”) benefit feature. Fees ceded
on the HDLT5 agreement, included in “Realized investments (losses) gains, net” on the financial statements, were $14.4 million, $14.8 million and $16.6 million for the years ended December 31, 2010, 2009 and 2008, respectively. Fees
ceded on the SLT5 agreement, included in “Realized Investments (losses) gains, net” on the financial statements, were $10.7 million, $9.8 million and $11.9 million for the years ended December 31, 2010, 2009 and 2008, respectively.
Since 2005, the Company reinsures 100% of the risk on its Lifetime Five (“LT5”) benefit feature sold on certain of
its annuities through an automatic coninsurance agreement with Pruco Re. Fees ceded under the LT5 agreement, included in “Realized investments (losses) gains, net” on the financial statements, were $35.8 million, $32.9 million and $40.2
million for the years ended December 31, 2010, 2009 and 2008 respectively.
Since 2004, the Company reinsures 100% of the
risk on its Guaranteed Minimum Withdrawal Benefit (“GMWB”) feature sold on certain of its annuities through an automatic coninsurance agreement with Prudential Insurance. Fees ceded on this agreement, included in “Realized investments
(losses) gains, net” on the financial statements, were $2.2 million, $2.2 million and $3.0 million for the years ended December 31, 2010, 2009 and 2008, respectively. The Company also entered into a 100% coinsurance agreement with Pruco Re
providing for the reinsurance of its guaranteed return option (“GRO”). In prior years, the Company entered into reinsurance agreements to provide additional capacity for growth in supporting the cash flow strain from the Company’s
variable annuity and variable life insurance business. Fees ceded on this agreement, included in “Realized investments (losses) gains, net” on the financial statements, were $5.7 million, $4.8 million and $12.6 million for the years ended
December 31, 2010, 2009 and 2008, respectively.
Debt Agreements
Short-term and Long-term borrowings
On December 29, 2009, the Company obtained a $600 million loan from Prudential Financial. This loan has an interest rate of 4.49% and matures on December 29, 2014. The total related interest
expense to the Company was $27 million for the year ended December 31, 2010 and $150 thousand for the year ended December 31, 2009. The accrued interest payable was $150 thousand as of December 31, 2010 and $150 thousand as of
December 31, 2009.
On January 11, 2008, the Company entered into a $350 million long-term loan with Prudential
Financial. The original lender under this loan was Prudential Funding, LLC (“Pru Funding”), with an original issue date of 12/31/07 and was transferred to Prudential Financial on January 11, 2008. This loan had an interest rate of
5.26% and a maturity date of January 15, 2013. This loan was subsequently paid off on December 29, 2008 with the proceeds received from a capital contribution from PAI. The total related interest expense to the Company for the year ended
December 31, 2008 was $18.3 million.
F-54
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
13. RELATED PARTY TRANSACTIONS
(continued)
On December 14, 2006, the Company obtained a $300 million loan from Prudential
Financial. This loan has an interest rate of 5.18% and matures on December 14, 2011. A partial payment was made to reduce this loan to $179.5 million on December 29, 2008 with the proceeds received from a capital contribution from PAI. On
March 27, 2009, a partial payment of $4.5 million was paid to further reduce this loan to $175 million. The total related interest expense to the Company was $9.1 million for the year ended December 31, 2010 and $9.1 million for the year
ended December 31, 2009. The accrued interest payable was $428 thousand as of December 31, 2010, and $428 thousand as of December 31, 2009.
On March 10, 2005, the Company entered into a $30 million loan with Prudential Funding, LLC. This loan has an interest rate of 5.52% and matured on March 11, 2008. The total related interest
expense to the Company was $322 thousand for the year ended December 31, 2008.
On May 1, 2004, the Company entered
into a $500 million credit facility agreement with Prudential Funding, LLC, as the lender. During 2009, the credit facility agreement was increased to $900 million. As of December 31, 2010 and December 31, 2009, $30.1 million and $54.6
million, respectively, was outstanding under this credit facility. Accrued interest payable was $4 thousand and $2 thousand as of December 31, 2010 and 2009, respectively.
Derivative Trades
In its ordinary course of business, the Company enters
into over-the-counter (“OTC”) derivative contracts with an affiliate, Prudential Global Funding, LLC. For these OTC derivative contracts, Prudential Global Funding, LLC has a substantially equal and offsetting position with an external
counterparty.
Purchase/sale of fixed maturities and commercial loans from/to an affiliate
During 2010, the Company sold fixed maturity securities to affiliated companies in various transactions. These securities were recorded at
an amortized cost of $818.8 million and a fair value of $913.2 million. The net difference between historic amortized cost and the fair value was $94.8 million and was recorded as a realized investment gain on the Company’s financial
statements.
In September 2009, the Company sold fixed maturities securities to an affiliated company, Prudential Insurance.
These securities were recorded at an amortized cost of $294.5 million and a fair value of $294.2 million. The net difference between historic amortized cost and the fair value was $0.3 million and was recorded as a capital distribution on the
Company’s financial statements.
In July 2009, the Company purchased commercial loans from an affiliated company,
Prudential Insurance. These securities were recorded at an amortized cost of $27.4 million and a fair value of $27.4 million. No adjustment was necessary to the Company’s financial statements as the amortized cost and fair value were equal.
In June 2009, the Company purchased fixed maturities securities from an affiliated company, Prudential Insurance. These
securities were recorded at an amortized cost of $662.0 million and a fair value of $680.4 million. The net difference between historic amortized cost and the fair value was $18.4 million and was recorded as a capital distribution on the
Company’s financial statements.
In June 2009, the Company sold commercial mortgage to an affiliated company, Prudential
Insurance. These securities were recorded at an amortized cost of $71.9 million and a fair value of $67.4 million. The net difference between historic amortized cost and the fair value was $4.5 million and was recorded as a capital distribution on
the Company’s financial statements.
During 2008, the Company purchased fixed maturities securities from an affiliated
company, Prudential Insurance. These securities were recorded at an amortized cost of $1,190 million and a fair value of $1,124 million. The net difference between historic amortized cost and the fair value was $66 million and was recorded as a
capital contribution on the Company’s financial statements.
F-55
Prudential Annuities Life Assurance Corporation
Notes to Financial Statements
14. LEASES
The Company entered into an eleven-year lease agreement for office space in Westminster, Colorado, effective January 1, 2001. Lease
expense for the years ended December 31, 2010, 2009, and 2008, was $4.0 million, $3.9 million, and $3.5 million, respectively. Sub-lease rental income was $1.9 million, $1.5 million, and $1.2 million for the years ended December 31, 2010,
2009, and 2008, respectively.
Future minimum lease payments and sub-lease receipts per year and in aggregate as of
December 31, 2010 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease
|
|
|
Sub-Lease
|
|
|
2011
|
|
$
|
3,483
|
|
|
$
|
1,337
|
|
|
2012
|
|
|
-
|
|
|
|
-
|
|
|
2013
|
|
|
-
|
|
|
|
-
|
|
|
2014
|
|
|
-
|
|
|
|
-
|
|
|
2015
|
|
|
-
|
|
|
|
-
|
|
|
2016 and thereafter
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
3,483
|
|
|
$
|
1,337
|
|
|
|
|
|
|
|
|
|
|
|
15. CONTRACT WITHDRAWAL PROVISIONS
Approximately 99% of the Company’s separate account liabilities are subject to discretionary withdrawal by contractholders at market
value or with market value adjustment. Separate account assets, which are carried at fair value, are adequate to pay such withdrawals, which are generally subject to surrender charges ranging from 9% to 1% for contracts held less than 10 years.
16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The unaudited quarterly results of operations for the years ended December 31, 2010 and 2009 are summarized in the table below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
|
|
|
|
|
March 31
|
|
|
June 30
|
|
|
September 30
|
|
|
December 31
|
|
|
|
|
(in thousands)
|
|
|
2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
$352,362
|
|
|
|
$419,159
|
|
|
|
$351,875
|
|
|
|
$450,629
|
|
|
Total benefits and expenses
|
|
|
324,969
|
|
|
|
738,557
|
|
|
|
3,504
|
|
|
|
(38,287)
|
|
|
Income (loss) from operations before income taxes and cumulative effect of accounting change
|
|
|
27,393
|
|
|
|
(319,398)
|
|
|
|
348,371
|
|
|
|
488,916
|
|
|
Net income (loss)
|
|
|
$32,046
|
|
|
|
$(191,643)
|
|
|
|
$234,593
|
|
|
|
$346,585
|
|
|
|
|
|
|
|
Three months ended
|
|
|
|
|
March 31
|
|
|
June 30
|
|
|
September 30
|
|
|
December 31
|
|
|
|
|
(in thousands)
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
$303,512
|
|
|
|
$275,715
|
|
|
|
$225,873
|
|
|
|
$330,456
|
|
|
Total benefits and expenses
|
|
|
948,237
|
|
|
|
(143,073)
|
|
|
|
151,640
|
|
|
|
146,635
|
|
|
Income (loss) from operations before income taxes and cumulative effect of accounting change
|
|
|
(644,725)
|
|
|
|
418,788
|
|
|
|
74,233
|
|
|
|
183,821
|
|
|
Net income (loss)
|
|
|
$(382,942)
|
|
|
|
$248,881
|
|
|
|
$79,158
|
|
|
|
$138,461
|
|
F-56
